Enovis CORP Q2 FY2022 Earnings Call

Ladies and gentlemen, thank you for standing by, and welcome to the Enovis Second Quarter 2022 Earnings Call. All lines have been placed on mute to prevent any background noise. After the speakers' presentation, there will be a question-and-answer session. I would now like to turn the call over to Derek Leckow. Please go ahead, sir.

Thank you, Paula. Good morning, everyone. Thank you for joining us today for our second quarter results conference call. I'm Derek Leckow, Vice President of Investor Relations. Joining me on the call today are Matt Trerotola, CEO; and Chris Hix, Executive Vice President and CFO; and also joining us this morning for a quick introduction before we get to the prepared remarks and Q&A is Ben Berry, who previously announced will serve as Enovis' CFO when Chris retires at the end of the year. Our earnings release was issued earlier this morning and is available in the Investors section of our website, enovis.com. We'll be using a slide presentation to walk you through today's call, which can also be found on our website. Both the audio and slide presentation of this call will be archived on the website later today and will be available until the next quarterly conference call. During this call, we'll be making some forward-looking statements about our beliefs and estimates regarding future events and results. These forward-looking statements are subject to risks and uncertainties, including those set forth in the safe harbor language in today's earnings release and in our filings with the SEC. Actual results may differ materially from any forward-looking statements that we make today. The forward-looking statements speak only as of today, and we do not assume any obligation or intent to update them except as required by law. With respect to any non-GAAP financial measures referenced during the call today, the accompanying reconciliation information relating to those measures can be found in our press release and in the appendix of today's slide presentation. You will note that we have provided reconciliation tables for each of the 2021 quarterly historical results on an adjusted stand-alone basis for comparability. With that, let me turn it over to Matt for some opening remarks, and then we will start with the earnings presentation. Matt?

Thank you, Derek. About a month ago, we announced our planned transition for the Enovis CFO role, which will culminate in Chris' retirement at the end of the year and Ben taking on the role. After his retirement, Chris will remain with us in an advisory capacity through 2023 to ensure a smooth transition. Chris was one of my first hires after I joined the Company as CEO back in 2015. His leadership has been pivotal to our operating improvements and to our strategic transformation to a pure-play MedTech company. He also raised the bar for the global finance function and attracted great talent like Ben, which strengthened the capabilities of the team. He had been considering his retirement path for a while, and I know that he's looking forward to spending more time with his family and friends and pursuing other passions. Ben joined us in early 2020 as the CFO of our MedTech segment after many years of finance leadership experience in the sector. We've been impressed with how quickly he's learned the business and immediately rose to the COVID challenges that emerged as he walked in the door. Ben has made a meaningful impact on our operational performance and growth strategy in a short time, and he's a strong leader with high integrity, and I'm confident that he'll build on the strong foundation that Chris has established. I look forward to working with Ben as we establish Enovis as a high-performing MedTech company. You'll get to know Ben more in the coming quarters. I've asked him to briefly introduce himself on this call. Ben?

Thanks, Matt. I'm really excited about the opportunity and the extremely bright future we have in front of us at Enovis. I've spent my entire career in the MedTech space. Prior to joining Enovis, I served in a number of finance leadership roles with Novartis and Alcon, and I played a key role in the successful spinout of Alcon in 2019. What attracted me to Enovis is the really great potential this business has—fast growth, expansion capabilities, and a great foundation and business system that was established by Colfax. Being part of the organization over the last couple of years has only strengthened my view of the significant growth opportunities we have at the Company. I really look forward to partnering with Chris during this transition and continuing to work with Matt, Brady, and the rest of the leadership team to build Enovis into a high-value growth company. Now I'll turn it back over to Matt, who will start on Slide 3.

Thanks, Ben. Now let's get into the Q2 discussion. We've had strong growth and solid operating performance so far this year, executing in line with our plan. We remain confident in achieving our strategic goals of sustainable, high single-digit organic revenue growth, 20% adjusted EBITDA margins, and over $2 billion in annual sales in the coming years. I want to take a moment here to acknowledge the foundation of our success: our global team of talented associates. I thank them for their contributions in the first half of 2022. In June, we had our first leadership conference at Enovis, and it was face to face. It's great to be doing things a lot more face to face these days. It was incredible to see the energy and excitement we created through the launch and the separation of Enovis. We discussed growth plans, how we're applying our EGX toolkit throughout the Company, and our purpose, values, and behaviors that shape our continuous improvement culture. I am incredibly proud of our team and confident in their ability to continue to build a fantastic growth company. Turning to Slide 4. We're achieving our operational goals in 2022 with double-digit top-line growth and organic growth in the solid mid-single digits. Our organic growth of just over 5% for the first half of the year has us on track for our 6% to 9% full-year guide and clearly shows our capability to grow high single-digit organic in more normalized markets. On this page, you can see our second-quarter highlights, including an 11% increase in sales. Once again, both of our business segments outperformed their markets, leveraging our innovation and commercial muscle to gain share while providing reliable service to customers despite the supply chain challenges. We also achieved 11% growth in EBITDA, and we held the line on EBITDA margins even with unprecedented inflation and some lingering COVID-related market impacts, such as delayed surgeries and pressure on staffing. We had 30 basis points of margin improvement in the first half and still expect to have strong improvement for the full year as a solid step towards our 20% strategic goal. We completed two acquisitions in the quarter, Insight Medical Systems and 360 Med Care. And on Slide 5, I want to highlight the ARVIS technology that we acquired via Insight. ARVIS AR is a key element of our surgical enabling technologies ecosystem. As part of our strategic focus on delivering measurably better outcomes, we are focused on creating technology-enabled workflows for surgeons tailored to their procedures and operating environments. In shoulder, our Match Point solution is used broadly by surgeons to digitally plan their surgery and create 3D-printed patient-specific instruments to enable greater efficiency and precision. In hip and knee, there is strong surgeon demand for guidance and positioning to drive repeatable outcomes and for the marketing benefits of having the newest technologies for patients. Existing guidance and robotics platforms improve accuracy but can be costly and consume quite a bit of time in the procedure and too much space in the operating theater. Our strategic focus has been on delivering even higher accuracy and efficiency at a smaller footprint and a lower cost. We partnered with Insight for the past three years to accelerate the development and commercialization of their breakthrough guidance technology. With the acquisition of Insight, we are launching our state-of-the-art augmented reality surgical guidance solution, ARVIS, with an initial focus on hip and knee. ARVIS is a cutting-edge, easy-to-use technology that is highly precise and accessible at a lower cost and footprint than current assisted surgery offerings in the marketplace. The ARVIS headset provides a surgeon with critical real-time data while leaving an unobstructed view so the surgeon never takes their eyes off the patient. With a single instrument set and no need for preoperative scan, ARVIS is a streamlined and efficient part of the overall surgical procedure. The feedback from our first 200 cases has been fantastic, with surgeons at the world's top institutions like the Mayo Clinic already seeing great success using this technology. Even more exciting, the small, lightweight, self-contained nature of ARVIS is a perfect solution for the high-growth ASC segment. ARVIS is just the fuel our teams need to continue our strong share gain in knee and hip implants in the U.S. and also generate additional high-margin revenue streams. We also see potential for extension into extremities and for globalization. Turning to Slide 6. We summarize our 47% Recon segment growth that includes high single-digit organic growth against a tough comp. This performance is well above market growth rates again and includes 14% growth in U.S. hips and knees and 8% growth in U.S. extremities, with double-digit growth in shoulder. Our year-to-date organic growth overall in U.S. Recon is 10%, which we believe is about 3x the market. Our Mathys business pro forma organic growth was about 10% in Q2, and we've only just begun to see the synergy benefits we expect as we proceed through the second half. As we commented last quarter, we're seeing some short-term fluctuations at this stage of the COVID recovery, but we remain encouraged by the continued growth in elective surgery volumes around the world. Our prevention and recovery business also demonstrated attractive growth as shown on Slide 7. Our 4% sales per day growth was better than underlying markets and in line with our three-year plan to create a consistent mid-single-digit grower in this segment. In this quarter, we grew faster in international P&R markets as U.S. growth moderated a bit due to a strong comp and some short-term market pressure. Our global bracing business also grew mid-single digits, and we have a strong pipeline of new product launches ahead, which will support solid mid-teens vitality index. We saw additional supply chain and wage inflation in Q2 in P&R and are deploying additional price increases to offset it. We remain confident in our ability to pull back the significant price/cost compression we saw in this business over the past few years as inflation stabilizes.

Thanks, Matt, and thank you for the kind words earlier. And Ben, it's absolutely great to have you as our future CFO. I'm really excited for you and the future of the Company with you as the finance chief for the business. Thank you. We had another quarter of double-digit sales growth in Q2, including strong contributions from our recent acquisitions. Year-over-year currency headwinds stepped in from one point last quarter to three points in the second quarter. As previously discussed, we had about two points of lower sales from fewer selling days, and our Q2 sales per day growth of 5% was similar to Q1 and about in line with our expectations for the upcoming third quarter. Matt covered other sales details earlier, including the impact from COVID on procedures and staffing and our continued significant outperformance versus the market. Gross margins were down 40 basis points versus the prior year due to the higher levels of inflation that ran through this quarter. The inflation pressures that started with COVID accumulated to about $30 million by the start of this year, and we have realized about $10 million of pricing increases through our sales channels. This $20 million of net pressure has further increased in the first half of this year. We continue to deploy pricing adjustments and are seeing signs of inflation stabilization that should lead to margin relief as we get deeper into the second half of the year. Our EBITDA grew in line with revenue and margins were consistent with our previous guidance. Despite the inflationary pressures, our existing businesses expanded margins by 70 basis points due to a combination of sales growth and structural cost reductions. This margin expansion would have been greater except for the inflation and currency translation impacts. As the U.S. dollar strengthened, we incurred a $2 million currency translation reduction in our EBITDA in the second quarter. In the second quarter, we also executed a tax planning project that created a one-time benefit and reduced our Q2 adjusted rate down to 9%. We are expecting the rate to be in the low to mid-20s for the remainder of the year and in the low 20s for the full year. Our Q2 adjusted EPS includes about $0.02 from the currency translation impact and $0.10 of tax benefit. Putting these together would normalize to about $0.51, which is in line with expectations. Overall, we delivered against our operating forecast for the quarter and dealt with some FX pressures. Let's turn to Slide 9 and talk about our outlook for the full year and some of the key contributing factors. Our organic growth range remains unchanged at 6% to 9%, which allows for a range of outcomes related to the COVID recovery pace. Our current trajectory likely points us toward the middle of that range. As observed throughout the MedTech space, July was a slower month, but we are seeing signals of an acceleration into the remainder of the quarter and are confident of again achieving mid-single-digit organic growth in Q3. We continue to expect further acceleration in the fourth quarter, in part due to easier comps. As commented earlier, we are experiencing an increased level of currency translation pressures and have updated our full-year outlook for this factor with another two to three points of pressure. Overall reported growth is now expected to be 8% to 12%. Acquisitions continue to be on track with earlier expectations. Our currency impacts are affecting both the top line and profitability. I mentioned that we took a $2 million hit to EBITDA in Q2 because of this, and the full-year impact is expected to be $10 million. We have been successfully battling the challenges in our operating environment and feel that it's prudent to leave our operating forecast in place, but we are shifting our overall guidance by $10 million to reflect this large currency impact. So we're now targeting $235 million to $255 million of EBITDA in 2022. Our full-year EPS range has shifted by $0.05 to reflect the net effects from currency and the tax benefit discussed earlier. For the third quarter, we expect sequentially lower revenue from Q2 to account for the slower July start and the vacation season. Despite this, we're expecting Q3 EBITDA margins to be in line with the second quarter due to the increasing momentum of our cost and pricing actions. Wrapping up on Slide 10. We're pleased that our strategy for organic growth outperformance continues to clearly reflect in our results. Our businesses are well positioned in their markets with robust innovation pipelines and effective operations that serve our customers well while managing through dynamic business conditions. Our operating execution is complemented by our proven M&A program, and we continue to acquire the right businesses and technologies to further strengthen our growth profile. And with that, Paula, let's go ahead and open up the call for questions.

Your first question comes from the line of Jeff Johnson of Baird.

Can you hear me okay?

Yes.

All right. So just a couple of questions here. I think you did a good job kind of explaining the pacing here that we should expect on organic growth over the next few quarters. That was going to be my first question. But let me shift instead, I guess. On Recon, I just want to understand, you put up 8% selling day adjusted growth. You did talk about 8% extremities growth in the U.S.; 14%, hip and knee. What— with hip and knee at 14% and U.S. extremities up 8%, what pulled you down then to 8% overall for Recon? I'm assuming maybe that's an OUS of your own business that's being deemphasized as Mathys kind of scales up. But just kind of help us understand the differential there.

Yes, there are two factors to consider. First, there is a slight impact from our limited international business, which is under some pressure as we transition from Mathys. However, this effect is minor. Secondly, in the U.S., we are experiencing strong growth in hip, knee, and shoulder segments, and our foot and ankle business is progressing well. Nonetheless, there are challenges to address in this area. Our MedShape business is showing significant growth, along with key technologies within it. Overall, the businesses we acquired, MedShape and Trilliant, are growing at or above market rates. However, the STAR business is currently facing some regulatory challenges, which is hindering its growth contribution. In the first half of the year, we also undertook a channel consolidation to establish a unified and strong channel for our foot and ankle business, which resulted in some temporary disruptions, particularly in the second quarter. Consequently, the foot and ankle segment accounts for single-digit growth, offsetting the stronger double-digit growth in other areas. We are on track to develop our Recon portfolio into a consistent double-digit performer at a larger scale, based on our existing components. We anticipate strong double-digit growth in the foot and ankle sector in the latter half of the year, which gives us confidence in our direction.

All right. That's helpful. And then maybe just two clarifying questions. One, you pointed out some market pressure on the P&R side. We kind of think about P&R often being driven by travel, trauma that happens, car accidents, sports, things like that. And obviously, the world is opening back up. So what's the market pressure there? And you've said you've seen some signs of inflationary pressure stabilizing. I think you'd be one of the first companies to acknowledge that. So any insight on stabilization there that you're seeing would be helpful?

Yes, sure. Yes. So first of all, in terms of P&R market pressure, one, a piece of that business is driven off of elective surgery, and we had a little bit of a delay there. Some of the Q1 pressure there was an elective surgery closed into Q2 market pressure for us in that business. In the U.S., there's a little impact on that elective surgery part of that business. There are some parts of that business that are very clinic-heavy and serve a much older population. Our foot care business there really focuses on diabetics and the more aging population. I think there were some drops in clinic visits through the second quarter as well in that business. So those were really the two sources of pressure in P&R. Both of those will fully clear as elective surgery continues to expand and we get to the other side of COVID. Regarding the stabilization of inflation, yes, if we go back six to nine months, we would still every month find about new inflation, right? We'd have the next supplier coming to us with an increase with all the reasons, or another increase in freight rates or a fuel surcharge on freight rates. We were in a period where things kept going up. That even lasted into the first quarter of the year. We expected some stabilization, but we continued to see increases. But in the last three months, we see a different texture and don’t see that kind of week-in, week-out increases coming through. Much more flattening of input prices and freight rates. In some cases, we are starting to get a little bit of a decrease. We're not calling it in terms of things coming back down, and we can't be certain they won't go up again, but we do see stabilization that we expect should enable us to start to pull back a little bit of price cost in the back half of the year, particularly in Q4 because we have a lot of price through that business and can turn that into margin reversal at the gross margin level.

Your next question comes from the line of Vik Chopra of Wells Fargo.

Two for me. I just wanted to dig a little bit deeper on the procedure volume trends that you saw. Can you talk about the impact that staffing shortages have had on procedure volumes across both P&R and Recon? And then I had a follow-up.

Yes. Sure, Vik. Volume trends, again, I think it's been talked about a lot out there, and I'll just give our version. The year started slow, building off of the slow finish to last year. As we headed through March and even April, there was really good momentum building there, and you heard very little about cancellations and staffing shortages. Then as we made our way through the second quarter, late in the quarter, kind of late May, early June, we started to hear again about higher cancellation rates related usually to COVID testing, sometimes to staffing issues. We've also seen isolated areas of staffing pressure, but in some cases, it's really about longer vacations. I think we've got some people that—whether it's the surgeons or their staffs—that have been kind of not doing much vacation in the last few years. In June and July, we saw, in some cases, kind of significant vacation downtime compared to the past. Those are some of the things we've seen in the elective surgery area, particularly in the U.S. However, we've also gotten really, really good signals about what's expected to happen in August and September. There's a better short-term trend in terms of cancellations, and the scheduling suggests that there's going to be a nice trend through the quarter regarding people getting back aggressively into a ramp of elective surgery. There is plenty of pent-up demand that people want to get at as we come down the stretch of the year here. On the P&R side, again, we get the secondary impact of those elective surgery trends on a part of that business. There has been a smaller effect of staffing pressure on different clinics that impacted the market in the first couple of quarters of the year as well.

Super helpful. My follow-up question was on M&A. You've closed a number of deals in the past couple of years, including two tuck-in acquisitions this quarter. Given the recent pullback in the market, should we expect a larger deal from you guys? Or is the focus going to remain on the tuck-in M&A late-stage technology deals?

Yes. Thanks, Vik. We've been consistent in saying that the things we've done over the past few years represent the kind of things we expect to do in the next couple of years. We've executed a set of highly strategic deals that, in some cases, bring great technologies that accelerate the growth of our business and/or open up new applications and segments. In some cases, we've brought new market landscapes, whether it's geographic like the Mathys deal or entering the foot and ankle segments. Those have all been driven off strategy, making our company better and creating a higher organic growth profile, a higher gross margin profile, and opportunities to get synergies and scaling that drive us up the EBITDA margin curve. That collection of things we've done over the past couple of years is very representative of what to expect in the coming years. These deals have ranged from no revenue to almost $150 million of revenue. So there are many possibilities in the next couple of years that will be similar. Of course, there are also larger opportunities to consider how they could accelerate our strategy, move our company forward, and create value for our shareholders. We have a great capability to do deals and successfully integrate them. But I would still say in the short term, we expect to see more of the same because there is plenty in our pipeline. It's also a bit different climate regarding valuation, and we are excited about M&A opportunities in the next couple of years here, Vik.

Your next question comes from the line of Matthew Mishan of KeyBanc.

Congratulations, Chris, on retirement. I just wanted to start with EBITDA. In the move down the revision of $10 million distinctly for FX, is the way to think about it that you are seeing incremental supply chain logistics inflation pressure, but your ability to offset those is keeping the range just to what FX looks like, given that the organic growth is seemingly coming in line with your expectations?

Yes, Matt. You've peeled that apart pretty well. There are two separate things we're dealing with. First, there's the inflation-related supply chain challenges that Matt spoke to earlier. We started pricing actions late last year, which helped ameliorate some of that, but there's still some accumulated pressure. We expect that the inflation stabilization will help us better manage this moving forward. The second issue is the currency, which we can't control. We thought it was important to emphasize that executing our operating plan is in line with expectations and that we have been navigating the inflation pressure and pricing dynamics effectively. However, we must account for the currency pressure that's coming through, so we are updating the guidance range to reflect these impacts. Yes, Matt. The revenues from the new acquisitions will represent just a handful of million dollars of impact this year. Regarding ARVIS, it is a terrific technology that we believe is part of the established appetite for these kinds of technologies in the industry. ARVIS is designed for more precision while also being smaller and more streamlined, which fits perfectly in the ASC environment. It is an implant-agnostic solution, but we are looking to use it to serve our surgeons and grow with them while also generating recurring revenue.

Your next question comes from Jason Wittes from Loop Capital.

First off, you mentioned you're implementing price increases. I'm wondering where you think you're going to have success. You've got somewhat of a wide range of orthopedic products in different markets such as hips and knees versus the extremities and obviously the physical therapy business. So could you give us some color in terms of where you think you’re seeing success or where you think you can succeed or where you’re seeing success right now?

Yes, Jason. Our P&R segment is where we had the most inflation early on, and where we've done a lot of pricing, continuing to do more. The bracing business, the largest part of the segment, has had multiple price increases. We're working through with other insurers to secure increases that help our reimbursement business. In that space, we've seen success as we engage with both clinics and distributors. We've made some headway with GPO price increases as well. Each channel has its nuances; hence it's an ongoing process. In the rehab business, we can enact direct price changes, which are straightforward. With more than 1% price realized in the P&R platform last year, we expect to achieve around 2% price this year. If inflation stabilizes, we can anticipate restoring some gross margin, particularly in Q4 and the following year. In the Recon segment, we have a different dynamic; while we have seen some instances of positive price increases, historically, we see about a couple of percent price drop every year. The trend towards flattening price programs this year is expected to continue behaving similarly next year.

That's very helpful. And then also, in terms of your longer-term EBITDA margin improvements, I think you put a pretty decent goal out there: around 500 basis points by 2024. How does inflation and FX and other pressures factor into that assumption? Are those pressures that may delay you from reaching that level? Or is that already integrated into your expectations?

Yes. We shared a clear plan for achieving those 500 basis points, and I'm confident we can reach that improvement and achieve 20% plus EBITDA margins. We are taking substantial steps towards that goal this year. The key elements are still intact. We've eliminated structural costs through our separation, are executing on cost actions this year and have plans for next year. We're experiencing growth and operational leverage, along with scaling of lower-margin acquisitions. The pressure from short-term inflation and currency is real, but our comprehensive plan to achieve that 500 basis point target is secure.

Got it. That's very helpful. One last housekeeping question. Can you give us some color in terms of what the hip and knee growth breakout was? And any kind of qualitative information regarding what's driving that growth?

Yes. The growth we shared on U.S. hips and knees was shared on the page—the hip and knee figures are based on U.S. performance. We are well into the double digits driven primarily from strong knee performance, exceeding market growth rates due to success in the ASC with our EMPOWR Knee product, and strong hip growth as well. We expect these robust growth trends to continue, particularly with the products we're bringing over from the U.S. to improve knee and shoulder growth further.

At this time, this does conclude today's question-and-answer session. I will now turn the floor back over to management for any additional or closing remarks.

Well, thank you, everyone. Thanks for joining us. If you have any further questions, please contact Investor Relations. Have a great day.

Thanks, everybody.

Ladies and gentlemen, this does conclude today's call. Thank you for your participation. You may now disconnect.