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, 2020 .
The following will be discussed and analyzed:
•Restructuring Activities
•Results of Operations and Related Information
•Liquidity and Capital Resources
•Legal Matters
•Critical Accounting Policies
•Information Concerning Forward-Looking Statements
Restructuring Activities
Our restructuring expenses for the three and six months ended June 30, 2021 and
2020 is summarized in the table below (in millions):
Three Months Ended June 30, Six Months Ended June 30,
2021 2020 2021 2020
Post divestiture restructuring plan $ 1.7 $ - $ 2.6 $ 0.5
Integration and restructuring of business
acquisitions - (0.8) - (0.7)
2020 Restructuring 8.5 - 8.7 -
Total Restructuring Costs $ 10.2 $
(0.8) $ 11.3
Post-Divestiture Restructuring Plan
In the fourth quarter of 2018, we began a three-phase restructuring plan (the
"Plan") intended to align our organizational structure, information technology
platform and supply chain and distribution channels ("Cost Transformation") to
be more appropriate for the size and scale of our business. Only the final
phase, Cost Transformation, remains in progress and is expected to be completed
by the end of 2021. Expenses incurred for Cost Transformation are included in
"Cost of products sold." Plan-to-date, we have incurred $7.7 million of costs
that were expensed as incurred and $4.3 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. Costs incurred were primarily for
employee retention, severance and benefits and lease termination costs.
Cumulative plan expenses were $9.6 million , included in "Selling and general
expenses," primarily for employee retention, severance, benefits and "Other
expense" for lease termination costs right-of-use asset impairment. The
integration of our acquisitions was substantially complete by the end of 2020.
2020 Restructuring
In the fourth quarter of 2020, we initiated activities to reduce the size of our
senior leadership team, consolidate certain operations within our pain
management franchise, exit unprofitable lines of business and research and
development initiatives and reduce the size of our office space to align with
expected requirements following the COVID-19 pandemic. Costs incurred will
primarily be for operating lease right-of-use impairments or lease terminations,
impairment of intangible and other assets and employee severance and benefits.
In the three months ended June 30, 2021 , the charge of $8.5 million consisted
primarily of non-cash asset and inventory write-offs associated with a
discontinued research and development initiative that was contemplated in the
2020 Restructuring plan, but was finalized in the second quarter of 2021.
Plan-to-date, we have incurred $36.3 million of expenses, which are included in
"Cost of products sold," "Selling and general expenses" and "Other expense,
net." We expect to substantially complete this restructuring by the end of 2021.
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Table of Contents
Results of Operations and Related Information
Use of Non-GAAP Measures
In this section, we present "Adjusted Gross Profit" and "Adjusted Operating
Profit" 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. Our non-GAAP measures exclude certain items,
as applicable, for the relevant time periods as indicated in the "Adjusted Gross
Profit" and "Adjusted Operating Profit" tables above. The excluded items
include:
•Incremental expenses associated with altering operations in response to the
COVID-19 pandemic.
•Expenses associated with restructuring activities.
•Expenses associated with post-divestiture transition activities.
•Certain acquisition and integration charges related to acquisitions.
•Expenses associated with European Union Medical Device Regulation (EU MDR)
compliance.
•Expenses associated with certain litigation matters.
•The amortization of intangible assets associated with prior business
acquisitions.
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 measures are provided under "Adjusted Gross Profit" and
"Adjusted Operating Profit," respectively.
Net Sales
Our net sales are summarized in the following tables for the three and six
months ended June 30, 2021 and 2020 (in millions):
Three Months Ended June 30, Six Months Ended June 30,
2021 2020 Change 2021 2020 Change
Chronic care $ 116.0 $ 120.2 (3.5) % $ 237.1 $ 235.9 0.5 %
Pain management 70.4 43.5 61.8 130.0 108.2 20.1
Net Sales $ 186.4 $ 163.7 13.9 % $ 367.1 $ 344.1 6.7 %
Total Volume Pricing/Mix Currency Other(a)
Net Sales - percentage change QTD 14 % 13 % (1) % 1 % 1 %
YTD 7 % 7 % (1) % 1 % - %
__________________________________________________
(a) Other includes rounding.
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 andNeoMed 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 provide minimally invasive pain relieving therapies, such as our Coolief pain therapy. Second Quarter 2021 Compared to Second Quarter 2020 Net sales of$186.4 million increased 14% compared to the prior year with improved volume and favorable currency exchange rates. Higher volume came primarily from our pain management business due to the continued recovery of elective surgical procedures and favorable comparison to last year's net sales which were negatively impacted by the COVID-19 pandemic. In addition, volume benefited from continued robust demand for digestive health, which was partially offset by lower volume in respiratory health due to the pandemic-fueled demand experienced last year. Volume growth was partially offset by unfavorable price and mix of 1%, while foreign currency exchange rates provided a 1% benefit. 17 -------------------------------------------------------------------------------- Table of Contents First Six Months of 2021 Compared to the First Six Months of 2020 Net sales of$367.1 million increased 7% compared to the prior year. Volume was driven by our pain management franchise due to the continued recovery of elective surgical procedures and favorable comparison to last year's net sales which were negatively impacted by the COVID-19 pandemic. In addition, volume benefited from continued robust demand in digestive health, which was partially offset by lower volume in respiratory health due to pandemic-fueled demand experienced last year. Volume growth was partially offset by unfavorable price and mix of 1%, while foreign currency exchange rates provided a 1% benefit.Net Sales By Geographic Region Net sales by region is presented in the table below (in millions): Three Months Ended June 30, Six Months Ended June 30, 2021 2020 Change 2021 2020 Change Net Sales North America$ 138.7 $ 118.9 16.7 %$ 272.0 $ 257.5 5.6 % Europe, Middle East and Africa 26.7 27.9 (4.3) 56.3 54.0 4.3 Asia Pacific and Latin America 21.0 16.9 24.3 38.8 32.6 19.0 Total Net Sales$ 186.4 $ 163.7 13.9 %$ 367.1 $ 344.1 6.7 % Adjusted Gross Profit Our gross profit and gross profit margin is summarized in the table below for the three and six months endedJune 30, 2021 and 2020 (in millions): Three Months Ended June 30, Six Months Ended June 30, 2021 2020 2021 2020 Gross Profit, as reported$ 85.7 $ 86.5 $ 177.0 $ 188.6 COVID-19 related expenses - 2.1 - 2.5 2020 Restructuring charges 2.8 - 3.0 - Post divestiture restructuring charges 1.7 0.6 2.6 1.1 Post divestiture transition charges 3.7 0.3 3.8 1.1 Acquisition and integration-related charges - 0.1 - 0.2 Intangibles amortization 1.7 1.6 3.3 3.3 Adjusted Gross Profit (non-GAAP)$ 95.6 $ 91.2 $ 189.7 $ 196.8 Gross profit margin, as reported 46.0 % 52.8 % 48.2 % 54.8 % Gross profit margin, as adjusted 51.3 % 55.7 % 51.7 % 57.2 % Adjusted gross profit margin decreased to 51.3% and 51.7% in the three and six months endedJune 30, 2021 compared to the prior year primarily due to higher freight costs associated with shippingNeoMed products fromChina tothe United States and delays in returning our manufacturing operations to pre-COVID efficiency levels. 18 -------------------------------------------------------------------------------- Table of Contents Adjusted Operating Profit A reconciliation of adjusted operating income, a non-GAAP measure, to operating income is provided in the table below (in millions): Three Months Ended June 30, Six Months Ended June 30, 2021 2020 2021 2020 Operating (Loss) Profit, as reported $ (7.3)$ (1.8) $ (19.7) $ (1.2) COVID-19 related expenses 0.2 3.2 0.2 3.7 2020 Restructuring charges 8.5 - 8.7 - Post divestiture restructuring charges 1.7 - 2.6 0.5 Post divestiture transition charges 3.6 3.1 3.6 7.1 Acquisition and integration-related charges 0.2 2.1 0.6 3.9 EU MDR Compliance 1.0 - 1.2 - Litigation and legal 2.7 1.2 25.2 3.4 Intangibles amortization 4.1 4.9 8.3 9.7 Adjusted Operating Profit (non-GAAP) $ 14.7 $
12.7 $ 30.7
In the three months endedJune 30, 2021 , on a GAAP basis, our operating loss was driven primarily by non-cash restructuring costs related to the previously announced restructuring in the fourth quarter of 2020. In the six months endedJune 30, 2021 , GAAP operating profit was impacted by the non-cash restructuring costs and costs associated with the resolution of theU.S. Department of Justice criminal investigation, as described in "Commitments and Contingencies" in Note 8 to the condensed consolidated financial statements. Other items impacting operating results include: COVID-19 Related Expenses: Incremental spending due to the COVID-19 pandemic was$0.2 million in each of the three and six months endedJune 30, 2021 , but were$3.2 million and$3.7 million in the three and six months endedJune 30, 2020 for additional personal protective equipment for our manufacturing employees, sanitation at our facilities and other costs. 2020 Restructuring Charges: As previously described under "Restructuring Activities," we incurred$8.5 million and$8.7 million of costs associated with activities in the three and six months endedJune 30, 2021 . Post Divestiture Restructuring Charges: As previously described under "Restructuring Activities," in the three and six months endedJune 30, 2021 , we incurred$1.7 million and$2.6 million , respectively. In the three and six months endedJune 30, 2020 , we incurred$0.0 million and$0.5 million , respectively. Post Divestiture Transition Charges: Costs related to the separation of the divested business were$3.6 million for each of the three and six months endedJune 30, 2021 compared to$3.1 million and$7.1 million in the three and six months endedJune 30, 2020 . Acquisition and Integration-related Charges: In the three and six months endedJune 30, 2021 , we incurred$0.2 million and$0.6 million of integration costs related to recent acquisitions. We incurred$2.1 million and$3.9 million of acquisition-related costs in the three and six months endedJune 30, 2020 . European Union Medical Device Regulation ("EU MDR") Compliance: In the three and six months endedJune 30, 2021 , we incurred$1.0 million and$1.2 million , respectively, of expenses associated with compliance to EU MDR which becomes progressively effective beginning in the second quarter of 2021. Litigation and Legal: We incurred$2.7 million and$25.2 million for certain litigation matters in the three and six months endedJune 30, 2021 compared to$1.2 million and$3.4 million in the three and six months endedJune 30, 2020 . 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$4.1 million and$8.3 million in the three and six months endedJune 30, 2021 compared to$4.9 million and$9.7 million in the three and six months endedJune 30, 2020 . Interest Income and Expense Interest expense consists of interest accrued and amortization of debt issuance costs on our revolving credit facility net of interest capitalized on long-term capital projects. See "Debt" in Note 5 to the condensed consolidated financial statements. Interest expense was$0.9 million and$1.7 million in the three and six months endedJune 30, 2021 , compared to$4.3 million 19 -------------------------------------------------------------------------------- Table of Contents and$8.6 million in the comparable period last year. Interest expense decreased due to the redemption of our$249.8 million of senior unsecured notes that bore interest at 6.25% in the fourth quarter of 2020. In the six months endedJune 30, 2021 interest accrued on our revolving credit facility at a weighted average rate of 1.62% and had balances of$165.0 million and$180.0 million as ofJune 30, 2021 andDecember 31, 2020 , respectively. Income Taxes The income tax benefit was$46.1 million and$51.7 million in the three and six months endedJune 30, 2021 compared to a benefit of$2.9 million and$9.6 million in the three and six months endedJune 30, 2020 . The effective tax rates were 562.2% and 241.6% in the three and six months endedJune 30, 2021 . The current year income tax benefit and effective tax rate are due to the impact of non-deductible charges and progression of earnings in the first six months of 2021. The effective tax rates were 49.2% and 107.9% in the three and six months endedJune 30, 2020 , respectively. The prior year income tax benefit and effective tax rate were due to the Coronavirus Aid, Relief and Economic Security Act ("CARES Act"), which was enacted onMarch 27, 2020 and allows for the carryback ofU.S. net operating losses, which were expected to be used in future years, but are now being carried back to prior years. 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 and is expected to remain sufficient to meet our working capital requirements and fund capital expenditures. 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 any remaining uncertainty related to the COVID-19 pandemic and fund capital expenditures and other investments necessary to grow our business for the foreseeable future for both our domestic and international operations. As ofJune 30, 2021 ,$61.6 million of our$99.9 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$11.6 million to$99.9 million as ofJune 30, 2021 compared to$111.5 million as ofDecember 31, 2020 . The decrease was driven by$15.0 million repaid on our revolving credit facility,$11.5 million of capital expenditures and$1.8 million of unfavorable currency exchange effects partially offset by$12.0 million provided by operations and$5.2 million of proceeds from the exercise of stock options. In the prior year, cash and cash equivalents decreased by$20.3 million to$185.0 million as ofJune 30, 2020 primarily due to$4.7 million used in operations,$12.1 million of capital expenditures and$3.8 million of unfavorable currency exchange effects. Long-Term Debt 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 . In the six months endedJune 30, 2021 , we repaid$15.0 million on our Revolving Credit Facility, leaving$165.0 million of borrowings and letters of credit for$1.2 million outstanding. To the extent we remain in compliance with certain financial covenants in our credit agreement, we have the ability to access our Revolving Credit Facility. InJuly 2021 , we borrowed an additional$20.0 million from our Revolving Credit Facility for a payment required pursuant to a Deferred Prosecution Agreement with theU.S. Department of Justice that is described in "Commitments and Contingencies" in Note 8 to the accompanying condensed consolidated financial statements. See "Debt" in Note 5 to the accompanying condensed consolidated financial statements for further details regarding our debt agreements. 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. 20 -------------------------------------------------------------------------------- Table of Contents 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 endedJune 30, 2021 and 2020 and our financial position as ofJune 30, 2021 andDecember 31, 2020 . 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, 2020 . 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, such expectation or belief is based on the current plans and expectations of our management and 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. 21 -------------------------------------------------------------------------------- Table of Contents
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