Enovis Corporation (ENOV) Earnings Call Transcript & Summary

And I think we're on. So good morning, everybody. Thanks for joining us. My name is Matt Miksic. I'm medical device analyst here at Crédit Suisse. We're very pleased to have with us this year at our Crédit Suisse Virtual Healthcare Conference, Colfax. We've known for some time in its prior form as DJO and all the businesses under it. So very pleased to have the team here to give us an update, with Matt Trerotola, President and CEO; Mike Macek, VP of Finance. I'm going to turn it over to Matt to give a 10- or 15-minute introduction and overview, and then we'll get into some Q&A. So with that, Matt, take it away.

Great. Thanks a lot, Matt. I appreciate it. It's great to be here virtually with everybody. I've got a handful of pages to tee up our company, and then we'll take questions. I'm going to -- I'm the CEO of Colfax. I'm going to skip through the disclaimer page, let you read that at your leisure, and start on Page 3, introducing our company. We were founded by Mitch and Steve Rales about a decade or so after they founded the enormously successful Danaher Company. I have spent part of my career at that company. We're a multi-platform business. I'll talk about the platforms in a minute. On this page, I want to talk a little bit about our strategy. We focus on really acquiring good businesses and making them great over time. We focus on working with our businesses really in 3 ways to drive value creation. The first is with our CBS lean business system and driving continuous improvement journey in the businesses, initially in the supply chain, but over time in all parts of the business. The second thing is working with our businesses on having winning strategies and fueling them through innovation and acquisitions to build great leading positions over time. And the third is a focus on talent and making sure we've got great talent in our businesses and great talent in our lean corporate center that supports the business. And over time, we do focus through our acquisitions on improving the quality of our portfolio, often in incremental steps. But as you'll see in the next page, in the last 2 years, we've been through a pretty significant transformation in our portfolio. You can see on this page that, in the past few years, we acquired DJO Global, and that was an acquisition into the med tech space, a space that we saw having great opportunity to apply our compounding value creation strategy over time. We acquired this leading position in DJO in orthopedic solutions, and we divested a couple of businesses that we had driven nice improvements in over time, but they had a pretty significant amount of cyclicality and volatility. And so we invested them as part of how we funded our acquisition into the med tech space. And so here in 2020, we've got 2 very strong global platforms, in MedTech and FabTech. And both of these have great opportunities for improvement, organic growth and inorganic growth over time. And we've stated our intention to disproportionately invest in the MedTech platform. And an initial step of that we talked about recently with the acquisition that we'll be making to step into the foot and ankle space with the acquisition of the STAR business from Stryker. These businesses have mostly recurring revenue, strong opportunity for cash flow conversion over time. And our gross margins, as we acquired the DJO business, which is well into the 50s, and divested businesses in the low 30s, we significantly shaped our gross margins up in this platform as well. Next page. This page introduces our FabTech business. This is a global leader in welding and cutting solutions. This is the business we bought back in 2012, and the journey we've taken the business on really demonstrates the power of the strategy that I talked about and our business system and our corporate capabilities. Over that time, we've built this business into a clear and strong global leader. You can see on this page the last 4, 5 years, some of the significant improvements, big improvements in the margins and cash flow of the business by driving continuous improvement through lean, by driving restructuring efforts, by driving continuous innovation in the business and by adding selective attractive acquisitions that strengthen and expanded the business. So some great improvement over time in this business. It's been continuously outperforming the growth of other leaders in the business for the past few years as we've seen the fruits of all the innovation and strategic improvements we've driven in the business. And continues to have great opportunities. This business had great momentum as we came into COVID, and we're confident we can come out the other side with great momentum and with the opportunity to keep expanding the margins of the business and keep driving strong growth outperformance. And this industry has got exposure to long-term growth drivers of industrial build-out, but also has some specific growth drivers related to automation and digital solutions. There's a shortage of skilled welders. There's a need to drive more labor productivity in manufacturing businesses. And this drives extra growth in automation, robotics. And an emerging growth wave there is around digital solutions in this industry as well. On the next page, we talk about our MedTech business. So we acquired DJO, a leading innovator across the orthopedic continuum of care. DJO has got a strong leading position in the $4 billion bracing and rehab business with its DonJoy products and Chattanooga products, Aircast products, leading brands, strong technologies, fantastic position in the clinical channel, really kind of be in the way that workflow is done in that channel. And then the other part of DJO is the other about 1/3 of DJO is in reconstructive, a very fast growing, attractive position in the very large $17 billion to $20 billion surgical implants business. We've got a leading position in shoulder, which is a very attractive segment there, and then a very strong -- a small but fast-growing position in hip and knee implants. So we bought the business in early '19, and we're able to continue the strong growth in reconstructive. We're able to strengthen the supply chain and the innovation engine in the prevention and rehabilitation part of that business And get the business back on kind of that mid-single-digit growth trajectory that we knew it was capable of and that we talked about. And so as we entered this year, I think we had some good momentum building in this business. We've got great opportunity over time here to build out a large and attractive MedTech business off of this start with DJO that can grow at mid-single digits and even try to push to shape that to the positive side of mid-single digits over time. And we see continuous improvement of margins possible. This is a business we're going to need to invest over time, but we also are confident that over time we can drive improvements in the margins as well through our business system and through the kind of innovation and improvements that we'll drive here. Next page. So this may give you a little bit of feel for how we've been navigating through 2020. We entered the year with some great momentum from how we exited 2019 and with a clear plan to drive strong growth here in 2020, drive improvements in our margins and to demonstrate strong cash flow conversion in this portfolio and use that to help to fuel additional growth. We clearly had a mid-March interruption from the COVID pandemic, and we've had to really focus on that. Since then, in terms of making sure we're keeping our associates safe and healthy, making sure we're keeping our customers supplied, but at the same time, we have continued to do the right things to make sure that we can pick up on the other side of COVID with even more momentum than we came in. So we've been continuing to drive the innovation engines of the businesses, the strategies of the businesses and continuing to drive improvement and restructuring efforts that position us to pick up with strong momentum on the other side and to driving the kind of cash flow improvements and EBITDA improvement that helped to bring our leverage down. You can see, in Q3, we had a dramatic recovery from the difficult Q2 that COVID created and got most of the way back, and then we expect to have an incremental improvement here in Q4 and have good line of sight on a good strong 2021. One of the things on the page is the free cash flow. As I talked about, these businesses have great cash conversion capability. And as we work through the balance of this year, we think that's going to be very clear. We showed some good cash flow in Q3, and we've shared what we expect to be able to do in Q4 that starts to really demonstrate the kind of cash these businesses can generate. Next page. This page talks a little bit about some of the growth drivers in our businesses and how we've been navigating through the COVID market changes and where we see things going from here. On MedTech, this is a business that, as I said, has long-term steady growth drivers from aging population, diseases like OA and diabetes, people being more active and doing the kinds of things that can lead to injuries. And globally, more access to health care, so we acquired this business because we see the long, steady growth drivers, noncyclical growth drivers. Certainly, COVID was a unique shock to this in Q2. The shutdown in elective surgery had significant impact in this business, and some of the other drivers of growth were curtailed for a little bit. But we saw a very strong recovery here in Q3 as elective surgery got close to back to pre-COVID levels and many of the activities have resumed over time. And as we shared, we actually had a little bit of positive growth year-over-year in our MedTech business. This had a little bit of help from some PPE sales that we don't expect to recur. So as we shared, our underlying growth was just a little bit negative in the third quarter. And we expect that to stabilize and to be somewhere between flat and a little bit negative here in the fourth quarter based on some of the recent infection flares and things around COVID. But at the same time, we're confident that there's the opportunity for steady improvement. And especially some of the news recently certainly would support what we've said that we expect this business to get back to healthy growth versus '19 in 2021. Our FabTech business is driven by a diversified set of industrial applications around the world. About half of this business is in the higher-growth emerging markets that are expected to outgrow the developed markets over time. And we're already seeing that this year in the COVID recovery those markets have already returned to growth here in Q3, and we expect that to continue. And I talked about the productivity solution opportunity in welding and cutting as well. Certainly, this business was also impacted pretty significantly in Q2, but had a strong recovery in Q3 as most regions and countries have shown economic improvement as we've moved through Q3 and even into Q4. Our developing regions turned to growth in Q3. Most of those countries growing in Q3. And overall, our developing regions grew in Q3. And as we've shared, September, October were stronger than the previous 2 months, which is a trend that suggests a little bit of improvement in Q4 versus Q3. But at the same time, we're cautious about the short term and realize that there could be a little bit of pressure that could keep us flat in Q4 based on some of the case trends. But also, obviously, some of the more positive news would suggest that this ramp back to '21 demand levels at some point in 2019 is very credible in terms of the kind of improvements we've seen so far and how those can continue as we move into '21. And this business is very well positioned for the return to growth. Next page. So this last page just talks a little bit about our current priorities and where we see things going from here for our company. We've got a really great future for our company. Certainly, the current priorities, we've got to make our way through the rest of this pandemic, keep our associates safe, support our customers, continue to execute on our strategies and build the pipeline of innovation and acquisitions that we'll be bringing through as markets recover. As we look forward, we've got this great opportunity to build out a MedTech platform initially in orthopedic solutions, a lot of runway for organic and inorganic growth there and certainly other possibilities for where we could go in the MedTech space over time. We've got the opportunity to continuously improve the margins of our businesses, demonstrate strong cash conversion and improve that over time. And we've got a really healthy funnel of bolt-on and adjacent acquisition opportunities that we're going to be driving through to strengthen and expand our businesses, particularly our MedTech business. So we see great opportunities going forward to drive compounding growth in our portfolio with our proven strategic capabilities and business system. Thank you.

Thank you. So maybe a couple of things to start. I think a lot of folks may know DJO more as a kind of more of a sports medicine-oriented business, in part because of bracing and in part because, I think, of your history of how the implants have been in with the rest of your business. I guess, maybe if you could talk a little bit about the parts of your implant and orthopedics business that are sort of working and really driving the growth in that segment, and then maybe we can talk a little bit about how the Stryker assets sort of fit into that distribution and call point sort of platform.

Yes, sure. Thanks. So one of the things, Matt, that excite us about this business is that part of the business within the reconstructive part of the business, is a very strong, very fast-growing surgical implants business that we believe has plenty of runway for growth on a go-forward basis. That's a very large market space. And it's got good, sound fundamental growth drivers and opportunity to drive share, gaining growth over time through innovation and commercial processes. And so that business is -- we participate in shoulder, hip and knee implants today, but a good portion of the business is a leading position in shoulder, which that extremities part of the surgical implants world is the most attractive part. And shoulder is a couple of billion dollar global market that has mid- to high single-digit growth. And we've got a strong position there. And in particular, our leading position in North America in reverse shoulder, which is the area that has been growing faster even than traditional products there. And so our shoulder business is a leading franchise that we see opportunity to keep bringing innovation and growth over time. We've got great KOLs there. Great products. Some additional products to keep developing. And also very, very strong position to continue the above-market growth in a strong growth shoulder market. And then in hip and knee, we've got small positions where we've been an innovator that's ready to partner with doctors and innovate the benefit of the DonJoy brand from bracing and the presence that it gives us in hospitals and with sports medicine docs and on contracts and things has been kind of part of how the business has been able to drive strong growth as a small player in hip and knee. And there, as 1% or so share player in a huge market, we've been growing at substantially above-market growth rates and see plenty of opportunity to continue that over time through continuing to fill out the bag, bring innovation to the business and to address some of the workflow-based growth opportunities that are coming, particularly in knee and some of the shifts coming in knee, like into the ASC environment. And so that's a business that we acquired there on the surgical implants front, one that grows sort of at multiple times market, and we expect it to be able to continue that over time.

Okay. And maybe if you could talk a little bit about -- I think a lot of folks familiar with the hip and knee market sort of know this is a large sort of, call it, consolidated market. And so sort of the David-versus-Goliath equation in the marketplace, trying to understand how it is or what about your orthopedics business is going to help you grow? And maybe, is this a matter, as you say, leading list shoulder and then just kind of breaking it down to kind of an account strategy, is that pulling in some of your implants into places where you're strong in shoulder? Or is it particular pockets of the orthopedic business where you mentioned ASCs, is it sort of more sports medicine folks that -- where you tend to be a little deeper? You're obviously not -- you're not rolling up to every major academic center in the country and just sort of banging on doors with your new business. You have a strategy that's worked. And I think it would be helpful to maybe understand how that works.

Yes. Well, for sure, Matt, there are different strategies, right? In shoulder, we've got a leading position that we're going to keep building on and growing over time and continue to serve the industry well, continuing to bring leading products and solutions that can support that leading position over time in a very attractive industry. In hip and knee, it's very different. We're a small player, but one that has been ready and willing to partner with doctors and innovate in an industry where innovation can be difficult if you got entrenched positions, sometimes making those incremental innovations to the implant products can be very costly, and we've been a player that is, as a smaller player, has been able to make those innovations, partner with doctors, drive strong growth in hip and knee. It's generally a different surgeon set. So we're not leveraging the same doctors there, but there's some overlap, but that's not the majority of the market. But certainly, we were able to leverage the channel capability. We're able to leverage contracts there. And we've got, I think, scale and credibility in our shoulder business that allows us to also bring that into the hip and knee space as well. And again, I think as a 1% or 2% share player, we can drive a lot of growth by focusing on specific segments and opportunities. And we've got plenty of runway for that, both through ongoing products that we can bring in that are not currently in the bag of surgeons that use our products or to serve the surgeons that use our products. And then certainly, in the knee area, as there's a shift to the ASC environment, that's creating new opportunities and challenges for everybody in the industry. And we think that sets up well for a player like that. We've got a knee player that -- a knee product that -- in our EMPOWR Knee that sets up well for the kind of patients that are the best to do in an ASC environment. We've been working on an instrument set over time to have it be as simple as possible for that constrained space environment. And we've got other aspects of strategy that we're driving to make sure that as that ASC shift continues to happen, that we'll be able to be one of the players that is taking advantage of that shift into the ASC.

That's great. And the ankle and the small bone extremities business that you're bringing in from Stryker, how does that fit into this? Is this a new sort of field force strategy? Does this fit into one of your existing distribution teams? How is that going to work? [indiscernible].

Yes. So one of the things we liked about DJO was that, in addition to the opportunities to improve the existing businesses, there were a lot of interesting adjacencies to think about that were attractive places to go with our strategy over time. And foot and ankle is one of those. It's -- foot and ankle surgery is over $1 billion market that has a number of different segments in terms of the procedures there. But the total ankle replacement is really a very strategic procedure to the doctors there in the foot and ankle space. And so we were very excited about the opportunity to acquire the STAR ankle, a fantastic product with a great set of data behind it in terms of the experiences that patients have had over time. And this steps us into a slice of that $1 billion foot and ankle space that grows at mid- to high single digits over time and that is still quite fragmented. And so we see the opportunity to step in with the STAR position and apply the same strategy that the DJO surgical team has been applying in other areas, and in particular in the shoulder area, to make sure that we've got leading technologies and workflow in terms of how we're serving that total ankle replacement part and then plenty of opportunities over time organically and/or through other acquisitions to move into other parts of that foot and ankle space that's got very attractive growth and profitability dynamics.

That's helpful. So maybe just switching gears a bit on sort of the margin structure and growth model for the 2 major sides of your business. How does that come together, I guess, over time? Where do you see -- where and how do you see the leverage and sort of ability to hit some of your intermediate- and long-term goals there?

Yes. So first of all, the growth model, we've talked about mid-single-digit growth, and that's -- we've demonstrated an ability to grow at least high single digits in our Reconstructive segment and in some quarters in the double digits range. And we started to demonstrate last year into early this year the ability to get the Prevention and Rehabilitation segment, where the bracing rehab products are, into that kind of low to mid-single digits range. And so if we get to even just even low single digits in Prevention and Rehabilitation and high single digits plus in Reconstructive, we wind up at that mid-single-digit range. And that's -- again, it's above-market growth in Reconstructive, which we've demonstrated consistently for years, and it's really getting us back to market growth in the Prevention and Rehabilitation range, which is, as the player with the leading brand position, very strong position that some -- in the past, that business -- those businesses have been able to drive above-market growth. We expect to be able to do that over time as well, but the path to mid-single digits for us is really just about getting back to market growth in those businesses and continuing to be above-market growth in Reconstructive. And then in terms of how do we drive margin improvement over time, well, certainly, if we get into the mid-single-digit growth range, we've got a little bit of a -- little bit of leverage coming through the business in terms of just productivity from growth. Our business system, as I talked about in ESAB example, has a proven ability to drive continued productivity in the supply chains and other parts of the businesses. We know that driving continual innovation gives a chance to kind of keep fighting some of the price pressure in the businesses. And so we've got the formula for how to make sure we can drive margin improvement over time. Now I think in our FabTech business, that's been a formula that over the past years, as you saw, got 50 to 100 basis points a year of margin -- of margin improvement. We know that in the MedTech business, you've got a little bit of price pressure all the time. And so the same amount of productivity work might get you a little bit less margin improvement, but we still see when we benchmark the DJO businesses and how they can be built and grown over time, we see plenty of opportunity to step-by-step improve the margins of the businesses as we are, at the same time, investing in the future growth of the business.

Okay. So if you look at the 2 sides -- and I apologize if this is -- if I missed this exactly, but maybe just in round numbers, the fab side of the business maybe rough margin profile, if you're comfortable. And then the sports medicine side of the business, the rehabilitation part of the business, sort of round numbers growth and EBITDA margins. And then in the sort of implant side, just put in perspective for folks so they can maybe understand how the 3 pieces can [indiscernible].