Enovis Corporation (ENOV) Earnings Call Transcript & Summary

Good morning, everyone. I'm Nathan Jones. I cover Colfax at Stifel, and I'm very pleased to have Colfax CEO, Matthew Trerotola, with us this morning, along with Mike Macek from Investor Relations. [Operator Instructions] We're going to start this session with a presentation from Matt. So Matt, over to you.

Great. Thanks, Nathan, and good morning, everyone. It's great to be with you here. Virtually, if you go through the disclosure to Page 3, there's just a summary of the key points that I'm going to hit in 10 or 15 minutes and really going to spend a little extra time on the MedTech platform as I work through these points. The next page, Page 4, talks about our strategy for our company. We were founded by Mitch and Steve Rales a decade or so after they founded Danaher. And we've been driving a compounding strategy for value creation. We're a diversified -- I'll talk about our businesses in a minute. And we really focus on making good business great, really focused in 3 ways of doing this. The first is around talent, having fantastic talent that is developed and powered and supported in our businesses and a lean corporate center to support that. The second is around strategy, having winning strategies in our businesses and supporting them with innovation and with acquisitions that help those businesses to win. And then third, around our business system, CBS, and driving lean business system journeys in our businesses to greatness. We also have a corporate strategic intent around shaping our portfolio in a positive direction, better growth, less cyclical growth, higher margins, better cash flow. Typically, incrementally, but in the past few years, as you'll see on the next page, we've been through a bit more of a transformation. We acquired DJO, a leading orthopedics player, stepped into the med tech space. And we divested 2 businesses that we had driven a lot of improvements in over time but had some heavy cyclicality and were more and more volatile because of the project-based content of those businesses. And so we're set up here in 2020 with a great portfolio, 2 leading platforms that have opportunities for strong improvement and organic growth as well as expansion through acquisitions. And you can see on the right, most of the revenues from recurring run rate types of product lines, strong cash conversion and with DJO coming in with gross margins well into the 50s, our gross margins of our company overall went up significantly. Now we've got a strong pipeline of acquisitions but have a stated intent around overinvesting in the Medical Technology part of our business in the coming years and disproportionately growing that part both organically and through acquisitions. The next page introduces our FabTech platform. ESAB is a global leader in welding and cutting solutions. And this platform really demonstrates the power of our strategy, of our CBS business system and our corporate capabilities. We bought this business back in 2012 and turned it into a very strong global leader in the business. Dramatically improved the margins of the business, built a growth engine over time that now systematically outgrows the industry and still have plenty of opportunity. This shows the last 4 years, some of the significant margin improvements with our business system improvements, with restructuring, with innovation, with price/cost value management. And we continue to work on these margin improvement efforts and also have plenty of opportunity in the future to keep using this growth engine to drive strong relative growth in the business and expand and strengthen business over time. Next page is our MedTech platform. Here, we acquired DJO, a leader in orthopedics. I'll talk a little bit about how DJO plays and where they play in the next few pages. We bought the business in early '19 and really focused initially on quickly driving the business to mid-single-digit growth by sustaining the strong performance of the Reconstructive part of the business and driving some CBS-driven and restructuring-based improvements in the Prevention and Rehabilitation part of the business. Quickly improved the service levels of the business, got the business back on a healthy growth arc and exited 2019 with some good strong momentum building. And we've got great opportunities in this business going forward to build a large and valuable MedTech platform and to drive continuous margin expansion and strong cash flow in this business over time. And one of the things we really like about the business was the various different directions that we could go with bolt-on acquisitions over time. Next page, I talked about this orthopedic continuum of care. This is one of the things that really excited us about DJO and the opportunity in acquiring this business and growing it over time. This shows how a patient's experience in orthopedics flows. And historically, most players have participated in usually 1 slice of this continuum of care, maybe 2. But DJO was driving a strategy that played throughout this continuum, from before surgery or before an injury right through the surgery or the treatment and to the rehabilitation and the protection on the back side. And historically, this has had some advantages in terms of opportunities to have key account management, some GPO contract leverage, a little bit of kind of crossover brand benefits and things like that. But looking forward, the opportunities to build leverage along this continuum are more substantial. In a connected world with health care consumerism, with bundled payments becoming a more important factor over time, the opportunities to drive strategic leverage around this continuum are going to grow. And we've already been exploiting one with MotionMD. This is a software platform that drives the workflow in 5000-or-so orthopedic clinics in the U.S. There are about 5000-or-so clinics that we drive the workflow in a significant portion, about 30% to 40% of them. And this is a position in the clinic that gives us a great advantage in terms of the way that we make -- simplify and improve the workflow. But it also creates opportunities for what happens before the patient's experience in the clinic and after the patient's experience in the clinic. For example, with attracting them to a more retail pharmacy product before they enter a clinic and with the opportunity maybe to attract them on the backside into rehabilitation and things like that. MotionIQ is newer. This is our solution that is focused on the surgeon at the center and then the things we can do before and after surgery as well. We've already provided the OARA risk score that helps the surgeon to assess surgeries that can fit well in the ambulatory environment. And then we have opportunities for a surgeon to track a patient before they come to their clinic as they're monitoring their pain and their exercises. And they have a connected brace that the patient can take home after they have surgery that will let them monitor recovery. So great opportunities over time along this continuum of care in a connected world. Next page. This next page talks about -- for the 2 reporting segments that we talk about, the major markets that we serve. The Reconstructive part of the business is about 30% of the business but growing faster and with great opportunities for expansion. And this business is mostly made up of our shoulder implant position and our hip and knee implants position. And you can see, in shoulder implants, we participate in a $1 billion-plus U.S. market that has attractive growth. We're top tier, have a leading position in the reverse shoulder, which is the faster-growing part. And we've systematically grown above this market based on bringing innovation to the marketplace, having great KOLs. And over time, there'll be opportunities to keep doing that but also continue to push forward on planning and guidance to help surgeons in that area. In Hip and Knee, we are a 1% to 2% share player in a $9 billion market that grows in kind of about 3% range and have, for a couple of years now, significantly outgrown the marketplace, based on having strong technologies, again, partnering with surgeons and recently focusing on having the right ASC solutions as more of the market moves into that ambulatory environment. And on a go-forward basis, there will also be opportunity to differentiate through surgical workflow here as well. So we see great opportunities to continue to grow fast from this small and valuable position in hip and knee. The others, about 70% of the business, is mostly in bracing and rehabilitation solutions. About a $4 billion global market, grows in about the 3% to 4% range globally. And we're a clear leader there, leading brands, iconic brands, strong position in clinic workflow like I talked about, historically have driven continuous innovation. And one of the things we've been working with the business is to bring that continuous innovation stream back. And we already demonstrated late last year, early this year, and even in the downturn from COVID, the opportunity to grow at above market levels in this business. And we see opportunities to sustain that as we come out the other side of COVID. And then certainly, over time, the opportunity to build an engine like we did in FabTech in the Prevention and Rehabilitation space that can systematically outgrow the market. The next page talks about a recent acquisition we made that shows the kind of attractive adjacencies that exist in MedTech for us. Extremities is known to be an extremely attractive area within orthopedics. On a global basis, this shows the U.S. part we're in. Shoulder implants, I already talked about, a large, fast growing, very attractive market where we've got a strong position. Foot and ankle surgery, overall, is over $1 billion market as well that grows very attractively. The implant piece of that is a smaller piece because this market is earlier in its development and more fragmented. We acquired into the Total Ankle Knee Reconstruction segment of that foot and ankle surgery market, attractive position with a strong technology. The opportunity to apply the same formula to the STAR ankle that we've applied in our shoulder and our hip and knee business, of bringing innovation to market, having a strong channel, partnering with surgeons, and we believe we can drive above-market growth over time similarly here in ankle. And then over time, there's opportunity to move organically and through acquisitions into other parts of ankle surgery, a very attractive adjacency. Just a great example of how we build compounding value in our businesses and one of a number of great opportunities in the MedTech space that we've already started to act on. Next page. This page just talks a little bit about how our financial performance has tracked through this year. We came in with some great momentum with a plan for healthy growth, margin expansion, strong cash flow through mid-March. We're right on track and had really good momentum. Obviously, then we had to deal with COVID. We've been focused on keeping our associates safe, keeping our customers supplied and continuing to drive the improvements and the initiatives that will make sure that we come out the other side of the crisis with as much or more momentum as we came in. And you can see in Q3, we already had some very strong improvements from Q2 and expect to improve a little in Q4 as well. And very importantly, we've started to demonstrate the kind of cash flow capabilities that these businesses have in the backside of this year and we think you'll really see that in Q4. And that will support the plan that we had this year for $250 million or more of cash flow and the opportunity for that as we come out the other side. And that cash is obviously very important as it relates to delevering and driving acquisitions related to our strategy. Next page. This page talks a little bit about the market drivers in each of our markets. In MedTech, you're all familiar with the long-term growth drivers of aging populations and access to health care around the world. In orthopedics, there are some specific drivers around OA and diabetes and some of the active lifestyle and the injuries and sections that are needed there. Great long-term growth drivers that have continued to march forward in many cases, even in a COVID environment. Certainly in Q2, this business was significantly impacted with the shutdown in elective surgery and some of the curtailment in activities but came back very quickly in June and July. And we actually were positive year-over-year in this business in the third quarter. We talked about being a little bit negative on an underlying basis. We think that speaks to the strength and resiliency of the business, how fast it came back. And as we've talked about, we expect to be stabilized in that flat to a little bit down range in Q4 based on some of the current cases in the U.S. and around the world, some of the flare-ups. But then if you look at how fast this business come back in June and July as well as some of the more positive news about path to vaccine, path to improvement, we still feel quite comfortable that '21 should be a strong year of growth over '19. FabTech is a business that serves a diverse set of industrial applications around the world. More than half of the business focused on high-growth markets that have grown faster than the developed markets over time and are expected to in the future. So a great opportunity for us over time and some extra growth drivers there as well from new technologies. This business also was constricted in the second quarter but came back fast in the third quarter, already turned back to growth in the high-growth markets overall. And in most of those markets, we expect the high-growth market to stay in that growth zone. And as we've talked about, we saw September, October better than the previous 2 markets -- 2 months, which shows the potential for some sequential improvement in Q4 and a path to turn over to growth at some point in 2019. Last page just reinforces that we do have a little work to do this year, making sure we stay focused on getting the other side of the crisis and coming out with great momentum as we come out the other side but then a very exciting future ahead, building strong and large and valuable MedTech platform and continuing to drive strong improvements and expansions in both of our platforms. Thank you.

Okay. Thanks for that, Matt. So a few questions. I'm going to start on Colfax Business System, CBS. Colfax is not your average health care company with a heritage in industrial manufacturing and perhaps a better focus on operational execution as a result. That broadly comes under the heading of the Colfax Business System. For those unfamiliar with the business system, can you describe it at a high level and talk about how you think that differentiates Colfax from other health care company owners? And how should investors judge the success of CBS implementation over time?

Yes. Sure. So our Colfax business system is really a culture, a toolkit and a set of process to create a way of working for how we drive continuous improvement journeys in our businesses. And this kind of approach certainly has been applied in a whole range of businesses over time and showing dramatic opportunities to sustainably improve the performance of the businesses. And also, certainly, this kind of approach has been demonstrated. I had some personal experience in my past kind of applying this kind of an approach into the life science industry, for example, and taking businesses and driving strong improvements there. So that's what our business system is all about. And so in a situation like the acquisition of DJO, we certainly confirm that there are plenty of opportunities to drive improvements with our business system in the business. We also confirmed that the team, with the team and the leader, Brady, was a leader who would be excited about our business system. And in fact, we found a really quite a good cultural match. Some of the cultural things that he had already been driving through the business based on his Stryker experience have some similarities to the kind of culture that we like to drive through our business system, being relentless about improvement, focused on winning in the marketplace, bringing innovation to fuel that winning. And so there was a great cultural fit that we've built on already as we worked with the team and the business. As we started the journey, we worked with the team on improving some of the fundamental processes, the business review processes, some of the innovation processes, particularly on the bracing and rehab side. And digging into the operations and helping bringing our toolkit to help with the sustainable operational improvement that helped to stabilize some service level challenges that the business had, had and now creates the platform for a continuous journey of productivity growth over time in the business. So we're off to a great start. And it's about getting the culture right. It's about kind of training and coaching and bringing some resources to score with the tools and then really empowering and enabling the team to drive that journey.

So following on to that, DJO wasn't a business that had that kind of CBS continuous improvement culture and mindset but has seemed to embrace it since you acquired the business. Can you talk about the adoption of CBS at DJO, where you are in that process? I mean it typically takes a number of years or even longer to really drive that culture deeply into the business. What do you expect the incremental benefits to be over the next several years? And how should we judge the cultural and operational improvement at DJO?

Yes, I know. Nathan, it certainly is a journey over time that actually builds and builds and builds over time in terms of value that is created by the business system as we get stronger and stronger in applying that. I think we're off to a terrific start. The team was excited and embraced bringing the tools in. They had some real needs, and we were able to step in and help with some needs, particularly on that P&R part of the business. And so I think that has been a great start for us and that the team was excited to have the help. And as we brought some resources and tools, that helped to lift up the growth of the business very quickly. So I think that was a good quick win. Like any other business, it's a business that had done leading things in the past. So there were plenty of kernels to grab onto of people who were excited about lean initiatives that have been started in the past that we could pick up and bring some new fuel back under. And so we've already got a lot of folks in the operational part of the business that are off and running, doing Kaizen, involving Shin. Just a lot of great momentum building and we're excited to see that. We've also got some great early traction in the innovation part of the business, again, particularly in the P&R part, that bracing rehab part that really needed to focus more on innovation. We've been able to help strengthen the processes and create a path for accelerated and continuous innovation over time in that part of the business. And we've been able to focus on some of the back-office processes. The reimbursement process in the business is a great opportunity that we've already done some good work to help with the front end of the process that supports revenue generation. And we've got great opportunities over time to drive productivity in the whole process.

Great. I'm going to switch over to the welding business in the interest of time here. You acquired that business in 2012. And when Colfax bought it, it was in pretty poor shape. The next few years, the business underperformed. It's 2 public peers on revenue growth. But that has flipped over the last 2, 3 years and your business has been outperforming. There's geographic and other differences between the companies. To what extent do you think the outperformance has been due to U.S. market being relatively weak versus Colfax gaining share overall in the market? And maybe you could discuss why you think that performance, that market share gain, is sustainable?

Yes. So we're confident that we gained share overall and that we have an ability to consistently outperform. Obviously, there will be a certain quarter where the markets are one way or the other way that could affect that. But I think if you look at now, a longer period of time, if you go back 4, 5, 6 quarters, there's times when the U.S. growth wasn't all that different from the global growth. And so I think that there's a clear demonstrated back pattern there. But we're really focused -- we know that what we need to focus on is just driving that continuous improvement engine. And if we do, the results come. And so what you're seeing is the result of a journey, not something we did in the last 2 years, where we started from the start, rebuilding the innovation engine and having a commitment to resolve, to continuously drive that innovation engine, to have high vitality levels in the business. We've rebuilt the supply chain, European first, North American second. I was involved a little bit in the North American rebuild in the beginning of my time. We rebuilt the supply chain to be able to have strong, sustainable supply chain to be able to deliver great service customers. We've driven improvements in the commercial processes over time to build stronger and stronger commercial capabilities. And we've done acquisitions over time that were strategically aimed at strengthening our position, sometimes related to strengthening our position with the channel, sometimes related to access and exposure to market segments that have more attractive growth characteristics, sometimes around bringing technology that we knew could over time drive better innovation-based growth. So I think that team is a great team. They've done fantastic work. It's great to see the momentum there. And we're confident that we've got great opportunities ahead as well in that business.

So margins have expanded significantly over the last several years, as you noted in the presentation. And before COVID came along, we're within reach of the kind of 16.5% EBITA equivalent target that had been set a long time ago. Can you talk about the big levers that have been pulled and those things that remain to be optimized? And assuming that volume gets back to 2019 levels and in light of the structural cost reductions that have been made late last year and into this year, could margins reach 16.5% EBITA margins on that 2019 volume levels, given the improvements that have been made in the business over the last 12 months?

Yes. Yes. First, Nate, so yes, the other thing that we said when we bought the business, in addition to saying we built a growth engine that would outperform, we said we would dramatically improve the margins over time. As you said, we've done that. And we've done it through a combination of continuous improvement with our business system driving productivity through thoughtful restructuring over time in the supply chain and some of the back office processes. We've done it through innovation because innovation gives you chances to reset price points and through price management, price value management. And we've done it through some acquisitions. We've consciously brought some acquisitions that helped with that equation. So it's a sustainable margin build that we've done there. And we're closing in on that goal that we articulated a while ago. I've said clearly, over time, that it's going to take execution to get to the goal and strategy to get further. And we're working on both and we have been working on both. And so while we've been driving towards that 16.5% EBITA number, we also have been consciously driving strategies that would make sure that there is headroom beyond that. I'm not going to give specific guidance. What I'll say is, we've said publicly that we have done the work so that the margins -- at '19 revenue levels, the margins can be higher than they were the last time that we were at '19 levels. And we're also certainly confident that we'll be able to drive past that 16.5% and continuously improve the margins over time, with a similar formula, step by step by step, improving the margins of the business just through great application of our businesses.