Enovis Corporation (ENOV) Earnings Call Transcript & Summary

Good morning, everyone. Thank you for joining. My name is Michael Klem. I'm a member of JPMorgan's health care investment banking team. It's my pleasure to introduce the Colfax team. We have Matt Trerotola, Chris Hix and Mike Macek, the CEO, CFO and VP of Finance, respectively. Quick housekeeping note. If you need to ask a question, there's a button you press to submit questions or ask a question feature right below the presentation. So without further ado, I'll jump out of the way and turn it over to you, Matt.

Great. Thanks. It's great to be here virtually, at least. I'm looking forward to the time when we could do these things face-to-face again. I'm not sure you are as well. So I'm Matt Trerotola, the CEO of Colfax. I've been in this role for about 5.5 years. And I want to share a little bit about our company, our strategy and the journey that we've been on and talk a little bit about our 2 great business platforms, but in particular, talk in more depth about our MedTech platform. You could follow along in the presentation. I'll let you read the disclaimer on Page 2 at your leisure, and we can move to Page 3. We were founded by Mitch and Steve Rales about 10 years after they founded the enormously successful Danaher Corporation. They are still significant investors in our company, and Mitch is our Chairman. And our strategy is a strategy of compounding value through driving improvements in businesses, driving organic growth through innovation and driving acquisitions that strengthen and improve and expand our businesses. And we also have a strategic focus on constantly improving the quality of our portfolio. We've got great positions in MedTech and FabTech, and I'm going to talk a little bit about those here today. If you go to Page 4, typically, the shaping of our portfolio is kind of step by step. But over the past few years, we've been working through a significant transformation of our portfolio. We divested 2 businesses that were pretty heavily cyclical, and we had driven some really nice improvements in those businesses and made successful divestitures and acquired DJO Global, establishing a position, a platform in the MedTech industry, a very strong position with great opportunities. And so as we made our way through 2020, we've got these 2 strong platforms, FabTech and MedTech that each have great opportunities for improvement and growth over time. And we've also had a stated intention to drive oversized growth of our MedTech platform over time, with the opportunity to build a $3 billion platform there over time in MedTech. And you can see on the right the great characteristics of our platform, a lot of recurring or run rate revenue, strong cash conversion opportunities. And the gross margins were substantially improved through this transformation, with the MedTech business coming in in the 55% to 60% range. And we've got a great pipeline of opportunities to drive our compounding value creation. On Page 5, I'll talk just a little bit about our FabTech platform. ESAB are a global leader in the cutting and welding industry. What's not on the page is that between 2012 and 2015, we drove substantial improvements to this business after we had bought it, about doubled the profit level of the business and really laid the foundation with our business system in terms of strong operating performance, strong innovation performance, strong commercial capabilities and talent. And you can see on the page what we've done over the past 4 to 5 years, where we have continued to substantially improve the margins of the business. And as our innovation pipeline has yielded fruit and our great supply chain has been delivering great service to customers, and we've got great talent around the world in our commercial teams and the rest of the business, we have driven consistent outperformance in this business for years now. Quarter in, quarter out, we delivered consistent growth outperformance. And so we think this business really demonstrates the power of our strategy and our business system applied into this business over a long journey. And the journey is not done. There's great opportunities into the future in this business. We've been working hard through this crisis period to continue to do the continuous improvement and the restructuring work and the innovation work so that when we come out the other side, when we get back to the same revenue levels in this business, we can have higher margins than when we came in, still have room for margin expansion, and we can continue to outperform the growth of our industries. Page 6 introduces our MedTech platform, DJO Global. This is a leader in orthopedics. We bought the business in early 2019. And when we bought the business, the surgical business had been on a very, very nice growth path that it continues to be on. But the P&R segment, bracing and rehabilitation was not growing. And we talked about a first priority being doing the operational work and bringing through some of the innovation that the team was working on in order to get that P&R segment back into a growth range, and that's how we could get the business in the mid single-digit growth range. Throughout '19, we were able to quickly drive those improvement works, working with the great team in DJO and bringing our business system, and got the business back into a solid growth range as we exited 2019 and even as we started out 2020. We've got great opportunities in this business over time to keep driving the strong growth in surgical as we come through the other side of the crisis and to have that P&R segment growing at market levels or better over time. And then through acquisitions and innovation, build out a $3 billion-plus mid-single-digit plus growth platform in MedTech. The next page, Page 7, provides a little bit more about our businesses. Our Prevention & Rehabilitation segment participates in about $4 billion global market, and we have strong leading positions in both bracing and in rehabilitation. You can see the iconic brands and products on the page, DonJoy, Aircast, Chattanooga. These are iconic global brands, and we have a very strong position in the U.S. and around the world in the channel and in clinics and great opportunities to extend our leadership in this business over time. And strategically, through innovation and the right bolt-on acquisitions, shape it to a better and better place in terms of the organic growth capability and gross margins of this P&R segment. Our Reconstructive segment is mostly our position in surgical implants. This is a huge market at $17 billion. But the shoulder part of it is smaller. We've got a leading position in shoulder and are the U.S. leader in reverse shoulder, which is the highest growth part of the shoulder industry. And here as well, here, we've leveraged the DJO brand. That's been part of how the team has been able to grow so successfully in implants as a smaller player, has been the knowledge and leverage of the DJO prime brand and some of the relationships and awareness in the KOLs and doctors, surgeons. And we've also done a lot of great innovation in this business. You can see our AltiVate Reverse Shoulder flagship products here. And so this business, again, has been on an aggressive growth path. We continue to invest for that, and we see great aggressive growth opportunities over time in this segment. The next page, Page 8, really talks about the orthopedic continuum of care. One of the things that really excited us about DJO was that the business was driving a strategy of winning in each of the businesses, but also driving leverage throughout this orthopedic continuum of care, leveraging the DJO brand, driving key accounts efforts with IDN networks that would be leveraged across the businesses as examples. And then really, in particular, driving digital strategies that created advantage along this continuum of care. And our MotionMD product is the workflow solution that is the standard in a very large number of orthopedic clinics around the U.S., approaching 2000. And this is how they do their inventory management, their fitting, their billing. And this entrenched position with MotionMD in the clinics really creates great opportunities for leverage up and down this continuum of care as we add additional functionality and capabilities to that MotionMD platform. Our Motion iQ platform is newer, and this pivots off of the surgeon and ultimately gives them the opportunity to be managing patients before surgery and being able to track them as they're moving towards a pain threshold where they might need to be able to be coming into to get their surgery. And then picks up on the backside and provides the opportunity to use connected medicine devices, connected braces to track the recovery pass of patients and ultimately, even to have them, over time, be able to do their own rehabilitation to complement other rehabilitation. And this kind of an offering really creates the opportunity to drive better outcomes at lower total cost, which is ultimately the key way to drive advantage in this industry over time. Page 9 provides a little bit more on the markets for prevention and rehabilitation. As I said, this is about a $4 billion global market, a highly diversified set of geographies and demand drivers around the world and different types of clinics. So this is a much more diversified set of demand drivers. Elective surgery is one of the major demand drivers for this segment, but activities, working, mobility, they -- those all contribute as well. Low single digits overall is the market growth here. And DJO has been the leader, a very strong leader in the past that grew above-market rate consistently, and we're in the process of building back into a very strong leader that can consistently grow at above-market rates. And as I said earlier, we've already made great progress on that journey. The key competition here are Össur and Breg. And I've talked a little bit about some of these key advantages. And so we've made some really good progress in this segment in the first couple of years and see great opportunities over time as well. Next page, Page 10, talks a little bit about our reconstructive markets. And this is -- on the page, we really focus in on the implant markets, which are the larger part of this segment for us. Shoulder implants is a $1 billion U.S. market, very attractive, high single -- mid-single to high single-digit market growth. And DJO, as a leader here, has driven consistent above-market growth, part because of the participation in the higher growth reverse area, but also part through the innovation and service that the business has been providing, partnering with KOLS, bringing innovative products and being an agile player serving the market very well. The hip and knee business -- market is much bigger, $9 billion U.S. market, grows low single digits. Here, DJO is a very small player at 1% to 2%, competing with the big 4 and others, and has been able to consistently grow at multiple times market growth rate as we've had strong products like our EMPOWR Knee. Been willing to continue to innovate in this space and have made sure that as the ASC has become an important part of the market there and surgical workflow is becoming more and more important, that we are bringing the right offerings and solutions in order to win in that environment. We -- this is a business that has consistently grown in the double-digit range, high single digits at times, but usually double digits. And we see opportunity, over time, to have this business continue that strong growth path, and we've continued to invest for that future strong growth path in this business. Page 11 talks a little bit about our acquisition opportunities in the MedTech space. This is one of the things we really liked about DJO and orthopedics, that there are a broad range of both bolt-on and adjacent acquisition opportunities. And we've already started to move on some of these, and I'll talk about a few that we've completed. We've got a very well-honed strategic capability in the acquisition area. We've done dozens -- since I've been here, dozens of acquisitions and have had great success with those. We've focused on things that are strategic to the businesses, that are going to strengthen the strategies and improve the momentum of the businesses. And we've focused on things that expand the boundaries of the businesses in attractive ways. And we've got a well-honed capability around how we do the market work to assess where the most attractive opportunities are, how we do the cultivation work to have most of our deals be more one-to-one versus broad auction processes. And then to do the diligence, the deals and, very importantly, the integration and value capture work on the backside of these acquisitions. And you can see, on the page, a broad range from technology adds, product adds, geographic expansion -- so, a broad range of opportunities. And as I said, we're off to a great start. We've already completed a few very exciting ones. And we've got a very healthy pipeline building as we're working through last year and this year, and we see great opportunities in the future to exercise against this pipeline. Page 12 introduces one of the acquisitions that we completed in the fourth quarter. We acquired the STAR ankle business from Stryker. Ankle -- foot and ankle surgery is another $1 billion, very attractive segment that grows at mid- to high single digits and has very high gross margins. And with the STAR acquisition, we step into the most strategic part of this segment. This is a product, a technology that is very important to the surgeons in terms of high dollar value, very important to patients. And the STAR technology is one that's got a tremendous history. It's got a lot of data behind it, and it's got a lot of surgeons that are very attached to it. And we see a great opportunity to apply the same formula that we have in our other implants businesses to drive this business to above-industry growth and sustain it over time. We also see a great opportunity to move to the right into the other procedures that you see on the side, the foot and ankle surgical business is -- it's got -- it's fragmented with a number of different procedures, and many of them have very attractive growth fundamentals and margin fundamentals. And we see opportunities pivoting off the start with STAR to organically and inorganically move into more of that attractive foot and ankle space over time. Page 13 introduces another acquisition that we completed in the fourth quarter. This is a very important strategic bolt-on into our rehabilitation business in the P&R segments. This is -- we acquired the LiteCure business, a market leader in therapeutic laser technologies for both animal and human health applications. This is just a great complementary product to our other rehabilitation products. The high-power laser technology is still on the steep part of the growth curve. And so the growth rate of that technology is higher than many of the other technologies that are being applied in rehabilitation. So mid-single-digit plus market growth opportunity for this technology. And we see the opportunity to grow this product line at high single digit to low double digits between the innovation that's coming through the business as well as the channel synergy that we have with the business as it's just a complementary product that comes on the human health side, right into our existing channels, and we combine there. So great, great opportunity. This is part of how we strengthen that P&R segment to be better and better and better over time. We're very excited that this business and the team have joined us. The business has some great IP in the applicator that is very important to the clinicians, and we see great opportunities here. And we think this is just -- this is a great example of the kind of bolt-ons that can strengthen and improve our trajectory in our P&R business and have a fast path to very attractive returns. On Page 14, I'm going to talk a little bit, I'd say as much as I can about financial performance. Obviously, with the timing of this discussion, I can't say really anything about the fourth quarter. But I'll talk a little bit about how things went as we worked through last year. We entered the year in 2020 with terrific momentum, a plan for strong growth and outperformance, strong cash flow conversion and margins. And we got off to a great start through the middle of March. Like everybody else, from the middle of March, we felt the COVID impact, and Q2 had a lot of pressure on it. But we really came back very quickly in Q3. And I think it was very encouraging to see in June and July how quick, in particular, the elective surgery and the things that pivot off of elective surgery. It was very encouraging to see how fast that came back. And with that, with the improvement in revenues, you can see from the page that our profitability and our cash flow started to come back quickly as well. We've been doing the right things as we've been working through the crisis to make sure that as we come out the other side, we're going to be stronger than we were. We've continued to drive improvements in both businesses. We've continued to invest in the commercial and innovation parts of the businesses so that we can drive continued outperformance from a growth standpoint. And so certainly, we're watching the markets carefully as we're moving from 2020 into 2021. And there's a lot of well-publicized things about both what's been going on in the MedTech markets over the last month or so, but also the expectation in terms of how the MedTech markets should make their way through 2020 with all the positive things that should come with the path to a vaccine and the vaccine. So certainly, later in the quarter, we'll be able to provide more clarity of what 2021 looks like, but we're certainly very excited about the way that we'll come out the other side of this crisis as it clears. The last page talks about our focus and our future. We're still very focused on keeping our associates safe and serving our customers as we get through the balance of the crisis here, but we've also continued to be focused on doing all the right things in terms of investment in the business and improvements in the business to be sure that we're gaining more and more momentum. And we see this great opportunity, over time, to keep improving both of these businesses and to build out a $3 billion-plus MedTech business that grows at greater than mid-single digits. And we're going to continue this dialogue with you as we're doing that. And at this point, we can take your questions.

Great. Hi, it's Mike Macek, VP of Finance at Colfax. I encourage everybody to submit questions. And in the meantime, I'll kind of kick it off here with a couple of questions for Matt as we wait for things to come through the chat line. Matt, where do you see the greatest opportunity for Colfax for making investments within the MedTech platform?

Yes, Mike, as I talked a little bit about a couple of pages back, we see a lot of great possibilities for investment in MedTech, and it's going to be a combination of bolt-ons that strengthen and improve the P&R segment. Like the LiteCure, it's going to be bolt-ons and adjacencies to the surgical segment. We see a larger number of bolt-on and adjacency opportunities in the surgical segment. So could be the right next technology directly within our surgical segment or could be additional things that move us further and further into foot and ankle and other attractive adjacent segments. We see some good global investment opportunities as well, expanding the attractive market space for our business. And so, yes, over the next few years, we see lots to do there with certainly more investment in the surgical part of the business, but investment in both. And then, over time, certainly, MedTech is a very attractive, very, very broad landscape of possibilities, and there's a number of logical places to go that are adjacent to orthopedics in MedTech.

Great. And once again, if anyone asks questions, please bring them through the Zoom chat function. I don't see any questions coming through as of yet. One more for you, Matt. The overall Colfax model has proven very successful, with all the improvements you've done at ESAB through the years really improving the overall operating profit margin, the R&D engine, et cetera. How do you see that model working with DJO? And where do you see the opportunities there?

Yes. Thanks, Mike. So as we looked at DJO, we were very focused on 2 things, right? One, how do we feel about this market? How do we feel about the growth opportunity for the market, the margins, the expectation that the growth is going to be good and steady over time, the structure and the kind of opportunities there. But then we also look very much at how do we look at the opportunities for value creation with our compounding value-creation strategy. And if you kind of look at the things that I talked about in terms of the journey that our ESAB business has been on, obviously, it's a very different business. But the kind of things that have driven that journey have been very similar to the kind of things that are going to be applied in order to make DJO a fantastic business and grow and expand it in attractive ways. First, it's about talent. We have done relentless work on the talent within DJO over time, getting stronger and stronger and stronger talent in that business, improving the engagement, improving the development of the talent. And I think we were very excited that Brady came to us as someone who is also passionate about talent and that he had already started working on getting that business stronger and stronger. And so we see opportunities to continue to strengthen and deepen the talent and the bench at DJO, just like we have in the ESAB business over time. Second, it's about a continuous improvement journey in the businesses. In ESAB, we started with the supply chain, got it very strong. At the same time, we made sure that the innovation engine was kind of well primed and being invested in. And then, over time, the supply chain work moved from getting the service levels great to driving continuous margin expansion and cash flow improvement, and the innovation started to yield fruit. And that's how we got margins up, ultimately, tremendous growth performance out of that business. And the DJO business has the same opportunity. There were some important supply chain things to do initially that we've already been working through with them over the past couple of years here, getting the supply chains stable and strong, and serving customers well. And then there's this journey over time in terms of driving continuous improvement in the supply chain there. And our CBS toolkit is exactly the way that you do that. And the innovation engine as well. Again, we were very excited that Brady already had built a great innovation engine in the surgical business and had started the work on building a great innovation in the P&R segment. And so just like we did at ESAB, we've come alongside him and the team and brought processing tools and capabilities and even some resources to finish the job on the P&R side, kind of create a very, very strong innovation engine and get the right level of investment coming into that engine. And then, finally, acquisitions and what we do with those over time. A part of how we have made ESAB so great has been [ about the ] strategic acquisitions that we've done over time that have brought great products and technologies and global expansions and have shaped the quality of that portfolio to be a better and better place, and strengthen the business and how the channel [indiscernible] business. And we have the exact same opportunity in the DJO businesses that the things we've talked about here on the call show the initial opportunities and fruits of those. So really, a very similar -- we totally understand they're totally very different businesses and industries, but it's remarkable, the extent that the same kind of toolkit and the same focus areas have already had some good impact -- good, strong impact on DJO and have the opportunity to have tremendous impact to create very strong long-term growth, growth outperformance, margin improvement and strong cash flow over time.

Great. Thanks, Matt. We do have a couple of questions coming in now. First one, why do you think the big ortho companies seem a little less interested in the shoulder and foot and ankle space?

Well, I don't think the big ortho companies are less interested. I think probably through the -- if there was a period of time where that space was a lot smaller than the spaces that they were the most focused on, and so I think players that were focused on those spaces were more successful, by and large. And so that's why there have been some very strong players created that are either completely or partially focused on that extremities space or parts of the extremities space. I think clearly, now, the bigger players are -- obviously, Stryker came in and paid a very, very high multiple to acquire rights. So clearly, the larger players are now focused on that space, but there are also some very strong small and medium-sized players who have been focused on those spaces over time. And so we say -- we see great opportunities to -- just like we have in the shoulder by being someone that's focused on shoulder from an innovation standpoint, we've been able to be very successful. And in foot and ankle, we see the same opportunity to be an agile player that's focused on that segment, treating it the way that it needs to be treated specifically. And we're confident that we can have some great success there, starting from STAR, but adding other things over time that will bring us more and more technologies, channel positions and more and more talent that is from the space and connected in the space.

Great. Next question. Backing up here a little, thinking about kind of the early strategy. What was the rationale behind entering the orthopedic segment of MedTech versus other sectors and other areas within health care?

Yes. So we had a set of criteria. And part of the criteria were about sort of fundamental attractiveness and that intention to improve the cyclicality and growth profile and margin profile of our business. And then part -- and then there was a set of criteria more around the expectation that our strategy and business system could add value like a degree of fragmentation to be able to do bolt-on acquisitions, as an example. And so we had a set of criteria. We had a number of possibilities. And then, ultimately, there's also got to be the right entry point. And DJO was an entry point that we could acquire a great leader. This is a business that is one of the fastest-growing, good-sized surgical businesses and then this iconic historical leader on the pricing and rehab side. So we had the opportunity to acquire a great business and acquire it for a very attractive multiple in the 12s. And so I think it was a combination of criteria and opportunity. And then, finally, Brady and the team were excited to join our company and knowing that we were stepping into a space that needed some depth in terms of knowledge of the space. To complement the things that we would bring corporately, it was very important that Brady was excited to join us and lead the business. So that was the kind of the set of things that came together for this to be the right entry point. And then, as I said, it's a place that has plenty of possibilities even in orthopedics. In the segments we're in, there's great growth possibilities. And the rest of orthopedics is great growth possibilities. And then the broader MedTech space, certainly, has other possibilities that are adjacent to orthopedics.

Great. An ESAB or a FabTech question for you. Can you remind or just talk through the mix of international kind of the revenue breakdown for ESAB and the large product mix of the business?

Yes. I guess what I'll say is, first of all, the revenue of ESAB is extremely balanced. We're the most global player, the most global large player. So very balanced revenue around the world. We are #1 outside the U.S. and #3 in the U.S. So our U.S. revenue portion is lighter than our European revenues portion, but we still have very balanced revenue around the world, and about half is in high-growth emerging markets. And we've always talked about, and I believe it very strongly, over time, there's every expectation that the GDPs of those markets are going to grow significantly above the GDPs of developed markets. And so that 50% exposure to emerging markets is going to be a great thing for us over time. And even coming out through last year as we've been -- we were public about the fact that those were the first markets to come back. They came back to growth. Most -- the market -- the emerging markets overall came back to growth. Most of the specific countries came back to growth. And certainly, if you kind of read the industrial economic external data that's out there, I think there's a pretty consistent expectation that the emerging markets just kind of keep along, while the developed markets have a kind of more step-by-step path back as more stimulus gets pushed into the markets and kind of see the concern about COVID reduced over time from managing the risk and then ultimately the vaccine. As far as project content, our -- strategically, in ESAB, we have been focused on having winning brands, great products across the full range of opportunities in welding, from equipment to consumables to gas control and then, ultimately, software solutions now. Our -- there is an innovation wave that's going on in that business that is in the area of automation robotics that is driving some extra growth in those parts of the market. And our participation in that mostly has been by providing the components of the solution to integrators. So like we acquired a great torch business, TBi, that allowed us to bring a great torch to the integrators and get exposed to that better growth part without participating in a significant way in the large projects. So we do participate a little bit in large projects, but it's a very small part of the business. And the vast majority of that business is more kind of run rate products into kind of normal manufacturing processes as well as products that are going into those larger products. And we've done that consciously. Our experience over time has led us to want to make that ESAB business more and more balanced, as balanced as possible in terms of applications served and minimize the amount of lumpiness in the business that would come from larger project participation.

Great. Flipping back over to the MedTech. Thinking about from an acquisition perspective, what are your -- what would be acceptable ROIs for bolt-on acquisitions in the MedTech space for over a 5-year period, with a view of -- are there enough high-quality opportunities where valuations are today?

Yes. Well, we've always talked about that our [Technical Difficulty] kind of a rough threshold of 5 years to 10% ROIC as a guide as we're doing our acquisition work. But the reality is that we often flex that. And if we're doing a channel acquisition or a bolt-on, we expect a much faster path to that 10%. And at times, we do kind of smaller technology acquisitions that we know are really about advancing the strategy and might take a little bit more time or might have a little kind of band of outcomes in terms of where we could be 5 years down the road. Within MedTech, we continue to be very disciplined about acquiring things that are going to advance our strategy and that are going to have a clear path to strong returns. And we certainly expect that we'll be thoughtfully flexing how we think about that path to 10%. I think the things that I've shared here today are things that have a stronger path to returns, a faster path to returns in the -- like your case, it's a direct bolt-on into the same channel. And so I think that always kind of helps us to take it up a bit. And the STAR Ankle was a bit of a unique situation in terms of Strykers' need to divest that for their transaction and us positioning ourselves as the logical acquirer. So I think both of those have a little faster path to return. But there's also some things in the pipeline that are things that are going to really enhance our growth and kind of step us into attractive segments and that would have a little bit longer path to returns.

Great. And we have -- it's about 3 minutes left in our session here. There's maybe opportunity for 1 or 2 more questions. We do have one left here within the chat. Kind of following on that, that same thing from an acquisition perspective, Matt. If the right opportunities present themselves in the future, would you consider entering other areas within MedTech? For example, like cardiac health or neuro or diabetes? Or is there anything that is certainly attractive to you at this point?

Yes. Well, what I'll say is that, again, one of the things that really excited us about DJO as an entry point in the MedTech was the amount of optionality. And first and foremost, the great amount of opportunities in and around the orthopedics space and kind of directly adjacent to that. And so we're clearly focused right now on the great opportunities there. You know, we're going to make DJO great. We're going to do acquisitions that strengthen, expand those businesses logically. We're going to expand the boundaries within orthopedics in attractive ways as we already have with the foot and ankle move. And I think, for the next couple of years, that's really going to be our focus. But there's no question that there's other opportunities where some of the same capabilities and opportunities that we're applying in orthopedics can have value in other attractive areas within the MedTech space. And I think we'll manage through that over time, but always with an eye towards logical. I think our participation in the MedTech space is going to be a logical set of opportunities in MedTech that have some logical capabilities that leverage across them.

Great. At this time, I don't see any other questions in our chat feature here. And so with that, we'll wrap up with only a minute left. I want to say thanks for everybody for joining today. And Matt, if you want to say a final word.

Yes. No, it's great to get a chance to talk to you again. Look forward to doing it person-to-person again. We're really excited about our progress and our future as a company. And hopefully, you got a little feel of that from this presentation and Q&A, and we're happy to spend time with people that want to learn more. Thanks.

Thank you, everyone.

Thanks, everybody.