Enovis Corporation (ENOV) Earnings Call Transcript & Summary

Thank you all. My name is Caroline Borowski, and I'm an associate here at the JPMorgan Health Care team. It is my pleasure to introduce Matt Trerotola, the CEO; Ben Berry, the CFO; and Derek Leckow, the Vice President of Investor Relations here at Enovis.

Great. Thank you. Thank you very much. It's great to be here and have a chance this afternoon to introduce you to our company, Enovis. In some ways, we're a brand-new company as of April 4th of last year, but we've got actually a very rich heritage. We came from a company called Colfax. It was founded by Mitch and Steve Rales, who founded the extremely successful Danaher Corporation. And our med tech businesses have rich and deep heritage within the orthopedics space as well. You can read the forward-looking statement. I'm going to talk a little bit about our markets and our positions in them and what's great about those positions in the markets, talk about our strategy for how we're going to grow our company high single digits organically, increase our margins over time and then complement that organic growth with strategic acquisitions that drive compounding shareholder value. And also going to talk a little bit along the way about some of the great progress and momentum that we've been building. So as I said, we were a brand-new company. This is a picture from April 4th. We had been a diversified company for a number of years and went through a reshaping of our portfolio that ultimately led to our -- all of our industrial businesses being sold or spun off and us becoming a focused med tech company initially in the orthopedic space. We renamed the company, symbolizing innovation and vision of the future and that "O" in the middle, that really shows how we're going to bring our continuous improvement history forward into these businesses to drive continuous improvement. As you can see from our vision, we're all about creating better patient outcomes and also bringing technologies to improve workflows in health care. We're also all about continuous improvement and having a culture and a business system to drive that. And our 6,000 associates around the world are absolutely passionate about what we do for our patients. This page introduces our company. We're about $1.6 billion of revenue. About 2/3 of that is in our prevention and recovery segment, which is leadership positions, and bracing and rehab, I'll talk more about that. About 1/3 of the company is our fast-growing Recon segment. And Recon was about 20% of the company back in 2018. So we've really been aggressively growing organically and inorganically that double-digit growth Recon part of our company. We're global, but with the largest position in the most attractive market, the U.S. here. And our P&R businesses have been very global for a long time. We really globalized our Recon business pretty aggressively in 2021 with the acquisition of a company called Mathys. We serve great markets, over $50 billion in the huge orthopedics market that grows about 4% overall, driven by the -- some of the drivers on the right-hand side, like aging populations. And our Recon business is in -- as you can see on the page, we participate in about $20 billion of surgical business in hips and knees and extremities. And we're disproportionately weighted towards the extremities, which as you can see on the page, is the highest growth part of the entire orthopedics space. Our P&R business, we're about a $1 billion player in a $5 billion global market, and so really more leadership positions there. And what's great about our P&R business, you can see on the page, it touches all of the surgical parts of orthopedics, the ones we're in and the ones we're not and it creates synergy into those businesses, but also deep insights into those businesses. So when we decide to go somewhere like foot and ankle, where we made 3 acquisitions in the past few years, we already know that market very deeply and know what it takes to win there, and we're able to choose whether we enter the whole market or the most attractive parts. And then as we enter, we've got some synergy back to our P&R businesses. A little bit more about the 2 segments. P&R, as I said, leading positions, #1 in bracing globally, iconic brands like DonJoy and Aircast, #1 globally in key areas of rehab with Chattanooga being a very powerful global brand. We acquired a fast-growing laser business called LiteCure a few years ago, a great addition to this business as well. Our Recon segment on the right, about $0.5 billion, very fast growing. And you can see shoulder and foot and ankle, they make up that extremities part. That's about half of this segment for us that is high single-digit market growth. And then we've got small positions in the huge hip knee market, where we're about a 1.5%, 2% share player that grow substantially higher than the market every year, as I'll talk about. Our Recon business has grown double-digit consistently, except for a COVID year for many years, and we've got a strategy to continue that double-digit growth. And the biggest part of the business, shoulder, one of the top shoulder companies in the world, and we've really pioneered the lateralized Reverse Shoulder. So Reverse Shoulder has become the preferred way to do shoulder implants and then lateralized as the design has also become the preferred design. And so we've really got a great leadership position in the technology within the shoulder space. And then we've acquired 3 foot and ankle businesses, and I showed the DynaNail technology. One of the 3 businesses we bought, a business called MedShape, has a tremendous technology with a lot of IP that's used in fracture healing. Something that makes us unique is that we're the only player in orthopedics that plays along the full continuum of care, from before surgery to surgery to the recovery after surgery. And historically, this has been an advantage as we were building our surgical business, the well-known DonJoy brand, and presence was something that helped us to get people to take a look at our great surgical products like our Empowr Knee that is just a better knee. And so we've had synergy over time from this position in the continuum of care. Today and going forward, there's even more strategic leverage from this continuum of care. The rapid growth in the ASC is leading to often entities that have multiple areas of participation within this continuum of care. They've got a surgical theater in ASC. They got rehab right next to it. And we already participate in the rehab side. Now we're involved in the surgery. In many cases, we've also got workflow solutions for their orthopedic clinics that are adjacent to that. And so the trends towards more ASCs are advantaging a player like us that plays along this continuum of care. And the new opportunity in connected medicine, which is early days in terms of things like connected braces that can follow the patient journey throughout this whole continuum are something that really creates a real opportunity for someone like us that plays before, after and during surgery to create strategic advantage over time. This page really shows what's exciting about us for investors. In orthopedics, there are a handful of very large players who play on the top of this triangle, tremendous companies, well-respected companies. But with the scale and scope that they have in the orthopedic space, there are limits to the kind of organic growth that they can consistently generate, then they show how high the margins can be, but it's challenging to keep driving the margins up from there. For us, in the mid-tier, we're scaled enough to have good margins and have the opportunity for good, healthy cash flow. But at the same time, we're agile enough to be able to grow consistently faster than the market and to pick and choose where else we go within orthopedics, so that we can enhance our growth as we expand in the space. And clearly, we have a lot of opportunity to grow our margins as you look at the larger players and where their margins are. And then finally, for a player like us that has compounding acquisitions as part of our strategy, that fragmented base of the triangle is extremely attractive as well. And we've already shown in the last 2 or 3 years how we can acquire companies and technologies and product lines from that base of the triangle, bring them in, create a strategic acceleration in our company, create a lot of value for shareholders in our company. And I think we've already got a reputation in the space as a great acquirer, someone that if we acquire a business, you're going to become a part of something exciting and special that's playing out at Enovis. We've been able to retain the lion's share of the talent of the businesses that we've acquired. And I think that over time, that's going to be a hallmark of ours. We've got a great team. Across the bottom, you can see our leadership team, a really great depth of orthopedics and broader med tech experience, but then also some terrific experience in very high-performing business systems and companies. Our Board is across the top, diverse, deep and wide in med tech, just great capabilities. We took the separation that we went through and the creation of a focused med tech company to continue to shape this Board to what it is today, and it's something I feel very fortunate to have such a tremendous Board to guide us as we go. One of the things that makes us distinctive is our commitment to our EGX business system. As I said, we were founded by the Rales Brothers and have roots that go back through Colfax to Danaher. And for many years at Colfax, we've been cultivating a culture of continuous improvement, a focus on talent that has an appetite for continuous improvement and how we train and develop that talent. And then tools and processes to drive continuous improvement that is sustainable across all parts of the business from the supply chain through the innovation engine, the commercial engines, how we do strategy, how we drive successful acquisitions and how we build a support infrastructure that can scale as we grow. We've got a great start. We're almost 4 years in now since we acquired our current MedTech businesses. So we've had a really a great start now in terms of getting moving on this journey of continuous improvement with our EGX business system. I showed a couple of the operational supply chain examples on the right of big improvements in our safety performance and our plans, great improvements in how well we serve customers, a large warehouse where we made dramatic improvements with a lot of different Kaizen in terms of our lines per hour of shipping. So these operational improvements with the business system are foundational. And over time, we've also made improvements to other areas, but making the foundational improvements in operations in all of the places that I've applied this business system over time are the start and then you build from there and keep moving through all different parts of the business as we've been doing in past years. So I'm very excited about the start that we've had, bringing EGX into these businesses, and we took the opportunity with the creation of Enovis to really put even more energy into our business system. We name it, Enovis Growth Excellence and really emphasize the growth parts of it as much as the operational parts of it and get our teams even more excited about applying this business system. We've got a clear view of how we're going to grow our company to $2 billion and beyond in the coming years. We really within our existing businesses, we've got a clear runway to get in the next couple of years to $2 billion between organic growth and a little bit of acquisition that we've got plenty of firepower for. Beyond that, there's plenty of opportunity to continue to expand and grow in existing segments, but also interesting opportunities that will be logically adjacent to orthopedics, but move us into other attractive areas within med tech. We're clearly focused on building a company that consistently can grow high single digits organically by growing our Recon business double digits as it gets to be a larger and larger part of the company and growing our P&R business in the mid-single-digit range, a little above those P&R markets. That's the formula for high single-digit growth and then doing acquisitions over the way is how we'll also then complement that and grow even faster. And we've got a clear view of how we'll expand our margins as we grow our company. This page talks a little bit about some of our key strategic focus areas. Within P&R, we're focused on shaping that business for sustained mid-single-digit growth, a little higher than the markets we participate in. We're a leader. So we know that if we do the right things, we can grow a little faster than the markets we participate in. In Recon, we're focused on aggressive growth, aggressive organic growth and also expansions of that platform into other attractive areas in the Recon space. And one of the great things about growing our Recon business fast is that the gross margins are meaningfully higher in Recon than in P&R. So as we grow our Recon business fast, we have a natural mix improvement that is happening in our portfolio. And then we're also focused on complementing that mix improvement with operational and scale-based improvement with our EGX business system that get us a long journey of margin improvement. And then finally, we're focused on the right acquisitions that accelerate our strategy and shape our company in an attractive direction. And on the right-hand side, you can see that the way that will drive these strategies at about innovation for better outcomes, digital technologies and using our business system to create the right supply chains and commercial engines. A little more about P&R on this page. We've been focused on rebuilding a strong innovation engine here. It's a business that under previous ownership, had not been invested in. And so the innovation had really tailed off to close to none for a couple of years. We quickly doubled the innovation, doubled the vitality in the business. It's gone up further in '22 and it'll get into the 20s in the coming years. So getting back to what we should do as a leader, right, consistent innovation in a business like that. We're also focused on digital workflows. Over the past handful of years, we have built a very strong position in orthopedic clinics with our MotionMD software that's used to really run key aspects of those clinics. It's very sticky, creates a strong position in those clinics. And then some of them gets us software revenues and others we get to participate more deeply in the products that we sell in those clinics. We're also starting a strategic journey on connected medicine. We launched a terrific connected knee brace and sleeve in 2022. A lot of excitement by surgeons about the potential to create better compliance on the backside of surgery to empower patients in their recovery and really lead to better outcomes at a lower total cost. This is something that's going to take time to build, but we're very excited to be out there leading the way in the industry, and we think it's going to create a whole another wave of innovation beyond form and function in bracing, a wave of innovation for many years to come in terms of connected braces. And then finally, we are focused on investing in attractive rehab and recovery modalities. That's the area that's growing the fastest in the rehab space. We acquired LiteCure, a high-powered laser company a few years back, really very fast growth going on with that technology. We've doubled the sales force that sells those lasers into human and companion environments. And we're also working organically on other forms of high-growth modalities to accelerate the growth of our rehab businesses. This page shows how the P&R growth has developed over time. If you went back further in time, there was a long run of time when the P&R businesses grew about mid-single digits, a little over market because they were managed well. There was a period of time they were not managed well. They were underinvested in. The growth slowed down to 3% and then went negative for about 1.5 years. We acquired the business, quickly got the supply chain back in good shape, put some investment into new products and into improving the innovation engine and leverage the position in the clinics with workflow, quickly got the business growing again, 2% for '19, much more than that for the back half of '19, outgrew the markets through COVID. There are some objective sources we can go to, to see how we go do versus the markets. So we've consistently outgrown the markets through COVID and grew about 4% for the first 9 months of last year, which we're confident is above the markets that we serve. So this is a business that we expect to be able to grow in the low single digits plus and then really solidify it in a mid-single-digit range as really a very strong and powerful cash generator in our company that helps to fuel the things that we do in other parts of the company. In Recon, we're focused on leveraging 2 flagship products for share gain. We've got ultimate Reverse Shoulder. We pioneered the Reverse Shoulder, and we developed a technology that is lateralized and has proven to be the better way to do Reverse Shoulder. And so we've been at for a number of years to grow very fast in the shoulder space based on our phenomenal AltiVate product. We continue to do very well in the U.S. And now that we've globalized our business, we're able to take AltiVate around the world. In knee, our Empowr 3D Knee is a better knee, is a knee that was designed with kinematics that more closely resemble the natural knee. And over time, as we've been able to get people to try that knee, they find that it makes their patients more satisfied and getting that -- there are always good outcomes in knee, but the satisfaction was lower. We're getting the satisfaction now higher as well. That's been able to get us systematically adding more and more and more knee surgeons over time. And then as we've innovated to bring other parts of the hip and knee and shoulder offering, we've been able to sell more and more into those surgeons. We're also focused on winning in the ASC. Our knee is a product that is a very good fit for the ASC. So we've done well there. We've had other offerings that are focused on that ASC environment, including our recent Arvis launch of an augmented reality solution that is small and inexpensive and adds very little time to the procedure. So a very fit-for-purpose solution for the ASC, plenty good for a hospital, but extremely good for an ASC. And then we're growing in scale in our foot and ankle business that we've acquired and -- we acquired Mathys to expand globally and have been really bringing our products from outside the U.S. into the Mathys channel in the second half of next last year to accelerate their growth and have got great cross-selling opportunities for many years to come through that Mathys acquisition and also some tremendous cost synergies that we've been working through in that acquisition as well. So the most common question we get is, well, you've been growing double digits in Recon, why do you believe you can keep doing that? And so I wanted to just spend a few minutes talking about that. This is a pretty detailed page that we created a little while back, and we just updated it with 9 months of 2022. But it essentially lays out the math piece by piece of how we have been growing double digits in Recon and how we will grow double digits in Recon. It starts from market exposure. Our Recon portfolio is 50% extremities. And so our weighted average market growth rate is already in the 5% to 6% range versus a Recon market that's in, say, the 3% to 4% range. So we start out with an advantage from the shape of our portfolio. Even within that, we've got extra exposure to Reverse Shoulder, extra exposure to the ASC. And so you might argue that we've got an even higher WAMGR than I show on the page. And then we've consistently outgrown the market through the innovation we bring and how that enables us to convert surgeons and sell more deeply into those surgeons. And it's been implant innovation, largely to date. But then with Arvis, now we're getting into more and more enabling technologies to complement those implant innovations. And then -- so we're confident that we can do that. The first 2 rows here are only just continuing what we've demonstrated, right? We have grown in this range. I'll show it on the next page, and we did it in the first 9 months of last year, and we expect to be able to continue to. Our foot and ankle business, 2 out of the 3 pieces we bought had been consistently growing well into the double digits. The third, the STAR Ankle, we knew we had to modernize. And as we do that, that whole portfolio, we'll be able to grow double digits. You can see it only grew 8% 9 months last year, but we announced on our Q3 call that it grew double digits in Q3 and that we expected it to grow double digits in Q4. So a very clear path to get foot and ankle solidly in the double-digit range. And Mathys historically was about a mid-single-digit grower, but with the synergy that we're bringing from bringing cross-selling products in and some of the investments that we've enabled them to make in channel, Mathys is already growing in the double digits. But over time, we expect it to be able to at least grow high single digits. This is just the U.S. part, so 60% of our Recon segment, almost 10 years of 14% CAGR, including the COVID year on the shoulder side, almost 10 years a 17% CAGR, including the COVID year on the hip and knee side, consistent year-by-year, quarter-by-quarter, and you can see the 9 months of last year numbers as well. So a lot of proven track record that we can grow these businesses very aggressively. And also, we've been still doing the right things in terms of putting fuel on them in terms of innovation, both traditional and newer innovation to be able to continue this growth path. And Mathys has opened up more pastures in terms of where we can go to expand and grow the business as well. Obviously, enabling tech and computer-assisted surgery has become an important part of the equation in Recon. We have a clear strategy there. We're focusing on making sure we've got the right solution for each part of the anatomy. We've had a great solution for shoulder with Match Point, a great planning and PSI solution, and we're going to continue to stay on the forefront in shoulder. In foot and ankle, we just brought out a terrific preoperative planning and PSI solution that was needed there for the STAR Ankle. And we launched Arvis last year that brings us a state-of-the-art guidance technology for hip and knee initially, but certainly with opportunities to extend into other technologies. And so we've been focused to make sure we got the right solution throughout the workflow and making sure that whatever we do is fit for purpose for the ASC. We figure if it's great in the ASC, it can just as well be used back in the hospital, but let's be great in the place that's growing the fastest and then make sure that we're good enough back in the environment that's not growing. Margins are a key part of how we're going to create value over time. We've got a clear path for how to expand our margins over time. I think we've talked very openly about the fact that we can clearly see getting from the 16 or so percent that we had back in '21 to 20% plus, and that 20% is not the ceiling, but that our EBITDA margins can continue to go from there when you benchmark and think about and look at what we can do. How we get there is a combination of the natural mix that comes from growing Recon faster, acquisitions that we've done that have high gross margins, but haven't scaled yet. And then a whole range of operational opportunities ranging from pulling back the price/cost pressure we've had during COVID in our P&R businesses. to operating leverage as we grow and productivity improvements and scale in our company as we grow. We're confident we can grow at least 50 basis points of margin expansion over time. Certainly, the opportunity to do a lot more than that should inflation abate quickly or should we bring more revenue in quicker that we can scale our structure, but we're confident that we can climb up the curve consistently and surpass that 20% plus margins over time. And then finally, acquisitions, lots of opportunities, both within our existing markets and extensions and expansions beyond. And really the things we've done in the past 3, 4 years are very representative of the opportunities that we have in our funnel today, right, an entry into the high-growth foot and ankle segment, buying through businesses, integrating them together, bringing technologies into our Recon business like augmented reality that enable us to continue our very strong share gain and growth there, high-growth modalities that shape our P&R platform in a positive direction and global expansion. There's well over $300 million of revenue on this page that we've acquired over the past handful of years that's growing at double digits, that's accretive to our gross margins, and there is opportunity to scale over time. And we've got plenty of firepower with about 1x leverage. We've got plenty of opportunity to invest in these kinds of acquisitions and others over time. So hopefully, you got a good feel for what we're all about as a company, the great position we've got in a great market for our strategy for how we're going to compound value through high single-digit organic growth, attractive acquisitions that complement that and driving our margins up continuously over time. We've got some great momentum building some great progress last year and very excited about what's come here in 2023. Thank you.

Thank you. So we'll move on to the Q&A a little bit. I guess being a little bit more broadly on high level, do you mind talking a little bit about what you're seeing within the elective surgery market specifically?

Yes, sure. I mean, obviously, we can't comment on our own business in the fourth quarter, but I can definitely talk about the things that are out there in the public domain that I've seen and heard. We talked on our quarterly call in Q3 about elective surgery trends, expecting kind of a normal seasonal increase as in the fourth quarter, which would then set things up well in terms of how things would roll over into 2023. And everything I've read supports that, that there was kind of that normal seasonal uptick. There's a few things about maybe some extra vacations in December and things. But by and large, everything I've read says that elective surgery saw that normal seasonal uptick. We also have a number of clinical businesses that drive our orthopedic clinics and get people getting into orthopedic clinics. I think if you look at a lot of the public information that's out there from the fourth quarter about med tech businesses that are in clinics, I think there's some -- there was some pressure in the fourth quarter in terms of clinic traffic and staffing issues and things like that. And so I think some transitory kinds of things going on in the clinic driven parts of the business, elective surgery, normal seasonal uptick.

Great. And maybe can you talk about the last 9 months since the spin and since you became a separate company, -- has it been what you experienced? And has there been any surprises, challenges or anything like that?

Yes, sure. Well, I'm incredibly proud of our team in that we got to the separation in great shape right on time, and I think it was very well executed. I think Enovis got to start its life in a powerful way with a new brand, some good momentum, building a great team and Board. And ESAB, the business we spun off, started its life in a terrific way with good momentum as well. And so I'm really proud of the team in terms of how everybody really worked through that separation. I think it's been extremely exciting for our team. I've been impressed at how fast we've been able to get the industry to know who Enovis is. This industry is a small industry. I've learned pretty quickly over the past 3 or 4 years. And Ortho world every day is talking about someone. And so it's been terrific how fast we have become Enovis and people know who Enovis is. And we haven't lost the heritage of DJO. We haven't lost the heritage of Colfax. I think people know that we've got each of those, but they know who Enovis is and have started to understand who we are and what we're going to be all about. So I'm extremely excited about that. I think we've made a lot of great progress in the year. I'm excited about our acquisitions and how they've been doing and also about some of the key share gain that we made. We made share gain, we think across essentially every business through the year, significant share gain in our Recon businesses, again. So a lot of great things in the year. Certainly, some of the kind of up and down markets as we worked through the year were not ideal. It felt in May, like things we're going to really kick for the rest of the year potentially. And that would have been really fun, our first year as a new company, just have the markets really terrific all the way through. But that summer slowdown took a little bit out of what could have been a pretty fantastic year in terms of how the markets -- the demand markets treated us. And certainly, the inflation and FX pressure through the year was not ideal and led to some extra things to deal with. But I think we're really proud. We're proud of what we did on the growth front in terms of outperforming our competition. And we're proud that in a year when most people are not improving margins, we're on track to have our margins improve, and we think that shows that we have that underlying capability to climb up the margin curve, and we'll be able to do it over time.

Yes. And so hitting on like the inflation and foreign exchange rates, has there been a specific impact in terms of your supply chain or just about the business in general, specifically? Or have you had any issues with that?

Yes. So as far as inflation, the biggest inflation we've seen is on inputs and freight. And we started to see that quickly in kind of late '20 in our P&R businesses. So we've been finding that for a couple of years. And we got quite a bit of squeeze in late '20 throughout '21 and then started to get some price through to offset that and got another wave of inflation here in early 2022 that was not ideal, but we've been working hard. And I think in the back half of the year, I've gotten back to where we're starting to pull back a little of price versus cost. Seems like that part of it has largely stabilized. And so we're trying to be a little careful in our planning in that there could be another wave of inflation. So let's be a little careful about how we plan for 2023. But we're hopeful that 2023 is a year where we start to pull back some of the price versus cost. In terms of availability in the supply chain, our teams have done a fantastic job. We had already laid the foundation of our business system. So there was a lot of good discipline there. We made the call on putting inventory in to protect our customers. And so we did consume quite a bit of cash and putting inventory in to protect our customers. But we're confident that in P&R, we serve customers better through this period than our competitors did. Within Recon, we've done a nice job continuing to serve customers. And so we feel like, yes, it's been tough in terms of product availability, but we've been able to navigate through it between the discipline of our business system, our willingness to invest to protect customers.

Great. And touching a little bit upon this in your presentation, but can you talk a little bit about your new capital structure and organic growth as it relates to following the monetization of your attained stake?

Yes, I'll take that one. Thanks. So as Matt said in the presentation, we're about 1x net leverage right now, have access to plenty of capital, about $1 billion if we wanted to lever up in terms of executing our strategy around M&A and investing in the growth drivers of the business. The retained stake was all part of the tax-free spin. All of that went as planned other than the fact that the market was a little bit softer than when we originally anticipated going forward. But overall, I'd say we have ample capacity for growth. We have great banking relationships, a great track record of being able to do deals and diversity of types of deals. So nothing should slow us down as we go to execute our strategy with capital structure.

Great. And maybe going a little bit more of detail into that, how are you thinking about your M&A strategy kind of looking into the new year?