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.
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, 2019. 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. Our estimates are subject to uncertainties associated with the ongoing COVID-19 pandemic which has caused volatility and adverse effects in global markets. Accordingly, 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.
Income Taxes
The Coronavirus Aid, Relief, and Economic Security Act (“CARES Act”) was enacted on March 27, 2020. The CARES Act allows for the carryback of U.S. net operating losses, which were expected to be used in future years, to prior years resulting in a $23.4 million and $33.1 million benefit that was recognized in the three and nine months ended September 30, 2020 respectively. Consequently, we recorded incremental income tax receivables in excess of $50.0 million as of September 30, 2020.
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 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 us. The market approach estimates the value of our company using a market capitalization methodology.
We completed our annual goodwill impairment test as of July 1, 2020, and we determined that the fair value of our reporting unit exceeds the net carrying amount.
Recently Adopted Accounting Pronouncements
Effective January 1, 2020, we adopted Accounting Standards Update (“ASU”) No. 2016-13, as amended by ASU 2019-05, Financial Instruments - Credit Losses (Topic 326). This standard addresses expected credit losses on financial instruments, including trade receivables, by replacing the incurred loss method with methodology that reflects expected credit losses that requires consideration of a broader range of information. Historically, our bad debt expense has not been material and our trade receivables are generally short-term in nature. Accordingly, adoption of this standard did not have a material impact on our financial condition, results of operations or cash flows.
Effective January 1, 2020, we adopted 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. Adoption of this ASU did not have a material effect on our financial position, results of operations or cash flows.
Effective January 1, 2020, we adopted 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. Adoption of this ASU did not have a material effect on our financial position, results of operations or cash flows.
Recently Issued Accounting Pronouncements
In December 2019, the Financial Accounting Standards Board (“FASB”) issued ASU No. 2019-12, Income Taxes (Topic 740): Simplifying the Accounting for Income Taxes. This ASU removes certain exceptions for recognizing deferred taxes for investments, performing intraperiod allocation and calculating income taxes in interim periods. The ASU also adds guidance to reduce complexity in certain areas, including recognizing deferred taxes for tax goodwill and allocating taxes to members of a consolidated group. This ASU is effective for annual periods and interim periods within those annual periods beginning after December 15, 2020, 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.
Note 2. Restructuring Activities
Our restructuring expenses for the three and nine months ended September 30, 2020 and 2019 is summarized in the table below (in millions):
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Three Months Ended September 30,
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Nine Months Ended September 30,
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2020
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2019
|
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2020
|
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2019
|
Post-Divestiture Restructuring Plan
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Cost Transformation
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$
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0.9
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$
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0.3
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|
$
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2.0
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$
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1.5
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Organizational Alignment & IT Transformation
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—
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8.1
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(0.6)
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14.7
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Total Post-Divestiture Restructuring Plan
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0.9
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8.4
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1.4
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16.2
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Integration and Restructuring of Business Acquisitions
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0.5
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5.3
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(0.2)
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5.3
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Total Restructuring Costs
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$
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1.4
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$
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13.7
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$
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1.2
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$
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21.5
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Post-Divestiture Restructuring Plan
In conjunction with the divestiture of our former Surgical & Infection Prevention business, we began a three-phase restructuring plan (the “Plan”) intended to align our organizational structure (“Organizational Alignment”), information technology platform (“IT Transformation”) and supply chain and distribution channels (“Cost Transformation”) to be more appropriate for the size and scale of our remaining Medical Devices business. Organizational Alignment and IT Transformation are substantially complete. However, in the nine months ended September 30, 2020, employee severance and retention that was previously accrued for Organizational Alignment was reversed due to employee attrition.
Cost Transformation
The Cost Transformation phase was initiated in June 2019, and is intended to optimize the Company’s procurement, manufacturing, and supply chain operations. The Company expects to incur between $11.0 million and $13.0 million of costs to execute the Cost Transformation, primarily consulting and other expenses that will be expensed as incurred. The Company also expects to spend between $8.0 million to $12.0 million of incremental capital through 2021 and expects to complete the Cost Transformation by the end of 2021. Expenses incurred for Cost Transformation are included in “Cost of products sold.” Plan-to-date we have incurred $4.3 million of costs that were expensed as incurred and $1.3 million of costs that were capitalized.
Integration and Restructuring of Business Acquisitions
During the third quarter of 2019, we initiated activities to integrate recent asset and business acquisitions into our operations, and where appropriate, re-align our organization accordingly. We expect to incur up to $11.0 million of costs, primarily for
employee retention, severance and benefits and lease termination costs. Attrition and the resulting reductions in severance and benefits caused a net credit in the nine months ended September 30, 2020. Plan-to-date, we have incurred $8.9 million of expense, included in “Selling and general expenses,” primarily for employee retention, severance, benefits and “Other expense, net” for right-of-use asset impairment. We expect the integration of our acquisitions will be substantially complete by the end of 2020.
Restructuring Liability
We have a liability for employee retention, severance, benefits and other costs associated with our restructuring activities, which is summarized below (in millions):
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Accrual
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Balance, December 31, 2019
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$
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8.5
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Charges and adjustments, net
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1.2
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Payments and other
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(7.3)
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Balance, September 30, 2020
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$
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2.4
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Note 3. Supplemental Balance Sheet Information
Accounts Receivable
Accounts receivable consist of the following (in millions):
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September 30, 2020
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December 31, 2019
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Accounts receivable
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$
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186.5
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$
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166.8
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Allowances and doubtful accounts:
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Doubtful accounts
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(3.9)
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(2.7)
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Sales discounts
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(0.3)
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(0.3)
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Accounts receivable, net
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$
|
182.3
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|
$
|
163.8
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As of September 30, 2020 and December 31, 2019, accounts receivable included $69.7 million and $14.3 million, respectively, in other receivables that were primarily related to tax refunds receivable. Additional information regarding the income tax receivable is included in “Accounting Policies” in Note 1 under “Income Taxes.”
Losses on receivables are estimated based on known troubled accounts and historical experience. Receivables are considered impaired and written off when it is probable that payments due will not be collected. Our provision for doubtful accounts was $0.3 million and $1.2 million in the three and nine months ended September 30, 2020, respectively.
Inventories
Inventories at the lower of cost (determined on the LIFO/FIFO or weighted-average cost methods) or market consist of the following (in millions):
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September 30, 2020
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December 31, 2019
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LIFO
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Non-
LIFO
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Total
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LIFO
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Non-
LIFO
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Total
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Raw materials
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$
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57.3
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$
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3.2
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$
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60.5
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$
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46.3
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$
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2.9
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$
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49.2
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Work in process
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31.6
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0.6
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32.2
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30.4
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0.5
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30.9
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Finished goods
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75.0
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18.0
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93.0
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49.5
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21.7
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71.2
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Supplies and other
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—
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5.8
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5.8
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|
—
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4.5
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4.5
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163.9
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27.6
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|
191.5
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126.2
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29.6
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|
|
155.8
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Excess of FIFO or weighted-average cost over LIFO cost
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(7.4)
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—
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(7.4)
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(9.9)
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—
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(9.9)
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Total
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$
|
156.5
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$
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27.6
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$
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184.1
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$
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116.3
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$
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29.6
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|
$
|
145.9
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Property, Plant and Equipment
Property, plant and equipment consists of the following (in millions):
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September 30, 2020
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|
December 31, 2019
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Land
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$
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0.8
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$
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1.0
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Buildings
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46.9
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48.3
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Machinery and equipment
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213.8
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215.0
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Construction in progress
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22.9
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|
18.9
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284.4
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|
283.2
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Less accumulated depreciation
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(107.1)
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(98.7)
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Total
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$
|
177.3
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$
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184.5
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Depreciation expense was $5.8 million and $17.5 million for the three and nine months ended September 30, 2020 compared to $3.5 million and $10.8 million for the three and nine months ended September 30, 2019, respectively. Depreciation expense in the three and nine months ended September 30, 2020 includes depreciation on $59.3 million of capital that was placed in service in late 2019 associated with (i) implementation of a new IT platform and (ii) post-divestiture network separation. We continue to monitor the effects of the ongoing COVID-19 pandemic on the recoverability of our fixed assets.
Goodwill and Intangible Assets
The changes in the carrying amount of goodwill are as follows (in millions):
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Goodwill
|
Balance, December 31, 2019
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$
|
800.9
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|
Purchase accounting adjustment
|
0.5
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|
Currency translation adjustment
|
(0.2)
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|
Balance, September 30, 2020
|
$
|
801.2
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Intangible assets subject to amortization consist of the following (in millions):
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|
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|
|
September 30, 2020
|
|
December 31, 2019
|
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Gross
Carrying
Amount
|
|
Accumulated
Amortization
|
|
Net Carrying Amount
|
|
Gross
Carrying
Amount
|
|
Accumulated
Amortization
|
|
Net Carrying Amount
|
Trademarks
|
$
|
90.9
|
|
|
$
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(60.1)
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|
|
$
|
30.8
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|
|
$
|
90.9
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|
|
$
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(56.7)
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|
|
$
|
34.2
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Patents and acquired technologies
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281.6
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|
(166.3)
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|
115.3
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|
|
281.1
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|
|
(157.2)
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|
123.9
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Other
|
61.4
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|
(37.4)
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|
24.0
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|
61.3
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(35.1)
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26.2
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Total
|
$
|
433.9
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|
|
$
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(263.8)
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|
$
|
170.1
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|
$
|
433.3
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|
|
$
|
(249.0)
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|
|
$
|
184.3
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|
Amortization expense for intangible assets was $4.9 million and $14.6 million for the three and nine months ended September 30, 2020 compared to $5.2 million and $14.8 million for the three and nine months ended September 30, 2019. We continue to monitor the effects of the ongoing COVID-19 pandemic on the recoverability of our intangible assets.
We estimate amortization expense for the remainder of 2020 and the following four years and beyond will be (in millions):
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Amount
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Remainder of 2020
|
|
$
|
4.9
|
|
2021
|
|
17.0
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2022
|
|
15.9
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|
2023
|
|
15.3
|
|
2024
|
|
15.1
|
|
Thereafter
|
|
101.9
|
|
Total
|
|
$
|
170.1
|
|
Accrued Expenses
Accrued expenses consist of the following (in millions):
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|
|
|
|
|
|
|
|
|
|
September 30, 2020
|
|
December 31, 2019
|
Accrued rebates and customer incentives
|
$
|
23.3
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|
|
$
|
51.1
|
|
Accrued salaries and wages
|
35.4
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|
|
23.6
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|
Accrued taxes
|
2.0
|
|
|
3.2
|
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Other
|
27.2
|
|
|
36.9
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Total
|
$
|
87.9
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|
|
$
|
114.8
|
|
Other Long-Term Liabilities
Other long-term liabilities consist of the following (in millions):
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|
|
|
|
|
|
|
|
|
|
|
September 30, 2020
|
|
December 31, 2019
|
Taxes payable
|
$
|
0.4
|
|
|
$
|
0.4
|
|
Accrued compensation benefits
|
5.6
|
|
|
5.4
|
|
Other
|
5.4
|
|
|
5.4
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Total
|
$
|
11.4
|
|
|
$
|
11.2
|
|
Note 4. Business Investments and Acquisitions
Minority Interest Investment
In the three months ended September 30, 2020, we acquired a minority interest in FUSMobile, Inc. (“FUSMobile”) for $4.0 million. FUSMobile is leading the development of novel, non-invasive tissue ablation procedures, utilizing high intensity focused ultrasound technology, which complements other therapies in our Pain Management franchise.
Acquisitions Completed in 2019
In the three months ended September 30, 2019, we completed the acquisition of substantially all of the assets of Endoclear, LLC and Summit Medical Products, Inc. In addition, we also completed the acquisition of NeoMed, Inc. (collectively, the “Acquisitions”). We accounted for the Acquisitions under the acquisition method of accounting for business combinations. Accordingly, the purchase price paid was allocated to the underlying net assets in proportion to their respective fair values. Any excess of the purchase price over the estimated fair values was recorded as goodwill. The final purchase price allocation for Acquisitions is shown in the table below (in millions):
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|
|
|
|
|
|
Purchase Price
|
Current assets acquired net of liabilities assumed
|
$
|
12.2
|
|
Property, plant and equipment
|
2.1
|
|
Identifiable intangible assets
|
36.4
|
|
Other non-current assets (liabilities), net
|
0.3
|
|
Deferred tax liabilities
|
(3.5)
|
|
Goodwill
|
19.3
|
|
Total
|
$
|
66.8
|
|
The following unaudited pro-forma information is presented in the table below for the three months and nine months ended September 30, 2019 as if each of the acquisitions had occurred on January 1 of the year prior to the acquisition date (in millions).
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|
|
Three Months Ended
|
|
Nine Months Ended
|
Unaudited
|
September 30, 2019
|
|
September 30, 2019
|
Net Sales
|
$
|
172.2
|
|
|
$
|
544.3
|
|
|
|
|
|
Net Loss
|
$
|
(21.2)
|
|
|
$
|
(50.2)
|
|
|
|
|
|
Loss per share:
|
|
|
|
Basic
|
$
|
(0.45)
|
|
|
$
|
(1.05)
|
|
Diluted
|
$
|
(0.45)
|
|
|
$
|
(1.05)
|
|
Note 5. 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.
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. The following table includes the fair value of our financial instruments for which disclosure of fair value is required (in millions):
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|
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|
|
|
|
|
|
September 30, 2020
|
|
December 31, 2019
|
|
Fair Value
Hierarchy
Level
|
|
Carrying
Amount
|
|
Estimated
Fair
Value
|
|
Carrying
Amount
|
|
Estimated
Fair
Value
|
Assets
|
|
|
|
|
|
|
|
|
|
Cash and cash equivalents
|
1
|
|
$
|
180.0
|
|
|
$
|
180.0
|
|
|
$
|
205.3
|
|
|
$
|
205.3
|
|
Liabilities
|
|
|
|
|
|
|
|
|
|
Senior Unsecured Notes
|
1
|
|
248.5
|
|
|
250.0
|
|
|
248.1
|
|
|
254.5
|
|
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 6. Debt
As of September 30, 2020 and December 31, 2019, our debt balances were as follows (in millions):
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|
|
|
|
|
|
|
|
|
|
Weighted-Average Interest Rate
|
|
Maturities
|
|
September 30, 2020
|
|
December 31, 2019
|
Senior Unsecured Notes
|
6.25
|
%
|
|
2022
|
|
$
|
249.8
|
|
|
$
|
249.8
|
|
Unamortized Debt Discounts and Issuance Costs
|
|
|
|
|
(1.3)
|
|
|
(1.7)
|
|
Total Debt, net
|
|
|
|
|
$
|
248.5
|
|
|
$
|
248.1
|
|
Senior Unsecured Notes
Interest accrues on the Senior Unsecured Notes (the “Notes”) 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, 2020.
The Senior Unsecured Notes (the “Notes”) were to mature on October 15, 2022. On October 15, 2020, we redeemed the Notes pursuant to a provision for early redemption without paying a premium at any time on or after October 15, 2020. The redemption resulted in an early-extinguishment loss of $1.3 million, which was charged to interest expense on the redemption date. The Notes were redeemed using $69.8 million of cash on hand and $180.0 million drawn from our Revolving Credit Facility.
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.
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 noted earlier under “Senior Unsecured Notes,” on October 15, 2020, we drew $180.0 million to retire the Notes. As of September 30, 2020, we had no borrowings and letters of credit of $0.7 million outstanding under the Revolving Credit Facility.
Note 7. Accumulated Other Comprehensive Income
The changes in the components of AOCI, net of tax, are as follows (in millions):
|
|
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|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Unrealized
Translation
|
|
Cash Flow
Hedges
|
|
Defined Benefit
Pension Plans
|
|
Accumulated
Other
Comprehensive Loss
|
Balance, December 31, 2019
|
$
|
(31.5)
|
|
|
$
|
0.1
|
|
|
$
|
(0.6)
|
|
|
$
|
(32.0)
|
|
Other comprehensive (loss) income
|
(5.2)
|
|
|
(0.1)
|
|
|
0.2
|
|
|
(5.1)
|
|
Balance, September 30, 2020
|
$
|
(36.7)
|
|
|
$
|
—
|
|
|
$
|
(0.4)
|
|
|
$
|
(37.1)
|
|
The changes in the components of AOCI, including the tax effect, are as follows (in millions):
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|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended September 30,
|
|
Nine Months Ended September 30,
|
|
2020
|
|
2019
|
|
2020
|
|
2019
|
Unrealized translation
|
$
|
4.9
|
|
|
$
|
(3.7)
|
|
|
$
|
(5.2)
|
|
|
$
|
(1.1)
|
|
Defined benefit pension plans
|
(0.1)
|
|
|
—
|
|
|
0.2
|
|
|
—
|
|
Tax effect
|
0.1
|
|
|
—
|
|
|
—
|
|
|
—
|
|
Defined benefit pension plans, net of tax
|
—
|
|
|
—
|
|
|
0.2
|
|
|
—
|
|
Cash flow hedges
|
—
|
|
|
—
|
|
|
(0.1)
|
|
|
—
|
|
Tax effect
|
—
|
|
|
—
|
|
|
—
|
|
|
—
|
|
Cash flow hedges, net of tax
|
—
|
|
|
—
|
|
|
(0.1)
|
|
|
—
|
|
Change in AOCI
|
$
|
4.9
|
|
|
$
|
(3.7)
|
|
|
$
|
(5.1)
|
|
|
$
|
(1.1)
|
|
Note 8. Stock-Based Compensation
Stock-based compensation expense for the three and nine months ended September 30, 2020 and 2019 is shown in the table below (in millions):
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|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended September 30,
|
|
Nine Months Ended September 30,
|
|
2020
|
|
2019
|
|
2020
|
|
2019
|
Stock options
|
$
|
0.7
|
|
|
$
|
0.7
|
|
|
$
|
2.0
|
|
|
$
|
2.4
|
|
Time-based restricted share units
|
1.8
|
|
|
0.6
|
|
|
4.2
|
|
|
3.2
|
|
Performance-based restricted share units
|
0.8
|
|
|
1.4
|
|
|
2.5
|
|
|
3.1
|
|
Employee stock purchase plan
|
0.1
|
|
|
0.1
|
|
|
0.2
|
|
|
0.1
|
|
Total stock-based compensation
|
$
|
3.4
|
|
|
$
|
2.8
|
|
|
$
|
8.9
|
|
|
$
|
8.8
|
|
Note 9. 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, 2020, we incurred $2.4 million and $5.8 million, respectively, of expenses related to these matters compared to $8.0 million and $21.4 million in the three and nine months ended September 30, 2019.
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. Under the Amended Judgment, the judgment against us was $0.4 million in compensatory damages and pre-judgment interest and $1.3 million in punitive damages. The judgment against Kimberly-Clark was $3.9 million in compensatory damages, $2.7 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. On July 23, 2020, the appellate court vacated the judgment against us and remanded the case to the district court with instructions to dismiss Avanos because Bahamas lacked standing to sue us. The appellate court also ruled that the district court abused its discretion by failing to decertify the class as defined and, therefore, vacated the judgment against Kimberly-Clark and remanded it to the trial court for further proceedings consistent with its ruling. On August 6, 2020, Bahamas petitioned the Ninth Circuit for a rehearing en banc, and on September 9, 2020, the appellate court denied their petition. On October 19, 2020, the trial court ordered that the entire case against Avanos is dismissed, the judgment against Kimberly-Clark is vacated, and the class claims are decertified. 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 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 sought 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 6, 2019, the appellate court affirmed the lower court’s ruling, finding that it did not have personal jurisdiction over Kimberly-Clark.
On September 4, 2020, Kimberly-Clark filed a Second Amended Complaint, which makes substantially similar allegations as their previous complaint and seeks a declaratory judgment on substantially similar grounds for the Bahamas matter and other actions they allege to be covered by the Distribution Agreement. Also on September 4, 2020, Kimberly-Clark filed a motion for summary judgment. On October 9, 2020, we filed a motion to dismiss their Second Amended Complaint and a motion for summary judgment. We intend to continue our vigorous defense of the matter.
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 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. On June 4, 2020, the appellate court vacated the district’s court order dismissing the case and remanded the case to the district court.
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.
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 Second Circuit Court of Appeals. On May 27, 2020, the appellate court affirmed the district court’s order dismissing the case. 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. On June 30, 2020 and July 14, 2020, the court in each of Pick and Richardson, respectively, ordered the dismissal of those cases pursuant to stipulations of voluntary dismissal with prejudice. On August 24, 2020, the court in Chiu ordered the dismissal of that case pursuant to a revised stipulation for voluntary dismissal without prejudice.
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.
On November 4, 2019, we filed the matter styled Avanos Medical Sales LLC v Medtronic Sofamor Danek USA, Inc., et al. (No. 2:19-cv-02754-JMP-TMP (W.D. Tenn.), alleging that Medtronic’s manufacture, marketing, sale, and importation of the Accurian system infringes certain claims of U.S. Patent 8,822,755. Medtronic’s motion to dismiss was denied. On June 1, 2020, Medtronic petitioned the U.S. Patent and Trademark Office (“USPTO”) for an inter partes review (“IPR”) of the patent at issue in the litigation. On October 23, 2020, the USPTO instituted an IPR. The IPR will not affect Avanos’s ability to manufacture, market or sell the products covered by the underlying patent. We will continue to vigorously prosecute and defend the litigation and IPR.
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.
We record provisions in the consolidated financial statements for pending litigation when we determine that an unfavorable outcome is probable and the amount of the loss can be reasonably estimated. For any matters that are reasonably possible to result in loss and for which no possible loss or range of loss is disclosed in this report, management has determined that it is unable to estimate the possible loss or range of loss because, in each case, at least the following facts applied: (a) early stage of the proceedings; (b) indeterminate (or unspecified) damages; and (c) significant factual issues yet to be resolved, or such amounts have been determined to be immaterial. At present, 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, 2020, we have an accrued liability for the matters described herein, and reasonably possible losses have been disclosed. 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.
Note 10. 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, 2020 and 2019 is set forth in the following table (in millions, except per share amounts):
|
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|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended September 30,
|
|
Nine Months Ended September 30,
|
|
2020
|
|
2019
|
|
2020
|
|
2019
|
Net (loss) income
|
$
|
19.3
|
|
|
$
|
(11.5)
|
|
|
$
|
20.0
|
|
|
$
|
(39.8)
|
|
|
|
|
|
|
|
|
|
Weighted Average Shares Outstanding:
|
|
|
|
|
|
|
|
Basic weighted average shares outstanding
|
47.8
|
|
|
47.7
|
|
|
47.8
|
|
|
47.6
|
|
Dilutive effect of stock options and restricted share unit awards
|
0.3
|
|
|
—
|
|
|
0.2
|
|
|
—
|
|
Diluted weighted average shares outstanding
|
48.1
|
|
|
47.7
|
|
|
48.0
|
|
|
47.6
|
|
Earnings (Loss) Per Share:
|
|
|
|
|
|
|
|
Basic
|
$
|
0.40
|
|
|
$
|
(0.24)
|
|
|
$
|
0.42
|
|
|
$
|
(0.84)
|
|
Diluted
|
$
|
0.40
|
|
|
$
|
(0.24)
|
|
|
$
|
0.42
|
|
|
$
|
(0.84)
|
|
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 the three and nine months ended September 30, 2020, 1.5 million and 1.4 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.
Note 11. Business and Products Information
We conduct our business in one operating and reportable segment that provides our medical device products to healthcare professionals and patients in more than 90 countries with manufacturing facilities in the United States, Mexico, France, Germany and Tunisia.
We provide a portfolio of innovative product offerings focused on pain management and chronic care 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,
|
|
2020
|
|
2019
|
|
2020
|
|
2019
|
Chronic care
|
$
|
119.3
|
|
|
$
|
98.0
|
|
|
$
|
355.2
|
|
|
$
|
300.3
|
|
Pain management
|
66.4
|
|
|
73.4
|
|
|
174.6
|
|
|
207.5
|
|
Total Net Sales
|
$
|
185.7
|
|
|
$
|
171.4
|
|
|
$
|
529.8
|
|
|
$
|
507.8
|
|
Chronic care is a portfolio of products that is focused on (i) digestive health products such as our Mic-Key enteral feeding tubes, Corpak patient feeding solutions and NeoMed neonatal and pediatric feeding solutions and (ii) respiratory health products such as closed airway suction systems and other airway management devices under the Ballard, Microcuff and Endoclear brands.
Pain management is a portfolio of products focused on non-opioid pain solutions including (i) acute pain products such as On-Q and ambIT surgical pain pumps and Game Ready cold and compression therapy systems and (ii) interventional pain solutions, which provides minimally invasive pain relieving therapies, such as our Coolief pain therapy.
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.