Enovis Corporation (ENOV) Earnings Call Transcript & Summary

All right. Thank you. Good morning. Why don't we get started? My name is Jeff Johnson. I'm the senior medical technology analyst at Baird, and our first presentation this morning is from Enovis Corporation, a leader in the $4 billion Prevention & Recovery markets and in the $38 billion global orthopedic implant market. With us today from Enovis, we're happy to have CEO, Matt Trerotola; Chief Financial Officer, Ben Berry. And Matt, I'm going to turn it over to you, if you have a few minutes of prepared remarks, and then we'll go straight into Q&A. Thanks.

Yes, sounds good. Thanks. Thanks a lot, Jeff. Hey, everybody. Great to see you. Thanks for being here and for tuning in. Glad to have an opportunity to share a little bit about our company. I'll start with forward-looking statements comments here. And to introduce our company, we are a MedTech growth company, Enovis. Historically, we were founded by Mitch and Steve Rales, the brothers that founded the enormously successful Danaher Corporation and they had a similar business system of acquiring and improving businesses and driving innovation and talent through those businesses to create compounding shareholder value. And in recent years, we've shaped our company into this MedTech focused Enovis with leading position in key areas in orthopedics. On the right side -- left side of the page, you can see, we're about $2 billion, approaching $2 billion of revenue, healthy margins but room to expand from there. Global, but room to continue to globalize as well, and a little over 60% of our companies in Prevention & Rehabilitation and approaching 40% is in Recon and a higher portion of our profits is there. And you can see our strategic financial goals on the right. We're really focused on building a company that consistently grows high single digits organically between the double-digit growth of the Recon segment as it gets larger and larger within our company and then mid-single-digit growth in P&R. Scaling to $2 billion plus in sales in the coming year or so and continuously expanding our margins by at least 50 basis points with a clear view of how to get to at least 20% EBITDA margins and certainly no opportunity -- plenty of opportunity to go beyond that. We participate in a huge and attractive markets, $50 billion-plus orthopedics market with some great growth drivers. And if you look at the left side of the page, the larger part of that market is all of the surgical parts that are shown in gray, and you can see circle there is the part that we participate in with our Recon business. And what's great about this is that our Recon business is about 50% extremities. And you can see from the page that extremities is the fastest-growing segment on the whole page. And so we've got a very attractive market footprint of our Recon business, better than the larger Recon players in terms of market footprint. We've also got small share growing very fast in the very large Hip and Knee markets. Our P&R segment participates in the $5 billion market, and you can see here is a great segment in that it connects with all of these surgical segments. I'll talk about that in a minute. And so we see and understand, have access to all these areas of surgery, and we have a leading position in key areas within that P&R segment that grows at about the overall average growth rate of the orthopedics market. A little more about our company here on the left. Our P&R segment leading positions, a global leadership position in embracing with our iconic DonJoy and Aircast brands, leading position in key areas of rehabilitation with our Chattanooga brand and more recently, the fast growth of our LiteCure laser technologies. And then on the right side, you can see our reconstructive segment. You can see that Shoulder and Foot & Ankle that makes up the 50% extremities that makes it such an attractive portfolio and then the smaller fast-growing positions in Hip and Knee. We've consistently grown this Recon business double digits organically, and that's powered by the Shoulder being the biggest segment and being the most attractive segment in the Recon space and by the innovation that we bring as a leader in Shoulder and also by innovation we bring across all these other segments. Across the bottom, you could see some of our key Recon products, the AltiVate Shoulder. We pioneered the lateralized reverse, which has proven to be the best way to do a reverse, and reverse is the technology that is taking over the majority of shoulder implants. So a terrific position there, a lot of data, a lot of history, very strong position that has fueled our strong growth in shoulder. Our EMPOWR knee is just a better knee. It pivots -- dual pivot immediately and laterally, leading to a patient having it feel more likely their own knee, being able to stay more active. It fits the more active patient better, which is the patient that is self select, being selected into the ASC. And so we've done very well in Hip and Knee with our EMPOWR franchise. And then finally, we have acquired and built a Foot & Ankle business with a number of great technologies. Highlighted on the page is DynaNail, which is a terrific technology for fusing bones together by a shaped metal alloy that creates continuous pressure to hold the joint together, a very differentiated technology that's been growing very fast in our Foot & Ankle business and one of a number of great differentiated technologies. We are unique in orthopedics, in that we have significant positions along this continuum of care before, during and after surgery. And historically, this has been a real asset as we've been able to get contract access and access to different KOLs to help with thinking about different kinds of designs and have brand strength and knowledge across this continuum. Currently and in the future, there are new dimensions of synergy through our participation across this continuum. As ASC is a very fast-growing part of the market and has helped to fuel our strong Recon growth in many ASCs and the ownership of ASCs cut across multiple parts of this continuum. And so our participation along the continuum is a strength as we compete in that ASC environment. In addition, as digital technologies can create connected medicine opportunities to track patients and follow data through this continuum, our participation along the continuum puts us in a great place to bring those kinds of digital solutions that create strategic advantage, opportunity to capture data, have feedback loops of data over time. So we've got great growth opportunities. We also have great margin opportunities and traction. We have a clear view of how we can expand our margins by at least 50 basis points a year. And really, that comes from, first, mix. We grow our Recon business faster. Our Recon business has significantly higher gross margins. And so we get that mix effect that just comes from our strategy and how we grow. Second, we've done a number of great acquisitions, and we've got an opportunity to scale these acquisitions that have high gross margins, and that's been helping and is going to continue to help as well. And then finally, operating leverage and productivity. We've got a powerful EGX business system, which is based on continuous improvement and lean, and we use that to drive productivity, operating leverage. We've also been using it to pull back the price cost squeeze that we had, particularly in our P&R businesses a few years ago. And you've started to see all of these elements reading through in the strong margin progress that we've been showing over the past couple of years, and we've got clear plans for how to continue that in the coming years. Acquisitions are also a key part of our model. We've done over a dozen acquisitions in the past handful of years in the orthopedic space. And these have been along with -- along the lines of the kind of things that you see on this page, Product Line adds, Technology adds, geographic expansions and entrances into a whole new attractive space like Foot & Ankle. We've still got plenty of opportunity in terms of pipeline for these kinds of acquisitions and larger ones to think about over time that might take us into other areas within orthopedics or even into attractive adjacent areas within MedTech. We've got plenty of acquisition capability, about $1 billion of firepower. And we're really focused on making sure that these are strategic, they advance our strategies, that they're about organic growth enhancement and they're about gross margin enhancement that allows us to invest more in innovation for growth and also creates that scaling headway and room on our bottom line margins. This page really talks about some of the huge impact we've had from acquisitions in recent years. A few years back, we globalized our Recon business with the acquisition of Mathys. That was a business that was approaching $150 million in revenue outside the U.S. when we acquired it. You could see, it was a mid-single-digit grower historically with margins in about the high single-digit range in terms of EBITDA margins. We're off to a fantastic first couple of years in this acquisition, growing well into the double digits, certainly some market tailwinds helping there. But even without those tailwinds, a very strong growth acceleration that has come in that business from some of the investments we've made and some of the initial cross-selling synergy. We've also taken, on the bottom, you could see their EBITDA margins have about doubled over that time period from high single digit to high teens, driven off of a combination of gross margin expansion through synergy and productivity and mix as well as from starting to scale the business. So just a great story of successful growth and margin impact as well as an expansion of our footprint to drive our great Recon products into. And then on the right, we acquired a handful of great businesses to enter the Foot & Ankle space. Great technologies. We've now put a great channel together and have built a business that is breaking through $100 million. It's going to be a strong double-digit grower over time, very highest gross margins here starting from a lower bottom line margin, but with great opportunity to scale that business over time as well. And then finally, we're having a great year this year. You can see we've taken the outlook up twice. And you can see our most recent outlook in August, which is that high single-digit organic growth. That's our strategic goal for the business. showing some healthy margin expansion even in a year where there's still some inflation and FX pressure. And we updated this in August and still feel very comfortable with this outlook for the year. Thank you.

Well, thanks, Matt. That's a great overview. And so why don't we spend the last, what is it, 18 minutes here on some questions, if I could?

First one, it's going to be probably the theme of this entire conference, but it's GLP-1. And how do you think about the potential impact, I guess, of bending that obesity curve over the next 10, 20 years? Does that help your business? Hurt your business? Just how are you thinking about the broader impact potentially of breakthrough in obesity here?

Yes, it's a timely question, Jeff, obviously, right? Everybody is trying to call big winners and big losers as it relates to that trend that will be coming over time. I think for us, as we've thought about it, it's -- we're not a big winner or a big loser in this. It's potentially a small -- probably neutral, potentially a small help to our business. The logic for that, -- the largest segment of our business is still P&R, as I just talked about. Within P&R, the growth drivers are sports medicine and sports injuries, trauma and then surgery. And within surgery, a whole range of surgery, as you saw from the page there. And sports medicine and trauma, honestly, if anything, probably might be a little help to have less obesity leads to more active lifestyles and could lead to some more sports injuries and prevention and things like that. If you get over to the surgical side, there's certainly parts of the surgical world that you could argue that it might be a help in as part of the surgical world, where you could argue that it might be a little bit of a headwind. And so I think overall for us, we'd see it as neutral to a small tailwind, but really not a big impact on our business.

Yes. Okay. Fair enough. One follow-up there. Just on your Hip and Knee business, especially, any sense on what percentage of your cases maybe are done, BMI over 35 or 40? Or how many of your surgeons will defer those procedures if the BMI is over 35 or 40, will say, like, look, we just probably shouldn't do it here, slower recovery, whatever?

Yes. I don't know off the top of my head. What I'd say is outside the U.S., it's very rare that we'd have those high -- high BMIs. And so this is really kind of more of a U.S. phenomenon. And there, I think it's a smaller percentage versus a larger percentage, but I certainly can see that you could argue that there might be a tailwind from some patients that are able to get a little bit down the obesity curve and come into the queue. But I guess you could also argue that there could be a countervailing headwind in terms of patients that are at the front end of the queue, and they take a little longer to get there. But net-net, I don't think there's going to be a big impact.

Yes. Fair enough. All right. So the other kind of timely conversation I've been having with investors right now is just kind of the summer holidays. Was this a revenge travel summer more so than even last summer? So between just kind of summer seasonality and COVID backlog is the other discussion point. Are we through them already? Is there still kind of this backlog that can persist for the next year or two? So just summer seasonality and then COVID backlogs, just your latest thoughts on those two points.

Yes. Yes, sure. As far as the summer seasonality we're seeing things play out in line with the guidance that I just shared again there. We had expected to have more vacations again this year like last year, that at least for now seems to be a new shape of the year for elective surgery. And so we've seen that kind of July and August higher vacation rate like last year. But we're also seeing a very aggressive September and very aggressive October planning in terms of surgery schedules, similar to last year have kind of come back quickly from that. So we are still very comfortable with the sequential progression through the year and expecting to see a good strong push to the finish in elective surgery here. As far as the backlog topic, I think it's clear that the way we think about it is we missed probably almost 3 years of surgery through COVID, 3 years of growth, right? If you look at the kind of how much growth there was across a 4-year period in the whole industry, it was a little more than one year of growth, right? So there's maybe somewhere between 2 and 3 years of growth that didn't happen. And that's patients that, for the most case, have advanced in terms of their needs and should create excess demand on a go-forward basis. Now I think what we've seen play out is that, that excess demand sometimes takes the form of a true backlog. So in Germany this year, the lines got -- it was too long a wait for surgery. They found a way to open up more capacity in the early part of the year. And that's a true direct backlog that created some extra growth in Germany in the first half of this year. We'll see if that happens in the back half of the year still as well. But in many other parts of the world, in the U.S., in particular, I think it's less of a direct backlog of a bunch of patients waiting for surgery right now and more of a little bit of excess demand that creates the opportunity for a little bit of demand tailwind year after year after year. And so we do think that there's a little bit of backlog tailwind, particularly outside the U.S. In the early part of this year, the U.S. growth early in the year probably had a little more of an earlier easier comp phenomenon. And we do feel like for the next number of years, there's the opportunity for the industry to have a little bit of growth tailwind each year. And it's unlikely to come in one big lump but more likely to come kind of year in, year out, depending on the situation, how much supply there is available of places to do the surgeries and people to support the surgeries. And that capacity will probably open up a little bit over time, a little bit faster than it would have without this excess demand.

Okay. And just remind me what percentage of the Mathys business is in Germany, just as we -- I'm thinking about my model now, and do I need to account maybe in the first half of next year a little bit for that?

I want to say it's probably in the 10-or-so -- of our international business. Yes. So it's an effect, but it's not a super large effect. And I will also say that there are some areas outside the U.S. that have still been held back in the first half of the year. So it's a little bit of a balancing act in terms of the overall tailwind in the first half is less than just the Germany tailwind.

Fair enough. And then the other topic, at least in orthopedics, it seems like it's been pretty relevant here over the last 6 to 12 months on pricing. Are you seeing kind of those 3% pricing headwinds come down to anything less than that 3%? Or I use 3% as an industry-wide standard. You guys may be a little bit different than that. But just what are you seeing in those pricing headwinds that have been pretty consistent for the past decade, any change in that gating?

Yes. So we have historically experienced closer -- maybe more in the kind of 1% to 2% range because we're doing a lot of innovation, and we continue to do a lot of innovation. But for sure, familiar with the overall industry headwinds. And definitely, we had hoped and expected that with some of the inflation, that this might be a year where those price pressures kind of flatten out for a bit. And we are seeing some positive signs of some flattening of price as we're working our way through the year. We don't expect that to be a long-term effect, but we do see it as something helpful in an environment where there's still kind of inflation in labor and some of the inputs and things on the Recon side.

Yes. And that's what I was going to ask. Is that a Recon comment? And then maybe in P&R, if some of the pricing initiatives have been accepted?

Yes. So in PR, it's been a different story. We had a lot of inflation years ago that compressed our margins there. And so there, we did -- as a leader, we did quite a bit of proactive pricing into the market wherever we could and a lot of education from a reimbursement standpoint. And so in P&R, we've been able to get a point or two of positive price now for a couple of years in a row that some of that is coming from direct price to the market, and some of it is coming from reimbursement changes and improvements that affect our reimbursement business, but they also affect their direct customers that we've taken the price through into the market. And so I think that's something that is -- has enabled us to start to pull back some of the price cost squeeze in P&R. And on go-forward basis, we do expect that industry to go back. It's probably more of a 1%-ish price headwind in P&R historically. That could flex up or down a little bit in any given year. We expect that on the other side of this price cost pressure, that we will have quite a bit more muscle in terms of strategic pricing. And while there will be some industry market price pressure that starts to come again in the future in P&R, we feel like we'll be able to offset some of that with strategic pricing and maybe settle in at 0.5% a year type of pressure in P&R after we get through the next year or so.

Yes. All right. Fair enough. And then you mentioned it in your prepared remarks, but that double-digit growth on the Recon side, still feel comfortable with that over the multiyear basis? And just always in my mind, conceptually tough to do 2, 3x the market on a sustained basis. And that's double digits is getting at least to 2.5, if not 3x market. So just comfort there over the long term? And then what really sustains that?

Yes. So Jeff, you've seen -- we've now got a decade plus if you take out the COVID year of growing well into the double digits organically in our U.S. Surgical business through fantastic products like the ones I talked about, AltiVate and EMPOWR, a commitment to continuous innovation, great service to our customers and some great offers now for the ASC. That's the fastest-growing part of the market. And so we feel very comfortable that we can continue to grow our U.S. Surgical business kind of comfortably into the double digits range. And then we've taken the Mathys business and accelerated it into double digits. Even if we just grow the Mathys business, high single digits and then we get double digits in U.S. Surgical and Foot & Ankle, that takes us into the double-digit range. And certainly, from what we're seeing so far, there's the potential for us to grow double digits outside the U.S. depending on the market environment and depending on the rate at which we get at more of the synergies there. So yes, the formula will be a little different on a go-forward basis than in the past but we're still comfortable. And really, as far as that U.S. surgical part, the strength of our market footprint in terms of 50% extremities really helps because you're already -- we're starting already kind of pressing on high single digits in terms of our market growth rate. And then we sell more technologies into existing surgeons like we've been coming up the anatomic curve with our surgeons, where we've sold reverses for many years. We've been bringing additional things like the Revision Knee in. That allows us to get at that part of the Knee segment, it's about 20%. So we've got the market that's higher for us. And then we've got the chance to sell into existing surgeons. And then we've got conversions, which is something that we've done year in, year out successfully. And that formula gets us into that multiple times market growth consistently. It's going to flex. It's going to vary a little in any given quarter. We're comfortable year in, year out, we should be able to stay in that double-digit range.

Yes. And you mentioned the anatomic on the shoulder side, and we already know that's been one of the drivers here. What -- the U.S. Shoulder business, competition is picking up maybe a little bit there. We've seen new shoulder launches from Zimmer, Stryker. It seems like both of those companies are talking about robotic applications here, maybe next year, probably mid-'24, late '24, respectively, from those 2. Just how do you think of again, about the sustainability of the competitive advantage there? You're, what, a strong #3, if not #2 in shoulders. I think somewhere in that range. So just how does that market play out here over the next few years as your competitors are taking their game up as well?

Yes. Well, yes, sure, it's a great segment. So obviously, there's a lot of innovation going on in the segment. And we are committed to remain a leader. So we've continued to innovate in our AltiVate platform. We brought industry-leading planning technology, which has really been a key enabling tech there for the Shoulder. And we've got the opportunity to bring other enabling techs into Shoulder over time as that becomes an important part of the equation. And so we certainly are aware of the environment, but feel like we can continue to be an innovation leader in that environment and as an innovation leader with the best shoulder with the best long-term data, we'll be able to grow faster than the market.

Okay. And you've mentioned Mathys now a few times. Obviously, that seems like it's been a home run deal so far. So it's been very good for you. But just remind me again, maybe on timing or maybe not timing isn't the right word because you might already be there with one of them, but just EMPOWR and AltiVate. I think both those products being able to take a more lateralized reverse on the shoulder side into Europe that they haven't always been as lateral as AltiVate is and obviously, the dual mobility on EMPOWR. Just both those sound like they should be very appealing, maybe a little bit of prospect analysis or whatever to some of those surgeons get them comfortable with the more lateral approach in that. But just where are you with getting both those products into Mathys? And how do you think about the uptake of those 2 products?

Yes. So both great opportunities, right? Outside the U.S. is still ramping up through the conversion to reverse and then also is increasingly moving to a lateralized reverse philosophy. So great opportunity in Shoulder and Mathys has pretty strong anatomic footprint for us to sell into. And then Mathys was not particularly strong in knee, but got good access through their strong hip, and so the opportunity to bring EMPOWR in, great opportunities. Over the last year or two, we've done a lot of work in terms of setting the foundation, again, the pipeline of surgeons interested, continuing -- starting getting some of the initial usage and getting some of the additional regulatory clearances to be able to cover more of the market. And so at this point, we've got really good momentum in interest building, only a little bit of revenue in our growth that's so great now. There's just a little bit of revenue, so less than a point of growth coming from the cross-selling so far. And we can see that ramping to as much as, say, 3% to 5% or more of growth from cross-selling as we go forward. And the reason it's ramped relatively slowly so far has been priming the market. Also on the AltiVate side, we've got some regulatory clearances on the Small Shell, which our -- people could start using it without it, but the Small Shell was important to get them kind of fully using it on the EMPOWR side. We don't have Australia access yet with the EMPOWR. So there's been some market access things, but also, honestly, we've been pouring more supply into the very strong U.S. market and being a little bit slower, directing that supply after these cross-selling opportunities because they're going to be there, and we're going to get after them in the years to come and should see a really significant ramp.

All right. That's great. And then maybe here in the last couple of minutes, I'm going to shift over maybe skip a couple of P&R. I would assume kind of in that 3 to 4-ish range is the way to think about P&R.

Yes. Yes.

Just going to lock that in and use it generate some cash flow to kind of fund the investments on the other side of the house. Is that -- anything...

Yes, it's absolutely right. We can certainly see over time how we can shape P&R to be more of a 4% to 5% grower with the things we focus on and the things we focus less on and how we drive up the innovation curve. But right now, we're comfortably in the 3% to 4% range for that business. And it is -- now that we've gotten through the COVID ups and downs, it's starting to show some good healthy cash generating that helps to fund what we do on the Recon side. And it's also a part of our margin story today and into the future. Some attractive growth things within that business, though, in terms of, for example, what we're doing with laser in the rehab space. That's a very fast-growing business that we acquired and now we're building on and expanding on and doing innovation in. So over time, we'll get more and more of those growth things coming through that help to shape the growth of the business and shape the margins. But we're still going to drive Recon to more than half of the portfolio as fast we can.

Yes. Fair enough. My next get -- and so I'll turn this way. And we'll make sure we get Ben at least one question here in the last 1.5 minutes, but just on cash flow, I'll give you the tough question. So Obviously, inventory has been a big investment with supply chain challenges, and then I'm sure building up on some of the new product launches, things like that. So I think you are free cash flow negative through the first half of this year, but you've been talking about kind of a strong recovery in the back half. Just remind me, can inventory come down this year? Are you still targeting kind of 40% to 50% free cash flow conversion this year? Does that get back to 80%, 90% at some point down the road? Just cash flow.

Yes, absolutely. So we definitely wanted to protect the supply chain as we were dealing with some challenges in the market over the last couple of years. So definitely opportunities for us to drive efficiency in inventory. However, we are a growing business. So we'll continue to invest in working capital to support that growth, but maybe there's opportunity for us to drive some of that position down based on the excess that we brought in to protect the supply chain. So very confident that we have a strong pathway to 80%-plus free cash flow conversion over time. Like I've said, we're about 40% to 50% this year, expect to take another step forward in next year. Matt talked about some of the benefits that we have with P&R as we get that up to scale curve and expand the margins about how that cash supports the growth of the Recon business and helps us to continue to drive up that conversion curve. So definitely feel like we're on a good pathway here. We got a really healthy balance sheet. We're about 1.5x leverage right now. So access to capital is not a problem. We've closed 2 transactions in the middle of this year on the Foot & Ankle side. So overall, I feel like we're in a really good spot from a cash perspective.

Well, great. I think our time is up, so we'll leave it at that. But please join me in thanking Matt and Ben for a great overview here of Enovis. Thank you.

Thanks, Jeff.