Enovis Corporation (ENOV) Earnings Call Transcript & Summary

Good afternoon, everyone. Welcome to Virtual Laguna. I'm Joshua Pokrzywinski, the firm's U.S. electrical equipment and multi-industry analyst. Here with me this afternoon is Chris Hix, EVP and CFO of Colfax. Chris, thanks for joining us this afternoon. Understand you have a few slides and opening remarks you'd like to make. Before I hand it off to you, though, I do need to read just a quick disclaimer before we get started. Please note that this webcast is for Morgan Stanley's clients and appropriate Morgan Stanley employees only. This webcast is not for members of the press. If you are a member of the press, please disconnect and reach out separately. For important disclosures, please see the Morgan Stanley research disclosure website at morganstanley.com/researchdisclosures. If you have any questions, please reach out to your Morgan Stanley sales representative. With that, Chris, welcome. Appreciate you taking the time here. Hope you are safe and healthy and mentally well-adjusted to what 2020 has to offer. Why don't you just take it away on some of the prepared remarks and refer folks to the slide deck posted on the IR website?

Okay. Very good. Well, Josh, first off, thank you, and thanks, Morgan Stanley, for having us at the conference here. Look forward to doing it when we can see the ocean again and see the surfers down there all day long. But -- and thanks to investors for your interest in Colfax. We do have some slides to accompany some brief remarks for those of you who are a little bit less familiar with our company or just wish to get grounded before we jump into Q&A. So if you have the slides in front, if you go to Slide 3, it's really just an overview slide that talks about who we are as a company. Most people know that we were founded by Mitch and Steve Rales back in the 1990s, with the idea of having a multi-platform company with a compounder strategy. And you compound 2 ways -- compound value 2 ways. One is by just continuously improving your businesses every day and not necessarily in heroic ways, but just it's the benefit of doing that longer term. And the second is deploying your capital for acquisitions that make your businesses bigger and stronger. And so by executing that right, it's a strategy that many companies have used to drive incredible value. If you go to the next slide, that's Slide 4, I think most people by now are aware of the change in the portfolio that we've executed over the last few years. Many of us are -- I've been with the company now for 4 or 5 years that represented a change in the leadership of the company. And when we came on board, we took a fresh strategic look at Colfax and realized that it's easier to compound value if you're a less cyclical company. It doesn't mean that the business system and the approach doesn't work. It does work, but it's easier to sustain if you're in less cyclical businesses. As a result of that, we sold off the original part of the company, the Fluid Handling business. And then we ultimately sold off the Air & Gas Handling business. So we exited our 2 deeply cyclical capital goods companies and instead invested in a medical business, an orthopedic business, DJO. So as we sit here today, we've got the industrial business, fabrication technology. That still is cyclical, but shorter and shallower cycles, it being a short-cycle business, with the ability to produce great cash flow throughout a cycle. And you've got DJO, the orthopedic business, on the medical side. And the 2 of those businesses, we believe, are both capable of being $3 billion in revenue. ESAB, the primary brand of our FabTech business, is obviously closer to that. So you'll see us investing a lot more in the MedTech side, which last year had revenue of closer to $1.3 billion and with lots of opportunity for investment. If you go to the next slide, really, this is just a way of saying we've created a portfolio that is, COVID aside, more predictable with better performance characteristics. We've got better margins, better growth, better cash flow production. It's -- we now have these 2 conveyor belts of cash flow, which is really terrific, speaking not just as a CFO, but speaking as a -- from -- on behalf of the company that deploys its cash flow to build up its business platforms as part of the compounder strategy, lots of opportunities for investment. On Slide 6, this is just a brief introduction to our FabTech business. And I think the real message here is that we took a business that was significantly underperforming that was acquired in 2012, and we've built the innovation engine. We've improved the operating tempo in the business. We've built a terrific team of leaders around the world. And now we're really the only truly global welding and cutting business out there. We've been able to improve the margin significantly, improve the cash flow characteristics. And now we're arguably the best innovator in the industry last year with over 80 new products. So it's really that road map that we have in our mind a little bit as we acquired DJO, which is on Slide 7, an idea of a business that has a terrific presence with the market and had been embedded in private equity ownership for perhaps a little longer than it needed to be. And so we recognized the opportunity was to improve the operating tempo of the business and capabilities, be able then to serve customers better to regain the sort of natural entitlement to a market share and then to extend that with new products and innovation for even more competitive advantage and growth. And so a similar road map to what we did with our FabTech business, as we think we can apply to the MedTech business. And heading into COVID, we had taken a business that was underperforming and turned it around to where it was meeting market -- achieving at market levels or outperforming in every case. And we had the margins on an improving track and a good view of cash flow. And that's all waiting for us as we get through the other side of the pandemic. Slide 8 is an overview of the financial performance highlights. I think the material point here is that we got through the depths of COVID in April. We thought we'd see sequentially improving performance each month thereafter and then each quarter, and that's exactly how the second quarter played out. And we gave guidance for Q3 that suggested an improving sequential performance in Q3 as well. And along the way, we kept the business healthy, kept the cash flow positive even at the depths of COVID. And most importantly, we worked hard to keep our associates safe as well. And there's nothing that we've sacrificed for the future growth of the business. And frankly, nothing that structurally changed in our businesses as a result of COVID. Slide 9. We're close to wrapping up. But on Slide 9, this is a recovery scenario that we had been laying out for investors really since the Q1 call in early May. And this has largely held intact. And we focused on, again, the long-term drivers of the business not being disrupted by COVID. We knew that the Q2 would be a rough ride, and we knew that we'd see sequential improvement from that point on for different reasons. In the DJO business, the -- our MedTech platform, it's really driven by 2 key dynamics on the preventative and rehabilitative side. It's driven by return to general activity level, people being out in the world again and being active as well as organized sports and the follow-on effect from surgeries or the reconstructive part of the business. The reconstructive part is driven more by disease. And so that demand is always there. And it was initially impacted by policy decisions to limit access to elective surgeries. And that is -- that's all been largely restored. And now you see the industry working through the backlog of demand, which is benefiting the revenue levels in the business. On the FabTech side, the view is for a stronger economic performance in the developing parts of the world versus developed. Since we've got the only truly global platform, we're benefited by the demand -- the higher demand levels outside the United States and Europe. And we expect to see continued outperformance versus our peers given the better positioning that we have and, to some degree, also operating execution and innovation. But we do expect that the recovery will play out a little bit longer being less policy driven and somewhat more economically driven. And so just to wrap up on Slide 10. Look, the business that we had going into COVID, the outperformance versus peers, the clear line of sight to good cash flow production, good margin performance, healthy growth, good acquisition opportunities, all that's still there waiting for us as we -- as COVID abates. And every day, we get closer to resuming the momentum that we had there. We do have an M&A team that -- an effort that took a little bit of a break for the first couple of months of COVID but is now reengaged. And we think there's plenty of opportunity there that you'll hear us talk more about as we build these $2 billion to $3 billion platforms and continue to drive excellent financial performance. So with that, Josh, I'm going to open it up for questions.

Perfect. Chris, appreciate that, and I'll keep an eye on the queue here from investors coming in. But I'll start it off. Maybe just give us a bit of an update on what you're seeing out there in more the traditional industrial markets, obviously, going to be more on the FabTech side of the portfolio. I think we've seen some of these industrial niches start to feel a bit more normal, not maybe back to 2019 levels. But we're building some momentum. People are going back to work and to the extent that most of what you do would be more kind of production-related than big heavy CapEx. Maybe some comments on how trends have progressed there and any observation how inventory might play a role in that as well.

Right. So for us, if you look at the depths of the downturn from COVID back in April, with the business -- industrial business was down about 28%. And then May had a little bit of a small recovery, and then June was even better from there, I think, down 20%. And so we gave guidance for Q3 that said that we'd be down kind of high single digits to mid-teens. And I think we gave some initial information about July being consistent with our view to drive that sort of level of performance. What was embedded in that was a belief that the developing parts of the world would recover a little bit more quickly. The disruption that we saw in Q2 oftentimes was more policy driven. For example, we had several countries that ordered all the businesses to be shut down for some period of time. I would contrast that with North America and Europe, where we expected to have the recovery lag the developing parts of the world, just given the -- some of the unique drivers in those markets, whether they were automotive or oil and gas or other drivers. So that's the picture that we painted going in, would be sequential improvement as we go from Q2 into Q3 and likely into Q4, as you do see the world returning to healthier levels. But we didn't make a call that you'd see a full-blown return to growth. Now we do think there's a lot of positive indicators that are out there. But generally, the industrial recessions take a little bit longer to correct. And then with respect to inventory, our industrial business is short cycle. It has a pretty lean distribution network, and our customers have learned to be lean as well. So generally, we don't have a big inventory buffer that can cause a lot of disruption at the front end of a change in the cycle or during the recovery phase.

Got it. And I guess maybe just one more on the industrial side of the house before we pivot to DJO. I think the notion that you're going to see more kind of regionalized manufacturing activity, near-shoring or whatever you want to call it, reexamination of supply chain, certainly seems to be getting a lot of discussion momentum. Tell me how Colfax would win in that scenario. Or how do you think you'd be positioned for kind of a bigger return to activity in, we'll call it North America, not just the U.S.?

So for us, Josh, I know you know this, our FabTech business is very much a regional business, where we are making much of the product in the regions in which we're selling. And the result of that is that you're not dragging a lot of heavy materials around the world, which is inefficient and costly. So to a large degree, the -- a change in politics or tariffs or a view of onshoring or offshoring is less likely to have a material impact on our Fabrication Technology business. Having said that, we're always examining our supply chain in a continuous improvement light, which causes us to think about how we consolidate our footprint, where is the best place for us to produce a product because you can't make everything everywhere and then just to drive further efficiencies. But we don't expect that the current onshoring has a big driver on our, let's say, the way we do business. Now it may have an impact on customers, which I think is the nature of your question, which is if there's more onshoring that happens, let's say, in North America, that could drive more demand in North America. Now as a globally positioned business and really, the only ones in the industry that have the sort of footprint that we have being everywhere, we would expect that we would be less disrupted by that. So we'd have to see how that would play out for us specifically.

Got it. And then just turning over to the DJO side. I guess how have electric procedures been trending? You mentioned a backlog that needed to get worked down in the second half. I think a lot of the industrial folks who are listening are probably less tuned into some of those health care trends. But yes, how has that been working? And where do we stand on that backlog reduction?

Yes. So for the most part, the -- so for us, elective -- let me back up here. So the business has the 2 pieces, the preventative and rehabilitation. And maybe about 1/4 of that roughly is tethered to surgical outcomes or surgical procedures. The reconstructive part is almost entirely tied to that. And so it's that part of the business, the reconstructive part, where the elective surgery slowdown was felt most acutely. And -- but also, the recovery has been very rapid. So at this -- and that business is largely for us in the U.S. The other part of the business, we have a pretty good presence throughout Europe and some other countries. In the United States, elective surgeries have been largely switched on completely and have been for a little while. And so now you do have this working down a backlog that's happening. We call these elective surgeries, but these aren't faceless. These are people living with chronic pain and immobility, and they need these surgeries to get back to life and to lead a healthy and productive life. And so there's a big demand for that. The backlog is getting worked down. On the other hand, there's still a reluctance among a small minority of the population to reenter the health care system. And so it's really those 2 countervailing forces that are at work here as we're going through the third quarter with some improvement in sales for us coming from the demand -- the backlog work down, on the other hand, not necessarily seeing the full return of patients into the system yet. And I think -- I suspect we'll be talking more about that as we reflect on the third quarter and talk about the fourth quarter. But largely, this part of the business -- you'll recall, in general, we said MedTech would be flat to down mid-single digits in the third quarter. So that suggests a pretty healthy and rapid recovery that we'd expect to see this quarter and then carry that momentum into Q4 and beyond.

Got it. So that reduction or conversion of that backlog is kind of consistent with the way you guys had thought about it.

Yes. We understood that, that dynamic would be very much in play in the third quarter.

Got it. And then I guess the bigger chunk of DJO about -- around rehabilitation prevention, just given that recreation activity, organized sports are still a little depressed, how has that kind of trended versus your thought? And do we need every gym to be open and every little league team to be out on the field for this business to get back to normal? Or is that kind of working its way back to normal as well?

Well, certainly, that part of the business, again, the preventative and rehabilitative part of the business versus the reconstructive or surgical base, that part of the business is very much tethered to general activity levels in the population, organized sports, to a lesser degree, employment levels. And if any of that is lagging, then I would argue that we're not quite back to normal. Now having said that, we've got this fast-growing reconstructive business, which in combination with the preventive and rehabilitative, which maybe is not hitting on all cylinders for market demand, you put those together and it still gives us the ability to talk about flat to down, only mid-single digits in the third quarter. So all of that was part of our thinking as we went into the third quarter and gave our guidance. We didn't expect to see everything returning to normal in the fall with fall sports and -- at the high school, junior high, college level, et cetera. We knew it would be a little bit choppy, and we're all sort of watching how this thing plays out together. But the business is well positioned, especially relative to most, as you think about most industrial businesses, which are struggling to find growth. And this is a business that's pretty rapidly getting back toward previous demand levels.

Right. I guess taking a step back on kind of the broader refresh and the change in ownership on DJO. What do customers like or dislike as that business has evolved and come together over the last 5 years as a portfolio? And what do you see as kind of the biggest changes that have been made under Colfax' ownership that have been big wins or still remain kind of areas of opportunity?

So here's what attracted us, as we did our strategic review back in 2017 and identified some really good vectors, noncyclical businesses that we could sort of build a new portfolio around, and this was one of them. It wasn't the only one, but it was one of them. And we did a lot of work on it. And what we found was a fundamentally sound business with a really strong brand in the marketplace and pockets of really good innovation. And as we dug in during our diligence, I think we pretty quickly zeroed in on the fact that the operational tempo in the business was far less than what it needed to be. We heard that from customers. We saw it with our own eyes during visits. And we recognize that, that would be a really good opportunity to get after quickly because then it gives you quicker access to your natural share of the customer's wallet, let's say. So that was an area of opportunity. We also recognized longer-term that the business had done a really good job investing in innovation on the reconstructive part. But on the rehabilitative and preventative, that, that had lagged a bit. Now it had gotten restarted under the current -- the business leaders, the CEO's leadership, but we knew that it would take more investment really in process first. Now other people think you just put money in and all that, but it's really about building a solid process. And then you can incrementally invest to drive better outcomes, just as we've done in the Fabrication Technology business. So to bring it all home, we invested a lot on the operational side in 2019. We got the business back to a healthier place much quicker than I think most investors thought we would. And now what we want to do is make sure that we sustain the improvements we've made. We battle our way through COVID, which obviously has some friction associated with it from an operational standpoint, and then we can -- then we just get continuously better from there and then work more and more every day on the innovation side of the house, while we start to bring in some nice bolt-on acquisitions. So we think that there's a difference in vision. We think that's where CBS matters, bringing a business system, a process orientation, a discipline to the business that, frankly, I think the leadership team and the associates of DJO responded very well to.