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
•The CARES Act
•Restructuring Activities
•Minority Interest Investment
•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
We continue to monitor the developments associated with the COVID-19 pandemic
and its effects on our employees, customers, supply chain and distribution
channels. 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 manufacturing,
distribution and supply 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:
•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, and
•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.
We have incurred $3.2 million and $6.9 million of incremental COVID-19 related
expense for the three and nine months ended September 30, 2020 . We may incur
significant additional expense as we expect to sustain altered operations
through the end of this year 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 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:
•Delayed planned 2020 merit compensation increases for certain
non-manufacturing, salaried employees;
•Postponed planned 2020 merit compensation increases for certain salaried
management 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 in Respiratory Health .
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•Manage working capital by focusing on accounts receivable and accounts payable
and controlling inventory levels.
The CARES Act
The Coronavirus Aid, Relief, and Economic Security Act ("CARES Act") was enacted
on March 27, 2020 . The CARES Act allows for the carryback of U.S. net operating
losses, which were expected to be used in future years, to prior years resulting
in a $23.4 million and $33.1 million benefit that was recognized in the three
and nine months ended September 30, 2020 respectively. Consequently, we recorded
incremental income tax receivables in excess of $50.0 million as of
September 30, 2020 .
Restructuring Activities
Our restructuring expenses for the three and nine months ended September 30,
2020 and 2019 is summarized in the table below (in millions):
Three Months Ended September 30, Nine Months Ended September 30,
2020 2019 2020 2019
Post-Divestiture Restructuring Plan
Cost Transformation $ 0.9 $ 0.3 $ 2.0 $ 1.5
Organizational Alignment & IT Transformation - 8.1 (0.6) 14.7
Total Post-Divestiture Restructuring Plan 0.9 8.4 1.4 16.2
Integration and Restructuring of Business
Acquisitions 0.5 5.3 (0.2) 5.3
Total Restructuring Costs $ 1.4 $ 13.7 $ 1.2 $ 21.5
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. However, in the nine months ended September 30, 2020 ,
employee severance and retention that was previously accrued for Organizational
Alignment was reversed due to employee attrition.
Cost Transformation
The Cost Transformation phase was initiated in June 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. Expenses
incurred for Cost Transformation are included in "Cost of products sold."
Plan-to-date, we have incurred $4.3 million of costs that were expensed as
incurred and $1.3 million of costs that were capitalized.
Integration and Restructuring 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 $11.0 million of
costs, primarily for employee retention, severance and benefits and lease
termination costs. Attrition and the resulting reductions in severance and
benefits caused a net credit in the nine months ended September 30, 2020 .
Plan-to-date, we have incurred $8.9 million of expense, included in "Selling and
general expenses," primarily for employee retention, severance, benefits and
"Other expense" for right-of-use asset impairment. We expect the integration of
our acquisitions will be substantially complete by the end of 2020.
Minority Interest Investment
During the third quarter we acquired a minority interest in FUSMobile, Inc. for
$4.0 million . FUSMobile is leading the development of novel, non-invasive tissue
ablation procedures, utilizing high intensity focused ultrasound technology,
which complements other therapies in our Pain Management franchise.
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Results of Operations and Related Information
Use of Non-GAAP Measures
In this section, we present "Adjusted Gross Profit" and "Adjusted Operating
Profit (Loss)" which are measures that are not calculated in accordance with
accounting principles generally accepted in the United States ("GAAP") and is
therefore referred to as a non-GAAP measure. We provide these non-GAAP measures
because we use them to measure our operational performance and provide greater
insight into our ongoing business operations. These measures are not intended to
be, and should not be, considered separately from, or an alternative to, the
most directly comparable GAAP financial measures. A reconciliation of the
non-GAAP measures to the most directly comparable GAAP measure are provided
under "Adjusted Gross Profit" and "Adjusted Operating (Loss) Profit,"
respectively.
Net Sales
Our net sales are summarized in the following tables for the three and nine
months ended September 30, 2020 and 2019 (in millions):
Three Months Ended September
30, Nine Months Ended September 30,
2020 2019 Change 2020 2019 Change
Chronic care $ 119.3 $ 98.0 21.7 % $ 355.2 $ 300.3 18.3 %
Pain management 66.4 73.4 (9.5) 174.6 207.5 (15.9)
Net Sales $ 185.7 $ 171.4 8.3 % $ 529.8 $ 507.8 4.3 %
Total Volume(a) Pricing/Mix Currency Other(b)Net Sales - percentage change QTD 8 % 8 % - % - % - % YTD 4 % 5 % - % - % (1) %
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(a)Volume includes incremental sales of NeoMed and Summit products. (b)Other includes rounding. Product Category Descriptions Chronic care is a portfolio of products that is focused on (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 products focused on 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. Third Quarter 2020 Compared to Third Quarter 2019 Net sales of$185.7 million increased 8% compared to the prior year. The increase was driven almost entirely by volume, led by pandemic-induced demand for respiratory health products including closed-suction catheters and oral care kits along with strong demand for digestive health, led by Corpak and NeoMed products. The higher volume in respiratory health and digestive health was partially offset by lower volume in our pain management portfolio due to fewer or delayed elective procedures, which is also a consequence of the ongoing pandemic. First Nine Months of 2020 Compared to the First Nine Months of 2019 Net sales of$529.8 million increased 4% compared to the prior year. The NeoMed and Summit acquisitions contributed 5% of volume growth. Accelerated demand for respiratory health due to the pandemic and continued demand for digestive health products was partially offset by declines in pain management due to pandemic-delayed elective procedures. 22 -------------------------------------------------------------------------------- Table of Contents
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 September
30, Nine Months Ended September 30,
2020 2019 Change 2020 2019 Change
Net Sales
North America $ 138.6 $ 133.9 3.5 % $ 396.1 $ 390.0 1.6 %
Europe , Middle East and
Africa 27.8 21.0 32.4 81.8 70.1 16.7
Asia Pacific and Latin
America 19.3 16.5 17.0 51.9 47.7 8.8
Total Net Sales $ 185.7 $ 171.4 8.3 % $ 529.8 $ 507.8 4.3 %
Adjusted Gross Profit
Our gross profit and gross profit margin is summarized in the table below for
the three and nine months ended September 30, 2020 and 2019:
Three Months Ended September 30, Nine Months Ended September 30,
2020 2019 2020 2019
As reported $ 95.8 $ 95.0 $ 284.4 $ 292.5
Gross profit margin, as reported 51.6 % 55.4 % 53.7 % 57.6 %
COVID-19 related expenses 1.8 - 4.3 -
Post divestiture restructuring and IT
charges 0.9 0.4 2.0 2.2
Post divestiture transition charges 0.6 1.7 1.7 4.5
Acquisition and integration-related charges 0.6 - 0.8 -
Intangibles amortization 1.7 1.3 5.0 3.7
As adjusted non-GAAP $ 101.4 $ 98.4 $ 298.2 $ 302.9
Gross profit margin, as adjusted 54.6 % 57.4 % 56.3 % 59.6 %
Adjusted gross profit margin decreased to 54.6% and 56.3%, respectively, in the
three and nine months ended September 30, 2020 compared to the prior year
primarily due to product mix along with incremental expenses associated with our
COVID-19 efforts and inventory write-offs associated with obsolescence.
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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 September 30, Nine Months Ended September 30,
2020 2019 2020 2019
Operating Loss, as reported $ (0.1) $ (18.1) $ (1.3) $ (52.5)
COVID-19 related expenses 3.2 - 6.9 -
Restructuring and IT charges 0.9 8.4 1.4 16.2
Post Divestiture transition charges 1.1 10.9 8.2 43.1
Acquisition-related charges 5.7 6.7 9.6 8.1
Litigation and legal 2.4 8.0 5.8 21.4
Intangibles amortization 4.9 5.1 14.6 14.6
Adjusted Operating Profit (non-GAAP) $ 18.1 In the the three and nine months endedSeptember 30, 2020 , on a GAAP basis, operating loss improved compared to the prior year due to higher sales, lower post-divestiture transition costs and lower legal costs. On an adjusted basis, operating profit was lower primarily due to lower gross margin due to changes in mix and partially offset by higher volume. Other 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 and other costs. In the three and nine months endedSeptember 30, 2020 , we incurred$3.2 million and$6.9 million of COVID-19 related costs, respectively. Post-Divestiture Restructuring Activities: As previously described under "Restructuring Activities," in the three and nine months endedSeptember 30, 2020 , we incurred$0.9 million and$2.0 million of costs related to Cost Transformation respectively, but released$0.6 million of costs related to Organizational Alignment in the nine months endedSeptember 30, 2020 . In the three months endedSeptember 30, 2019 , we incurred$8.4 million of costs including$0.3 million for Cost Transformation and$8.1 million for earlier phases of the Plan. In the nine months endedSeptember 30, 2019 , we incurred$16.2 million of costs, including$1.5 million for Cost Transformation and$14.7 million for earlier phases of the Plan. Post Divestiture Transition Charges: Costs related to the separation of the S&IP business were$1.1 million and$8.2 million in the three and nine months endedSeptember 30, 2020 . In the prior year, we incurred$10.9 million and$43.1 million of costs in the three and nine months endedSeptember 30, 2019 . Acquisition and Integration-related Charges: In the three and nine months endedSeptember 30, 2020 , we incurred$5.7 million and$9.6 million of integration costs related to recent acquisitions, which includes$0.5 million of costs and net reversals of$0.2 million associated with restructuring activities described previously under "Integration and Restructuring of Business Acquisitions." In the prior year, we incurred$6.7 million and$8.1 million of acquisition-related costs in the three and nine months endedSeptember 30, 2019 . These amounts include$5.3 million incurred in the three months endedSeptember 30, 2019 associated with restructuring activities. Legal Costs: We incurred$2.4 million and$5.8 million for certain litigation matters in the three and nine months endedSeptember 30, 2020 compared to$8.0 million and$21.4 million in the three and nine months endedSeptember 30, 2019 . Litigation matters are described in "Commitments and Contingencies" in Note 9 to the condensed consolidated financial statements. Intangibles Amortization: Intangibles amortization related to intangibles acquired in prior business acquisitions was$4.9 million and$14.6 million in the three and nine months endedSeptember 30, 2020 compared to$5.1 million and$14.6 million in the three and nine months endedSeptember 30, 2019 . 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 6 to the condensed consolidated financial statements. Interest expense was$4.3 million and$12.9 million in the three and nine months endedSeptember 30, 2020 , respectively, 24 -------------------------------------------------------------------------------- Table of Contents compared to$3.5 million and$10.7 million in the comparable periods last year. Interest was lower last year due to large capital projects that were completed in the fourth quarter of 2019, on which$0.9 million and$2.2 million of interest was capitalized in the three and nine months endedSeptember 30, 2019 , respectively. Income Taxes As a result of the CARES Act, as previously described under "The CARES Act," the income tax benefit was$23.5 million and$33.1 million and the effective tax rate was 559.5% and 252.7% in the three and nine months endedSeptember 30, 2020 . In the three and nine months endedSeptember 30, 2019 , the tax benefit was$8.8 million and$17.7 million and the effective tax rate was 43.3% and 30.8%. 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. Our operating cash flow has historically been sufficient to meet our working capital requirements and fund capital expenditures. As a result of the COVID-19 pandemic, we may see a delay in collection of accounts receivable. However, we anticipate that our current cash position and our ability to generate cash flows from domestic and international operations will provide sufficient liquidity to manage the business and fund working capital during this uncertainty without using our available borrowing capacity. In addition, with our borrowing capacity, we expect to have the ability to fund capital expenditures and other investments necessary to grow our business for the foreseeable future for both our domestic and international operations. As ofSeptember 30, 2020 ,$85.5 million of our$180.0 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. Cash and cash equivalents decreased by$25.3 million to$180.0 million as ofSeptember 30, 2020 compared to$205.3 million as ofDecember 31, 2019 . The decrease was driven by$3.6 million used in operations,$15.1 million of capital expenditures and$0.9 million of unfavorable currency exchange effects. In the prior year, cash and cash equivalents decreased by$170.1 million to$214.4 million as ofSeptember 30, 2019 primarily due to$71.6 million used in operations and$42.5 million of capital expenditures. Operating Activities Operating activities used$3.6 million in the nine months endedSeptember 30, 2020 primarily driven by changes in operating assets and liabilities. Operating activities used$71.6 million in the same period last year. Investing Activities Investing activities used$19.1 million in the nine months endedSeptember 30, 2020 , which includes$15.1 million of capital expenditures and$4.0 million used to acquire a minority interest investment. Investing activities used$100.0 million in the nine months endedSeptember 30, 2019 , including$57.5 million used to acquire assets and businesses described in "Business Acquisitions" in Note 2 to the condensed consolidated financial statements and$42.5 million of capital expenditures. Financing Activities Financing activities used$1.7 million in the nine months endedSeptember 30, 2020 , including$2.7 million paid to settle contingent liabilities associated with previously completed business acquisitions and$0.4 million used to purchase treasury stock partially offset by$1.4 million of proceeds received from stock option exercises. In the comparable period last year, financing activities provided$1.6 million primarily from proceeds received from stock option exercises partially offset by purchases of treasury stock. Long Term Debt As ofSeptember 30, 2020 , debt was$248.5 million , net of unamortized discount, on our 6.25% Senior Unsecured Notes (the "Notes"). The "Notes" were to mature onOctober 15, 2022 . However, onOctober 15, 2020 , we redeemed the Notes pursuant to a provision for early redemption without paying a premium at any time on or afterOctober 15, 2020 . The redemption resulted in an early-extinguishment loss of$1.3 million , which was charged to interest expense on the redemption date. The Notes were redeemed using$69.8 million of cash on hand and$180.0 million drawn from our Revolving Credit Facility. Following the redemption, our remaining cash position was in excess of$100.0 million and, to the extent we comply with certain financial covenants, the remaining$70.0 million of our Revolving Credit Facility is available to finance any strategic investments, capital expenditures or working capital needs. 25 -------------------------------------------------------------------------------- Table of Contents 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 . As ofSeptember 30, 2020 , we had no borrowings and letters of credit of$0.7 million outstanding under the Revolving Credit Facility. See "Debt" in Note 6 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): Three Months Ended Nine Months Ended Summarized Income Statement Information: September 30, 2020 September 30, 2020 Net Sales $ 175.2 $ 497.7 Gross Profit 87.6 255.2 Net (Loss) Income 19.3 20.0 Summarized Balance Sheet Information: As of September 30, 2020 Current assets $ 504.6 Non-current assets 1,425.5 Total Assets $ 1,930.1 Current liabilities $ 324.8 Non-current liabilities 315.5 Total Liabilities $ 640.3 Legal Matters See Item 1, Note 9, "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 and nine months endedSeptember 30, 2020 and 2019 and our financial position as ofSeptember 30, 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: 26 -------------------------------------------------------------------------------- Table of Contents •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. 27 -------------------------------------------------------------------------------- Table of Contents
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