Avanos (AVNS) Q2 2023: Digestive Health Surges 17%, Pain Recovery Hinges on Supply Chain Relief
Digestive health strength offset pain management softness as Avanos navigated portfolio transformation and persistent supply challenges. Cost reduction and margin improvement remain central to the investment case, with management signaling accelerating operational discipline into 2024. Execution on new product launches and pain segment stabilization will determine Avanos’ ability to achieve its midterm growth and cash flow targets.
Summary
- Digestive Health Outperformance: Core franchise posted double-digit growth, anchoring Avanos’ transformation narrative.
- Pain Management Headwinds: Supply chain disruptions constrained pain and recovery sales, masking underlying demand.
- Transformation Plan in Focus: Execution on cost takeout and stranded cost reduction will shape margin and cash flow trajectory.
Business Overview
Avanos is a medical technology company focused on delivering products for digestive health and pain management. Revenue is generated through sales of enteral feeding systems, Neomed neonatal devices, and pain management solutions including surgical pain pumps and hyaluronic acid (HA) injections. The business is organized around two main segments: Digestive Health, which includes legacy feeding and NeoMed product lines, and Pain Management & Recovery, covering interventional pain, surgical pain pumps, and HA products. Avanos recently divested its respiratory health business, sharpening its focus on higher-margin categories.
Performance Analysis
Digestive Health delivered standout performance, growing nearly 17% in constant currency, led by robust demand for NeoMed and legacy enteral feeding products. This segment now serves as the primary growth engine, benefiting from NFIT conversions and expansion of core tract offerings in North America and globally. Management highlighted above-market growth and flagged further innovation and M&A as ongoing levers.
By contrast, Pain Management & Recovery sales fell close to 11%, held back by persistent supply chain bottlenecks, particularly in interventional pain, game-ready, and five-shot HA categories. Surgical pain pumps were flat, with underlying procedure demand rising but constrained by backorders and component shortages. Management expects these headwinds to ease by year-end, positioning the segment for a potential rebound in 2024.
- Gross Margin Dynamics: Adjusted gross margin approached 60%, reflecting portfolio optimization, but was pressured by Mexican peso inflation and HA product mix.
- SG&A Efficiency Gains: SG&A as a percentage of revenue improved sequentially, driven by cost savings and organizational streamlining.
- Cash Flow and Capital Allocation: Free cash flow guidance was trimmed for 2023 due to higher tax and interest, but management reiterated a $100 million target for 2025.
Portfolio rationalization and cost takeout are driving incremental margin improvement, but execution risk remains, especially as Avanos works through stranded costs from the respiratory divestiture and seeks to stabilize pain management performance.
Executive Commentary
"We continue to deliver above-market growth and leadership in our core digestive health markets and are poised to sustain this momentum through innovations that we plan to launch over the next 12 months, expansion into high-potential global markets, and actionable M&A targets in large, attractive adjacencies."
Joe Woody, CEO
"We anticipate SG&A as a percentage of revenue to be approximately 43 to 44% for the full year from a continuing operations standpoint, with substantial improvement in 2024, ultimately leading to our 2025 goal between 38 to 39%."
Michael Greiner, CFO & Chief Transformation Officer
Strategic Positioning
1. Digestive Health as Growth Anchor
Digestive health, enteral feeding and NeoMed neonatal products, are now the company’s primary growth vector. Management is prioritizing innovation and global expansion, with bolt-on M&A flagged as an accelerant. Sustained double-digit growth here is critical for offsetting pain management volatility.
2. Pain Management Turnaround Plan
Pain management, interventional and surgical pain solutions, faces a multi-pronged recovery strategy: resolving supply chain bottlenecks, integrating DEROS radiofrequency technology to access ambulatory surgery center (ASC) markets, and shifting commercial focus to higher-growth, higher-margin subsegments. Management expects procedure growth to translate into sales as backorders clear by Q4.
3. Cost Transformation and Margin Expansion
Transformation program, focused on cost reduction and portfolio optimization, targets $45-55 million in gross savings by 2025. The company is aggressively working to eliminate stranded costs from the respiratory divestiture and drive SG&A as a percentage of sales below 40% by 2025, supporting EBITDA and free cash flow expansion.
4. Capital Allocation Discipline
Capital allocation, share repurchase and tuck-in M&A, remains disciplined. The new $25 million buyback program is positioned as opportunistic, with management signaling no impact on M&A firepower. Digestive Health is the preferred area for future bolt-ons.
5. Portfolio Simplification and Focus
Portfolio simplification, divestiture of low-growth or low-margin products, is ongoing, with the respiratory health exit and selective product discontinuations sharpening focus on higher-return categories. This is designed to improve both gross margin and ROIC over time.
Key Considerations
Avanos’ quarter underscored the importance of operational execution and portfolio discipline as it seeks to reset its earnings base and deliver on mid-term targets.
Key Considerations:
- Digestive Health Sustainability: NeoMed and legacy enteral feeding growth must persist as pain management recovers, with innovation and global expansion as key levers.
- Pain Management Inflection: Supply chain resolution and DEROS integration are critical to restoring growth and margin in this challenged segment.
- Cost Takeout Execution: Delivery of $45-55 million in cost savings and elimination of stranded costs is central to achieving EBITDA and FCF goals.
- Margin Improvement Trajectory: Portfolio optimization and SG&A efficiency are driving margin gains, but inflation and product mix remain variables to monitor.
- Capital Deployment Flexibility: Share buybacks and selective M&A signal management’s confidence in intrinsic value and cash flow prospects.
Risks
Execution risk is elevated as Avanos navigates simultaneous supply chain normalization, cost reduction, and integration of new technologies. Stranded costs from the respiratory divestiture and continued inflationary pressures, particularly in Mexico, could weigh on margin expansion if not offset by pricing or efficiency gains. Pain management recovery is not assured, with procedure growth dependent on timely resolution of component shortages and competitive pricing dynamics in HA.
Forward Outlook
For Q3 and Q4, Avanos guided to:
- Adjusted diluted EPS of $1.05 to $1.15 for the full year
- Gross margins near 60% and adjusted EBITDA margins of approximately 15%
For full-year 2023, management maintained guidance:
- Low single-digit organic revenue growth (excluding portfolio rationalization)
Management highlighted several factors that will shape results:
- Digestive Health expected to maintain above-market growth, with tough comparables in 2024
- Pain Management recovery dependent on supply chain normalization and DEROS ramp
Takeaways
Avanos’ Q2 results highlight a business in operational transition, with Digestive Health providing stability as Pain Management works through cyclical and structural headwinds.
- Digestive Health Momentum: Double-digit growth in core franchises is anchoring the company’s transformation and offsetting pain management volatility.
- Cost Discipline as Key Lever: The pace and effectiveness of cost takeout and stranded cost elimination will dictate margin and cash flow realization.
- Pain Management Recovery Watch: Investors should monitor supply chain normalization and DEROS execution as leading indicators for 2024 growth inflection.
Conclusion
Avanos is executing on a multi-year transformation, with Digestive Health outperformance and cost discipline driving near-term results. Restoring growth in Pain Management and realizing stranded cost savings will determine whether Avanos can deliver on its midterm financial commitments and sustain margin expansion into 2024 and beyond.
Industry Read-Through
Avanos’ experience reflects broader medtech trends: Supply chain normalization remains uneven, especially for specialized components and disposables, impacting revenue conversion even as procedural volumes rebound. Portfolio simplification and focus on higher-margin categories are becoming industry standard, with companies divesting non-core assets to drive margin and cash flow. Cost management and SG&A discipline are now central to value creation, as inflation and currency volatility persist. For peers in pain management and enteral feeding, innovation, channel expansion, and operational agility will be key to sustaining growth as market comparables toughen and pricing dynamics evolve.