AVANOS MEDICAL, INC. - Quarter Report: 2019 September (Form 10-Q)
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
☒QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2019
OR
☐TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from ________ to ________
Commission file number 001-36440
AVANOS MEDICAL, INC.
(Exact name of registrant as specified in its charter)
Delaware | 46-4987888 | |||||
(State or other jurisdiction of incorporation) | (I.R.S. Employer Identification No.) | |||||
5405 Windward Parkway | ||||||
Suite 100 South | ||||||
Alpharetta, | Georgia | 30004 | ||||
(Address of principal executive offices) | (Zip code) | |||||
Registrant’s telephone number, including area code: (844) 428-2667
Securities registered pursuant to Section 12(b) of the Act:
Title of each class | Trading Symbol | Name of exchange on which registered |
Common Stock - $0.01 Par Value | AVNS | New York Stock Exchange |
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ☒ No ☐
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes ☒ No ☐
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company” and “emerging growth company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer | ☒ | Accelerated filer | ☐ | |
Non-accelerated filer | ☐ | Emerging growth company | ☐ | |
Smaller reporting company | ☐ | |||
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
Yes ☐ No ☒
As of October 31, 2019, there were 47,928,872 shares of the Corporation’s common stock outstanding.
Table of Contents
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PART I – FINANCIAL INFORMATION
Item 1. Financial Statements
AVANOS MEDICAL, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED INCOME STATEMENTS
(in millions, except per share amounts)
(Unaudited)
Three Months Ended September 30, | Nine Months Ended September 30, | ||||||||||||||
2019 | 2018 | 2019 | 2018 | ||||||||||||
Net Sales | $ | 171.4 | $ | 165.1 | $ | 507.8 | $ | 482.4 | |||||||
Cost of products sold | 76.4 | 60.4 | 215.3 | 191.9 | |||||||||||
Gross Profit | 95.0 | 104.7 | 292.5 | 290.5 | |||||||||||
Research and development | 9.6 | 10.5 | 29.3 | 31.2 | |||||||||||
Selling and general expenses | 94.4 | 86.3 | 295.5 | 252.5 | |||||||||||
Other expense (income), net | 9.1 | 0.9 | 20.2 | (2.0 | ) | ||||||||||
Operating (Loss) Income | (18.1 | ) | 7.0 | (52.5 | ) | 8.8 | |||||||||
Interest income | 1.3 | 2.2 | 5.7 | 5.4 | |||||||||||
Interest expense | (3.5 | ) | (4.2 | ) | (10.7 | ) | (22.9 | ) | |||||||
(Loss) Income Before Income Taxes | (20.3 | ) | 5.0 | (57.5 | ) | (8.7 | ) | ||||||||
Income tax benefit (provision) | 8.8 | (0.8 | ) | 17.7 | 2.9 | ||||||||||
(Loss) Income from Continuing Operations | (11.5 | ) | 4.2 | (39.8 | ) | (5.8 | ) | ||||||||
Income from Discontinued Operations, net of tax | — | — | — | 65.5 | |||||||||||
Net (Loss) Income | $ | (11.5 | ) | $ | 4.2 | $ | (39.8 | ) | $ | 59.7 | |||||
(Loss) Earnings Per Share | |||||||||||||||
Basic: | |||||||||||||||
Continuing Operations | $ | (0.24 | ) | $ | 0.09 | $ | (0.84 | ) | $ | (0.12 | ) | ||||
Discontinued Operations | — | — | — | 1.39 | |||||||||||
Basic (Loss) Earnings Per Share | $ | (0.24 | ) | $ | 0.09 | $ | (0.84 | ) | $ | 1.27 | |||||
Diluted: | |||||||||||||||
Continuing Operations | $ | (0.24 | ) | $ | 0.09 | $ | (0.84 | ) | $ | (0.12 | ) | ||||
Discontinued Operations | — | — | — | 1.39 | |||||||||||
Diluted (Loss) Earnings Per Share | $ | (0.24 | ) | $ | 0.09 | $ | (0.84 | ) | $ | 1.27 | |||||
See Notes to the Condensed Consolidated Financial Statements.
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AVANOS MEDICAL, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(in millions)
(Unaudited)
Three Months Ended September 30, | Nine Months Ended September 30, | ||||||||||||||
2019 | 2018 | 2019 | 2018 | ||||||||||||
Net (Loss) Income | $ | (11.5 | ) | $ | 4.2 | $ | (39.8 | ) | $ | 59.7 | |||||
Other Comprehensive (Loss) Income, net of tax | |||||||||||||||
Unrealized currency translation adjustments | (3.7 | ) | 1.6 | (1.1 | ) | 0.9 | |||||||||
Defined benefit plans | — | — | — | 0.7 | |||||||||||
Cash flow hedges | — | — | — | (0.8 | ) | ||||||||||
Total Other Comprehensive (Loss) Income, net of tax | (3.7 | ) | 1.6 | (1.1 | ) | 0.8 | |||||||||
Comprehensive (Loss) Income | $ | (15.2 | ) | $ | 5.8 | $ | (40.9 | ) | $ | 60.5 | |||||
See Notes to the Condensed Consolidated Financial Statements.
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AVANOS MEDICAL, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(in millions, except share data)
(Unaudited)
September 30, 2019 | December 31, 2018 | ||||||
ASSETS | |||||||
Current Assets | |||||||
Cash and cash equivalents | $ | 214.4 | $ | 384.5 | |||
Accounts receivable, net of allowances | 157.7 | 150.5 | |||||
Inventories | 144.5 | 121.4 | |||||
Prepaid expenses and other current assets | 29.9 | 57.2 | |||||
Total Current Assets | 546.5 | 713.6 | |||||
Property, Plant and Equipment, net | 182.1 | 154.1 | |||||
Operating Lease Right-of-Use Assets | 64.0 | — | |||||
Goodwill | 800.5 | 783.6 | |||||
Other Intangible Assets, net | 189.5 | 168.2 | |||||
Deferred Tax Assets | 12.3 | 6.3 | |||||
Other Assets | 12.8 | 7.6 | |||||
TOTAL ASSETS | $ | 1,807.7 | $ | 1,833.4 | |||
LIABILITIES AND STOCKHOLDERS’ EQUITY | |||||||
Current Liabilities | |||||||
Current portion of operating lease liabilities | $ | 14.5 | $ | — | |||
Trade accounts payable | 94.7 | 169.9 | |||||
Accrued expenses | 108.9 | 94.4 | |||||
Total Current Liabilities | 218.1 | 264.3 | |||||
Long-Term Debt | 247.9 | 247.7 | |||||
Operating Lease Liabilities | 62.5 | — | |||||
Deferred Tax Liabilities | 0.5 | 4.4 | |||||
Other Long-Term Liabilities | 11.8 | 19.8 | |||||
Total Liabilities | 540.8 | 536.2 | |||||
Commitments and Contingencies | |||||||
Stockholders’ Equity | |||||||
Preferred stock - $0.01 par value - authorized 20,000,000 shares, none issued | — | — | |||||
Common stock - $0.01 par value - authorized 300,000,000 shares, 47,719,954 outstanding as of September 30, 2019 and 47,444,340 outstanding as of December 31, 2018 | 0.5 | 0.5 | |||||
Additional paid-in capital | 1,592.1 | 1,578.1 | |||||
Accumulated deficit | (282.2 | ) | (242.4 | ) | |||
Treasury stock | (8.7 | ) | (5.3 | ) | |||
Accumulated other comprehensive loss | (34.8 | ) | (33.7 | ) | |||
Total Stockholders’ Equity | 1,266.9 | 1,297.2 | |||||
TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY | $ | 1,807.7 | $ | 1,833.4 | |||
See Notes to the Condensed Consolidated Financial Statements.
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AVANOS MEDICAL, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENT OF STOCKHOLDERS’ EQUITY
(in millions)
(Unaudited)
Three Months Ended September 30, | Nine Months Ended September 30, | ||||||||||||||
2019 | 2018 | 2019 | 2018 | ||||||||||||
Common Stock | $ | 0.5 | $ | 0.5 | $ | 0.5 | $ | 0.5 | |||||||
Additional Paid-in Capital, beginning of period | 1,586.8 | 1,567.7 | 1,578.1 | 1,550.5 | |||||||||||
Exercise or redemption of share-based awards | 2.5 | 5.4 | 5.2 | 17.0 | |||||||||||
Stock-based compensation expense | 2.8 | 2.4 | 8.8 | 8.0 | |||||||||||
Additional Paid-in Capital, end of period | 1,592.1 | 1,575.5 | 1,592.1 | 1,575.5 | |||||||||||
Accumulated Deficit, beginning of period | (270.7 | ) | (244.4 | ) | (242.4 | ) | (299.9 | ) | |||||||
Net (loss) income | (11.5 | ) | 4.2 | (39.8 | ) | 59.7 | |||||||||
Accumulated Deficit, end of period | (282.2 | ) | (240.2 | ) | (282.2 | ) | (240.2 | ) | |||||||
Treasury Stock, beginning of period | (8.6 | ) | (5.1 | ) | (5.3 | ) | (4.4 | ) | |||||||
Purchases of treasury stock | (0.1 | ) | — | (3.4 | ) | (0.7 | ) | ||||||||
Treasury Stock, end of period | (8.7 | ) | (5.1 | ) | (8.7 | ) | (5.1 | ) | |||||||
Accumulated Other Comprehensive Loss, beginning of period | (31.1 | ) | (32.1 | ) | (33.7 | ) | (31.3 | ) | |||||||
Other comprehensive (loss) income, net of tax | (3.7 | ) | 1.6 | (1.1 | ) | 0.8 | |||||||||
Accumulated Other Comprehensive Loss, end of period | (34.8 | ) | (30.5 | ) | (34.8 | ) | (30.5 | ) | |||||||
Total Stockholders’ Equity, end of period | $ | 1,266.9 | $ | 1,300.2 | $ | 1,266.9 | $ | 1,300.2 | |||||||
See Notes to the Condensed Consolidated Financial Statements.
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AVANOS MEDICAL, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED CASH FLOW STATEMENTS
(in millions)
(Unaudited)
Nine Months Ended September 30, | |||||||
2019 | 2018 | ||||||
Operating Activities | |||||||
Net (loss) income | $ | (39.8 | ) | $ | 59.7 | ||
Depreciation and amortization | 25.6 | 24.5 | |||||
Stock-based compensation expense | 8.8 | 8.0 | |||||
Net non-cash gain on Divestiture | — | (98.4 | ) | ||||
Net loss on asset dispositions | 0.5 | 1.3 | |||||
Changes in operating assets and liabilities, net of acquisition: | |||||||
Accounts receivable | 7.9 | 57.3 | |||||
Inventories | (20.2 | ) | (34.3 | ) | |||
Prepaid expenses and other assets | 28.9 | (36.9 | ) | ||||
Accounts payable | (72.1 | ) | (71.5 | ) | |||
Accrued expenses | (9.6 | ) | (37.9 | ) | |||
Other | (1.6 | ) | (10.0 | ) | |||
Cash Used in Operating Activities | (71.6 | ) | (138.2 | ) | |||
Investing Activities | |||||||
Capital expenditures | (42.5 | ) | (31.4 | ) | |||
Acquisition of assets and businesses, net of cash acquired | (57.5 | ) | (65.6 | ) | |||
Proceeds from the Divestiture | — | 754.3 | |||||
Cash (Used in) Provided by Investing Activities | (100.0 | ) | 657.3 | ||||
Financing Activities | |||||||
Debt repayments | (0.2 | ) | (339.0 | ) | |||
Purchases of treasury stock | (3.4 | ) | (0.6 | ) | |||
Proceeds from the exercise of stock options | 5.2 | 16.8 | |||||
Cash Provided by (Used in) Financing Activities | 1.6 | (322.8 | ) | ||||
Effect of Exchange Rate Changes on Cash and Cash Equivalents | (0.1 | ) | (4.2 | ) | |||
(Decrease) Increase in Cash and Cash Equivalents | (170.1 | ) | 192.1 | ||||
Cash and Cash Equivalents - Beginning of Period | 384.5 | 219.7 | |||||
Cash and Cash Equivalents - End of Period | $ | 214.4 | $ | 411.8 | |||
See Notes to the Condensed Consolidated Financial Statements.
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AVANOS MEDICAL, INC. AND SUBSIDIARIES
NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
Note 1. Accounting Policies
Background and Basis of Presentation
Avanos Medical, Inc. is a medical technology company focused on delivering clinically superior breakthrough medical device solutions to improve patients’ quality of life. Headquartered in Alpharetta, Georgia, Avanos is committed to addressing some of today’s most important healthcare needs, such as reducing the use of opioids while helping patients move from surgery to recovery. We develop, manufacture and market clinically superior solutions around the globe. References to “Avanos,” “Company,” “we,” “our” and “us” refer to Avanos Medical, Inc. and its consolidated subsidiaries.
On April 30, 2018, we closed the sale of our Surgical and Infection Prevention (“S&IP”) business, including the name “Halyard Health” (and all variations thereof and related intellectual property rights) (the “Divestiture”). Accordingly, the Company’s name was changed from “Halyard Health, Inc.” to “Avanos Medical, Inc.” effective June 30, 2018. The results of operations from our former S&IP business are reported in the accompanying condensed consolidated income statements as “Income from Discontinued Operations, net of tax” for the three and nine months ended September 30, 2018.
Interim Financial Statements
We prepared the accompanying condensed consolidated financial statements in accordance with accounting principles generally accepted in the United States (“GAAP”) for interim financial information and the instructions to the Quarterly Report on Form 10-Q and Rule 10-01 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by GAAP for complete financial statements, and the condensed consolidated financial statements in this Quarterly Report on Form 10-Q should be read in conjunction with our Annual Report on Form 10-K for the year ended December 31, 2018. Our unaudited interim condensed consolidated financial statements contain all necessary material adjustments, which are of a normal and recurring nature, to fairly state our financial condition, results of operations and cash flows for the periods presented.
Use of Estimates
Preparation of our condensed consolidated financial statements in accordance with GAAP requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of net sales and expenses during the reporting periods. Estimates are used in accounting for, among other things, distributor rebate accruals, future cash flows associated with impairment testing for goodwill and long-lived assets, loss contingencies, and deferred tax assets and potential income tax assessments. Actual results could differ from these estimates, and the effect of the difference could be material to our financial statements. Changes in these estimates are recorded when known.
Annual Goodwill Impairment Test
We test goodwill for impairment annually or more frequently whenever events or circumstances more likely than not indicate that the fair value of the reporting unit may be below its carrying value. We operate as a single reportable operating segment with one reporting unit. The fair value of our reporting unit was estimated using a combination of income (discounted cash flow analysis) and market approaches. The income approach is dependent upon several assumptions regarding future periods such as future sales growth and a terminal growth rate. A weighted average cost of capital (“WACC”) was used to discount future estimated cash flows to their present values. The WACC was based on externally observable data considering market participants’ cost of equity and debt, optimal capital structure and risk factors specific to our company. The market approach estimates the value of our company using a market capitalization approach.
We completed our annual goodwill impairment test as of July 1, 2019, and we determined that the fair value substantially exceeds the net carrying value of our reporting unit.
Recently Adopted Accounting Pronouncements
Effective January 1, 2019, we adopted Accounting Standards Update (“ASU”) No. 2016-02, Leases (“Topic 842”), using the transition method provided in ASU No. 2018-11, Leases (Topic 842) - Targeted Improvements, which allows for initial application on the date of adoption with recognition of a cumulative-effect adjustment, if applicable, to the opening balance of retained earnings. As of December 31, 2018, all our existing leases were operating leases, and accordingly, no adjustment to beginning retained earnings was required. In addition, we elected to use all available expedients allowed under ASU 2018-11. Other prior period amounts are not adjusted and continue to be reported under Topic 840, the previous lease guidance.
Topic 842 replaces the former guidance in Topic 840 and requires the recognition of right-of-use (“ROU”) assets and liabilities for leases with terms of more than twelve months. The recognition, measurement and presentation of expenses and cash flows
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arising from leases depend primarily on its classification as a finance or an operating lease, with the classification criteria for distinguishing between the two types being similar to the classification for distinguishing between capital and operating leases under Topic 840. In addition to recognition of ROU assets and liabilities, disclosures regarding lease obligations are required to help financial statement users better understand the amount, timing and uncertainty of cash flows arising from leases.
As a result of Topic 842 adoption, we have operating lease liabilities of $77.0 million and corresponding ROU assets of $64.0 million as of September 30, 2019. For other disclosures regarding our lease obligations, see “Leases” in Note 6 herein.
Effective January 1, 2019, we adopted ASU No. 2018-02, Reporting Comprehensive Income (Topic 220): Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income. This ASU is intended to help companies reclassify certain stranded income tax effects in accumulated other comprehensive income (“AOCI”) resulting from the Tax Cuts and Jobs Act of 2017 (the “Act”), which was enacted in December 2017. ASU 2018-02 provides for the elimination of stranded tax effects of the Act by allowing reclassification of stranded tax effects from AOCI to retained earnings. We elected not to reclassify stranded tax effects from AOCI to retained earnings, and accordingly, adoption of this ASU did not have a material effect on our financial position, results of operations and cash flows.
Recently Issued Accounting Pronouncements
In August 2018, the Financial Accounting Standards Board (“FASB”) issued ASU No. 2018-15, Intangibles – Goodwill and Other – Internal Use Software (Subtopic 350-40): Customer’s Accounting for Implementation Costs Incurred in a Cloud Computing Arrangement That is a Service Contract. This ASU is intended to reduce complexity by aligning the requirements for capitalizing implementation costs incurred in cloud-based arrangements with the requirements for capitalization of costs incurred to develop internal-use software. Any implementation costs in cloud-based arrangements would then be amortized over the term of the service contract. This ASU is effective for annual periods, and interim periods within those annual periods beginning after December 15, 2019, with early adoption permitted. We do not expect adoption of this ASU to have a material effect on our financial position, results of operations or cash flows.
In August 2018, the FASB issued ASU No. 2018-13, Fair Value Measurement (Topic 820): Disclosure Framework – Changes to the Disclosure Requirements for Fair Value Measurement. This ASU removes certain disclosure requirements regarding the amounts and reasons for transfers between Level 1 and Level 2 of the fair value hierarchy and the policy for timing of transfers between the levels. The ASU also adds disclosure requirements regarding unrealized gains and losses included in Other Comprehensive Income for recurring Level 3 fair value measurements and regarding the range and weighted average of unobservable inputs used in Level 3 fair value measurements. This ASU is effective for annual periods and interim periods within those annual periods beginning after December 15, 2019. The removal of certain disclosures is to be applied retrospectively for all periods presented, but the additional required disclosures are to be prospectively applied, and early application is permitted. We do not expect any transfers between Level 1 and Level 2 of the fair value hierarchy, and as of September 30, 2019, we have no assets or liabilities with fair value measurements in Level 3 of the fair value hierarchy. Accordingly, we do not expect adoption of this ASU to have a material effect on our financial position, results of operations or cash flows.
Note 2. Business Acquisitions
Endoclear LLC
On September 19, 2019, we acquired substantially all the assets of Endoclear, LLC (“Endoclear”). The initial purchase price was $3.5 million plus future contingent payments with an estimated fair value of $5.5 million, subject to certain adjustments as defined in the purchase agreement. Endoclear develops and markets airway management devices that are complementary to our existing respiratory health portfolio.
Summit Medical Products, Inc.
On August 7, 2019, we acquired substantially all the assets of Summit Medical Products, Inc. (“Summit”) for $15.6 million plus future contingent payments with an estimated fair value of $1.7 million, subject to certain adjustments as defined in the purchase agreement. Summit develops and markets the ambIT® family of ambulatory electronic infusion pumps, with annual net sales of approximately $7 million. The accompanying condensed consolidated income statement includes approximately $1.2 million of net sales of Summit products.
NeoMed, Inc.
On April 16, 2019, we acquired a minority interest in NeoMed, Inc. (“NeoMed”) for $7.0 million. NeoMed is a market-leading medical device company that is focused on specialized feeding and medication dosing for low birth weight, neonatal and pediatric patients. On July 8, 2019, we acquired all of the outstanding shares of NeoMed for a purchase price of $33.5 million, which includes the base purchase price of $28.0 million plus certain agreed-upon items at the closing date, net of cash acquired, and subsequently adjusted for certain items as defined in the purchase agreement. NeoMed’s net sales were $37 million in
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2018. NeoMed’s net sales for the period from July 8, 2019 through September 30, 2019 were $9.3 million and are included in the accompanying condensed consolidated income statement.
Cool Systems, Inc.
On July 1, 2018, we acquired Cool Systems, Inc. for $65.7 million, net of cash acquired, which was based on a purchase price of $65.0 million plus certain adjustments as provided in the purchase agreement. Cool Systems is marketed as Game Ready® and is hereinafter referred to as “Game Ready.” In the nine months ended September 30, 2019, the purchase price allocation for Game Ready was finalized, resulting in a $1.9 million reduction of goodwill. The goodwill arising from the Game Ready acquisition is now $18.7 million.
Purchase Price Allocation
We accounted for each of the acquisitions described above under the acquisition method of accounting for business combinations. Accordingly, the purchase price paid is allocated to the underlying net assets in proportion to their respective fair values. Any excess of the purchase price over the estimated fair values is recorded as goodwill. The allocation of the purchase price for each of the acquisitions described above is as follows:
EndoClear(a) | Summit(a) | NeoMed(a) | Game Ready(b) | ||||||||||||
Current assets acquired net of liabilities assumed | $ | 0.5 | $ | 0.5 | $ | 11.2 | $ | 8.8 | |||||||
Property, plant and equipment | — | 0.1 | 2.0 | 1.0 | |||||||||||
Identifiable intangible assets | 4.0 | 16.3 | 16.1 | 40.0 | |||||||||||
Other noncurrent assets (liabilities), net | — | — | 0.3 | (0.3 | ) | ||||||||||
Deferred tax liabilities | — | — | (3.0 | ) | (0.2 | ) | |||||||||
Goodwill | 4.5 | 0.4 | 13.9 | 18.7 | |||||||||||
Total | $ | 9.0 | $ | 17.3 | $ | 40.5 | $ | 68.0 | |||||||
_______________________________________________
(a) | The EndoClear, Summit and NeoMed transactions closed during the third quarter of 2019. Accordingly, the purchase price allocations in the table above are preliminary. |
(b) | Game Ready was acquired on July 1, 2018 and the purchase price allocation was finalized on June 30, 2019. |
The following unaudited pro-forma information is presented in the table below for the three and nine months ended September 30, 2019 and 2018 as if each of the acquisitions had occurred on January 1 of the year prior to the acquisition date.
Three Months Ended September 30, | Nine Months Ended September 30, | ||||||||||||||
2019 (unaudited) | 2018 (unaudited) | 2019 (unaudited) | 2018 (unaudited) | ||||||||||||
Net Sales | $ | 172.2 | $ | 178.0 | $ | 544.3 | $ | 535.2 | |||||||
Net Income | $ | (21.2 | ) | $ | 5.7 | $ | (50.2 | ) | $ | 58.1 | |||||
Earnings per share: | |||||||||||||||
Basic | $ | (0.45 | ) | $ | 0.12 | $ | (1.05 | ) | $ | 1.23 | |||||
Diluted | $ | (0.45 | ) | $ | 0.12 | $ | (1.05 | ) | $ | 1.22 | |||||
The pro-forma financial information has been adjusted to include the effects of acquisition, including acquisition-related costs, amortization of acquired intangibles and related tax effects. The pro-forma financial information is not necessarily indicative of the results of operations that would have been achieved had the acquisitions occurred on January 1 of the year prior to the acquisition date.
We have initiated activities to integrate the assets and businesses acquired into our operations, which are described in Note 3, “Restructuring Activities.” We expect the integration of our acquisitions will be substantially complete by the end of 2020.
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Note 3. Restructuring Activities
Post-Divestiture Restructuring Plan
In conjunction with the Divestiture, we began a multi-phase restructuring plan (the “Plan”) intended to align our organizational structure, information technology platform, supply chain and distribution channels to be more appropriate for the size and scale of our remaining Medical Devices business. Each phase of the restructuring plan is described below:
Organizational Alignment: In December 2017, we initiated the first phase of the Plan, which was intended to align our organizational and management structure with our remaining Medical Devices business. We expect to incur up to $18.0 million of pre-tax costs, of which approximately $10.0 million is for employee retention, severance and benefits and the remainder for third-party services and other related costs. These are cash costs that will be incurred as we execute the Plan, which we expect to substantially complete by the end of 2019.
In the three and nine months ended September 30, 2019, we incurred $0.5 million and $2.5 million, respectively, of costs that are included in “Selling and general expenses” in the accompanying condensed consolidated income statement, compared to $1.9 million and $6.4 million, respectively, in the three and nine months ended September 30, 2018.
Plan-to-date, we have incurred $17.2 million of expenses, of which $10.1 million was for employee retention, severance and benefits and the remainder for third-party services and other costs.
Information Technology Systems: The sale price the Company received upon closing the Divestiture included the sale of the Company’s IT systems. The sale of the IT systems enables the Company to migrate to an IT platform that is more appropriate for its business and size. Accordingly, in March 2018, we launched the second phase of the Plan to restructure and enhance the Company’s IT systems (the “ITS Plan”).
Based on milestones achieved to date, the Company’s current expectation is to incur up to $75.0 million to complete the implementation of the ITS Plan, of which $55.0 million qualified for capitalization. The remainder, primarily consulting and other costs, are expensed as incurred. We incurred $7.6 million and $12.2 million, respectively, of costs related to the ITS Plan in the three and nine months ended September 30, 2019 which are included in “Selling and general expenses” in the accompanying condensed consolidated income statements compared to $3.2 million and $5.5 million, respectively, in the three and nine months ended September 30, 2018. Plan-to-date, we have incurred $18.6 million of costs that were expensed as incurred and $54.6 million of costs that were capitalized, including $5.0 million of capitalized internal labor costs. The Company will complete the migration to its new IT platform in conjunction with post-divestiture network separation in the fourth quarter of 2019, and accordingly, expects to substantially complete the ITS Plan by the end of 2019.
Cost Transformation: In June 2019, the third and final phase of the Plan was approved. This third phase relates to optimizing the Company’s procurement, manufacturing, and supply chain operations (the “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 in support of the Cost Transformation. The Company expects to complete the Cost Transformation by the end of 2021. We have incurred $0.3 million and $1.5 million of costs related to Cost Transformation in the three and nine months ended September 30, 2019.
Integration of Business Acquisitions
During the third quarter of 2019, we initiated activities to integrate the asset and business acquisitions described in Note 2, “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 ended September 30, 2019, we have incurred $5.3 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.
Restructuring Liability
We have a liability for employee retention, severance and benefits associated with our restructuring activities, which is summarized below (in millions):
Accrual | |||
Balance, December 31, 2018 | $ | 5.7 | |
Charges and adjustments, net | 6.8 | ||
Payments | (6.4 | ) | |
Balance, September 30, 2019 | $ | 6.1 | |
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Note 4. Discontinued Operations
The results of operations from our former S&IP business are reported in the accompanying condensed consolidated income statements as “Income from Discontinued Operations, net of tax” for the three and nine months ended September 30, 2018.
The following table summarizes the financial results of our discontinued operations for the three and nine months ended September 30, 2018 (in millions):
Three Months Ended September 30, 2018 | Nine Months Ended September 30, 2018 | ||||||
Net Sales | $ | — | $ | 353.0 | |||
Cost of products sold | — | 260.3 | |||||
Research and development | — | 1.1 | |||||
Selling, general and other expenses | — | 38.1 | |||||
Gain on Divestiture | — | (89.9 | ) | ||||
Other expense, net | — | 0.4 | |||||
Income from Discontinued Operations before income taxes | — | 143.0 | |||||
Tax provision from discontinued operations | — | (77.5 | ) | ||||
Income from Discontinued Operations, net of tax | $ | — | $ | 65.5 | |||
In accordance with GAAP, only expenses specifically identifiable and related to a business to be disposed may be allocated to discontinued operations. Accordingly, certain expenses that were historically presented as a component of the S&IP business were kept in continuing operations. These expenses, on a pre-tax basis, were $37.0 million for the nine months ended September 30, 2018.
The following table provides operating and investing cash flow information for our discontinued operations (in millions):
Nine Months Ended September 30, 2018 | |||
Operating Activities: Stock-based compensation expense | $ | (1.5 | ) |
Investing Activities: Capital expenditures | 2.9 | ||
Note 5. Supplemental Balance Sheet Information
Accounts Receivable
Accounts receivable consist of the following (in millions):
September 30, 2019 | December 31, 2018 | ||||||
Accounts receivable | $ | 160.5 | $ | 152.2 | |||
Allowances and doubtful accounts: | |||||||
Doubtful accounts | (2.5 | ) | (1.4 | ) | |||
Sales discounts | (0.3 | ) | (0.2 | ) | |||
Sales returns | — | (0.1 | ) | ||||
Accounts receivable, net | $ | 157.7 | $ | 150.5 | |||
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Inventories
Inventories at the lower of cost (determined on the LIFO/FIFO or weighted-average cost methods) or market consist of the following (in millions):
September 30, 2019 | December 31, 2018 | ||||||||||||||||||||||
LIFO | Non- LIFO | Total | LIFO | Non- LIFO | Total | ||||||||||||||||||
Raw materials | $ | 42.6 | $ | 2.8 | $ | 45.4 | $ | 39.6 | $ | 1.5 | $ | 41.1 | |||||||||||
Work in process | 31.8 | 0.4 | 32.2 | 22.1 | 0.4 | 22.5 | |||||||||||||||||
Finished goods | 55.2 | 18.3 | 73.5 | 50.1 | 13.7 | 63.8 | |||||||||||||||||
Supplies and other | — | 4.3 | 4.3 | — | 5.8 | 5.8 | |||||||||||||||||
129.6 | 25.8 | 155.4 | 111.8 | 21.4 | 133.2 | ||||||||||||||||||
Excess of FIFO or weighted-average cost over LIFO cost | (10.9 | ) | — | (10.9 | ) | (11.8 | ) | — | (11.8 | ) | |||||||||||||
Total | $ | 118.7 | $ | 25.8 | $ | 144.5 | $ | 100.0 | $ | 21.4 | $ | 121.4 | |||||||||||
Property, Plant and Equipment
Property, plant and equipment consists of the following (in millions):
September 30, 2019 | December 31, 2018 | ||||||
Land | $ | 0.9 | $ | 0.9 | |||
Buildings | 46.6 | 43.5 | |||||
Machinery and equipment | 150.3 | 141.2 | |||||
Construction in progress | 77.6 | 52.7 | |||||
275.4 | 238.3 | ||||||
Less accumulated depreciation | (93.3 | ) | (84.2 | ) | |||
Total | $ | 182.1 | $ | 154.1 | |||
Construction in progress includes $59.8 million and $37.3 million of costs capitalized in connection with (i) implementation of a new IT platform (see Note 3 for further discussion) and (ii) post-divestiture network separation as of September 30, 2019 and December 31, 2018, respectively.
Depreciation expense was $3.5 million and $10.8 million for the three and nine months ended September 30, 2019 compared to $3.5 million and $9.8 million for the three and nine months ended September 30, 2018, respectively.
Goodwill and Intangible Assets
The changes in the carrying amount of goodwill are as follows (in millions):
Goodwill | |||
Balance, December 31, 2018 | $ | 783.6 | |
Goodwill acquired(a) | 18.8 | ||
Purchase accounting adjustment | (1.9 | ) | |
Currency translation adjustment | — | ||
Balance, September 30, 2019 | $ | 800.5 | |
(a) We acquired goodwill in connection with the acquisitions described in Note 2, “Business Acquisitions.”
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Intangible assets subject to amortization consist of the following (in millions):
September 30, 2019 | December 31, 2018 | ||||||||||||||||||||||
Gross Carrying Amount | Accumulated Amortization | Net Carrying Amount | Gross Carrying Amount | Accumulated Amortization | Net Carrying Amount | ||||||||||||||||||
Trademarks | $ | 83.5 | $ | (55.6 | ) | $ | 27.9 | $ | 83.1 | $ | (52.2 | ) | $ | 30.9 | |||||||||
Patents and acquired technologies | 260.8 | (153.7 | ) | 107.1 | 259.5 | (144.4 | ) | 115.1 | |||||||||||||||
Other | 88.8 | (34.3 | ) | 54.5 | 54.4 | (32.2 | ) | 22.2 | |||||||||||||||
Total | $ | 433.1 | $ | (243.6 | ) | $ | 189.5 | $ | 397.0 | $ | (228.8 | ) | $ | 168.2 | |||||||||
Amortization expense for intangible assets was $5.2 million and $14.8 million for the three and nine months ended September 30, 2019 compared to $5.4 million and $14.6 million for the three months and nine months ended September 30, 2018, respectively. We estimate amortization expense for the remainder of 2019 and the following four years and beyond will be (in millions):
For the years ending December 31, | Amount | |||
2019 | $ | 5.4 | ||
2020 | 18.5 | |||
2021 | 17.0 | |||
2022 | 15.9 | |||
2023 | 15.3 | |||
Thereafter | 117.4 | |||
Total | $ | 189.5 | ||
Accrued Expenses
Accrued expenses consist of the following (in millions):
September 30, 2019 | December 31, 2018 | ||||||
Accrued rebates | $ | 40.3 | $ | 26.1 | |||
Accrued salaries and wages | 23.7 | 27.0 | |||||
Accrued taxes | 3.8 | 6.5 | |||||
Other | 41.1 | 34.8 | |||||
Total | $ | 108.9 | $ | 94.4 | |||
Accrued rebates represent amounts accrued for estimated incentives earned by customers.
Other Long-Term Liabilities
Other long-term liabilities consist of the following (in millions):
September 30, 2019 | December 31, 2018 | ||||||
Taxes payable | $ | 0.4 | $ | 0.4 | |||
Accrued compensation benefits | 6.1 | 4.3 | |||||
Other | 5.3 | 15.1 | |||||
Total | $ | 11.8 | $ | 19.8 | |||
Note 6. Leases
Our lease obligations relate primarily to our principal executive offices along with various manufacturing, warehouse and distribution facilities located throughout the world. For leases with terms greater than twelve months, we record an ROU asset and corresponding lease obligation. As of September 30, 2019, all our leasing arrangements were operating leases. Many of our
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leases include escalating rent payments, renewal options and termination options, which are considered in our determination of straight-line rent expense when appropriate. Many of our leases also include additional amounts for common area maintenance and taxes. We have elected not to separate lease and non-lease components in the determination of straight-line rent expense. For a majority of our leases, an implicit lease rate is not available. Accordingly, we use a rate that approximates our incremental secured borrowing rate.
The table below summarizes information related to ROU assets and lease liabilities that are included in the accompanying condensed consolidated balance sheet (dollars in millions):
As of September 30, 2019 | |||
Assets | |||
Operating lease right-of-use assets | $ | 64.0 | |
Liabilities | |||
Current portion of operating lease liabilities | 14.5 | ||
Operating lease liabilities | 62.5 | ||
Total Operating Lease Liabilities | $ | 77.0 | |
Weighted average remaining lease term | 7.4 years | ||
Weighted average discount rate | 4.6 | % | |
The table below summarizes costs and cash flows arising from our lease arrangements in the three and nine months ended September 30, 2019 (in millions):
Three Months ended September 30, 2019 | Nine Months Ended September 30, 2019 | ||||||
Operating lease cost | $ | 3.4 | $ | 9.3 | |||
Short-term lease cost | 0.4 | 1.5 | |||||
Variable lease cost | 0.6 | 1.4 | |||||
Total lease cost | $ | 4.4 | $ | 12.2 | |||
Cash paid for amounts included in the measurement of lease liabilities | $ | 4.0 | $ | 13.0 | |||
Right-of-use assets obtained in exchange for new operating lease liabilities | $ | — | $ | 21.2 | |||
The future minimum obligations under operating leases having non-cancelable terms in excess of one year for the remainder of 2019 and the following four years and beyond will be (in millions):
For the years ending December 31, | Amount | |||
2019 | $ | 4.3 | ||
2020 | 14.9 | |||
2021 | 14.1 | |||
2022 | 13.7 | |||
2023 | 11.5 | |||
Thereafter | 34.7 | |||
Future minimum obligations | $ | 93.2 | ||
Note 7. Fair Value Information
The following fair value information is based on a fair value hierarchy that prioritizes the inputs to valuation techniques used to measure fair value. The three levels in the hierarchy used to measure fair value are:
Level 1: Unadjusted quoted prices in active markets accessible at the reporting date for identical assets and liabilities.
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Level 2: Quoted prices for similar assets or liabilities in active markets. Quoted prices for identical or similar assets and liabilities in markets that are not considered active or financial instruments for which all significant inputs are observable, either directly or indirectly.
Level 3: Prices or valuations that require inputs that are significant to the valuation and are unobservable.
A financial instrument’s level within the fair value hierarchy is based on the lowest level of any input that is significant to the fair value measurement.
In the nine months ended September 30, 2019, there were no transfers among Level 1, 2 or 3 fair value determinations.
The following table includes the fair value of our financial instruments for which disclosure of fair value is required (in millions):
September 30, 2019 | December 31, 2018 | ||||||||||||||||
Fair Value Hierarchy Level | Carrying Amount | Estimated Fair Value | Carrying Amount | Estimated Fair Value | |||||||||||||
Assets | |||||||||||||||||
Cash and cash equivalents | 1 | $ | 214.4 | $ | 214.4 | $ | 384.5 | $ | 384.5 | ||||||||
Liabilities | |||||||||||||||||
Senior Unsecured Notes | 1 | 247.9 | 254.4 | 247.7 | 250.9 | ||||||||||||
Cash equivalents are recorded at cost, which approximates fair value due to their short-term nature. The fair value of the senior unsecured notes was based on observable market prices based on trading activity on a primary exchange.
Note 8. Debt
As of September 30, 2019 and December 31, 2018, our debt balances were as follows (in millions):
Weighted-Average Interest Rate | Maturities | September 30, 2019 | December 31, 2018 | |||||||||
Senior Unsecured Notes | 6.25 | % | 2022 | $ | 249.8 | $ | 250.0 | |||||
Unamortized Debt Discounts and Issuance Costs | (1.9 | ) | (2.3 | ) | ||||||||
Total Debt, net | $ | 247.9 | $ | 247.7 | ||||||||
Senior Unsecured Notes
The Senior Unsecured Notes (the “Notes”) will mature on October 15, 2022. Interest accrues at a rate of 6.25% per annum and is payable semi-annually in arrears on April 15 and October 15 of each year. Unamortized debt discount and issuance costs are being amortized over the life of the Notes using the interest method, resulting in an effective interest rate of 6.51% as of September 30, 2019.
Following a divestiture of significant assets, such as the Divestiture, the credit agreement allows re-investment of the net proceeds into the business through acquisition of another business or through capital expenditures for a period of one year following the divestiture. We were required to offer to redeem a portion of the Notes at par value to the extent re-investments were not made by May 1, 2019. Accordingly, $130.5 million of the Notes were offered for redemption in the second quarter of 2019, of which $0.2 million were redeemed.
Revolving Credit Facility
We have a senior secured revolving credit facility (“Revolving Credit Facility”) that matures on October 30, 2023 which allows for borrowings up to $250.0 million, with a letter of credit sub-facility in an amount of $75 million and a swingline sub-facility in an amount of $25 million.
Borrowings under the Revolving Credit Facility bear interest, at our option, at either (i) a reserve-adjusted LIBOR rate, plus a margin ranging between 1.50% to 2.25% per annum, depending on our consolidated total leverage ratio, or (ii) the base rate plus a margin ranging between 0.50% to 1.25% per annum, depending on our consolidated total leverage ratio. The unused portion of the Revolving Credit Facility is subject to a commitment fee equal to (i) 0.25% per annum, when our consolidated total leverage ratio is less than 2.25 to 1.00 or (ii) 0.38% per annum, otherwise.
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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. As of September 30, 2019, we had no borrowings and letters of credit of $0.7 million outstanding under the Revolving Credit Facility.
Note 9. Accumulated Other Comprehensive Income
The changes in the components of AOCI, net of tax, are as follows (in millions):
Unrealized Translation | Cash Flow Hedges | Defined Benefit Pension Plans | Accumulated Other Comprehensive (Loss) Income | ||||||||||||
Balance, December 31, 2018 | $ | (34.3 | ) | $ | 0.1 | $ | 0.5 | $ | (33.7 | ) | |||||
Other comprehensive income | (1.1 | ) | — | — | (1.1 | ) | |||||||||
Balance, September 30, 2019 | $ | (35.4 | ) | $ | 0.1 | $ | 0.5 | $ | (34.8 | ) | |||||
The changes in the components of AOCI, including the tax effect, are as follows (in millions):
Three Months Ended September 30, | Nine Months Ended September 30, | ||||||||||||||
2019 | 2018 | 2019 | 2018 | ||||||||||||
Unrealized translation | $ | (3.7 | ) | $ | 1.6 | $ | (1.1 | ) | $ | 0.9 | |||||
Defined benefit pension plans | — | — | — | 0.9 | |||||||||||
Tax effect | — | — | — | (0.2 | ) | ||||||||||
Defined benefit pension plans, net of tax | — | — | — | 0.7 | |||||||||||
Cash flow hedges | — | — | — | (1.0 | ) | ||||||||||
Tax effect | — | — | — | 0.2 | |||||||||||
Cash flow hedges, net of tax | — | — | — | (0.8 | ) | ||||||||||
Change in AOCI | $ | (3.7 | ) | $ | 1.6 | $ | (1.1 | ) | $ | 0.8 | |||||
Note 10. Stock-Based Compensation
Aggregate stock-based compensation expense was $2.8 million and $8.8 million for the three and nine months ended September 30, 2019. For the three and nine months ended September 30, 2018, stock-based compensation was $2.4 million and $8.0 million.
Stock-based compensation expense related to stock options was $0.7 million and $2.4 million in the three and nine months ended September 30, 2019 compared to $0.3 million and $1.9 million in the three and nine months ended September 30, 2018, respectively.
Expense related to time-based restricted share units was $0.6 million and $3.2 million in the three and nine months ended September 30, 2019 compared to $0.7 million and $2.8 million in the three months and nine months ended September 30, 2018, respectively.
Stock-based compensation expense related to performance-based restricted share units was $1.4 million and $3.1 million in the three and nine months ended September 30, 2019 compared to $1.4 million and $3.3 million in the three months and nine months ended September 30, 2018, respectively.
Note 11. Commitments and Contingencies
We are subject to various legal proceedings, claims and governmental inspections, audits or investigations pertaining to issues such as contract disputes, product liability, tax matters, patents and trademarks, advertising, governmental regulations, employment and other matters, including the matters described below. Under the terms of the distribution agreement we entered into with Kimberly-Clark Corporation (“Kimberly-Clark”) prior to the spin-off, legal proceedings, claims and other liabilities that are primarily related to our business are our responsibility and we are obligated to indemnify and hold Kimberly-Clark harmless for such matters (“Indemnification Obligation”). For the three and nine months ended September 30, 2019, we incurred $8.0 million and $21.4 million, respectively, of expenses related to these matters compared to $3.7 million and $6.6 million in the three and nine months ended September 30, 2018, respectively.
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Surgical Gown Litigation and Related Matters
Bahamas Surgery Center
We have an Indemnification Obligation for the matter styled Bahamas Surgery Center, LLC v. Kimberly-Clark Corporation and Halyard Health, Inc., No. 2:14-cv-08390-DMG-SH (C.D. Cal.) (“Bahamas”), filed on October 29, 2014. In that case, the plaintiff brought a putative class action asserting claims for common law fraud (affirmative misrepresentation and fraudulent concealment) and violation of California’s Unfair Competition Law (“UCL”) in connection with our marketing and sale of MicroCool surgical gowns.
On April 7, 2017, a jury returned a verdict for the plaintiff, finding that Kimberly-Clark was liable for $3.9 million in compensatory damages (not including prejudgment interest) and $350.0 million in punitive damages, and that Avanos was liable for $0.3 million in compensatory damages (not including prejudgment interest) and $100.0 million in punitive damages. Subsequently, the court also ruled on the plaintiff’s UCL claim and request for injunctive relief. The court found in favor of the plaintiff on the UCL claim but denied the plaintiff’s request for restitution. The court also denied the plaintiff’s request for injunctive relief.
On May 25, 2017, we filed post-trial motions seeking, among other things, to have the award of punitive damages reduced. On April 11, 2018, the court issued an Amended Judgment in favor of the plaintiff and against us and Kimberly-Clark that substantially reduced the punitive damages awards. The judgment against us is now $0.3 million in compensatory damages and pre-judgment interest and $1.3 million in punitive damages. The judgment against Kimberly-Clark is now $3.9 million in compensatory damages, $1.3 million in pre-judgment interest, and $19.4 million in punitive damages.
On April 12, 2018, we filed a notice of appeal to the Ninth Circuit Court of Appeals. We intend to continue our vigorous defense of the Bahamas matter.
Kimberly-Clark Corporation
We have notified Kimberly-Clark that we have reserved our rights to challenge any purported obligation to indemnify Kimberly-Clark for the punitive damages awarded against them. In connection with our reservation of rights, on May 1, 2017, we filed a complaint in the matter styled Halyard Health, Inc. v. Kimberly-Clark Corporation, Case No. BC659662 (County of Los Angeles, Superior Court of California). In that case, we seek a declaratory judgment that we have no obligation, under the Distribution Agreement or otherwise, to indemnify, pay, reimburse, assume, or otherwise cover punitive damages assessed against Kimberly-Clark in the Bahamas matter, or any Expenses or Losses (as defined in the distribution agreement) associated with an award of punitive damages. On May 2, 2017, Kimberly-Clark filed a complaint in the matter styled Kimberly-Clark Corporation v. Halyard Health, Inc., Case No. 2017-0332-AGB (Court of Chancery of the State of Delaware). In that case, Kimberly-Clark seeks a declaratory judgment that (1) we must indemnify them for all damages, including punitive damages, assessed against them in the Bahamas matter, (2) we have anticipatorily and materially breached the Distribution Agreement by our failure to indemnify them, and (3) we are estopped from asserting, or have otherwise waived, any claim that we are not required to indemnify them for all damages, including punitive damages, that may be awarded in the Bahamas matter.
On May 26, 2017, we moved to dismiss or stay Kimberly-Clark’s Delaware complaint, and on June 16, 2017, Kimberly-Clark moved for summary judgment. On September 12, 2017, the Delaware court granted our motion to stay Kimberly-Clark’s complaint and therefore did not take any action on Kimberly-Clark’s motion for summary judgment. On May 30, 2018, Kimberly-Clark moved to quash service of summons we served on Kimberly-Clark in California for lack of personal jurisdiction. On December 12, 2018, the court granted Kimberly-Clark’s motion. On December 18, 2018, we filed a notice of appeal to the California Court of Appeal. On December 19, 2018, Kimberly-Clark sought to lift the stay of their complaint in Delaware, and on March 4, 2019, the court denied their motion. We intend to vigorously pursue our case against Kimberly-Clark in California and to vigorously defend against their case against us.
Government Investigation
In June 2015, we were served with a subpoena from the Department of Veterans Affairs Office of the Inspector General (“VA OIG”) seeking information related to the design, manufacture, testing, sale and promotion of MicroCool and other Company surgical gowns, and, in July 2015, we also became aware that the subpoena and an earlier VA OIG subpoena served on Kimberly-Clark requesting information about gown sales to the federal government are related to a United States Department of Justice (“DOJ”) investigation. In May 2016, April 2017 and September 2018, we received additional subpoenas from the DOJ seeking further information related to Company gowns. The Company is cooperating with the DOJ investigation.
Shahinian
On October 12, 2016, after the DOJ and various States declined to intervene, a qui tam matter was unsealed and a complaint was subsequently served on us in a matter styled U.S. ex rel. Shahinian, et al. v. Kimberly-Clark Corporation, No. 2:14-cv-08313-JAK-JPR (C.D. Cal.) (“Shahinian”), filed on October 27, 2014. The case alleges, among other things, violations of the federal and various state False Claims Acts in connection with the marketing and sale of certain surgical gowns. On March
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8, 2017, Kimberly-Clark moved to dismiss the Shahinian complaint, and on July 14, 2017, the California court granted Kimberly-Clark’s motion. The plaintiff then filed a second amended complaint, and on August 11, 2017, Kimberly-Clark moved to dismiss that one as well. The plaintiff then filed a third amended complaint. On January 18, 2018, Kimberly-Clark moved to dismiss that one too. On September 30, 2018, the court granted Kimberly-Clark’s motion with prejudice. On November 13, 2018, Shahinian filed a notice of appeal to the Ninth Circuit Court of Appeals.
We may have an Indemnification Obligation for the Shahinian matter under the distribution agreement with Kimberly-Clark and have notified Kimberly-Clark that we reserve our rights to challenge the obligation to indemnify Kimberly-Clark for any damages or penalties which are not indemnifiable under applicable law or public policy. We intend to continue our vigorous defense of the matter.
Kromenaker
On March 17, 2017, the DOJ submitted a filing declining to intervene in another qui tam matter, and the complaint was unsealed and subsequently served on Kimberly-Clark and Avanos. That matter is styled U.S. ex rel. Kromenaker v. Kimberly-Clark Corporation and Halyard Health, Inc., No. 1:15-cv-04413-SCJ (N.D. Ga.) (“Kromenaker”), filed on December 21, 2015. In that case, the plaintiff alleges, among other things, violations of the federal False Claims Act in connection with the marketing and sale of certain products, including feminine hygiene products, surgical gowns and endotracheal tubes. On June 12, 2017, Kimberly-Clark and Avanos moved to dismiss the complaint. On August 21, 2017, Kromenaker filed an amended complaint, and Kimberly-Clark and Avanos filed motions to dismiss it. On March 27, 2019, the court granted Kimberly-Clark’s and our motions to dismiss. On April 24, 2019, Kromenaker filed a Motion with the trial court seeking to have the court alter, amend, or vacate the dismissal.
We may have an Indemnification Obligation for certain parts of this matter under the distribution agreement with Kimberly-Clark and have notified Kimberly-Clark that we reserve our rights to challenge the obligation to indemnify Kimberly-Clark for any damages or penalties which are not indemnifiable under applicable law or public policy. We intend to continue our vigorous defense of this matter.
Jackson
We were served with a complaint in a matter styled Jackson v. Halyard Health, Inc., Robert E. Abernathy, Steven E. Voskuil, et al., No. 1:16-cv-05093-LTS (S.D.N.Y.), filed on June 28, 2016. In that case, the plaintiff brings a putative class action against the Company, our former Chief Executive Officer, our former Chief Financial Officer and other defendants, asserting claims for violations of the Securities Exchange Act, Sections 10(b) and 20(a). The plaintiff alleges that the defendants made misrepresentations and failed to disclose certain information about the safety and effectiveness of our MicroCool gowns and thereby artificially inflated the Company’s stock prices during the respective class periods. The alleged class period for purchasers of Kimberly-Clark securities who subsequently received Avanos securities is February 25, 2013 to October 21, 2014, and the alleged class period for purchasers of Avanos securities is October 21, 2014 to April 29, 2016. On February 16, 2017, we moved to dismiss the case. On March 30, 2018, the court granted our motion to dismiss and entered judgment in our favor. On April 27, 2018, the plaintiff filed a Motion for Relief from the Judgment and for Leave to Amend. On April 1, 2019, the court denied the plaintiff’s motion. On May 1, 2019, Jackson appealed the dismissal of the action to the 2nd Circuit Court of Appeals. We intend to continue our vigorous defense of this matter.
Richardson, Chiu and Pick
We were also served with a complaint in a matter styled Margaret C. Richardson Trustee of the Survivors Trust Dated 6/12/84 for the Benefit of the H&M Richardson Revocable Trust v. Robert E. Abernathy, Steven E. Voskuil, et al., No. 1:16-cv-06296 (S.D.N.Y.) (“Richardson”), filed on August 9, 2016. In that case, the plaintiff sues derivatively on behalf of Avanos Medical, Inc., and alleges that the defendants breached their fiduciary duty, were unjustly enriched, and violated Section 14(A) of the Securities and Exchange Act in connection with our marketing and sale of MicroCool gowns. We were also served with a complaint in a matter styled Kai Chiu v. Robert E. Abernathy, Steven E. Voskuil, et al., No. 2:16-cv-08768 (C.D. Cal.), filed on November 23, 2016. In that case, the plaintiff sues derivatively on behalf of Avanos Medical, Inc., and makes allegations and brings causes of action similar to those in Richardson, but the plaintiff also adds causes of action for abuse of control, gross mismanagement, and waste of corporate assets. We were also served with a complaint in a matter styled Lukas Pick v. Robert E. Abernathy, Steven E. Voskuil, et al., No. e:18-cv-00295 (D. Del.) filed on February 21, 2018. In that case, the plaintiff sues derivatively on behalf of Avanos Medical, Inc. and makes allegations and brings causes of action similar to those in Richardson and Chiu. We intend to continue our vigorous defense of this matter.
Medline Industries
We were also served with a complaint in the matter styled Medline Industries, Inc. v. Kimberly-Clark Corporation, Halyard Health, Inc., et al., No. 2:16-cv-08571 (C.D. Cal.), filed on November 17, 2016. In that case, the plaintiff makes allegations similar to those in Bahamas and Shahinian and brings causes of action under federal and state false advertising laws and state unfair competition laws. On March 31, 2017 we moved to dismiss certain of Medline’s claims and to transfer any surviving
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claims from California to Georgia. On June 2, 2017, the court granted our motion to transfer the case to Georgia and denied without prejudice our motion to dismiss. On June 30, 2017, now before the court in Georgia and with the case re-styled as Medline Industries, Inc. v. Kimberly-Clark Corporation, Halyard Health, Inc., et al., No. 1:17-cv-02032 (N.D. Ga.), Kimberly-Clark and Avanos filed renewed motions to dismiss certain of Medline’s claims. On February 28, 2018, the court granted our motion to dismiss. On March 14, 2018, Medline filed a second amended complaint. On March 28, 2018, we filed our answer and counterclaims. The counterclaims allege violations of false advertising law and state unfair competition laws. On May 9, 2018, Medline filed its answer to our counterclaims.
Effective September 10, 2019, Kimberly-Clark, Avanos and Medline entered into a confidential settlement agreement and mutual release that resolved all asserted claims and counterclaims, and that agreement has no material effect on Avanos’s financial condition or results of operations.
Naeyaert
On April 13, 2017, Kimberly-Clark was served with a complaint in the matter styled Christopher Naeyaert v. Kimberly-Clark Corporation, et al., No. PSC 1603503 (County of Riverside, Superior Court of California), filed on July 21, 2016. In that case, the plaintiff makes allegations similar to those in Bahamas and brings causes of action similar to those in Bahamas, except the allegations and causes of action relate to the Ultra surgical gown. On June 5, 2017, Kimberly-Clark moved to dismiss the complaint. On August 21, 2017, Naeyaert filed an amended complaint and on September 18, 2017, Kimberly-Clark filed a motion to dismiss the amended complaint. On September 28, 2018, the court granted in part Kimberly-Clark’s motion but allowed Naeyaert leave to amend his complaint. On October 12, 2018, Naeyaert filed a Third Amended Complaint. On October 26, 2018, Kimberly-Clark answered the Third Amended Complaint. On September 23, 2019, Kimberly-Clark moved for summary judgment in this matter on the basis that there is no competent evidence to support plaintiff’s claims.
On October 16, 2019, Kimberly-Clark reached a confidential oral agreement with Naeyaert to settle all claims, and to dismiss this action with prejudice. The parties are finalizing a confidential written settlement agreement which is expected to be signed during November. The terms of the settlement will have no material effect on Avanos’s financial condition or results of operations.
Patent Litigation
We operate in an industry characterized by extensive patent litigation and competitors may claim that our products infringe upon their intellectual property. Resolution of patent litigation or other intellectual property claims is typically time consuming and costly and can result in significant damage awards and injunctions that could prevent the manufacture and sale of the affected products or require us to make significant royalty payments in order to continue selling the affected products. At any given time we may be involved as either a plaintiff or a defendant in a number of patent infringement actions, the outcomes of which may not be known for prolonged periods of time.
General
While we maintain general and professional liability, product liability and other insurance, our insurance policies may not cover all of these matters and may not fully cover liabilities arising out of these matters. In addition, we may be obligated to indemnify our directors and officers against these matters.
Although the results of litigation and claims cannot be predicted with certainty, we believe that the ultimate resolution of these matters will not materially impact our liquidity, access to capital markets or ability to conduct our daily operations.
As of September 30, 2019, we have an accrued liability for the matters described herein. The accrued liability is included in “Accrued Expenses” in the accompanying condensed consolidated balance sheet. Our estimate of these liabilities is based on facts and circumstances existing at this time, along with other variables. Factors that may affect our estimate include, but are not limited to: (i) changes in the number of lawsuits filed against us, including the potential for similar, duplicate or “copycat” lawsuits filed in multiple jurisdictions, including lawsuits that bring causes or action or allege violations of law with regard to additional products; (ii) changes in the legal costs of defending such claims; (iii) changes in the nature of the lawsuits filed against us; (iv) changes in the applicable law governing any legal claims against us; (v) a determination that our assumptions used in estimating the liability are no longer reasonable; and (vi) the uncertainties associated with the judicial process, including adverse judgments rendered by courts or juries. Thus, the actual amount of these liabilities for existing and future claims could be materially different than the accrued amount. Additionally, the above matters, regardless of the outcome, could disrupt our business and result in substantial costs and diversion of management attention.
Environmental Compliance
We are subject to federal, state and local environmental protection laws and regulations with respect to our business operations and are operating in compliance with, or taking action aimed at ensuring compliance with, these laws and regulations. None of our compliance obligations with environmental protection laws and regulations, individually or in the aggregate, is expected to have a material adverse effect on our business, financial condition, results of operations or liquidity.
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Note 12. Earnings Per Share (“EPS”)
Basic EPS is calculated by dividing net income by the weighted average number of common shares outstanding during each period. Diluted earnings per share is calculated by dividing net income by the weighted average number of common shares outstanding and the effect of all dilutive common stock equivalents outstanding during each period, as determined using the treasury stock method.
The calculation of basic and diluted earnings per share for the three and nine months ended September 30, 2019 and 2018 is set forth in the following table (in millions, except per share amounts):
Three Months Ended September 30, | Nine Months Ended September 30, | ||||||||||||||
2019 | 2018 | 2019 | 2018 | ||||||||||||
(Loss) Income from continuing operations | $ | (11.5 | ) | $ | 4.2 | (39.8 | ) | (5.8 | ) | ||||||
Income from discontinued operations, net of tax | — | — | — | 65.5 | |||||||||||
Net (Loss) Income | $ | (11.5 | ) | $ | 4.2 | (39.8 | ) | 59.7 | |||||||
Weighted Average Shares Outstanding: | |||||||||||||||
Basic weighted average shares outstanding | 47.7 | 47.3 | 47.6 | 47.1 | |||||||||||
Dilutive effect of stock options and restricted share unit awards | — | 1.3 | — | — | |||||||||||
Diluted weighted average shares outstanding | 47.7 | 48.6 | 47.6 | 47.1 | |||||||||||
(Loss) Earnings Per Share: | |||||||||||||||
Basic: | |||||||||||||||
Continuing operations | $ | (0.24 | ) | $ | 0.09 | $ | (0.84 | ) | $ | (0.12 | ) | ||||
Discontinued operations | $ | — | $ | — | $ | — | $ | 1.39 | |||||||
Basic (Loss) Earnings Per Share | $ | (0.24 | ) | $ | 0.09 | $ | (0.84 | ) | $ | 1.27 | |||||
Diluted: | |||||||||||||||
Continuing operations | $ | (0.24 | ) | $ | 0.09 | $ | (0.84 | ) | $ | (0.12 | ) | ||||
Discontinued operations | $ | — | $ | — | $ | — | $ | 1.39 | |||||||
Diluted (Loss) Earnings Per Share | $ | (0.24 | ) | $ | 0.09 | $ | (0.84 | ) | $ | 1.27 | |||||
Restricted share units (“RSUs”) contain provisions allowing for the equivalent of any dividends paid on common stock during the restricted period to be reinvested into additional RSUs at the then fair market value of the common stock on the date the dividends are paid. Such awards are to be included in the EPS calculation under the two-class method. Currently, we do not anticipate any cash dividends for the foreseeable future and our outstanding RSU awards are not material in comparison to our weighted average shares outstanding. Accordingly, all EPS amounts reflect shares as if they were fully vested and the disclosures associated with the two-class method are not presented herein.
For each of the three and nine months ended September 30, 2019, 1.2 million of potentially dilutive stock options and restricted share unit awards were excluded from the computation of earnings per share as their effect would have been anti-dilutive. In the prior year, the 1.2 million shares were excluded from the earnings per share calculation for the nine months ended September 30, 2018 due to a year-to-date loss from continuing operations.
Note 13. Business and Products Information
We conduct our business in one operating and reportable segment that provides our medical device products to healthcare providers and patients in more than 90 countries with manufacturing facilities in the United States, Mexico, France, Germany and Tunisia.
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We provide a portfolio of innovative product offerings focused on pain management and chronic care, which includes respiratory and digestive health, to improve patient outcomes and reduce the cost of care. Our management evaluates net sales by product category within our single reportable segment as follows (in millions):
Three Months Ended September 30, | Nine Months Ended September 30, | ||||||||||||||
2019 | 2018 | 2019 | 2018 | ||||||||||||
Chronic care | $ | 98.0 | $ | 93.6 | $ | 300.3 | $ | 287.8 | |||||||
Pain management | 73.4 | 71.5 | 207.5 | 194.6 | |||||||||||
Total Net Sales | $ | 171.4 | $ | 165.1 | $ | 507.8 | $ | 482.4 | |||||||
Chronic care is focused on (i) digestive health products such as our Mic-Key enteral feeding tubes, Corpak patient feeding solutions and NeoMed neonatal feeding solutions and (ii) respiratory health products such as our Ballard closed airway suction systems and oral care kits.
Pain management is focused on non-opioid 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.
Due to the nature of our business, we receive purchase orders for products under supply agreements which are normally fulfilled within three to four weeks. Our performance obligations under purchase orders are satisfied and revenue is recognized at a point in time, which is upon shipment or upon delivery of our products to unaffiliated customers, depending on shipping terms. Accordingly, we normally do not have transactions that give rise to material unfulfilled performance obligations.
Note 14. Supplemental Guarantor Financial Information
In October 2014, Avanos Medical, Inc. (referred to below as “Parent”) issued the Notes (described in Note 8, “Debt”). The Notes are guaranteed, jointly and severally by each of our domestic subsidiaries that guarantees the Revolving Credit Facility (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 dated October 17, 2014. Each Guarantor Subsidiary is directly or indirectly 100%-owned by Avanos Medical, Inc. Each of the guarantees of the Notes is a general unsecured obligation of each Guarantor Subsidiary and ranks equally in right of payment with all existing and future indebtedness and all other obligations (except subordinated indebtedness) of each Guarantor Subsidiary.
The following condensed consolidating balance sheets as of September 30, 2019 and December 31, 2018, the condensed consolidating statements of income for the three and nine months ended September 30, 2019 and 2018 and cash flows for the nine months ended September 30, 2019 and 2018 provide condensed consolidating financial information for Parent, the Guarantor Subsidiaries on a combined basis, the non-guarantor subsidiaries on a combined basis and the Parent and its subsidiaries on a consolidated basis.
The Parent and the Guarantor Subsidiaries use the equity method of accounting to reflect ownership interests in subsidiaries that are eliminated upon consolidation. Eliminating entries in the following condensed consolidating financial information represent adjustments to (i) eliminate intercompany transactions between or among the Parent, the Guarantor Subsidiaries and the non-guarantor subsidiaries and (ii) eliminate the investments in subsidiaries.
22
AVANOS MEDICAL, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATING INCOME AND COMPREHENSIVE INCOME STATEMENTS
(in millions)
Three Months Ended September 30, 2019 | |||||||||||||||||||
Parent | Guarantor Subsidiaries | Non-Guarantor Subsidiaries | Eliminations | Consolidated | |||||||||||||||
Net Sales | $ | — | $ | 161.4 | $ | 36.6 | $ | (26.6 | ) | $ | 171.4 | ||||||||
Cost of products sold | — | 74.9 | 28.1 | (26.6 | ) | 76.4 | |||||||||||||
Gross Profit | — | 86.5 | 8.5 | — | 95.0 | ||||||||||||||
Research and development | — | 9.6 | — | — | 9.6 | ||||||||||||||
Selling and general expenses | 10.3 | 73.4 | 10.7 | — | 94.4 | ||||||||||||||
Other expense (income), net | 0.4 | 9.7 | (1.0 | ) | — | 9.1 | |||||||||||||
Operating Loss | (10.7 | ) | (6.2 | ) | (1.2 | ) | — | (18.1 | ) | ||||||||||
Interest income | 0.9 | — | 1.1 | (0.7 | ) | 1.3 | |||||||||||||
Interest expense | (4.4 | ) | 0.3 | (0.1 | ) | 0.7 | (3.5 | ) | |||||||||||
Loss Before Income Taxes | (14.2 | ) | (5.9 | ) | (0.2 | ) | — | (20.3 | ) | ||||||||||
Income tax benefit | 3.5 | 5.0 | 0.3 | — | 8.8 | ||||||||||||||
Equity in earnings of consolidated subsidiaries | (0.8 | ) | 1.6 | — | (0.8 | ) | — | ||||||||||||
Net (Loss) Income | (11.5 | ) | 0.7 | 0.1 | (0.8 | ) | (11.5 | ) | |||||||||||
Total other comprehensive loss, net of tax | (3.7 | ) | (1.0 | ) | (3.8 | ) | 4.8 | (3.7 | ) | ||||||||||
Comprehensive Loss | $ | (15.2 | ) | $ | (0.3 | ) | $ | (3.7 | ) | $ | 4.0 | $ | (15.2 | ) | |||||
23
AVANOS MEDICAL, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATING INCOME AND COMPREHENSIVE INCOME STATEMENTS
(in millions)
Three Months Ended September 30, 2018 | |||||||||||||||||||
Parent | Guarantor Subsidiaries | Non-Guarantor Subsidiaries | Eliminations | Consolidated | |||||||||||||||
Net Sales | $ | — | $ | 170.9 | $ | 13.4 | $ | (19.2 | ) | $ | 165.1 | ||||||||
Cost of products sold | — | 73.7 | 5.8 | (19.1 | ) | 60.4 | |||||||||||||
Gross Profit | — | 97.2 | 7.6 | (0.1 | ) | 104.7 | |||||||||||||
Research and development | — | 10.5 | — | — | 10.5 | ||||||||||||||
Selling and general expenses | 11.4 | 65.3 | 9.6 | — | 86.3 | ||||||||||||||
Other expense (income), net | 1.0 | 1.4 | (1.7 | ) | 0.2 | 0.9 | |||||||||||||
Operating (Loss) Income | (12.4 | ) | 20.0 | (0.3 | ) | (0.3 | ) | 7.0 | |||||||||||
Interest income | 0.7 | — | 2.5 | (1.0 | ) | 2.2 | |||||||||||||
Interest expense | (4.3 | ) | (0.8 | ) | (0.1 | ) | 1.0 | (4.2 | ) | ||||||||||
(Loss) Income Before Income Taxes | (16.0 | ) | 19.2 | 2.1 | (0.3 | ) | 5.0 | ||||||||||||
Income tax benefit (provision) | 4.1 | (0.1 | ) | (4.8 | ) | — | (0.8 | ) | |||||||||||
Equity in earnings of consolidated subsidiaries | 16.2 | 2.5 | — | (18.7 | ) | — | |||||||||||||
Net Income (Loss) | 4.3 | 21.6 | (2.7 | ) | (19.0 | ) | 4.2 | ||||||||||||
Total other comprehensive income, net of tax | 1.6 | 2.7 | 2.1 | (4.8 | ) | 1.6 | |||||||||||||
Comprehensive Income (Loss) | $ | 5.9 | $ | 24.3 | $ | (0.6 | ) | $ | (23.8 | ) | $ | 5.8 | |||||||
24
AVANOS MEDICAL, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATING INCOME AND COMPREHENSIVE INCOME STATEMENTS
(in millions)
Nine Months Ended September 30, 2019 | |||||||||||||||||||
Parent | Guarantor Subsidiaries | Non-Guarantor Subsidiaries | Eliminations | Consolidated | |||||||||||||||
Net Sales | $ | — | $ | 477.9 | $ | 96.4 | $ | (66.5 | ) | $ | 507.8 | ||||||||
Cost of products sold | — | 209.4 | 72.4 | (66.5 | ) | 215.3 | |||||||||||||
Gross Profit | — | 268.5 | 24.0 | — | 292.5 | ||||||||||||||
Research & development | — | 29.3 | — | — | 29.3 | ||||||||||||||
Selling and general expenses | 25.6 | 239.5 | 30.4 | — | 295.5 | ||||||||||||||
Other expense (income), net | 0.4 | 26.4 | (6.6 | ) | — | 20.2 | |||||||||||||
Operating (Loss) Income | (26.0 | ) | (26.7 | ) | 0.2 | — | (52.5 | ) | |||||||||||
Interest income | 4.2 | 0.1 | 4.0 | (2.6 | ) | 5.7 | |||||||||||||
Interest expense | (13.0 | ) | (0.1 | ) | (0.2 | ) | 2.6 | (10.7 | ) | ||||||||||
(Loss) Income Before Income Taxes | (34.8 | ) | (26.7 | ) | 4.0 | — | (57.5 | ) | |||||||||||
Income tax benefit (provision) | 8.5 | 10.1 | (0.9 | ) | — | 17.7 | |||||||||||||
Equity in earnings of consolidated subsidiaries | (13.5 | ) | 6.3 | — | 7.2 | — | |||||||||||||
Net (Loss) Income | (39.8 | ) | (10.3 | ) | 3.1 | 7.2 | (39.8 | ) | |||||||||||
Total other comprehensive (loss) income, net of tax | (1.1 | ) | 1.4 | (1.9 | ) | 0.5 | (1.1 | ) | |||||||||||
Comprehensive (Loss) Income | $ | (40.9 | ) | $ | (8.9 | ) | $ | 1.2 | $ | 7.7 | $ | (40.9 | ) | ||||||
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AVANOS MEDICAL, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATING INCOME AND COMPREHENSIVE INCOME STATEMENTS
(in millions)
Nine Months Ended September 30, 2018 | |||||||||||||||||||
Parent | Guarantor Subsidiaries | Non-Guarantor Subsidiaries | Eliminations | Consolidated | |||||||||||||||
Net Sales | $ | — | $ | 513.9 | $ | 125.4 | $ | (156.9 | ) | $ | 482.4 | ||||||||
Cost of products sold | (0.8 | ) | 247.6 | 101.9 | (156.8 | ) | 191.9 | ||||||||||||
Gross Profit | 0.8 | 266.3 | 23.5 | (0.1 | ) | 290.5 | |||||||||||||
Research and development | — | 31.2 | — | — | 31.2 | ||||||||||||||
Selling and general expenses | 32.0 | 187.3 | 33.2 | — | 252.5 | ||||||||||||||
Other (income) expense, net | (1.2 | ) | 2.7 | (7.6 | ) | 4.1 | (2.0 | ) | |||||||||||
Operating (Loss) Income | (30.0 | ) | 45.1 | (2.1 | ) | (4.2 | ) | 8.8 | |||||||||||
Interest income | 2.5 | 0.1 | 5.7 | (2.9 | ) | 5.4 | |||||||||||||
Interest expense | (23.2 | ) | (2.4 | ) | (0.2 | ) | 2.9 | (22.9 | ) | ||||||||||
(Loss) Income before Income Taxes | (50.7 | ) | 42.8 | 3.4 | (4.2 | ) | (8.7 | ) | |||||||||||
Income tax benefit (provision) | 12.9 | (1.3 | ) | (8.7 | ) | — | 2.9 | ||||||||||||
Equity in earnings of consolidated subsidiaries | 104.0 | 143.1 | — | (247.1 | ) | — | |||||||||||||
Net Income (Loss) from Continuing Operations | 66.2 | 184.6 | (5.3 | ) | (251.3 | ) | (5.8 | ) | |||||||||||
(Loss) Income from discontinued operations, net of tax | (6.5 | ) | (49.9 | ) | 121.9 | — | 65.5 | ||||||||||||
Net Income | 59.7 | 134.7 | 116.6 | (251.3 | ) | 59.7 | |||||||||||||
Total other comprehensive income, net of tax | 0.8 | 5.5 | 1.4 | (6.9 | ) | 0.8 | |||||||||||||
Comprehensive Income | $ | 60.5 | $ | 140.2 | $ | 118.0 | $ | (258.2 | ) | $ | 60.5 | ||||||||
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AVANOS MEDICAL, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATING BALANCE SHEETS
(in millions)
As of September 30, 2019 | |||||||||||||||||||
Parent | Guarantor Subsidiaries | Non-Guarantor Subsidiaries | Eliminations | Consolidated | |||||||||||||||
ASSETS | |||||||||||||||||||
Current Assets | |||||||||||||||||||
Cash and cash equivalents | $ | 113.7 | $ | 31.7 | $ | 69.0 | $ | — | $ | 214.4 | |||||||||
Accounts receivable, net of allowances | 2.2 | 1,184.4 | 202.9 | (1,231.8 | ) | 157.7 | |||||||||||||
Inventories | — | 129.2 | 15.3 | — | 144.5 | ||||||||||||||
Prepaid expenses and other current assets | 2.6 | 25.7 | 1.6 | — | 29.9 | ||||||||||||||
Total Current Assets | 118.5 | 1,371.0 | 288.8 | (1,231.8 | ) | 546.5 | |||||||||||||
Property, Plant and Equipment, net | — | 157.8 | 24.3 | — | 182.1 | ||||||||||||||
Operating Lease Right-of-Use Assets | — | 56.2 | 7.8 | — | 64.0 | ||||||||||||||
Investment in Consolidated Subsidiaries | 2,444.3 | 334.0 | — | (2,778.3 | ) | — | |||||||||||||
Goodwill | — | 785.5 | 15.0 | — | 800.5 | ||||||||||||||
Other Intangible Assets, net | — | 181.8 | 7.7 | — | 189.5 | ||||||||||||||
Other Assets | 1.6 | 21.6 | 1.9 | — | 25.1 | ||||||||||||||
TOTAL ASSETS | $ | 2,564.4 | $ | 2,907.9 | $ | 345.5 | $ | (4,010.1 | ) | $ | 1,807.7 | ||||||||
LIABILITIES AND EQUITY | |||||||||||||||||||
Current Liabilities | |||||||||||||||||||
Current portion of operating lease liabilities | $ | — | $ | 12.2 | $ | 2.3 | $ | — | $ | 14.5 | |||||||||
Trade accounts payable | 1,036.6 | 242.7 | 32.4 | (1,217.0 | ) | 94.7 | |||||||||||||
Accrued expenses | 11.5 | 99.7 | 12.5 | (14.8 | ) | 108.9 | |||||||||||||
Total Current Liabilities | 1,048.1 | 354.6 | 47.2 | (1,231.8 | ) | 218.1 | |||||||||||||
Long-Term Debt | 247.9 | — | — | — | 247.9 | ||||||||||||||
Operating Lease Liabilities | — | 56.6 | 5.9 | — | 62.5 | ||||||||||||||
Other Long-Term Liabilities | 1.5 | 7.9 | 2.9 | — | 12.3 | ||||||||||||||
Total Liabilities | 1,297.5 | 419.1 | 56.0 | (1,231.8 | ) | 540.8 | |||||||||||||
Total Equity | 1,266.9 | 2,488.8 | 289.5 | (2,778.3 | ) | 1,266.9 | |||||||||||||
TOTAL LIABILITIES AND EQUITY | $ | 2,564.4 | $ | 2,907.9 | $ | 345.5 | $ | (4,010.1 | ) | $ | 1,807.7 | ||||||||
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AVANOS MEDICAL, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATING BALANCE SHEETS
(in millions)
As of December 31, 2018 | |||||||||||||||||||
Parent | Guarantor Subsidiaries | Non-Guarantor Subsidiaries | Eliminations | Consolidated | |||||||||||||||
ASSETS | |||||||||||||||||||
Current Assets | |||||||||||||||||||
Cash and cash equivalents | $ | 303.9 | $ | 29.3 | $ | 51.3 | $ | — | $ | 384.5 | |||||||||
Accounts receivable, net of allowances | 4.5 | 1,257.3 | 212.1 | (1,323.4 | ) | 150.5 | |||||||||||||
Inventories | — | 106.2 | 15.2 | — | 121.4 | ||||||||||||||
Prepaid expenses and other current assets | 1.1 | 23.8 | 34.2 | (1.9 | ) | 57.2 | |||||||||||||
Total Current Assets | 309.5 | 1,416.6 | 312.8 | (1,325.3 | ) | 713.6 | |||||||||||||
Property, Plant and Equipment, net | — | 132.6 | 21.5 | — | 154.1 | ||||||||||||||
Investment in Consolidated Subsidiaries | 2,404.2 | 234.7 | — | (2,638.9 | ) | — | |||||||||||||
Goodwill | — | 758.7 | 24.9 | — | 783.6 | ||||||||||||||
Other Intangible Assets, net | — | 159.8 | 8.4 | — | 168.2 | ||||||||||||||
Other Assets | 1.6 | 10.8 | 1.5 | — | 13.9 | ||||||||||||||
TOTAL ASSETS | $ | 2,715.3 | $ | 2,713.2 | $ | 369.1 | $ | (3,964.2 | ) | $ | 1,833.4 | ||||||||
LIABILITIES AND EQUITY | |||||||||||||||||||
Current Liabilities | |||||||||||||||||||
Trade accounts payable | $ | 1,160.7 | $ | 268.2 | $ | 52.4 | $ | (1,311.4 | ) | $ | 169.9 | ||||||||
Accrued expenses | 8.2 | 77.3 | 22.8 | (13.9 | ) | 94.4 | |||||||||||||
Total Current Liabilities | 1,168.9 | 345.5 | 75.2 | (1,325.3 | ) | 264.3 | |||||||||||||
Long-Term Debt | 247.7 | — | — | — | 247.7 | ||||||||||||||
Other Long-Term Liabilities | 1.5 | 20.0 | 2.7 | — | 24.2 | ||||||||||||||
Total Liabilities | 1,418.1 | 365.5 | 77.9 | (1,325.3 | ) | 536.2 | |||||||||||||
Total Equity | 1,297.2 | 2,347.7 | 291.2 | (2,638.9 | ) | 1,297.2 | |||||||||||||
TOTAL LIABILITIES AND EQUITY | $ | 2,715.3 | $ | 2,713.2 | $ | 369.1 | $ | (3,964.2 | ) | $ | 1,833.4 | ||||||||
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AVANOS MEDICAL, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATING STATEMENTS OF CASH FLOWS
(in millions)
Nine Months Ended September 30, 2019 | |||||||||||||||||||
Parent | Guarantor Subsidiaries | Non-Guarantor Subsidiaries | Eliminations | Consolidated | |||||||||||||||
Operating Activities | |||||||||||||||||||
Cash (Used in) Provided by Operating Activities | $ | (23.8 | ) | $ | (70.4 | ) | $ | 22.6 | $ | — | $ | (71.6 | ) | ||||||
Investing Activities | |||||||||||||||||||
Capital expenditures | — | (38.1 | ) | (4.4 | ) | — | (42.5 | ) | |||||||||||
Acquisition of assets and businesses, net of cash acquired | (57.5 | ) | — | — | — | (57.5 | ) | ||||||||||||
Intercompany contributions | — | 110.4 | 0.1 | (110.5 | ) | — | |||||||||||||
Cash (Used in) Provided by Investing Activities | (57.5 | ) | 72.3 | (4.3 | ) | (110.5 | ) | (100.0 | ) | ||||||||||
Financing Activities | |||||||||||||||||||
Intercompany contributions | (110.5 | ) | — | — | 110.5 | — | |||||||||||||
Debt repayments | (0.2 | ) | — | — | — | (0.2 | ) | ||||||||||||
Purchases of treasury stock | (3.4 | ) | — | — | — | (3.4 | ) | ||||||||||||
Proceeds from the exercise of stock options | 5.2 | — | — | — | 5.2 | ||||||||||||||
Cash (Used in) Provided by Financing Activities | (108.9 | ) | — | — | 110.5 | 1.6 | |||||||||||||
Effect of Exchange Rate on Cash and Cash Equivalents | — | 0.5 | (0.6 | ) | — | (0.1 | ) | ||||||||||||
(Decrease) Increase in Cash and Cash Equivalents | (190.2 | ) | 2.4 | 17.7 | — | (170.1 | ) | ||||||||||||
Cash and Cash Equivalents, Beginning of Period | 303.9 | 29.3 | 51.3 | — | 384.5 | ||||||||||||||
Cash and Cash Equivalents, End of Period | $ | 113.7 | $ | 31.7 | $ | 69.0 | $ | — | $ | 214.4 | |||||||||
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AVANOS MEDICAL, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATING STATEMENTS OF CASH FLOWS
(in millions)
Nine Months Ended September 30, 2018 | |||||||||||||||||||
Parent | Guarantor Subsidiaries | Non-Guarantor Subsidiaries | Eliminations | Consolidated | |||||||||||||||
Operating Activities | |||||||||||||||||||
Cash (Used in) Provided by Operating Activities | $ | (139.3 | ) | $ | (5.9 | ) | $ | 7.0 | $ | — | $ | (138.2 | ) | ||||||
Investing Activities | |||||||||||||||||||
Capital expenditures | — | (24.9 | ) | (6.5 | ) | — | (31.4 | ) | |||||||||||
Acquisition of business, net of cash acquired | (65.6 | ) | — | — | — | (65.6 | ) | ||||||||||||
Proceeds from the Divestiture | 540.0 | 9.1 | 205.2 | — | 754.3 | ||||||||||||||
Cash dividends received from subsidiaries | — | 233.5 | — | (233.5 | ) | — | |||||||||||||
Intercompany contributions | — | (200.7 | ) | — | 200.7 | — | |||||||||||||
Cash Provided by Investing Activities | 474.4 | 17.0 | 198.7 | (32.8 | ) | 657.3 | |||||||||||||
Financing Activities | |||||||||||||||||||
Intercompany contributions | 200.7 | — | — | (200.7 | ) | — | |||||||||||||
Debt repayments | (339.0 | ) | — | — | — | (339.0 | ) | ||||||||||||
Purchases of treasury stock | (0.6 | ) | — | — | — | (0.6 | ) | ||||||||||||
Proceeds from the exercise of stock options | 16.8 | — | — | — | 16.8 | ||||||||||||||
Cash dividends paid to Guarantor | — | — | (233.5 | ) | 233.5 | — | |||||||||||||
Cash Used in Financing Activities | (122.1 | ) | — | (233.5 | ) | 32.8 | (322.8 | ) | |||||||||||
Effect of Exchange Rate on Cash and Cash Equivalents | — | (0.5 | ) | (3.7 | ) | — | (4.2 | ) | |||||||||||
Increase (Decrease) in Cash and Cash Equivalents | 213.0 | 10.6 | (31.5 | ) | — | 192.1 | |||||||||||||
Cash and Cash Equivalents, Beginning of Period | 114.5 | 16.0 | 89.2 | — | 219.7 | ||||||||||||||
Cash and Cash Equivalents, End of Period | $ | 327.5 | $ | 26.6 | $ | 57.7 | $ | — | $ | 411.8 | |||||||||
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Item 2. | Management’s Discussion and Analysis of Financial Condition and Results of Operations |
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, 2018.
The following will be discussed and analyzed:
• | Business Acquisitions |
• | Post-Divestiture Transition |
• | Discontinued Operations |
• | Restructuring Activities |
• | Results of Operations and Related Information |
• | Liquidity and Capital Resources |
• | Legal Matters |
• | Critical Accounting Policies |
• | Information Concerning Forward-Looking Statements |
Business Acquisitions
Endoclear LLC
On September 19, 2019, we acquired substantially all the assets of Endoclear, LLC (“Endoclear”). The initial purchase price was $3.5 million plus future contingent payments with an estimated fair value of $5.5 million, subject to certain adjustments as defined in the purchase agreement. Endoclear develops and markets airway management devices that are complementary to our existing respiratory health portfolio.
Summit Medical Products, Inc.
On August 7, 2019, we acquired substantially all the assets of Summit Medical Products, Inc. (“Summit”) for $15.6 million plus future contingent payments with an estimated fair value of $1.7 million, subject to certain adjustments as defined in the purchase agreement. Summit develops and markets the ambIT® family of ambulatory electronic infusion pumps, with annual net sales of approximately $7 million.
NeoMed, Inc.
On April 16, 2019, we acquired a minority interest in NeoMed, Inc. (“NeoMed”) for $7.0 million. NeoMed is a market-leading medical device company that is focused on specialized feeding and medication dosing for low birth weight, neonatal and pediatric patients. On July 8, 2019, we acquired all of the outstanding shares of NeoMed for a purchase price of $33.5 million, which includes the base purchase price of $28.0 million plus certain agreed-upon items at the closing date, net of cash acquired, and subsequently adjusted for certain items as defined in the purchase agreement. NeoMed’s net sales were $37 million in 2018.
Cool Systems, Inc.
On July 1, 2018, we acquired Cool Systems, Inc. for $65.7 million, net of cash acquired, which was based on a purchase price of $65.0 million plus certain adjustments as provided in the purchase agreement. Cool Systems is marketed as Game Ready® and is hereinafter referred to as “Game Ready.” In the nine months ended September 30, 2019, the goodwill arising from our acquisition of Game Ready was reduced by $1.9 million to $18.7 million.
We expect the integration of our acquisitions will be substantially complete by the end of December 2020.
Partnership Agreement
In addition to the acquisitions described above, in July 2019, we signed a partnership and supply agreement with BioQ Pharma, which designs ready-to-use delivery systems for infusible drugs.
Post-Divestiture Transition
Following last year’s divestiture of the Surgical and Infection Prevention (“S&IP”) business (the “Divestiture”), we have been engaged in certain commercial agreements, including transition services agreements (“TSA”), the majority of which are complete. The remainder will terminate by the end of the third quarter of 2020.
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In the three and nine months ended September 30, 2019, we have incurred $10.9 million and $43.1 million, respectively, of Divestiture-related costs, consisting primarily of IT consulting and other separation costs. In the nine months ended September 30, 2018, we incurred $17.4 million of costs which are included in “Income from discontinued operations, net of tax” in the condensed consolidated income statement in Item 1 of this report.
Discontinued Operations
As a result of the Divestiture, the results of operations from our former S&IP business are reported as “Income from discontinued operations, net of tax” for the three and nine months ended September 30, 2018. See “Discontinued Operations” in Note 4 to the condensed consolidated financial statements in Item 1 of this report.
Restructuring Activities
Post-Divestiture Restructuring Plan
In conjunction with the Divestiture, we began a multi-phase restructuring plan (the “Plan”) intended to align our organizational structure, information technology platform, supply chain and distribution channels to be more appropriate for the size and scale of our remaining Medical Devices business. Each phase of the restructuring plan is described below:
Organizational Alignment: In December 2017, we initiated the first phase of the Plan, which was intended to align our organizational and management structure with our remaining Medical Devices business (“Organizational Alignment”). We expect to incur up to $18.0 million of pre-tax costs, of which approximately $10.0 million is for employee retention, severance and benefits and the remainder for third-party services and other related costs. These are cash costs that will be incurred as we execute the Plan, which we expect to substantially complete by the end of 2019.
In the three and nine months ended September 30, 2019, we incurred $0.5 million and $2.5 million, respectively, of costs that are included in “Selling and general expenses” in the accompanying condensed consolidated income statement, compared to $1.9 million and $6.4 million, respectively, in the three and nine months ended September 30, 2018.
Plan-to-date, we have incurred $17.2 million of expenses, of which $10.1 million was for employee retention, severance and benefits and the remainder for third-party services and other costs.
Information Technology Systems: The sale price the Company received upon closing the Divestiture included the sale of the Company’s IT systems. The sale of the IT systems enables the Company to migrate to an IT platform that is more appropriate for its business and size. Accordingly, in March 2018, we launched the second phase of the Plan to restructure and enhance the Company’s IT systems (the “ITS Plan”).
Based on milestones achieved to date, the Company’s current expectation is to incur up to $75.0 million to complete the implementation of the ITS Plan, of which $55.0 million qualified for capitalization. The remainder, primarily consulting and other costs, are expensed as incurred. We incurred $7.6 million and $12.2 million, respectively, of costs related to the ITS Plan in the three and nine months ended September 30, 2019 which are included in “Selling and general expenses” in the accompanying condensed consolidated income statements compared to $3.2 million and $5.5 million, respectively, in the three and nine months ended September 30, 2018. Plan-to-date, we have incurred $18.6 million of costs that were expensed as incurred and $54.6 million of costs that were capitalized, including $5.0 million of capitalized internal labor costs. The Company will complete the migration to its new IT platform in conjunction with post-divestiture network separation in the fourth quarter of 2019, and accordingly, expects to substantially complete the ITS Plan by the end of 2019.
Cost Transformation: In June 2019, the third and final phase of the Plan was approved. This third phase relates to optimizing 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 in support of the Cost Transformation. The Company expects to complete the Cost Transformation by the end of 2021. We have incurred $0.3 million and $1.5 million of costs related to Cost Transformation in the three and nine months ended September 30, 2019.
Integration of Business Acquisitions
In the quarter, we initiated activities to integrate the asset and business acquisitions described in Note 2, “Business Acquisitions” into our operations, and where appropriate, re-align our organization accordingly (“Integration”). 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 ended September 30, 2019, we have incurred $5.3 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.
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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 in the 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 and nine months ended September 30, 2019 and 2018 (in millions):
Three Months Ended September 30, | Nine Months Ended September 30, | ||||||||||||||||||||
2019 | 2018 | Change | 2019 | 2018 | Change | ||||||||||||||||
Chronic care | $ | 98.0 | $ | 93.6 | 4.7 | % | $ | 300.3 | $ | 287.8 | 4.3 | % | |||||||||
Pain management | 73.4 | 71.5 | 2.7 | 207.5 | 194.6 | 6.6 | |||||||||||||||
Net Sales | $ | 171.4 | $ | 165.1 | 3.8 | % | $ | 507.8 | $ | 482.4 | 5.3 | % | |||||||||
Total | Volume(a) | Pricing/Mix | Currency | Other(b) | |||||||||||||||||
Net Sales - percentage change | QTD | 4 | % | 5 | % | (1 | )% | — | % | — | % | ||||||||||
YTD | 5 | % | 7 | % | (2 | )% | (1 | )% | 1 | % | |||||||||||
_______________________________________________
(a) | Volume includes incremental sales of NeoMed, Summit and Game Ready products. |
(b) | Other includes rounding. |
Product Category Descriptions
Chronic care is focused on (i) digestive health products such as our Mic-Key enteral feeding tubes, Corpak patient feeding solutions and NeoMed neonatal feeding solutions and (ii) respiratory health products such as our Ballard closed airway suction systems and oral care kits.
Pain management is focused on non-opioid 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 2019 Compared to Third Quarter 2018
Net sales of $171.4 million increased 4% compared to the prior year. The NeoMed and Summit acquisitions contributed 6% of volume growth. Besides acquisitions, continued demand for Coolief and respiratory health products was more than offset by lower volume in acute pain and digestive health, along with unfavorable price and mix. Volume was unfavorably affected by a $5.0 million increase in product backorders as a result of our recent migration to a new IT platform. In addition, distributors drew down their inventories during the quarter, primarily in chronic care products, resulting in lower volume.
First Nine Months of 2019 Compared to the First Nine Months of 2018
Net sales of $507.8 million increased 5% compared to the prior year. Game Ready, NeoMed and Summit provided 6% of volume growth. Besides acquisitions, continued demand for Coolief, respiratory health and digestive health products was more than offset by lower volume in acute pain and unfavorable pricing and mix.
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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, | ||||||||||||||||||||
2019 | 2018 | Change | 2019 | 2018 | Change | ||||||||||||||||
Net Sales | |||||||||||||||||||||
North America | $ | 133.9 | $ | 130.0 | 3.0 | % | $ | 390.0 | $ | 374.1 | 4.3 | % | |||||||||
Europe, Middle East and Africa | 21.0 | 20.4 | 2.9 | 70.1 | 63.9 | 9.7 | |||||||||||||||
Asia Pacific and Latin America | 16.5 | 14.7 | 12.2 | 47.7 | 44.4 | 7.4 | |||||||||||||||
Total Net Sales | $ | 171.4 | $ | 165.1 | 3.8 | % | $ | 507.8 | $ | 482.4 | 5.3 | % | |||||||||
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, | ||||||||||||||
2019 | 2018 | 2019 | 2018 | ||||||||||||
Operating (Loss) Profit, as reported | $ | (18.1 | ) | $ | 7.0 | (52.5 | ) | 8.8 | |||||||
Restructuring and IT charges | 8.4 | 5.4 | 16.2 | 12.2 | |||||||||||
Post Divestiture transition charges | 10.9 | 2.3 | 43.1 | (1.0 | ) | ||||||||||
Acquisition-related charges | 6.7 | 0.8 | 8.1 | 1.1 | |||||||||||
Litigation and legal | 8.0 | 3.7 | 21.4 | 6.6 | |||||||||||
Intangibles amortization | 5.1 | 5.4 | 14.6 | 14.6 | |||||||||||
Adjusted Operating Profit (non-GAAP) | $ | 21.0 | $ | 24.6 | $ | 50.9 | $ | 42.3 | |||||||
The as-reported operating profit in the prior year comparable periods exclude the S&IP business, which is reported in “Income from discontinued operations, net of tax” in the condensed consolidated income statement for the three and nine months ended September 30, 2018. In accordance with GAAP, only costs specifically identifiable and attributable to a business to be disposed may be allocated to discontinued operations. Accordingly, certain expenses that were historically presented as a component of the S&IP business were kept in continuing operations. These expenses, on a pre-tax basis, were $37.0 million in the nine months ended September 30, 2018.
Other items impacting operating results include:
Post-Divestiture Restructuring Activities: As previously described under “Restructuring Activities,” in the three months ended September 30, 2019, we incurred $8.4 million of costs, including $7.6 million for the ITS Plan, $0.5 million related to Organizational Alignment and $0.3 million for Cost Transformation. In the nine months ended September 30, 2019, we incurred $16.2 million of costs, including $12.2 million for the ITS Plan, $2.5 million related to organizational alignment and $1.5 million for Cost Transformation.
In the three months ended September 30, 2018, we incurred $5.1 million of costs, including $3.2 million for the ITS Plan and $1.9 million related to Organizational Alignment. In the nine months ended September 30, 2018, we incurred $11.9 million of costs, including $5.5 million for IT Transformation and $6.4 million for Organizational Alignment.
Post Divestiture Transition Charges: Costs related to the separation of the S&IP business were $10.9 million and $43.1 million in the three and nine months ended September 30, 2019, respectively. Costs incurred are net of amounts realized from TSA arrangements. In the prior year, we incurred $2.3 million of costs in the three months ended September 30, 2018 and realized $1.0 million, net, from TSA arrangements from the Divestiture date on April 30, 2018 through September 30, 2018.
Acquisition and Integration-related Charges: In the three months ended September 30, 2019, we incurred $6.7 million and $8.1 million, respectively, of costs related to the acquisitions described under “Business Acquisitions.” In the quarter, $5.3 million was for employee retention, severance and benefits related to restructuring and integration of our recent acquisitions. In the
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prior year, we incurred costs of $0.8 million and $1.1 million in the three and nine months ended September 30, 2018, respectively, primarily related to our acquisition of Game Ready.
Legal Costs: We incurred $8.0 million and $21.4 million for certain litigation matters in the three and nine months ended September 30, 2019, respectively, compared to $3.7 million and $6.6 million in the three and nine months ended September 30, 2018, respectively. Litigation matters are described in “Commitments and Contingencies” in Note 11 to the condensed consolidated financial statements.
Intangibles Amortization: Intangibles amortization related to intangibles acquired in prior business acquisitions was $5.1 million and $14.6 million in the three and nine months ended September 30, 2019, respectively, compared to $5.4 million and $14.6 million in the three and nine months ended September 30, 2018, respectively.
Interest Income and Expense
Interest expense was $3.5 million and $10.7 million in the three and nine months ended September 30, 2019, respectively, compared to $4.2 million and $22.9 million in the comparable periods last year. Following the Divestiture, we repaid the remaining amount owed on our Term Loan Facility, resulting in lower interest expense this year.
Income Taxes
The income tax benefit was $8.8 million and $17.7 million in the three and nine months ended September 30, 2019, respectively, compared to income tax expense of $0.8 million and benefit of $2.9 million in the comparable periods last year. The corresponding effective tax rates were 43.3% and 30.8% in the three and nine months ended September 30, 2019, respectively, compared to 16.0% and 33.3% in the comparable periods last year.
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. We expect to return to positive operating cash flow after we complete the migration to our IT platform and the separation of the S&IP business. Afterwards, operating cash flow is expected to be a primary source of funds. The cash used in operations is primarily driven by Divestiture and IT-related activities. As of September 30, 2019, $92.4 million of our $214.4 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 of the United States to have a material effect on our overall liquidity, financial condition or result of operations for the foreseeable future. We 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 $170.1 million to $214.4 million as of September 30, 2019 compared to $384.5 million as of December 31, 2018. The decrease was driven by $71.6 million used in operations, $57.5 million used to acquire assets and businesses and $42.5 million of capital expenditures.
In the prior year, cash and cash equivalents increased by $192.1 million to $411.8 million as of September 30, 2018 primarily due to $754.3 million of Divestiture proceeds partially offset by $339.0 million of debt repayments, $138.2 million used in operations, $65.6 million used to acquire Game Ready and $31.4 million of capital expenditures.
Operating Activities
Operating activities used $71.6 million in the nine months ended September 30, 2019 primarily driven by our net loss and changes in operating assets and liabilities. Operating activities used $138.2 million in the same period last year, including $98.0 million used to settle Divestiture-related liabilities.
Investing Activities
Investing activities used $100.0 million in the nine months ended September 30, 2019, including $57.5 million used to acquire assets and businesses as described in “Business Acquisitions,” and capital expenditures of $42.5 million. In the prior year, investing activities provided $657.3 million, which includes Divestiture proceeds of $754.3 million partially offset by $65.6 million used to acquire Game Ready and $31.4 million of capital expenditures.
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Financing Activities
Financing activities provided $1.6 million in the nine months ended September 30, 2019, and was primarily proceeds from the exercise of stock options partially offset by purchases of treasury stock. In the comparable period last year, financing activities used $322.8 million driven by $339.0 million to retire our senior secured term loan.
Long Term Debt
As of September 30, 2019, debt was $247.9 million, net of unamortized discount, on our Senior Unsecured Notes (the “Notes”) that mature on October 15, 2022.
Following a divestiture of significant assets, such as the Divestiture, the credit agreement allows re-investment of the net proceeds into the business through acquisition of another business or through capital expenditures for a period of one year following the divestiture. We were required to offer to redeem a portion of the Notes at par value to the extent re-investments were not made by May 1, 2019. Accordingly, $130.5 million of the Notes were offered for redemption in the second quarter of 2019, of which $0.2 million were redeemed.
We retired our senior secured term loan following the Divestiture last year. Notwithstanding the retirement of our senior secured term loan, the senior secured revolving credit facility (“Revolving Credit Facility”) remains and is secured by substantially all of our assets located in the United States and a certain percentage of our foreign subsidiaries’ capital stock. The Revolving Credit Facility matures on October 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 of September 30, 2019, we had no borrowings and letters of credit of $0.7 million outstanding under the Revolving Credit Facility.
See “Debt” in Note 8 to the accompanying condensed consolidated financial statements for further details regarding our debt agreements.
Legal Matters
See Item 1, Note 11, “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 ended September 30, 2019 and 2018 and our financial position as of September 30, 2019 and December 31, 2018. 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 in the United States, |
• | fluctuations in global equity and fixed-income markets, |
• | 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, |
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• | 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 ended December 31, 2018. |
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.
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Item 4. | Controls and Procedures |
With the participation of management, our Chief Executive Officer (principal executive officer) and our Senior Vice President, Business Strategy and Interim Chief Financial Officer (principal financial officer) carried out an evaluation, pursuant to Rule 13a-15(b) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), of the effectiveness of our disclosure controls and procedures (as defined in Rule 13a-15(e) of the Exchange Act) as of the end of the period covered by this report. Based upon that evaluation, our Chief Executive Officer and our Senior Vice President, Business Strategy and Interim Chief Financial Officer concluded that our disclosure controls and procedures were operating effectively as of September 30, 2019.
Changes in Internal Control Over Financial Reporting
IT System Implementation
As of September 30, 2019, the Company was finalizing the implementation of a new global IT platform. The new IT platform and related applications are designed to support business activities following the divestiture of the S&IP business and post-divestiture network separation. The implementation of a global IT platform affects many of the processes that constitute the Company’s internal control over financial reporting and requires testing for effectiveness during implementation. The Company expects the implementation will improve internal control over financial reporting overall, but the implementation is not in response to any identified deficiency. In the second quarter of this year, we completed the migration to the new IT platform with respect to our businesses in the EMEA region and expect to complete the migration globally in the fourth quarter of 2019.
Transition Services Agreements
In connection with the divestiture of the S&IP business, the Company entered into a series of reciprocal transition services agreements with the buyer pursuant to which the two organizations will provide each other information technology and other back office services to allow both companies to establish their own infrastructure and capabilities. Management has established controls to mitigate risks that personnel of either company may obtain unauthorized access to the other company’s data and will continue to monitor and evaluate the sufficiency of controls. We expect all transition service agreements to terminate by the end of the third quarter of next year.
Except as noted above, there have been no changes in our internal control over financial reporting that occurred during the three months ended September 30, 2019 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
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PART II – OTHER INFORMATION
Item 6. Exhibits
(a) | Exhibits |
Exhibit Number | Description | |
101.SCH | XBRL Taxonomy Extension Schema Document | |
101.CAL | XBRL Taxonomy Extension Calculation Linkbase Document | |
101.DEF | XBRL Taxonomy Extension Definition Linkbase Document | |
101.LAB | XBRL Taxonomy Extension Label Linkbase Document | |
101.PRE | XBRL Taxonomy Extension Presentation Linkbase Document | |
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
AVANOS MEDICAL, INC. | |||
(Registrant) | |||
November 5, 2019 | By: | /s/ Warren J. Machan | |
Warren J. Machan | |||
Senior Vice President, Business Strategy | |||
and Interim Chief Financial Officer | |||
(Principal Financial Officer) | |||
November 5, 2019 | By: | /s/ Renato Negro | |
Renato Negro | |||
Vice President and Controller | |||
(Principal Accounting Officer) | |||
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