Avanos (AVNS) Q1 2023: Margin Rises 200bps as Cost Transformation Offsets Portfolio Headwinds
Avanos delivered a first quarter marked by margin expansion and disciplined cost control, even as revenue declined amid supply chain and product rationalization headwinds. Management reaffirmed full-year guidance, emphasizing confidence in a stronger second half as transformation efforts accelerate and supply constraints ease. Investors should watch for upcoming portfolio moves and M&A updates at the June Investor Day, which could reshape the company’s growth profile.
Summary
- Margin Expansion Amidst Revenue Dip: Cost actions and manufacturing gains drove profitability higher despite top-line softness.
- Portfolio Rationalization Shifts Mix: Exiting lower-margin lines and supply chain issues weighed on revenue, but set up future growth.
- Second Half Acceleration Expected: Management signals stronger execution and potential portfolio moves in H2 2023.
Business Overview
Avanos Medical is a medical device company focused on products for digestive health and orthopedic pain management. The company generates revenue by selling devices such as catheters, pain pumps (like OnQ and Ambit), and radiofrequency ablation systems (Coolief), with a portfolio spanning both chronic care and acute pain. Its business model relies on a combination of recurring consumables and capital equipment, with major segments including Digestive Health, Interventional Pain, and Orthogen (hyaluronic acid injections for osteoarthritis).
Performance Analysis
Avanos reported a 2.9% year-over-year sales decline for the quarter, with revenue softness concentrated in certain pain management and Orthogen products. Despite the top-line pressure, adjusted EBITDA improved and margins advanced by 200 basis points, reflecting disciplined cost actions, manufacturing efficiency, and targeted portfolio rationalization. Gross margin rose to 56.4%, up 50 basis points, as the company exited lower-margin product lines and improved supply chain execution.
Operating expense leverage was a highlight, with SD&A as a percentage of revenue improving by 140 basis points. Free cash flow was negative for the quarter, impacted by restructuring costs and lower revenue, but management reiterated that Q1 would be the low point for cash generation this year. The company ended with $96 million in cash and a low leverage ratio of 0.8, providing financial flexibility for ongoing transformation and potential M&A.
- Cost Transformation Drives Margin: Manufacturing efficiency and SG&A discipline offset volume declines and supported profitability.
- Portfolio Moves Impact Revenue: The $35 million annualized impact from rationalization weighed on organic growth, but positions Avanos for higher-margin future sales.
- Supply Chain Constraints Persist: Backlogs in key products like OnQ, Coolief, and Ambit limited revenue by $4-5 million, but are expected to clear in the second half.
Overall, profitability outperformed revenue trends, validating the company’s transformation thesis, but near-term growth remains challenged by both internal and external factors.
Executive Commentary
"We are excited to embark on our transformation journey and are confident we will improve on each of our financial metrics as 2023 progresses, with a slow start for the first quarter followed by acceleration in the back half of the year, similar pacing to what we experienced in 2022."
Michael [Last Name Unknown], Chief Transformation Officer
"We feel the demand and fundamentals of our products remain strong. We are committed to obviously creating meaningful shareholder value through thoughtful strategic capital allocation. This all positions us for growth, margin expansion, and cash flow, as we've outlined and as Michael has talked about in the transformation process."
Joe [Last Name Unknown], Chief Executive Officer
Strategic Positioning
1. Cost Transformation and Margin Focus
Avanos is executing a multiyear cost transformation targeting $45-55 million in gross savings by 2025, with $10 million expected in 2023. These efforts include streamlining operations, reducing external spend, and driving manufacturing efficiency, which are already reflected in margin expansion this quarter. The company expects the bulk of savings to materialize in 2024, supporting improved free cash flow and return on invested capital (ROIC).
2. Product Portfolio Rationalization
Management is actively rationalizing lower-margin product lines, with a $35 million annualized impact in 2023. This move is designed to shift the portfolio toward higher-growth and higher-margin categories, especially in digestive health and orthopedic pain. The rationalization is expected to suppress near-term organic growth, but set the stage for improved quality of revenue and long-term expansion.
3. Supply Chain and Backlog Resolution
Persistent supply chain constraints in key products (notably OnQ and Coolief) limited revenue by $4-5 million in Q1. Leadership expects these issues to gradually resolve through Q2, with a much stronger second half anticipated as backlog clears and availability improves—mirroring the seasonal pattern seen in 2022.
4. Strategic M&A and Portfolio Actions
Avanos is pursuing bolt-on acquisitions and considering potential divestitures to reshape its portfolio for growth. Management hinted at an imminent transaction in the orthopedic pain space and signaled the possibility of a more significant portfolio move, potentially a divestiture, that would be a multiple of its current rationalization efforts. Updates are expected at the June Investor Day.
5. Segment Dynamics and International Upside
Digestive health is expected to offset some weakness in pain management and Orthogen, while international markets offer incremental growth opportunities. Management cited digestive health and acute pain as potential sources of upside to guidance, especially as supply issues resolve and international momentum builds.
Key Considerations
This quarter underscores Avanos’ pivot from revenue growth to margin and cash flow quality, with multiple moving parts across the portfolio and cost base. The company is navigating a complex transition, balancing near-term revenue pressure with longer-term value creation.
Key Considerations:
- Supply Chain Normalization Pace: The timing and completeness of backlog clearance will be critical for hitting second-half targets.
- Portfolio Rationalization Drag: The near-term sales impact from exiting lower-margin lines may persist longer if market conditions worsen or if further rationalization is needed.
- M&A and Divestiture Timing: The ability to execute accretive bolt-ons or significant divestitures could alter the growth and margin trajectory, but timing remains uncertain.
- Segment Volatility: Orthogen, particularly the five-injection product, faces ongoing reimbursement and competitive pressures, while digestive health and international remain potential bright spots.
Risks
Key risks include continued supply chain disruptions, slower-than-expected realization of cost savings, and execution risk around portfolio moves. The Orthogen segment faces reimbursement pressures and customer churn, while acute pain products remain exposed to input availability. If portfolio rationalization or divestitures are not well-timed or if M&A integration falters, growth and profitability could fall short of targets. Macro headwinds and competitive dynamics in core markets may further pressure results.
Forward Outlook
For Q2 2023, Avanos guided to:
- Revenue and margin performance largely similar to Q1, with incremental gross margin improvement expected.
- SD&A levels to remain stable, with material improvement in the second half as cost actions accelerate.
For full-year 2023, management reaffirmed guidance:
- Adjusted diluted EPS of $1.60 to $1.80
- At least $60 million in free cash flow, excluding one-time restructuring costs
- Low single-digit organic revenue growth, inclusive of portfolio rationalization impact
Management highlighted several factors that will drive second-half acceleration:
- Resolution of supply chain constraints and backlog clearance
- Ramping cost savings and transformation benefits
- Potential portfolio actions and M&A to be detailed at June Investor Day
Takeaways
Avanos is prioritizing margin and cash flow quality over near-term growth, using portfolio rationalization and cost transformation as levers to reset its base. The second half of 2023 is positioned as an inflection point, with supply chain normalization and potential portfolio moves offering catalysts for improved performance.
- Margin Over Growth: Cost discipline and manufacturing gains are cushioning the impact of lower sales, with margin expansion validating the transformation strategy.
- Portfolio in Transition: Rationalization and possible divestitures set the stage for a higher-quality, more focused business, but introduce execution and timing risks.
- H2 Execution Critical: Investors should closely track supply chain resolution, cash flow cadence, and any announced portfolio changes at the June Investor Day for signs of sustainable improvement.
Conclusion
Avanos’ first quarter demonstrates the early results of a margin-focused transformation, with cost actions offsetting revenue softness from product exits and supply chain issues. The next phase depends on clearing operational bottlenecks and executing strategic portfolio moves, both of which will be critical to delivering on full-year commitments and unlocking long-term value.
Industry Read-Through
Avanos’ experience reflects broader medtech trends of margin prioritization over top-line growth, as supply chains stabilize but not fully normalize. The company’s willingness to exit lower-margin lines and consider divestitures signals a sector-wide shift toward portfolio optimization and operational discipline. Competitors with similar chronic care and pain management exposure may face parallel headwinds from reimbursement and supply volatility, while those able to drive cost transformation and targeted M&A could emerge stronger. Investors should watch for further rationalization and consolidation across the medical device landscape as companies seek to balance profitability with sustainable growth.