Halyard Health's (HYH) CEO Robert Abernathy on Q4 2016 Results - Earnings Call Transcript

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Halyard Health, Inc. (NYSE:HYH) Q4 2016 Results Earnings Conference Call February 27, 2017 9:00 AM ET

Executives

Dave Crawford - Vice President Investor Relations

Robert Abernathy - Chairman and Chief Executive Officer

Steve Voskuil - Senior Vice President and Chief Financial Officer

Analysts

Rick Wise - Stifel

Lawrence Keusch - Raymond James & Associates

Jonathan Demchick - Morgan Stanley

Matthew Mishan - KeyBanc Capital Markets

Kristen Stewart - Deutsche Bank

Operator

Good morning and welcome to the Halyard Health Fourth Quarter Earnings Conference Call. All participants will be in listen-only mode. [Operator Instructions] After today’s presentation there will be an opportunity to ask questions. [Operator Instructions] Please note today's event is being recorded.

I would now like to turn the conference over to Dave Crawford, Vice President, Treasurer, Investor Relations. Please go ahead sir.

Dave Crawford

Thank you, and good morning, everyone. It is my pleasure to welcome you to the Halyard Health fourth quarter earnings conference call. With me this morning are Robert Abernathy, Chairman and CEO; and Steve Voskuil, Senior Vice President and CFO.

Robert will begin with an assessment of our fourth quarter and full-year performance against our 2016 priorities and provide an overview of our 2017 priorities and outlook. The Steve will review our results and provide additional detail on our planning assumptions for the year. We will finish with Q&A.

A presentation for today’s call is available on the Investors section of our website halyardhealth.com. As a reminder, our comments today contain forward-looking statements related to the company, our expected performance, economic conditions and our industry. No assurance can be given as to the future financial results. Actual results could differ materially from those in the forward-looking statements. For more information about forward-looking statements and the risk factors that could influence future results, please see today’s press release and our prior filings with the SEC.

Additionally, we will be referring to adjusted results and outlook; both exclude certain items described in this morning’s press release. The press release has further information on these adjustments and reconciliations to comparable GAAP financial measures.

Now, I'll turn the call over to Robert.

Robert Abernathy

Thanks, Dave and good morning, everyone. I appreciate your interest in Halyard Health. Let me start by saying 2016 was a strong year for Halyard. We delivered results ahead of our financial plan, successfully integrated our first acquisition, increased our research and development investment and generated $160 million of free cash flow. My management team and I are pleased with our accomplishments and the progress we made advancing Halyard's transformation into a leading medical devices company.

At this time last year we laid out two main priorities; deliver our plan and fuel our growth pipeline. We delivered on both counts. Fourth quarter adjusted diluted earnings per share was $0.50 and full year adjusted diluted earnings per share was $1.97 which came in, in the high end of our guidance. Our fourth quarter net sales are net sales of $410 million puts us at $1.6 billion for the year of Medical Devices and S&IP produced sales in line with or above our expectations.

Medical Devices net sales increased 15% for the second consecutive quarter and 11% for the year, strengthened by our CORPAK acquisition and solid demand across all categories. S&IP sales were down 2% for the year and declined 4% for the fourth quarter due to lower selling prices.

Looking at our growth pipeline, we successfully executed our first acquisition to augment our Medical Devices polio. We are ahead of plan with our integration and have realized synergies earlier than we expected. We will continue to pursue M&A to fuel growth. We also laid the foundation for growth by increasing our research and development spending last year to $41 million. In 2016 we launched 11 products exceeding our expectations and up from six the prior year. Finally, we generated free cash flow above our plan. Our strong cash position allows us to invest for more growth in 2017.

Now turning to our 2017 priorities, they remain consistent. We're going to deliver our plan and we're going to fuel our growth pipeline. We will maintain our momentum in Medical Devices and expect the segment to grow 7% to 9% next year. We will continue to focus on delivering our Pain Management portfolio by increasing investment in market development and the global expansion of non-opioid pain therapies.

In S&IP we expect 2017 sales to be flat to down 2%. We expect total net sales on a constant currency basis to be flat to up 2% compared to last year. We will continue to increase our investment in innovation and plan to launch more than a dozen new products in 2017. We expect these product introductions to accelerate Medical Devices growth and maintain our leading market positions in S&IP.

Finally, we will look to execute M&A to help round out our Medical Devices portfolio and enhance our performance through operational synergies. Overall we plan to deliver adjusted diluted earnings per share of $1.70 to $2 which reflects our updated commodity planning assumptions.

Now let me update you on our vision to transform Halyard into a leading medical devices company. As a reminder our transformation centers on three areas; portfolio, company and culture. Shifting our portfolio to higher margin, fast growing Medical Devices has always been the cornerstone of our strategy. Let me give you two examples of our progress to date.

First, sales of Medical Devices represented 38% of our portfolio in the fourth quarter up from 30% at the time of our separation. We have also experienced a meaningful shift in operating profit during the same period as Medical Devices generated 64% of our operating profit up from 37%. We will advance our portfolio shift through continued research and development investment, increased market adoption of non-opioid pain therapies and M&A.

The second part of transformation is company, which focuses on our cost structure, supply chain efficiencies, and tax rate. These are key areas for us to increase cash flow and enhance our bottom line. While we've made incremental progress in reducing our IT spend as a percent of sales, we have more work ahead of us. In 2017 will begin to implement steps to consolidate our IT systems. In 2016 we saw the benefit from our enhanced supply chain abilities which helped us deliver an improvement in primary working capital. We will seek further opportunities to drive efficiencies.

Our tax team remains focused on long range planning. Their efforts to date have resulted in a 2016 adjusted effective tax rate of 31.9% better than our expectations. The final area of Halyard's transformation is culture. As a standalone medical devices company, we are driving our teams to be top leaders across the healthcare landscape emphasizing value-based innovation and empowering them to make bold decisions and a customer centric environment. This is our continuing vision for Halyard.

In summary, I'm pleased with our 2016 accomplishments. We are carrying momentum into 2017 and are well positioned to continue our transformation into a leading medical devices company.

Now, I'll turn the call over to Steve who will provide more details on our 2016 performance and 2017 outlook.

Steve Voskuil

Thank you, Robert. Let me start by saying that I’m pleased that we achieved our 2016 priorities, delivered another solid quarter of earnings, and generated strong cash flow. For the quarter sales increased 2% to $410 million including CORPAK which contributed 3% of the growth. Favorable currency exchange rates benefited sales by 1%. Excluding CORPAK, volume increased 2% which was offset by 4% lower price.

Adjusted gross margin was 37% for the quarter compared to 34% a year ago. Our portfolio shift to Medical Devices bolstered by CORPAK, manufacturing savings, and favorable currency exchange rates drove our margin expansion which more than offset lower selling prices in S&IP. Adjusted operating profit and operating margin for the quarter were $40 million and 10% respectively compared to $41 million and 10% in the prior year.

During the quarter, we incurred $10 million of post-spin related charges, $3 million for acquisition-related charges, $5 million for litigation matters and $6 million in intangible amortization expense. Adjusted EBITDA was $51 million for the quarter, which was even compared to the prior year.

As Robert mentioned, we reported $0.50 adjusted diluted earnings per share for the quarter. several factors contributed to our performance. First, our adjusted effective tax rate for the quarter was 25.7% which helped drive our full-year tax rate to 31.9%, 110 basis points below the low end of our planning assumptions. While a portion of the decrease was the result of our team's continued tax planning work, we also received a one-time benefit that drove the improvement.

Second, we continued to see a favorable benefit from currency exchange rates with the Mexican peso driving most of the favorability this quarter. Finally, we saw higher volume in our S&IP business as increased demand for Exam Gloves continued. Higher than expected price loss in S&IP partially offset these benefits. Additionally, research and development and SG&A spending were higher than expected due to the timing of the projects.

Now, turning to our segment results, Medical Devices delivered another solid quarter of growth. Net sales increased 15% to $154 million driven by 4% organic growth and 10% growth from CORPAK. Medical Devices operating profit was $33 million a 57% increase from 21 million a year ago. The performance was driven by higher sales volumes which were partially offset by planned higher selling expenses as well as research and development investment to support our growth opportunities.

S&IP markets remained challenging. On a constant currently basis net sales decreased by 5% during the quarter to $252 million. Overall S&IP sales volumes were flat compared to the prior year. Volume growth at Exam Gloves was partially offset by anticipated lower volume in surgical drapes and gowns.

As we previously discussed a significant customer is beginning to transition to a GPO where Halyard is not currently on contract. Lower selling price primarily our Exam Gloves and Sterilization categories led to a 5% price loss for the quarter. This was above our expectations as we cycled a tough comparison to last year due to the timing of distributor fees and rebates.

Finally, favorable currency exchange rates added 1% of growth. For quarter S&IP operating profit was $19 million compared to $27 million in the prior year. Lower selling prices offset manufacturing cost savings and favorable currency exchange rates compared to the prior year.

Now, for a brief recap of our full-year 2016 results, sales increased 1% to $1.6 billion including CORPAK which contributed 2% of the growth. Excluding CORPAK and the expected $22 million declining corporate sales volumes increased 3% though were offset by 3% lower prices compared to the prior year. Adjusted gross margin was 36% compared to 35% a year ago. Our mix shift to Medical Devices, cost saving and favorable currency rates more than offset lower S&IP selling prices.

Adjusted operating profit was 11% which was even with the prior year. Higher gross margin was offset by higher planned research and development investment to support growth opportunities in Medical Devices. Adjusted EBITDA totaled $211 million in 2016 compared to $220 million in the prior year.

Turning to our segments, Medical Devices sales increased 11% to $567 million up from $510 million in the prior year driven by 4% organic growth across all categories and 7% growth from CORPAK. Operating profit increased 15% to $124 million from $108 million a year ago. We achieved positive operating leverage as higher sales volumes more than offset higher selling expenses and research and development investment to support growth opportunities.

Moving to S&IP, volumes increased 2% driven by continued robust demand for exam gloves. For the year volume growth was offset by 3.5% lower selling prices. Price loss continued to be concentrated in exam gloves and sterilization. Operating profit was $91 million compared to $98 million a year ago. Results were impacted by lower selling prices which were partially offset by favorable currency exchange rates and manufacturing cost savings.

Shifting to our balance sheet and cash generation, we ended the year on strong financial position with $114 million of cash on hand. Cash from operating activities less capital expenditures or free cash flow totaled $38 million for the quarter and $160 million for the year. I am pleased that we continued to generate strong free cash flow. The improvement this quarter was driven by a significant decrease in our inventories. As a result of our strong cash flow we repaid the remaining debt used to acquire CORPAK.

Let me turn now to our 2017 outlook and our key planning assumptions for the year. Building on our momentum in 2016 we expect sales of Medical Devices on a constant currency basis to increase 7% to 9% compared to 2016. This includes approximately 3% growth attributed to CORPAK and an increase in our lower margin respiratory health category as we recently won a new GPO contract.

Based on the current market conditions and excluding sales to Kimberly-Clark we expect S&IP sales on a constant currency basis to be flat to down 2% compared to the prior year. Our outlook for S&IP contemplates lower selling prices of 2% to 4%. S&IP sales to Kimberly-Clark which were $52 million in 2016 are expected to range between $40 million and $45 million. Corporate sales which were $11 million in 2016 are expected to range between $10 million and $15 million.

We expect our foreign currency translation impact to net sales of zero to negative 2% compared to the prior year. In the past month the cost of nitrile, a key commodity in our exam gloves business has increased significantly due to supply availability. Therefore we anticipate commodity inflation for the year to range between $10 million and $20 million. While there is market movement, we believe the underlying factors impacting costs will not continue long term.

As Robert mentioned, we are well on our way to doubling our research and development investment. As a result, we are increasing our 2017 investment to be between $40 million and $45 million. Our adjusted effective tax rate is expected to be in the range of 32% to 34%.

In summary, for the quarter and for the year, we delivered adjusted diluted earnings per share ahead of our guidance. We have a strong balance sheet and remain committed to investing in growth opportunities that advance our transformation into a leading medical devices company.

With that, operator we are ready to take questions.

Question-and-Answer Session

Operator

Thank you. [Operator Instructions] And today's first question comes from Rick Wise of Stifel. Please go ahead.

Rick Wise

Good morning everybody. Robert, let's start off with a question about the M&A pipeline outlook for 2017. Also you've done a great job with CORPAK, it sounds like there is more to come, as you look ahead to 2017 maybe just if you would kindly reflect on your priorities, reflect on what's in the pipeline and do you feel more optimistic, less optimistic today than you did three to six months ago about getting something additional done in 2017?

Robert Abernathy

Thanks for the question Rick. Clearly CORPAK has been a tremendous acquisition for us. It just fell right in line in terms of the strategic direction that we want with Medical Devices so that we can continue to grow Medical Devices. We were able to deliver synergies earlier than we expected and it is quite frankly delivering accretions with the EPS line at a nice strong level. So that's exactly what we want to duplicate again.

To be on strategy we need to do an acquisition every year. Our radar screen is still quite healthy in terms of the number of potential acquisition targets that are there. We continuously probably smaller acquisition targets than we had originally hoped for when we were completing this spin, we had hoped for targets that were more $100 million in revenue up to $200 million in revenue.

We're tending to see acquisition targets that are more $30 million up to about $70 million. We were concerned coming into the year that may be a lot of companies would wait until they saw tax proposals before they were ready to bring them to market, but we actually haven't seen that. We've seen pretty healthy conversations about bringing companies to market and we're optimistic that we'll be able to get an acquisition done this year.

Rick Wise

That's great. On the R&D front you've called out you would spend $40 million in 2016, now you are contemplating $40 million to $50 million. You launched 11 products, may be you know that's a significant increase. I assume 90% of that is Medical Devices, please correct me if that is not the right way to think about it, but how do we think about the contribution to sales and margins and growth, is that all, is if you will upside from I assume better price, better mix, better share, is that all down into your forecast or could we imaging that as you build momentum here is that could be upside? How do we think about it?

Robert Abernathy

This is part of strategy to continue investing in R&D to double our research and development spending over a four-year period. We've now completed two years of that ramping up and we have increased our Medical Devices spending by 50% from the time of the spin. And you are right, the majority of this extra spending is in Medical Devices, the vast majority of it.

We formed a new research area which would help the pain center of excellence. But with that spend we are also spending slightly higher on our S&IP business to make sure that we're refreshing the product lines. We've been having more and more product launches, that's an indication that the increased spending is paying dividends. We went from two product launches to six product launches, to 11 product launches and now we're signaling next year it will be a bit higher.

I have been warned to stop counting, but it will be even more product launches, more than a dozen we said in the script this morning. So far the product launches have been more line extensions or replacements of current products. So side play on the revenue line they have predominantly cannibalized some of our own products which is still important to us that we refresh the portfolio gives us better leverage in terms of price negotiations.

It also gives news in the marketplace in terms of improved products. But long term Rick what we'd like to see is more new to the industry product launches and that's why we're investing in things like our pain center of excellence. Over time we do expect there would be more revenue generated from the new product launches and we have built in revenue generation into the guidance that we're giving today relative to the 11 new products that we launched last year.

Some of those new products we're getting thus into some new categories. A line of gloves that we call BLACK-FIRE gets us into the first responder category. Another line of gloves gets us into the dental market. So there is optimism about us getting some higher revenue from some of the product launches that happened in 2016.

Rick Wise

Okay, and just last from me on the EPS guidance, in 2016 you guided to $1.50 to $1.70 to $1.97, let's say half of that was M&A and against the organic upside came from may be a little faster CORPAK, some ongoing cost-cutting et cetera. How about think through – obviously your guidance for 2017 doesn’t include M&A, but it sounds like you're really hopeful you can get something done this year. How about think to Robert some of the puts and takes in maybe getting to the upper end of the range? What's the most critical, is it less headwind than expected from the S&IP, is it something with current mean cycle, a lot of factors are at work here, how do you think to that if you would?

Robert Abernathy

Yes, I will and first let me reflect a little bit on 2016 we did beat our initial guidance b $0.42 and $0.12 of that was CORPAK and the rest really came from over delivery and volume from S&IP versus our original guidance as well as big hits from currency and commodity during the year. So it was a combination of some things that were just pleasant surprises in terms of tailwinds and other things were are lot of hard work like CORPAK and like the volume broken and S&IP.

This year looking forward what would get us to the top into the range I think there's two things to point out. Number one is if the commodity impact from nitrile doesn't hit as hard as we've currently built into the forecast that would certainly allow us to get to the top end. So we have built in the negative impact from nitrile pricing that just came through in January.

We expect that pricing to hit predominantly in the first half of the year. So we will be able to see just in the next few months whether it comes in about where we planned or maybe not quite as impactful as we have built into the plan. So that's one way we will be getting to the top end of the range.

You mentioned S&IP price, that's obviously the second big element. If we came in at that low end of that pricing range more of a 2% price loss rather than that midpoint of 3% that would allow us to get to the top into the range as well. So those are the two factors that moved a lot.

Well looking at the work on some other things we over delivered cost savings this year and we've got strong plan going into the year to generate even higher cost savings to help offset some of the commodity into the costs that are there. We've talked a lot during this last year about potentially 2016 being the trough year for us in terms of EPS and we're certainly going to do everything we can to get to the high end of this range that we've given you so that 2016 will end up being the trough year for us.

Rick Wise

Thank you very much.

Robert Abernathy

Thanks Rick.

Operator

And our next question comes from Larry Keusch from Raymond James. Please go ahead.

Robert Abernathy

Good morning Larry.

Lawrence Keusch

Good morning guys, thanks for taking the question. I guess Robert, just sort of big picture on S&IP, I just want to make sure I understand how you are seeking to optimize that portfolio and I guess I am thinking in the context of you saw negative 5% price headwind in the fourth quarter, you're looking for minus 2% to minus 4% for next year. I think you indicated you saw some soft demand in surgical drapes and gowns, are you seeing good volume in gloves? And it sounds like you are taking price there.

So just to help us think on a big picture how we should be thinking about how you are optimizing that overall portfolio?

Robert Abernathy

Yes let me just start by talking about price loss in S&IP. We didn’t really see any fundamental differences in the fourth quarter in terms of price dynamics in the marketplace than we had in the quarters before that. What we did see though was some timing on distributor fees and rebates that caused the number to be slightly higher compared to prior year. And as we analyzed that and then take that away we're quite comfortable with the price range that we got that we're guiding you to for this year of a 2% to 4% price loss in S&IP.

In terms of how we think about it, we’ve had strong growth, volume growth in Gloves. We will continued to leverage that to be able to make sure that were growing the topline, getting some volume growth in the business. We’ll continue to use the levered hold down price loss. Just a reminder, I think we’ve updated many times had about a half of the price loss is coming in, in our Glove business and potentially with slightly higher nitrile prices which is the key raw material that goes into Gloves. May be there won’t be as much price pressure in this year as we built into the plan.

The other way we think about the S&IP business is maintaining our market leading position. So doing everything we can to hold margins, drive volume and get cost savings that will help offset some of the price loss. So, that’s really how we are managing the business with very strong cost savings programs to help offset some price loss to help hold margins while we maintain our market leading positions.

Lawrence Keusch

Okay, terrific and then two other ones, I guess just thinking broadly about your tax structure, how should we think about, I’m assuming obviously the guidance is based on the current tax codes, but how are guys thinking about the fact that you do a lot of manufacturing of the blue non-woven materials here and then you know move that down to Mexico for cutting and selling and then bring it back into the U.S. does that make you a net import or net export or what’s the right way to think about it?

And Steve also just relative to free cash flow in the outlook for 2017 can you help us think about obviously 2016 was a very strong year, but help us think about cash flow from Ops for 2017 as well as CapEx spending?

Robert Abernathy

Sure, right let me just start with tax and then it’s a good news story. At the time of the spin off we had a tax rate of 38% and we’ve just completed this year with a tax rate right at 32%. So a lot of hard work by the tax team to get the tax rate down to 32%. Now we did get a benefit in the fourth quarter that was sort of a onetime benefit, that was worth about may be $0.02, 2 pennies, so that won't happen again, but it was a nice benefit for the fourth quarter to get that $0.02 of extra tax.

Going forward we are a net importer, specific to your question. Yes we manufacture the blue fabric in North America then send it across the border either to Honduras or Mexico where those products are then converted into the finished product. It is then brought back. We have about anywhere how you look at it anywhere from 20% to 40% of our COGs are produced outside the U.S. So we are a net importer.

Also as a remainder though, the way our tax structure is set up in Mexico we are a full U.S. tax payer for our manufactured products in Mexico. So that makes us slightly different than others that might be importing from Mexico and if there is any legislation that would look at duties imported from Mexico, we would certainly remind and lobby specific to the fact that we're already a full U.S. tax payer on those manufactured products.

Steve Voskuil

Yes, what I would add, I'll switch to the cash flow question is, until the legislations settle down and we get more visibility to tough to call, what the impacts are going to be, I could say we’ve got war room here with a model built, whether it is importer or adjustment scheme or something else to react to and get more clarity, but today as Robert said, how [indiscernible] are treated and what is considered a cost in market is still not fully defined.

Robert Abernathy

And but the good news story is a corporate tax rate adjustment would be a great benefit for how you heard it, if that was to come through without any offsetting adjustments cross border imports we certainly would have a nice upside benefit to us on the tax line.

Steve Voskuil

That’s right. On the cash flow question, the fantastic year in 2016. It certainly exceeded our expectations. And as we've talked about all year and especially the back half of the year when you got, we got a lot of help by working capital improvement and in particular inventories. We had talked in the past that once we got past the bolus of the TC branded inventory and the complexities of the spin that we would have some opportunity to reduce inventory. And so we’re able to take advantage of that as well as some new planning tools help manage inventory more thoughtfully.

So as we go to 2017 we’d love to see some more improvement from the working capital standpoint, but I doubt we’re going to drop $40 million, $50 million like we did this year through cash flow. So from a guidance standpoint I’d like to see for a free cash flow again to be over a $100 million for the year. I think that’s where we'd start out and then we'll get after things like working capital and cost savings and other things that contribute to that as well.

And I think we’re going to see in 2017 CapEx returned to a little bit more normal level like 2% to 3% of sales were it was fairly light on CapEx in 2016.

Lawrence Keusch

Okay, terrific. Thanks guys.

Robert Abernathy

Thanks Larry.

Operator

And our next question comes from Jonathan Demchick of Morgan Stanley. Please go ahead.

Jonathan Demchick

Hello, thanks for taking the questions.

Robert Abernathy

Hi Jon.

Jonathan Demchick

Robert I wanted to start off with a question on guidance and I guess specifically on margins. So I mean you mentioned we kind of talked about with earlier in the call, but 2016 there is a lot of upside. The original earnings guidance number even adjusted for the CORPAK deal this year it looks basically at similar levels of upside are going to be a little more challenging with, I guess pricing and commodity headwinds.

And I guess [indiscernible] this could be roughly a 2-point headwind to margins. So, two questions, first does the math on headwinds from pricing commodities sound about right? And second, are there enough offsets to hold margins flat year-over-year even as you continued to invest in the device business.

Robert Abernathy

Yes, on the margin front we were very pleased with what we are able to accomplish in 2016, margins, gross margins are up 190 basis points and that came from a number of areas, cost savings be a big part of that CORPAK of course. That's benefits from currency as well as some volume gains with mix shift to Medical Devices. So as we go into 2017, I’d say our challenge is to hold that margin level where we are and not allow it to go down. In order to do that, we’ve got offset the higher commodity input cost.

So it's going to be back to service some more thing to what we had in 2016, strong cost savings to help offset part of that continuing to see that mix shift and getting the full year of CORPAK benefit. So, those things are the levers that we’ll have available to us to offset any of the commodity headwind that we’ve had to be able to roughly hold those margins flat year-on-year.

Jonathan Demchick

Thanks and I had a quick follow up on the device franchise and I guess organically it looks like you are expecting about 4% to 6% which is encouraging and looks to expected to basically stability from this past year even acceleration and as I think about the acceleration, obviously part of that seems to be related to the new GPO contract in respiratory that you mentioned. So can you help us quantify how large of an impact that is and then what you’re assuming your broader sort of pain franchises and how they are going to contribute relative to the last year?

Steve Voskuil

Yes, we typically don’t give a size of an individual contract, but think of it more in kind of the $10 million to $15 million in sales range for that particular contract. So that's what's delivering about, over a two-year period sorry. Dave just told me, over two-year period that’s what the sales would be delivered. So it counts for most of that sort of 1% extra growth in the category. So instead of 3 to 5 think of it as just as you said Jonathan 4 to 6 and it is slightly lower margins, so factor that into your models as well.

But underlying that, we’re really pleased that our surgical pain business, ON-Q business it returned growth this last year. We’re expecting good growth next year. We’re expecting continued strong double-digit growth in our COOLIEF interventional pain business and we're expecting nice continued growth from CORPAK and our digested health business and then just strong continued growth low signal digit growth in our respiratory care. So the fundamentals of the business are still right on play and right on strategy and then layering on that new contract is certainly a benefit for us.

Jonathan Demchick

Understood, thank you very much.

Steve Voskuil

Thank you.

Operator

[Operator Instructions] Today’s next question comes from Matthew Mishan of KeyBanc. Please go ahead.

Matthew Mishan

Hey, good morning and thank you for taking the questions.

Robert Abernathy

Hi, Matt.

Matthew Mishan

Could you kind of give us a little bit more color on the commodity inflation? I think you mentioned that there is a shortage, what’s causing the shortage? One, is expected to elevate? And then also, I think the last couple of quarters you mentioned the FX benefit of the peso was an offset to commodities, is that going to be the case in 2017 as well?

Robert Abernathy

Yes, let me start with the commodity increase. The base material for the Gloves, the nitrile gloves is butadiene and acrylonitrile and those have gone up predominately because those same materials are used in our mobile parts manufacturing, specifically tyres in China. So some of the base material have swing away from natural rubber latex and has swing into making automobile tyres for China.

There has also been some manufacturing downs for the yearly maintenance that have occurred, so despite that we're seeing is really going to be in the first quarter of this year and then may be end of the second quarter. So, that’s why I say I think the entire hit will happen in the first half of the year. The forecast coming out for the second half of the year really pulled the prices down to what we have been experiencing over the last couple of years. So that’s why in our tax we talked about returning to serve more normal levels.

In terms of long term prospects there is really nothing that’s out of balance in terms of the supply-demand ratio in this business that just we think it’s a couple of months to spike in the particular cost of butadiene and the input cost for the nitrile for the Glove business.

Steve Voskuil

And just with respect to the peso I think as we started the year and have the plan I think we expected that currency benefit to help offset most of the commodity impact as Robert said this most recent update on the nitrile. The front will make that more challenging now.

Matthew Mishan

Okay, perfect. And then if I’m not mistaken the consolidation of IT was, is a big piece of the synergies you had talked about when you there post spin. Could you kind of quantify the savings and what you’ve said in the past on what could potentially be the benefit of bringing that up to scale?

Robert Abernathy

Yes, we’ve talked in the past about potentially a couple of 100 basis points of margin improvement coming from the consolidation of IT. When we first spun off we were 6% of sales was our IT cost. After getting becoming independent from Kimberly-Clark we got that down a bit, but we still got a ways to go to get down to 3% of sales. So, there is a couple of 100 basis points of cost savings left to be delivered in the IT area and its really does come from consolidation of systems and then all the benefits that can come from that you know just better utilization of the systems across our businesses.

Steve Voskuil

Yes, lot of focus in that area we talked I think on the last earnings call doing some consulting pre work, in the last the fourth quarter getting ready for the next step. And as you imagine, it is something you want to manage the disruption and the transition very carefully and so we’ve got some data harmonization and another pre work that we will need to complete before we kind go full speed ahead with the actual system transition but as Robert said that remains very high priority because of the leverage it can bring to the P&L.

Matthew Mishan

Yes, perfect and on the [indiscernible] was to be moving closure to a nerve block indication and how confident are you that versus 2014 when they did, they were able to impact yourself, how confident are you that if they did get the nerve block indication that it wouldn’t impact you know overall med device growth?

Robert Abernathy

Well certainly if they got the indication that would be a competitive issue that we'd have to overcome. We’ve got a strong position there. We’ve been following closely there are comments about getting the indication, but we feel strongly that our product categories, particularly search for painful categories with the [indiscernible] pump business, ON-Q business and its return to grow.

We think it's more about penetration of the category in our key businesses on ON-Q that we're still less than 10% of the surgeries that we believe should be using our products. So it's really less about market shared gain versus competition as more about growing the total category against opioids in our product pain medications.

Matthew Mishan

Okay and then last question just on the percentage of GPO contracts that you’ve now renegotiated at a lower price. I mean what, how many like what percentage you still have that’s going less to go there.

Robert Abernathy

Yes, we’ve completed over 80% now because of the largest contract the busiest contract we’ve talked about that. That’s now been negotiated. It goes into effect on April 1. We were pleased with the outcome of that contract as we’ve signalled a number of times. So with that, when complete we’re at over 80% of the contracts that now have been negotiated at the lower input cost. So, that tale has left to complete for that rest of this year. And then as reminder, Glove contracts come up all the time, so that net sale presents 50% of our price loss, but the main GPO contracts were into the last stretch here.

Matthew Mishan

All right, thank you very much.

Robert Abernathy

Thank you.

Operator

And our next question comes from Kristen Stewart of Deutsche Bank. Please go ahead.

Kristen Stewart

Hey, guys good morning.

Robert Abernathy

Good morning, Kristen.

Kristen Stewart

I was just curious if – just go through just the - I guess spread in terms of the guidance. If I look at the guidance for this year it’s a $1.70 to $2 and last year the least beginning was $1.45 to $1.65 so clearly you guys have surpassed that. But I was wondering what’s the reason behind the $0.30 prior is it just lack in, I guess confidence of prices or is interest made itself a little bit more room in terms of the commodity costs or I guess why is it still a little bit more widespread this year relative to last year?

Robert Abernathy

Now it is a good question because we did spread it out this year. We for the last two years we’ve had $0.20 spread and we like that $0.20 spread, but we got the higher nitrile price right at the time, but we’re reporting this guidance together and the numbers were pretty, the range of numbers was big and we said well, let’s take into account of the full range if it goes in our favour we could hit that top into the range and then 2016 would be the trough year and we’d be able to grow earnings year-on-year.

And if it swung as I said the first half of the year most of the impact of the higher nitrile prices there, if that was to continue longer in the year then we built in the lower into the range it would be if it stayed higher for more of the full year rather than just part of the year. But you are right, we went through a wider range entirely because of the nitrile price, no other reason.

Kristen Stewart

Okay and then just thinking about I guess the GPO contract that has gone off has the amount of business that you have been able to retain been and in line with your expectations on the SI&P side?

Robert Abernathy

Yes, it has. We don’t see a lot of change in business particularly in surgical drapes and gowns. We see more churn in other businesses like Gloves, but yes, we have been to retain the business, are quite pleased with our overall maintaining market leadership positions and haven’t seen specific loss other than what we accounted for from the post 60 minutes report, loss of about $2 million there and then from the change of the GPO contract that we signalled last year that happened through the fourth quarter and is now under way. But we’re right on target of what we had modelled to lose in those areas.

Kristen Stewart

Okay, then last question just in terms of having all these, but I guess 80% of the contracts renegotiated the lower input cost, is nitrile the main input that we should be looking to I guess in terms of in price or cots going up as a main concern in terms of margin compression for you guys or there other things that we should take us now that all these contracts are renegotiated at lower prices?

Robert Abernathy

So there are two big input costs that we have are polymer which is polyethylene, polypropylene as well as nitrile. We’re actually getting a slight improvement in price on the polymer for the year and then nitrile is the only one that is really moving negatively.

Steve Voskuil

The only thing I’d is in the last two forecasts we, although polymers have benefited we’ve seen it move up in the forecast a little bit and I'd say probably as you've seen oil pick up a little bit as well, but for us right now as Robert said, nitrile is the big mover.

Robert Abernathy

Right, but we will get a benefit on polymer year-on-year and slight benefit so that’s good news.

Kristen Stewart

Okay, great. Thanks a lot guys.

Robert Abernathy

Thanks, Kristen.

Operator

[Operator Instructions] And our next question is a follow from Kristen Stewart of Deutsche Bank. Please go ahead.

Kristen Stewart

I’m back. Just one last one, how much is CORPAK accretion in 2017 because I know you guys over achieved in 2016 and I’m just wondering if that number has changed for 2017?

Robert Abernathy

No, it’s a good news story. We had originally said that we would expect $0.05 of earnings in 2016, we end up delivering $0.12 and now we are modelling $0.20 for the full year 2017.

Kristen Stewart

Okay, that’s incremental over 2016?

Robert Abernathy

No, no, it would be at $0.08 incremental. So we’re delivered $0.12 now this year full year we will deliver $0.20.

Kristen Stewart

Okay, perfect, all right. Thanks very much. That’s it from me.

Operator

That concludes the question and answer session. I’d like to turn the conference back over Mr. Robert Abernathy for any closing remarks.

Robert Abernathy

Well, thank you again for your interest in Halyard Health. As you can probably tell, we're optimistic about 2017. Thanks everyone.

Operator

Thank you, sir. Today’s conference has now concluded and we thank you all for attending today’s presentation. You may now disconnect your lines and have a wonderful day.

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