Enovis CORP Q1 FY2023 Earnings Call

Good day, and welcome to the Enovis First Quarter 2023 Earnings Conference Call. Please note, today's event is being recorded. I would now like to turn the conference over to Derek Leckow, Vice President of Investor Relations. Please go ahead, sir. Thanks, everyone. Thank you for joining us today for our first quarter 2023 results conference call. I'm Derek Leckow, Vice President of Investor Relations. Joining me on the call today are Matt Trerotola, Chief Executive Officer; and Ben Berry, Chief Financial Officer. Our earnings release was issued earlier this morning and is available on the Investors section of our website, enovis.com. We'll be using a slide presentation on today's call, which can also be found on our website. Both the audio and the slide presentation of this call will be archived on the website later today. During this call, we'll make some forward-looking statements about our beliefs and estimates regarding future events and results. Those forward-looking statements are subject to risks and uncertainties, including those set forth in the safe harbor language in today's earnings release and our filings with the SEC. Actual results may differ materially from any forward-looking statements that we may make today. The forward-looking statements speak only as of today, and we do not assume any obligation or intend to update them, except as required by law. With respect to any non-GAAP financial measures referenced in the call today, the accompanying reconciliation information related to those measures can be found in our earnings press release in the appendix of today's slide presentation. With that, let me turn the call over to Matt who will begin on Slide 3.

Thanks, Derek. Hello, everyone, and thanks for joining us today. We had a strong first quarter. But before I discuss the results, I want to recognize the efforts of our fantastic global team of dedicated associates who work hard every day to execute our strategies and help our patients live more active and fulfilling lives. It was a great quarter. Let's go to Slide 3 and talk about some of the highlights. We grew organically by over 9% with 19% growth in Recon and 4% growth in P&R. Clearly, there were some tailwinds out there on the Recon side, but the step back view is continued strong outperformance in a strong Recon market and the expected market recovery in P&R. We expanded our adjusted EBITDA margins by 120 basis points, reflecting the mix impact of strong Recon growth, productivity from EGX, price progress, and moderation in some areas of inflation. We signed a key strategic acquisition in Foot & Ankle in the quarter and another one in April. And we're seeing strong growth momentum and healthy scaling of the full set of acquisitions we completed in the last few years. Overall, a really great start toward our 2023 objectives. In recap on Slide 4, we had high double-digit growth in the U.S., led by over 20% organic growth in knees and hips. Extremities grew 14% led by shoulder. Outside the U.S., we grew over 20% organically, also led by knee and hip. And we're pleased to see our brand and presence flourishing in a strong European market and a recovery building momentum in Australia. I'm excited about the initial traction we're seeing as we begin to cross-sell our market-leading EMPOWR and Altivate products internationally. And we have a strong pipeline of innovation in the U.S. as we continue the rollout of the EMPOWR Revision Knee and the Altivate Augmented Glenoid. The markets were strong in Q1, and we took full advantage, once again growing well above the other Recon leaders. Turning to Slide 5. I want to take a moment to discuss what we're doing to further strengthen our position in the fast-growing Foot & Ankle market. We've built a strong foundation with differentiated product offerings in the hindfoot and mid-foot segments, and we're adding some key new technologies for the rapidly growing bunion and forefoot space. We announced the acquisition of Novastep, which gives us a comprehensive set of products for bunion surgery, the largest and fastest-growing part of the foot and ankle market, at almost $1 billion per year of market. Whenever possible, surgeons want to address these issues with a minimally invasive solution. And now we have the leading percutaneous MIS solution for these procedures. And in Q2, we will launch EVOLVE 34, a product focused on the large, fast-growing Lapidus segment of the bunion market. This will be a terrific complement to the Novastep MIS offering and coupled with our great plating and staple lines gives us a robust offering for the entire bunion segment, regardless of severity or indication. Novastep also brings channel and approved products outside the U.S., accelerating our global progress in foot and ankle. We also announced the acquisition of Seal's leading External Fixation product line, which complements our existing offerings and strengthens our channel position. Overall, I'm very pleased with the progress we're making to build a leading Foot & Ankle platform. In P&R on Page 6, our 4% organic growth reflects a rebound in volume as markets recovered. You can see on the right that over the past 5 quarters, we've had average growth in the 3% to 4% range in line with our expectations. We've applied EGX principles and tools to improve and strengthen our supply chain, and we're seeing the results with more resiliency and better service levels even as we begin to bring back down inventory levels in some areas. And stay tuned. We have a nice pipeline of additional bracing launches coming later in 2023 that will help us support P&R growth. Now I'll let Ben take you through the P&L details and our positive guidance update.

Thanks, Matt, and thanks, everyone, for joining our call today. I'll start my prepared remarks on Slide 7. We had a very solid start to 2023, delivering strong growth and margin improvement. For the growth for the quarter, we grew 8% or 9% organically. Foreign currency had a 150 basis point negative impact on sales. We delivered another quarter of double-digit Recon growth and achieved mid-single-digit growth in our P&R business. Gross margins increased 170 basis points versus prior year, reflecting our faster-growing and higher-margin Recon segment as well as taking some ground on price versus cost. We saw strong performance in our operations, realizing the benefits from our business mix, our proven business system, and strong leverage from growth. In the quarter, our operating expenses were up 40 basis points as a percentage of sales. This is largely driven by investments in research and development, primarily in our Recon segment as we continue to integrate and scale recent acquisitions and fuel a healthy innovation pipeline. Our Q1 EBITDA grew 18% versus prior year, resulting in a margin expansion of 120 basis points and reflecting our strong profitable growth in the quarter. Our effective tax rate for the quarter was 21% and interest expense came in at $5.7 million. Overall, we posted strong adjusted earnings per share of $0.44 or 19% growth versus prior year. We are pleased with our results in the quarter and our clear progress executing against our strategic goals. Moving to Slide 8. Considering our Q1 momentum, we are raising our organic sales growth outlook for the year to 6% to 7%. Recon markets got off to a strong start, and our P&R business grew in line with our expected levels. We expect a slightly more difficult prior year comparison in the coming quarters, but we are confident that our Q1 results will lift the overall growth performance for the year. Q2 has roughly 1 point of growth headwind due to less selling days, and we expect the Q2 growth to be within the updated guidance range. We are raising the full year adjusted EBITDA and EPS ranges to reflect our Q1 performance. Our new outlook for adjusted EBITDA is $259 million to $267 million, with adjusted EPS of $2.18 to $2.32. While we are still experiencing some headwinds from inflation and currency on our operations, we expect our Q1 performance to read through for the full year. We are excited about our recently announced acquisitions, complementing our existing Foot & Ankle platform. Those acquisitions will initially bring approximately $25 million to $30 million of annualized sales, strong gross margins and a double-digit growth profile. We expect these deals to have a slightly negative impact on earnings for the full year but they should turn accretive to earnings beginning in 2024 as they scale. To summarize, on Slide 9, we had a strong Q1 leading us to raise our full year guide. We demonstrated strong above-market growth and are confident in our strategy of building a sustainable, high single-digit growth company. We took another step forward in expanding our margins and have a clear path to continue this momentum. We continue to execute our M&A strategy as evidenced by the two deals that we highlighted on this call. They are an example of our rich funnel across our business of prospective deals and a strong balance sheet with ample capacity to execute.

And now we will move to Q&A. Please open the call for questions.

Today's first question comes from Vik Chopra with Wells Fargo.

Two questions for me. I'm going to ask them both upfront. I guess first on P&R, I would love to hear kind of what you're seeing in the market with regards to volumes and how you now think about that business going forward the rest of 2023? And my second question is just on guidance. You raised guidance after a nice beat. Could you just kind of help us frame out how you think about the guidance, what gets you to the top end versus the low end?

So yes, as we've been saying through the quarter, we expected P&R volumes to recover in the first quarter after a little bit of pressure there in the back half of last year that showed up in Q4. And we saw that recovery back into kind of a normal range for P&R, especially if you actually look at our P&R business back to '19, it's in kind of a normal place in terms of the growth from '19 in Q1. And we do expect P&R to stay in a similar growth range as we go through the balance of the year. The comps get actually a little bit tougher in the next quarter or two and then easier in Q4, and we expect to be in that similar kind of growth range as what we've shown as where the business has been performing.

Yes, Vik, and I'll take the guidance question. I think we have a good start to the year. We're excited about the start. We're still being a little bit cautious as we think about the balance of the year in terms of what may or may not happen with regards to the market in general. So we're trying to keep the approach of being a little bit more cautious just to anticipate that there could be some bumps on the road as we think about the balance of the year. But hopefully, we'll continue to see this momentum in Q1 continue to play through and then have a little bit of upside.

Our next question comes from Vijay Kumar with Evercore ISI.

Two-part question. First is a lot of your peers have cited greater-than-expected procedure recovery and staffing and supply improvements. Can you give any update on what you're seeing? And can you provide any color on how much backlog contributed to organic growth this quarter?

We experienced a robust first quarter, with the U.S. showing normal and healthy levels of activity. There was no staffing pressure, ample demand, and no impact from COVID. Overall, the U.S. performance was perhaps even slightly above normal, especially considering the softer comparisons from last year. Both our company and others in the industry achieved significant growth during Q1, with our growth surpassing that of other leaders. Internationally, alongside a milder comparison, some countries are operating at full capacity and addressing substantial surgical backlogs, such as Germany, which is handling a considerable number of surgeries at elevated levels. We observed over 20% growth outside the U.S. Looking ahead, we anticipate typical seasonal patterns in the U.S., which will result in lower but still healthy growth as comparisons normalize in future quarters. Outside the U.S., we might see elevated activity for another quarter, but we should be cautiously optimistic about the latter half of the year as countries begin to stabilize from their overdrive. Overall, we are starting off strongly in the elective surgery sector within Recon and expect the remainder of the year to unfold positively, albeit without the additional advantages we experienced in Q1, yet still maintaining a healthy performance.

And then just one quick follow-up. So gross margin performance in the quarter, it was up 100 bps quarter-over-quarter. Can you talk about what the inflation impact was and what pricing was in the quarter? And just kind of overall, what drove that performance? And should we think about Q2 being in line with Q1? Or kind of above that level?

Yes, happy with our gross margin expansion in the quarter. A lot of that driven by our business mix, like I mentioned in my remarks, strong Recon performance, which brings above average margins compared to our overall company. We have taken some ground on the price cost equation. I would say that we're getting about 1% to 2% price on the P&R side of the business. We've seen some inflation moderate in certain areas with regards to inbound freight, some plastics. We still see some inflation around outbound freight surcharges, wage inflation, and some metal challenges in certain parts of our supply chain. But overall, I feel confident that we continue to take good ground, make productivity in our operations to overcome some of the challenges that we're seeing and claw back some of that inflation that came after us over the last couple of years. So I would expect gross margins to be kind of in line, a little bit maybe lower than what we saw in Q1 as we think about the coming quarters. But overall, a good strong start here in the year.

And our next question today comes from Kyle Rose of Canaccord Genuity.

I have two questions. First, how should we evaluate the impact of the revision platform in the U.S. as we progress through the year? Are you attracting new customers who were possibly waiting for a revision set before adopting primary, or are you gaining additional market share with existing new customers?

Yes, it should be a combination of both, just like some of the other key products we brought out that complement our lines in the past years. It gives us an opportunity to sell into existing customers, surgeons that we've converted already and now serve that part of their offering, which revision is kind of 15% to 20% of the overall market. So we get a chance to sell some more into existing customers. And then we also have some surgeons that wouldn't convert until we had an EMPOWR Revision, and now we do. So it will be a combination of both. That product is really just ramping as we make our way through this year. And we already have extremely strong knee growth right now, and that will just continue to put fuel on that as we work our way through this year and into next year.

How should we approach the growth of U.S. versus international markets moving forward? The international market is smaller, but there are cross-selling opportunities by integrating the Mathys portfolio with the existing DJO portfolio. On the U.S. side, we also have products like EMPOWR Revision coming. Should we expect both markets to grow at a similar rate until EMPOWR annualizes, or will the international market likely experience stronger growth than the U.S. market?

I think on a longer-term basis, we expect to probably grow a little bit higher in the U.S. than OUS, based on a combination of the kind of strong double-digit growth that we've done for a decade now in the U.S. and continuing to fuel that with innovation and fuel that commercial engine we've got there with innovation. And then the Foot & Ankle growing well into the double digits as well as it continues to grow in scale. We think that combination over the kind of medium term should have the U.S. business further into the double digits. And we've always talked about the outside the U.S. business being at least high single digits and pushing double digits and that combination getting us our double-digit growth over time. Now in the short term, I think the outside the U.S. business has the potential for more tailwind certainly in the coming quarters in line with some of my earlier comments and even as we move from this year into next year and we ramp up some of that synergy sales, I think there is the possibility for the outside U.S. business to grow faster than the U.S.

And then last question, and I'll hop back in is just M&A expectations moving forward. I mean Ben talked about the strength of the balance sheet there. Obviously, it's been a little bit more on a tuck-in strategy historically. Just wanted to see how we should think about tuck-ins versus transformational adjacent type of deals longer term?

We're really excited about the two deals we're discussing on this call. They truly strengthen our Foot & Ankle platform. We've always believed that we could expand it organically or by incorporating strategic technologies. The deals, especially with Novastep, complete our robust offering for all aspects of Foot & Ankle, appealing to both surgeons and the distribution channel. We feel positive about our position and recognize there are more opportunities within that space, but our focus will be on organic growth. We're also considering strategic options related to Recon and somewhat in the P&R sector. We have a solid pipeline of potential initiatives aimed at boosting our growth and improving gross margins, whether through technologies that expedite our progress or by opening up attractive adjacent markets or regions. We plan to continue executing effectively with our strong balance sheet, concentrating on smaller and mid-sized deals instead of pursuing large transformational projects.

And our next question today comes from Jeff Johnson at Baird.

Matt, I wanted to follow up on one comment you made about the European market, just kind of being maybe even a little faster to recover here and really burning through some of that backlog. In the U.S., I think none of us probably know, but we've been kind of operating under the assumption that maybe it would take a couple of years to get through the U.S. backlog just as ORs operate at pretty high capacity utilization already and you can't get all those patients back right away. Are there different dynamics outside the U.S., I think you cited the German market specifically, but are there different dynamics, different capacity utilizations where maybe that backlog catch-up could be even faster in Europe? And how are you thinking about the backlog catch-up in the U.S.?

I understand your point and will elaborate on it. In the U.S., when we compare growth to 2019 in the first quarter, we see an average growth of about 10% over that four-year period, which equates to roughly two years of growth for the industry. Our growth during that time was between 30% and 40%, while the industry as a whole grew around 10%. This suggests that the U.S. industry has lost a couple of years of growth, although there remains a strong demand for surgeries. However, we haven't seen this translate into an increase in surgeries at any specific time. In the first quarter, surgeries were performed at healthy levels with adequate staffing, but no one is suggesting that they are significantly exceeding normal operational levels to clear the backlog; they are simply operating at full capacity. Additionally, the U.S. faced an easier comparison in the previous period. In contrast, the situation outside of the U.S. is different. Some countries have significant waiting lists and have managed to operate at an accelerated pace, leading to impressive growth in specific markets. However, the growth outside the U.S. compared to 2019 is less robust than that observed in the U.S., indicating more ground to cover. Some countries are pushing their capacities to catch up. This requires some caution in forecasting how the year will unfold outside the U.S.—whether growth will remain at elevated levels or revert to more typical levels. Nonetheless, even with the accelerated operations in international markets earlier this year, we anticipate a sustained demand that could potentially support growth, as many surgeries that were missed over the past few years still need to be addressed in the future.

Can you tell me about the growth in your U.S. Extremities business, specifically how much of the 14% growth can be attributed to shoulders? What is your outlook for the shoulder market? It seems you are performing very well, and you are a market leader in that area. Stryker also appears to be doing well with their shoulder products. Additionally, Zimmer has introduced a new modular system that could increase competition. How do you view the market dynamics and your competitive position as other companies work on strengthening their offerings?

Well, I'll say that it was above, as we said, it was enough above we're comfortable that we continue to take nice share in shoulder. And so we feel comfortable that we continue to have good market leadership there in terms of our phenomenal Altivate and a lot of the different things we brought out our anatomic has been doing tremendously well, our new augmented glenoid is ramping. And so we're still leading in shoulder. We've talked about growing more 1.5x, 2x market in shoulder versus 3x to 5x in knee and hip, and that's consistent with the fact that we're a leader in shoulder and as a leader with significant share, if you innovate and drive aggressively commercially, you can grow more than the market, but not 3x to 5x the market, whereas as a 2% share player in knee and hip with the amount of innovation we do in the phenomenal EMPOWR product we've got and now some of the enabling tech we're bringing there. We're comfortable. We continue to grow at multiple times market. Now certainly outside the U.S., as we can ramp up the Altivate, we've got the potential to grow more at multiples of market levels, but that's going to take a little time here.

And our next question today comes from Xuyang Li with Jefferies.

Congrats to a good start to the year. Maybe on the Foot & Ankle business. Did Foot & Ankle grow double digits as well? I was wondering if we can get some latest updates on progress with the STAR Ankle. And can you talk about the growth outlook for the year for Foot & Ankle?

The Foot & Ankle business was just under double digits in the quarter, and that's with our STAR continuing to decline a little bit as we're kind of working through some of the final stages of modernization on that product, very strong growth in the other products, and we exited the quarter comfortably into the double digits in Foot & Ankle. And so we're very comfortable that our Foot & Ankle business will grow double digits in the year and will be well into the double digits here in Q2. And we're thrilled with the additions that we've made that will kind of build on top of that. And from a STAR standpoint, we're just ramping up the cutting guide, which is kind of a critical piece of how we get that business back on a positive growth footing. We're continuing to work through the polymer swap out with the FDA and expect that later this year we should have that resolved as well. Even with the new cutting guide, we're getting plenty of interest. And so we'd expect to be able to turn back to growth here in the coming quarters in Foot & Ankle. And with the very strong growth of everything else, we're comfortable that we'll grow Foot & Ankle well into the double digits here in Q2.

And then on Novastep. Can you maybe talk a little bit about the growth rate for the business as well as the growth outlook and plans to expand it globally as well as into the U.S.?

So the Novastep business is pretty balanced between the phenomenal position in MIS bunion in the U.S. and outside the U.S. position that has multiple product lines that have the approvals outside the U.S. and that has been growing well into the double digits. And so we expect to be able to bring that product in and have it continue to grow well into double digits, but also to have it really strengthen our position here in the U.S. and in terms of our ability to continue to make our channel and our presence with the doctors more and more powerful. And we also have an opportunity to accelerate the path that we move into some key areas outside the U.S. based on the channel presence and the approvals that Novastep has. So it's the larger portion of that $25 million to $30 million of annualized revenue that Ben talked about, and it's been growing kind of comfortably into the double digits range, and it has very high gross margins.

And our next question today comes from Matt Mishan with KeyBanc.

This is Brett Fishbin. Thank you for including us today. I would like to follow up on the M&A strategy. It seems that much of the focus over the past few years has been on the Foot & Ankle market. I’m curious if, given your comprehensive portfolio in that area, other markets will become more prominent as you consider potential deal activity in the future. I’d like to know how you are prioritizing in that regard.

You are correct that our most significant capital deployment has been in the Recon sector, particularly with Foot & Ankle and the Mathys global expansion being major highlights, along with some important technology acquisitions. We also made a solid investment in an impressive laser technology on the P&R side, which is showing strong growth. As we look ahead, we certainly see various investment opportunities in technologies or key indications within the Recon space, as well as expanding into new geographies. Additionally, we are exploring adjacent segments within orthopedics that could be appealing, along with opportunities in high-growth modalities in the rehab sector, which is also attractive.

I have just one follow-up question. You mentioned several factors contributing to the strong international performance this quarter, noting that some of it was due to backlog. It also sound like you're highlighting some success from cross-selling opportunities and the expansion of the DJO brand presence in Europe after the Mathys deal. I'm curious how these initiatives are influencing performance and how you believe they will impact the growth outlook moving forward.

We experienced double-digit growth in the Mathys business last year without additional market support. While a growth rate of over 20% isn't sustainable, we believe we can maintain double-digit growth outside the U.S. even without that extra market boost. Currently, there's only a modest contribution from synergies, but we are witnessing positive momentum in the market. Investments made by Mathys over the past few years, even during COVID, are starting to yield results in terms of more personnel on the ground. There’s also strong confidence in our business and in our distribution channels due to Mathys' historical strength and the new offerings coming from our U.S. operations. Most of the synergy benefits are still to be realized. At this stage, we’re seeing initial product usage by a number of doctors, who are also preparing to adopt our products. We're being cautious about how quickly we introduce products to the market given the widespread growth globally. Right now, there's a small synergy benefit reflected in revenues, along with a positive impact on our brand and increased confidence from our channel and surgeons eager to switch to us. As the market tailwinds decrease, we believe the synergy contributions will continue to grow, positioning us well for sustained growth in this business not only this year but in the future as well.

Ladies and gentlemen, this concludes our question and answer session. I'd like to turn the conference back over to the management team for any closing remarks.

Thank you, everyone, for joining us today. If you have any further follow-ups, please contact Investor Relations. Have a great day.

Thank you, sir. This concludes today's conference call. We thank you all for attending today's presentation. You may now disconnect your lines, and have a wonderful day.