AVANOS MEDICAL, INC. Introduction
This Management's Discussion and Analysis of Financial Condition and Results of
Operations ("MD&A") is intended to provide investors with an understanding of
our recent performance, and should be read in conjunction with the condensed
consolidated financial statements contained in Item 1, "Financial Statements" in
this Quarterly Report on Form 10-Q and our audited consolidated financial
statements and related notes included in our Annual Report on Form 10-K for the
year ended December 31, 2019 .
The following will be discussed and analyzed:
•Effects of the COVID-19 Pandemic
•Restructuring Activities
•Results of Operations and Related Information
•Liquidity and Capital Resources
•Guarantor Financial Information
•Legal Matters
•Critical Accounting Policies
•Information Concerning Forward-Looking Statements
Effects of the COVID-19 Pandemic
On January 30, 2020 , the World Health Organization ("WHO") declared the COVID-19
outbreak a global health emergency and on March 11, 2020 , declared COVID-19 a
global pandemic. The pandemic has thrown global financial markets into turmoil,
caused disruption in global supply and distribution channels and dramatically
changed the way companies do business.
From the beginning of this global health crisis, our first priority has been the
safety and well being of our employees. In the quarter ended March 31, 2020 , we
have taken steps to ensure the health and safety of our employees and customers
and to comply with shelter-in-place or quarantine orders that are in effect in
various jurisdictions throughout the world. We have made work-from-home
arrangements for nearly all of our global non-manufacturing workforce and have
put measures in place to monitor and protect our manufacturing employees.
We continue to monitor the developments associated with the COVID-19 pandemic
and its effects on our employees, customers, supply chain and distribution
channels. Considering the timing of the WHO's pandemic declaration, we did not
experience significant disruption in our business in this quarter, but we cannot
quantify the impact the COVID-19 pandemic will have on our future results of
operations. The ongoing impact of the pandemic depends on a number of factors
including the severity and duration of the COVID-19 pandemic and the extent and
severity of the impact on our customers, which is uncertain and not predictable.
Our future results of operations and cash flows may suffer adverse effects from
delays in payments on outstanding accounts receivable, potential supply and
distribution chain disruptions and uncertain demand, and effects of any actions
we may take to address financial and operational challenges our customers may
face. Other risks and uncertainties that we face include, but are not limited to
the postponement or cancellation of elective medical procedures and their
uncertain return which adversely impacts our business, potential temporary or
prolonged office, production facility or distribution center closures, the
health of our employees and ability to meet staffing needs, potential new or
continued governmental actions that may limit employees' ability to work, civil
unrest relating to government, corporate and societal responses to the pandemic,
volatility in economic conditions and the financial markets as well as other
unanticipated effects that remain unknown.
We are actively managing our response to the COVID-19 pandemic in collaboration
with our customers, government agencies, vendors, suppliers and business
partners and assessing the potential effects to our financial position, results
of operations and cash flows. For further information regarding the potential
impact of the COVID-19 pandemic on our company, see "Risk Factors" in Item 1A of
this report.
In conjunction with our altered operations previously described, we have
incurred $0.5 million of expense. However, many of the developments associated
with the COVID-19 pandemic occurred late in the first quarter, and therefore, we
may incur significant additional expense as we expect to sustain altered
operations through the second quarter and perhaps beyond. Some of these
additional expenses may be considered unusual and excluded from our calculation
of "Adjusted Operating Profit" as described later in "Results of Operations and
Related Information."
In the three months ended March 31, 2020 , we did not experience significant
disruption in our business. However, while there is a surge in demand for
products in our respiratory health product category, delayed elective surgical
procedures have caused declining demand for products in the pain management
portfolio. Accordingly, we expect adverse effects beginning in the second
quarter of 2020 and continuing through the remainder of 2020, and perhaps
beyond.
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In response to the expected continued adverse impacts from the COVID-19 pandemic, we are taking the following actions to reduce operating expenses, minimize cash outflow and ensure the Company remains strong as the crisis passes: •Postponing planned 2020 merit compensation increases for all non-manufacturing, salaried employees; •Decreasing discretionary spending across the organization; •Streamlining processes, while leaving vacant non-critical positions open; •Postponing certain capital expenditures and R&D projects; and •Adjusting manufacturing production, while ensuring sufficient inventory levels to support the higher demand inRespiratory Health . Restructuring Activities Post-Divestiture Restructuring Plan In conjunction with the divestiture of our former S&IP business, we began a three-phase restructuring plan (the "Plan") intended to align our organizational structure ("Organizational Alignment"), information technology platform ("IT Transformation") and supply chain and distribution channels ("Cost Transformation") to be more appropriate for the size and scale of our remaining Medical Devices business. Organizational Alignment and IT Transformation are substantially complete. In the three months endedMarch 31, 2020 , expenses were occurred only for the final phase, Cost Transformation. The Cost Transformation phase was initiated inJune 2019 , and is intended to optimize the Company's procurement, manufacturing, and supply chain operations ("Cost Transformation"). The Company expects to incur between$11.0 million and$13.0 million to execute the Cost Transformation, primarily consulting and other expenses that will be expensed as incurred. The Company also expects to spend between$8.0 million to$12.0 million of incremental capital through 2021 and expects to complete the Cost Transformation by the end of 2021. In the three months endedMarch 31, 2020 , we incurred$0.5 million and plan-to-date we have incurred$2.8 million of costs related to Cost Transformation. Integration of Business Acquisitions During the third quarter of 2019, we initiated activities to integrate recent asset and business acquisitions into our operations, and where appropriate, re-align our organization accordingly. We expect to incur up to$17.0 million of costs, primarily for employee retention, severance and benefits and lease termination costs. In the three months endedMarch 31, 2020 , we incurred$0.1 million and plan-to-date we have incurred$9.2 million of expense for employee retention, severance and benefits. We expect the integration of our acquisitions will be substantially complete by the end of 2020. Results of Operations and Related Information Use of Non-GAAP Measures In this section, we present "Adjusted Operating Profit (Loss)" which is a profitability measure that is not calculated in accordance with accounting principles generally accepted inthe United States ("GAAP") and is therefore referred to as a non-GAAP measure. We provide this non-GAAP measure because we use it to measure our operational performance and provide greater insight into our ongoing business operations. This measure is not intended to be, and should not be, considered separately from, or an alternative to, the most directly comparable GAAP financial measure. A reconciliation of "Adjusted Operating Profit (Loss)" to the most directly comparable GAAP financial measure is provided under "Adjusted Operating (Loss) Profit."Net Sales Our net sales are summarized in the following tables for the three months endedMarch 31, 2020 and 2019 (in millions):
Three Months Ended
2020 2019 Change
Chronic care $ 115.7 $ 100.0 15.7 %
Pain management 64.7 64.2 0.8
Net Sales $ 180.4 $ 164.2 9.9 %
Total Volume(a) Pricing/Mix Currency Other(b)
Net Sales - percentage change 10 % 11 % (1) % - % - %
_______________________________________________
(a)Volume includes incremental sales of NeoMed and Summit products. (b)Other includes rounding.
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Product Category Descriptions Chronic care is a portfolio of products that include (i) digestive health products such as our Mic-Key enteral feeding tubes, Corpak patient feeding solutions and NeoMed neonatal and pediatric feeding solutions and (ii) respiratory health products such as closed airway suction systems and other airway management devices under the Ballard, Microcuff and Endoclear brands. Pain management is a portfolio of non-opioid pain solutions including (i) acute pain products, such as On-Q and ambIT® surgical pain pumps and Game Ready cold and compression therapy systems and (ii) interventional pain solutions, which provides minimally invasive pain relieving therapies, such as our Coolief pain therapy. First Quarter 2020 Compared to First Quarter 2019 Net sales of$180.4 million increased 10% compared to the prior year. The NeoMed and Summit acquisitions contributed 7% of volume growth. Besides acquisitions, the remaining volume growth was driven by demand for COOLIEF through the first half of March, and a surge in demand in respiratory health due to the COVID-19 pandemic, partially offset by lower volume in acute pain and digestive health, along with unfavorable price and mix. The COVID-19 crisis has caused a surge in demand for respiratory health. We are unable to predict how long the higher demand will be sustained or if it will be followed by a sustained decline when the crisis passes and business and inventories return to a normalized level. While demand for our digestive health solutions has remained relatively consistent during the COVID-19 crisis, demand in our pain management portfolio, and particularly in acute pain, has been severely impacted. We expect to see adverse impacts in pain management for the remainder of 2020 and perhaps beyond.Net Sales By Geographic Region The factors causing volume growth were consistent throughout our geographic regions. Net sales by region is presented in the table below (in millions): Three Months Ended March 31, 2020 2019 ChangeNet Sales North America$ 138.6 $ 127.6 8.6 % Europe, Middle East and Africa 26.1 22.4
16.5
Asia Pacific and Latin America 15.7 14.2 10.6 Total Net Sales$ 180.4 $ 164.2 9.9 % Adjusted Operating (Loss) Profit A reconciliation of adjusted operating profit, a non-GAAP measure, to operating loss is provided in the table below (in millions): Three Months Ended March 31, 2020
2019
Operating (Loss) Profit, as reported$ 0.6 $ (24.6) COVID-19 related expenses 0.5 - Restructuring and IT charges 0.5 2.0 Post Divestiture transition charges 4.0 18.7 Acquisition-related charges 1.8 0.7 Litigation and legal 2.2 8.7 Intangibles amortization 4.8 4.9 Adjusted Operating Profit (non-GAAP)$ 14.4 $
10.4
Items impacting operating results include: COVID-19 Related Expenses: As a result of the ongoing COVID-19 pandemic, we have incurred incremental expenses for additional personal protective equipment for our manufacturing employees, sanitation at our facilities, capacity expansion for respiratory health products and other costs. In the three months endedMarch 31, 2020 , we incurred$0.5 million of COVID-19 related costs. 20
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Post-Divestiture Restructuring Activities: As previously described under "Restructuring Activities," in the three months endedMarch 31, 2020 , we incurred$0.5 million of costs related to Cost Transformation. In the three months endedMarch 31, 2019 , we incurred$2.0 million of costs, including$1.5 million related to Organizational Alignment and$0.5 million for IT Transformation. Post Divestiture Transition Charges: Costs related to the separation of the S&IP business were$4.0 million in the three months endedMarch 31, 2020 . Costs incurred are net of amounts realized fromTSA arrangements. In the prior year, we incurred$18.7 million of costs in the three months endedMarch 31, 2019 . Acquisition and Integration-related Charges: In the three months endedMarch 31, 2020 , we incurred$1.8 million of integration costs related to recent acquisitions. In the prior year, we incurred$0.7 million of acquisition-related costs. Legal Costs: We incurred$2.2 million for certain litigation matters in the three months endedMarch 31, 2020 compared to$8.7 million in the three months endedMarch 31, 2019 . Litigation matters are described in "Commitments and Contingencies" in Note 8 to the condensed consolidated financial statements. Intangibles Amortization: Intangibles amortization related to intangibles acquired in prior business acquisitions was$4.8 million in the three months endedMarch 31, 2020 compared to$4.9 million in the three months endedMarch 31, 2019 . Adjusted operating profit improved in the three months endedMarch 31, 2020 compared to the prior year due to higher net sales volume and cost savings partially offset by lower gross profit margin. Interest Income and Expense Interest expense consists of interest accrued and amortization debt discount and issuance costs on our long-term debt net of interest capitalized on long-term capital projects. See "Debt" in Note 5 to the condensed consolidated financial statements. Interest expense was$4.3 million in the three months endedMarch 31, 2020 , respectively, compared to$3.7 million in the comparable periods last year. Income Taxes The Coronavirus Aid, Relief, and Economic Security Act ("CARES Act") was enacted onMarch 27, 2020 . The CARES Act allows for the carryback ofU.S. net operating losses to prior years resulting in a$7.4 million benefit that was recognized in the three months endedMarch 31, 2020 . As a result, the income tax benefit was$6.7 million and the effective tax rate was 223.3% in the three months endedMarch 31, 2020 . In the three months endedMarch 31, 2019 , the tax benefit was$5.6 million and the effective tax rate was 21.6%. Liquidity and Capital Resources General Our primary sources of liquidity are cash on hand provided by operating activities and amounts available under our revolving credit facility. While we have recently experienced negative operating cash flow, our operating cash flow has historically been sufficient to meet our working capital requirements and fund capital expenditures. As ofMarch 31, 2020 ,$77.5 million of our$187.7 million of cash and cash equivalents was held by foreign subsidiaries. We consider the undistributed earnings of our foreign subsidiaries to be indefinitely reinvested overseas and currently do not have plans to repatriate such earnings. We do not expect restrictions on repatriation of cash held outside ofthe United States to have a material effect on our overall liquidity, financial condition or result of operations for the foreseeable future. As a result of the COVID-19 pandemic, we may see a delay in collection of accounts receivable in future quarters. However, we anticipate that our current cash position will provide sufficient liquidity to manage the business during this uncertainty, and we continue to believe that our ability to generate cash from domestic and international operations and the borrowing capacity under our available credit facilities are adequate to fund our requirements for working capital, capital expenditures and other investments necessary to grow our business for the foreseeable future for both our domestic and international operations. Cash and cash equivalents decreased by$17.6 million to$187.7 million as ofMarch 31, 2020 compared to$205.3 million as ofDecember 31, 2019 . The decrease was driven by$5.8 million used in operations,$5.2 million of capital expenditures and$6.6 million of unfavorable currency exchange effects. In the prior year, cash and cash equivalents decreased by$36.2 million to$348.3 million as ofMarch 31, 2019 primarily due to$23.1 million used in operations and$12.5 million of capital expenditures. Operating Activities Operating activities used$5.8 million in the three months endedMarch 31, 2020 primarily driven by changes in operating assets and liabilities. Operating activities used$23.1 million in the same period last year. 21
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Investing Activities Capital expenditures were$5.2 million in the three months endedMarch 31, 2020 , compared to$12.5 million in same period last year. Financing Activities There were no significant financing activities or transactions in the three months endedMarch 31, 2020 . In the comparable period last year, financing activities used$1.7 million for purchases of treasury stock. Long Term Debt As ofMarch 31, 2020 , debt was$248.2 million , net of unamortized discount, on our 6.25% Senior Unsecured Notes (the "Notes") that mature onOctober 15, 2022 . Our senior secured revolving credit facility ("Revolving Credit Facility") is secured by substantially all of our assets located inthe United States and a certain percentage of our foreign subsidiaries' capital stock. The Revolving Credit Facility matures onOctober 30, 2023 . To the extent we remain in compliance with certain financial covenants in our credit agreement, funds under the Revolving Credit Facility are available for our working capital and other liquidity requirements. As ofMarch 31, 2020 , we had no borrowings and letters of credit of$0.7 million outstanding under the Revolving Credit Facility. See "Debt" in Note 5 to the accompanying condensed consolidated financial statements for further details regarding our debt agreements. Guarantor Financial Information The Notes described under "Long Term Debt" were issued byAvanos Medical, Inc. and are guaranteed, jointly and severally, by each of our domestic subsidiaries (each, a "Guarantor Subsidiary" and collectively, the "Guarantor Subsidiaries"). The guarantees are full and unconditional, subject to certain customary release provisions as defined in the Indenture datedOctober 17, 2014 . Each Guarantor Subsidiary is directly or indirectly 100%-owned byAvanos Medical, Inc. Each of the guarantees of the Notes is a general unsecured obligation of each Guarantor and ranks equally in right of payment with all existing and future indebtedness and all other obligations (except subordinated indebtedness) of each Guarantor. The following tables present summarized income statement and balance sheet information forAvanos Medical, Inc. and the Guarantor Subsidiaries on a combined basis (in millions): Summarized Income Statement Information: Three Months Ended March 31, 2020 Net Sales $ 169.0 Gross Profit 92.2 Net Income 3.7 Summarized Balance Sheet Information: As of March 31, 2020 Current assets $ 452.5 Non-current assets 1,462.4 Total Assets $ 1,914.9 Current liabilities $ 352.7 Non-current liabilities 305.6 Total Liabilities $ 658.3 22
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Legal Matters See Item 1, Note 8, "Commitments and Contingencies," to the condensed consolidated financial statements for a discussion of current legal matters. Critical Accounting Policies See Item 1, Note 1, "Accounting Policies," to the condensed consolidated financial statements for updates to our critical accounting policies and a discussion of recent accounting pronouncements. Information Concerning Forward-Looking Statements The preceding discussion and analysis summarizes the factors that had a material effect on our results of operations during the three months endedMarch 31, 2020 and 2019 and our financial position as ofMarch 31, 2020 andDecember 31, 2019 . You should read this discussion in conjunction with our historical condensed consolidated financial statements and the notes to those historical condensed consolidated financial statements included elsewhere in this Quarterly Report on Form 10-Q. This MD&A contains "forward-looking statements" within the meaning of the Private Securities Litigation Reform Act of 1995. Forward-looking statements include all statements that do not relate solely to historical or current facts, and can generally be identified by the use of words such as "may," "believe," "will," "expect," "project," "estimate," "anticipate," "plan," or "continue" and similar expressions, among others. The matters discussed in these forward-looking statements are based on the current plans and expectations of our management and are subject to certain risks and uncertainties that could cause actual results to differ materially from those projected, anticipated or implied in the forward-looking statements. These factors include, but are not limited to: •general economic conditions particularly inthe United States , •fluctuations in global equity and fixed-income markets, •risks related to the ongoing COVID-19 pandemic, •the competitive environment, •the loss of current customers or the inability to obtain new customers, •litigation and enforcement actions, •disruption in supply of raw materials or the distribution of finished goods, •price fluctuations in key commodities, •fluctuations in currency exchange rates, •changes in governmental regulations that are applicable to our business, •changes in asset valuations including write-downs of assets such as inventory, accounts receivable or other assets for impairment or other reasons, and •any other matters described elsewhere in this MD&A or in the Risk Factors section of this Form 10-Q or our Annual Report on Form 10-K for the year endedDecember 31, 2019 . You are cautioned not to unduly rely on such forward-looking statements, which speak only as of the date made, when evaluating the information in this Quarterly Report on Form 10-Q. Where, in any forward-looking statement, an expectation or belief as to future results or events is expressed in good faith and believed to have a reasonable basis, but there can be no assurance that the expectation or belief will result, or be achieved or accomplished. 23
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