Colfax Corporation

Welcome to the Colfax Third Quarter 2021 Earnings Call. My name's Annette and I'll be your operator for today's call. At this time, all participants are in a listen-only mode. Later, we will conduct a question and answer session. During the Q&A session, if you have a question, please press star then 1 on your touchtone phone. I will now turn the call over to Mike Masek. Mr. Masek, you may begin.

Thanks, Annette. Good morning, everyone, and thank you for joining us. I am Mike Masek, Vice President of Finance. Joining me on the call today are Matt Tarotola, President and CEO, Shyam Kambayanda, Executive Vice President and CEO of ESOP, and Chris Hicks, Executive Vice President and CFO. Our earnings release was issued earlier this morning and is available in the Investors section of our website, colfaxcorp.com. We'll be using a slide presentation to walk through 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 and will be available until the next quarterly earnings 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 risk and uncertainties, including those set forth in the Safe Harbor language in today's earnings release and in our filings with the FCC. Actual results might 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 intend to update them except as required by law. With respect to any non-GAAP financial measures made during the call today, the accompanying reconciliation information related to those measures can be found in our earnings press release and today's slide presentation. With that, let me turn it over to Matt, who will start on slide three.

Thanks Mike. Welcome everyone and thanks for joining our call today. I'm pleased to report that our businesses performed well in the quarter and we made strong progress on key strategic priorities. We met our third quarter commitments by growing organic revenues 15% and achieving adjusted EPS growth of 32% despite the challenging environment. We also outperformed our markets as a result of our amazing teams around the world. I want to take a moment to thank our teams for their continued dedication to our customers and patients and to the success of our businesses. ESAB exceeded our expectations this quarter with better-than-expected growth and strong margin expansion. We continue to see strong execution here, and as a result, we're increasing our full-year organic growth and margin expectations outlook for ESAB. I've asked Shyam Kambianda, the CEO of ESAB, to join the call this morning to talk further about this great performance and progress. MedTech performed well. given the challenges faced by the industry. We outperformed the market in both P&R and recon again, but were impacted by COVID-driven slowing of elective procedures, which I'll touch on more in a few minutes. We're making strong progress integrating the recent acquisitions, and I'll share some highlights later in the call. Finally, we're fully on track for the expected tax-free spinoff of our ESOP business to Colfax shareholders. We've made substantial progress towards creating two independent boards with relevant skills, experiences, and diversity, and with limited overlap. Also, we've filled all the key corporate leadership positions for ESAB with tremendous talent, readying them to become an independent public company. And as you'll see in a few moments, we've also selected our new corporate name, which symbolizes our exciting future. We continue to target the separation for the first quarter of 2022, and we're confident that we'll position both companies for maximum long-term growth and value creation. Slide four gives an update of our MedTech business. Sales for the quarter increased 14% or 1% on an organic sales per day basis. This includes a two-point headwind from one-time PPE sales in Q3 last year. While this is below the expectations that we had entering the quarter, we believe that it's very strong top line performance given the temporary pressure on elective surgeries in the quarter. The key thing to note is that both businesses, Recon and PNR, continue to outperform their markets. We've grown well ahead of peers for a number of periods over the past several years. The year-to-date organic growth figures versus 2019 on the slide tell the story. Our recon business is up 7% year-to-date versus 2019, and our P&R business is approximately flat. These are organic numbers, both significantly better than market rates. In recon, our shoulder implants grew double digits year-to-date versus 2019, continuing to take share through innovation and commercial execution. As we move past COVID and return to normalized market growth, both of our MedTech businesses are well positioned to show strong growth in 2022 and consistent market outperformance over time. In the quarter, we had some unexpected impact from COVID, primarily in recon. After a strong June and July, we saw a slowing of elective procedures in certain regions of the US. However, we did see improvement in October, giving us confidence in our expectation of gradual improvement in Q4. This points to a more normal market environment in 2022 and an opportunity to recapture some of the missed demand from 2020 and 2021 as pressure on hospital space and staffing subsides. Additionally, during the quarter, we continue to see MedTech supply chain inflation and inefficiencies. Our teams are doing what it takes to serve our customers, which is driving costs higher and temporarily impacting our profitability. We still made sequential progress in the quarter as organic EBITDA margins improved on lower organic volumes. We also were able to implement some price increases to offset part of the inflation that we're seeing. These took effect late this quarter. And along with expected volume improvement, support our guidance of sequential margin improvement in Q4. We have other CBS initiatives driving price cost, productivity, and SG&A simplification to accelerate margin improvement in 2022. And we remain confident in our ability to substantially expand MedTech segment margins over time and achieve the longer-term targets outlined earlier this year of 25%. Slide five highlights two recent product introductions. We continue to innovate, bringing clinically differentiated products to the market to broaden and strengthen our portfolio. Having robust vitality is a key part of our strategy to drive above market organic growth. And these two launches are good examples of us filling out our offerings for surgeons, increasing our clinical relevance, and expanding our market reach. The Empower Dual Mobility Hip System is the latest addition to the Empower Hip portfolio that provides surgeons a solution to treat a large patient group needing better joint stability. Dual mobility is a sizable and important segment of the hip market, and this launch will help us to secure additional business in existing surgeons and also attract new surgeons. Next, we continue to expand our robust suite of foot and ankle products with the DynaNail Hybrid Fusion Systems. a member of the proprietary Dynanail family of products. The Dynanail hybrid features a unique design with ease of insertion and dynamic compression. Our early results on this launch have been very positive. We're exceeding our sales plans and have gotten excellent feedback from customers and our channel. Slide six highlights the great progress we've made on the integration of the highly strategic recon acquisitions that we completed over the past year. Along with our very successful U.S. surgical business, these lay the foundation for sustained double-digit organic growth in a much larger addressable market. During our July earnings call, we announced the acquisition of Mathis, a highly complementary global expansion of our fast-growing reconstructive platform. Since then, we've been rapidly integrating the business, and there is great cultural fit between the two companies. We expect to accelerate Mathis growth by introducing several of our market leading products into their channel. Together, we've already established a clear product roadmap and an aligned forecast for revenue synergies. In the first half of 2022, Mathis will launch our Altivate Reverse Shoulder and Empower 3D Knee, which already have the required regulatory approvals. We're also working on a pipeline of other growth synergies. Beyond growth, Our teams are collaborating to secure a three-year path to $15 million of annual savings from increased scale and operating synergies. Our early focus is on insourcing projects that will generate savings next year. We continue to expect this business to generate approximately $150 million of revenue in 2022 and build over time to double-digit growth and accretive EBITDA margins. Also, we continue to build strong momentum in our foot and ankle platform, which was formed through three different acquisitions over the past year. These additions established a differentiated product portfolio in the high growth, high gross margin foot and ankle market segment. We combined our new foot and ankle businesses into a cohesive growth platform led by a very strong team with deep foot and ankle experience. This allows us to create a powerful channel focused on the 10,000 foot and ankle surgeons in the US that will extend our reach and scale as we grow. We also aligned on a combined innovation pipeline and acquisition priorities to expand our bag of clinically differentiated products to address the full foot and ankle market opportunity. We continue to expect this business to grow rapidly and reach $100 million of revenue with accretive margins and strong double digit growth over the next three years. And finally, I'm really excited to introduce our new company name on slide seven, Inovus. Inovus symbolizes the powerful combination of innovation and vision fueled by our passion for continuous improvement and reinforced by our drive to deliver superior clinical outcomes. As we strategically pivot to a specialty med tech company focused on creating solutions that improve lives, the Inovus brand emphasizes the differentiated value and accretive foresight we will bring to healthcare professionals and their patients around the world. And in recognition of our successful history of growth and innovation, the distinctive O in the new Inovus logo was deliberately carried over from the Colfax logo as it represents continuous improvement, the cornerstone of compounding value creation that we will continue as Inovus. With that, I'll turn it over to Sham, who will start on slide eight.

Good morning, everyone. Thank you, Matt. We had a strong quarter at ESAB, and I'm proud of the progress and effort by the team. I want to share a few things before we get into slide eight. Recently, we celebrated our 117th year as a company. Our passionate and committed associates are looking forward to shaping the future of fabrication technology for many years to come. We are outpacing our end markets and further expanding our margins, reflecting strong execution by our global teams, and I'm thrilled with the progress that our engineering teams are making to deliver exciting new products to our customers, and I'll share more on this later. To give you a bit more color on our end markets, we continue to experience a broad recovery across most segments, and especially strong underlying demand in infrastructure, construction, and renewable energy. We're also beginning to see modest improvement in energy and markets And lastly, the one segment that continues to show some weakness is automotive as a result of their supply constraints. Along with innovation and a broad recovery, our next advantage is our strong global footprint. Our footprint provides great diversification and resiliency, which has been on display during and after the pandemic. Last and most important, we continue our journey with CBS. Recently, I had the chance to visit several of our manufacturing facilities, and was especially impressed with our MRCO plan and its adoption of lean principles. This facility has been and continues to be a major factor in our margin expansion and customer satisfaction journey. Getting into the numbers. In the third quarter, total sales increased 24% versus last year, affecting high single-digit volume growth and 15 points of price. Our volume growth is fueled by our innovative products and a strong local ground game focused on customers. Drilling down another layer, third quarter volumes in the Americas rose 11%, reflecting a strong underlying demand and continued share gain. A price increase of 24% was substantially influenced by South America. The South America team did a fantastic job of balancing price and cost while providing best-in-class service to our customers. EMEA and APAC increased 6% versus the same period a year ago. These are strong results considering some of the regions began to rebound earlier from COVID restrictions. That said, we believe our Europe business has yet to fully rebound due to weakness in the auto sector. On the flip side, the auto sector recovery in Europe could provide upside for growth as we head into 2022. Our GCE business continued its strong multi-year growth path. We acquired this business a few years ago, and it continues to set the bar on growth and margin expansion, and we expect another strong performance from them in 2022. Turning now to slide nine, we are accelerating our innovation strategy. Our relentless focus on innovation delivered 80 new products last year, and we're on pace to deliver over 100 new products in 2021. In particular, I'm pleased with the performance of our new Rogue product range This product has been very well received by our customers globally and positions ESOP to increase our market share in the light industrial equipment category. We recently had a grand opening of our newly redesigned innovation facility in Gothenburg. I'm very proud of the detail, passion, and thought that went into the design. One could feel the energy and excitement even though most attended the opening virtually. To complement Gothenburg, we continue to invest in our R&D center in Chennai, As a result, we have a strong funnel of new products to come. With the recent acquisition of Octopus, we added capability of offline programming of robots, strengthening our digital offering. Recently, we were able to win a key customer by providing a full workflow robotic solution that included our equipment, filament and digital solutions. This is a great example of a software acquisition that furthers our strategic goals and increases our ability to gain more of our customers' wallet. In summary, we're confident in our ability to achieve our long-term strategic goals of $3 billion plus in revenue, 20 plus percent in EBITDA segment margins, and strong free cash flow. With that, let me hand it over to Chris.

Thank you, Shyam. I'll start on slide 10. We entered the third quarter with decreasing COVID pressures. This reversed in early August when increasing Delta variant cases disrupted elective surgeries, temporarily reducing expected revenues in our medtech business. Despite this, our total company achieved 20% sales growth with a small FX tailwind and six points from acquisitions. The COVID force has placed a further strain on an already stressed global supply chain network. Our operating teams executed effectively to supply customers, but this came at a higher cost, especially in freight and logistics that slowed our sequential margin expansion. Our Fabtech business continued to successfully pass through its raw material cost inflation to customers, protecting profit but affecting gross margins. Total company EBITDA margins grew 20 basis points, which was 90 basis points better before the effect from acquisitions. Overall, we achieved adjusted EPS of 54 cents in the quarter toward the upper end of our guidance range, but a little lower than our trajectory before the COVID resurgence. This included a higher tax rate that we are expecting for the second half of the year due to profit mix changes and FX. We had another strong quarter of free cash flow generating $68 million. Year-to-date, we are approaching $200 million and are well on our way to approximately a $275 million for the year excluding separation costs. This includes higher inventory levels related to supply chain and logistics challenges. Turning to slide 11, our ESOP business posted strong results this quarter. Shyam already covered the market commentary, so I'll highlight that our 23% total growth included volume growth this quarter over both 2020 and 2019 levels. We are using dynamic customer pricing to stay on top of raw material inflation pressures, and we expect to see a small amount of additional price reading through in the fourth quarter based on actions already taken in the third quarter. EBITDA margins were again at healthy levels, up 180 basis points to 16.5%. Volume leverage and benefits from restructuring programs underpin this terrific performance. And we had favorable timing on the resolution of some previously reserved matters that contributed about half of the improvement and won't recur in Q4. On slide 12, our MedTech business grew by 14% over 2020 Q3 results, including organic sales per day growth of 3%, excluding PPE. The acquisitions are contributing as expected and are on solid paths for strong growth and healthy margin expansion. This quarter's performance reflects at least 500 basis points of reduced organic growth from the Delta variant impact on elective surgeries and related clinical and patient services. Because of our high gross margins in this business, the revenue drag also impacted margins in the quarter. As growth strengthens, we expect strong volume leverage that will contribute to healthy margin expansion. Our operating teams are pointed in the right direction to serve customers first and foremost. They're working hard to overcome COVID-driven global supply chain constraints, which added approximately $3 million of cost this quarter versus last year's Q3. This friction is likely to persist into at least the first half of 2022. Included on this page is a chart that peels apart the EBITDA performance progression this year to separate our organic performance versus acquisitions. Our Q3 organic margins stepped up from Q2 levels despite having approximately 20 million of sequentially lower revenues. We expect even higher organic margins in Q4 as the Delta variant pressures moderate and as we benefit from seasonally higher revenues. We expect our fast-growing high gross margin acquisitions to become EBITDA-accretive over the next three years, including the benefit from cost synergies. Our outlook for the year is included on slide 13. We started the year with an EPS forecast of $2 to $2.15. As our performance strengthened throughout the first half of the year, we improved our outlook a few times and landed in July at $2.10 to $2.20. Entering the fourth quarter, we expect the transitional impacts of COVID and our tax rate to keep us in this range, shaping toward the lower end. Our current forecast includes the continual gradual recovery of elective surgeries that we experienced in October, as well as the current level of COVID-driven friction in our supply chains. We also expect the typical sequential seasonal revenue improvements in both of our businesses. As noted earlier, our free cash flow performance remains on track for approximately $275 million this year before costs related to the separation. I'll conclude our prepared remarks on slide 14. Our teams are performing very well this year in a difficult environment. We are outperforming market growth levels and driving continuous operational improvements. We've completed acquisitions to shape the MedTech business for faster growth and margin expansion in the coming years, and the integrations are right on track. Our two businesses continue to gather momentum as we approach the first quarter 2022 separation, and our teams are excited and ready for their new futures. And with that, Annette, let's go ahead and open up the call for questions.

All right, thank you. We will now begin the question and answer session. If you have a question, please press star then one on your touchtone phone. If you wish to be removed from the queue, please press the pound sign or the hash key. If you're using a speakerphone, you may need to pick up the handset first before pressing the numbers. Once again, if you have a question, star then one on your touchtone phone. And our first question is from Mr. Scott David of Mellius Research. You may go ahead.

Thanks, operator. Good morning, guys. Hello, Scott. Good morning. I'm curious on what steps are left to get done, to get to the finish line on the splits.

Yeah, thanks, Scott. As you would imagine, this has been a pretty well orchestrated effort by our team, and we're well into the process here. We've talked about getting Sean's team built out for the corporate support capabilities that he needs. He's already got, of course, all the operating team and momentum there, and we're close to getting our boards fully built out as well. We've talked about capital structure and getting that aligned, and And so really at this point, it's just following some of the more typical steps that you would expect, getting filings ready and so on. So we're right on track. We don't expect any significant challenges here as we approach the separation.

Okay. And then on the same line of questioning, how many of those positions were you able to fill internally at each of the senior positions, or however you guys want to define it, at least in certain levels?

Yeah, so first, as we shared already, Sham and the leadership team of ESAB, most of the roles there are people that have been with us for a number of years, like Kevin Johnson, the CFO, who you all are familiar with as he was our IR leader before he was in this role and has been with the business for a number of years and with the company for for many years. So that leadership team was mostly in place when we announced the separation. And then there have been a few specific additional ads there. And then as far as the sort of corporate leadership support team, there's a few roles there that have come from our Colfax team here. And then there's been a fair amount of hiring as well. And boy, it's been... It's been great. I think the talent that the team has been able to attract really shows the excitement that people have for the opportunity ahead for ESOP as an independent company.

Okay. And just real quickly, will price offset costs in MedTech and 4Q?

So for MedTech price versus cost, you know, I think the answer is no. in that when we get price increases in that business, there is part of the business where we can pass the price through, and then there's other parts of the business where we can't immediately pass the price through, and there's mechanisms like changes to reimbursement rates over time and GPO contract changes over time and things like that. You know, we did make a healthy price move within the parts of the business where we could to start to regain, you know, some of the inflation that's come through the business. And we plan to continue to fight that price versus cost battle as we move into next year. And, you know, I think we'll see how much of it we can get back through price versus how much of it decides as inflation as the quarters play out.

Okay. Thank you, guys. I'll pass it on. Good luck this quarter. Thanks, Scott.

All right. The next question is from Andrew Obin of Bank of America. Go ahead, please. Hey, good morning.

Good morning, Andrew.

Chris, Mike, how are you? Sean? Yeah, just a question. I know it's sort of a tough one to answer, but as we think about sort of MedTech recovery and elective procedures coming back, based on your conversation, what's your best guess how just this progresses over the next six to nine months? Because I think this is a fairly unprecedented pause in growth for the industry you guys are doing as well as anybody. But just what are you hearing from the channel in terms of how this recovery will progress into the first half of next year? Thank you.

Yeah, so first, thanks for the question and the comment that we're doing as well as anybody. I think, you know, we try to share some clear year-to-date organic data that, hopefully lets you take a look because we really feel like we are outperforming nicely there in this environment and showing that we'll be able to outperform on the other side. As far as the external environment, what we saw play out in the quarter was there was a pretty strong momentum there in that sort of June-July period and near the end of July is when it started to be some pressure and so really In August and September, I think the sort of data sets out there all suggest that elective surgery pulled back at least 5%. Some say more and as much as 10, but we feel like there was at least 5% pressure on elective surgery versus what we were seeing going into the quarter and expecting. But then as we got through the end of September and into October, you know, we're starting to see, you know, a little bit more activity and certainly there is, you know, desire and intent and plans by the surgeons to, you know, try to make up a little ground here in the fourth quarter and show a little bit of improvement as we go month to month. You know, there's some limitations on that. Obviously, the compression was caused, you know, by, you know, some of the COVID spikes around the country and in the regions that have lower vaccination rates, you see the, you know, the the more significant compression. But the recovery is being limited by some other factors, you know, space in hospitals and operating rooms. Staffing is a new issue that's being talked about a lot, you know, and not being able to get enough staffing. And so we do expect and we're seeing, you know, an improvement of elective surgery as we work through the fourth quarter so that as we roll into next year, you know, we can be kind of more in, you know, getting to more normal levels and move forward. And as we move through next year, you know, we certainly feel like there is ground to be made up. There's a lot of surgeries that were not done in 2020 and 2021 and need to be done. And so the whole industry has, you know, some extra opportunity. And I think that, you know, most of the conventional wisdom out there suggests that it's going to take, you know, a couple years for that to be made up, you know, given, you know, how much, you know, space and time, et cetera, would be needed. And so that gives the opportunity for the industry to have you know, a little extra market growth for each of the coming years, and we expect that we'll be able to see that and continue to outperform it.

Thank you. And just a follow-up question. Given the number of the deals you guys are doing and given pervasive, you know, supply chain bottlenecks, specifically on the MedTech business, can you just tell us how are you taking advantage of CBS, or I guess it's now called EBS. Is it still CBS? Yes, it is still. It's still CBS now. Okay. You know, how are you guys using CBS to straight line, you know, sort of interacting with your supply base and sort of being able to get the product out of the door? And as I said, particularly given the fact that you're bringing on a number of acquisitions. Thanks.

Yeah. So, you know, the team had started a really nice CBS journey already, you know, as we went through 2019 and we were starting to see real growth real benefits in terms of the service levels to customers and progress on productivity initiatives that we were fully confident we're going to start to turn into some nice margin expansion as we move forward. That work continues, but for sure a lot of our CBS efforts have been redirected in the last few years here to focusing on customer service. you know, things like, you know, our plant that produces our bracing products uses the CBS tools really every week to, you know, look forward at the production forecast, understand what they're going to be able to produce and where the limitations are in terms of different elements of the product supply and Pareto that and then problem solve to be able to either find a way to expedite the supply to be able to produce or redirect some of the resource in the facility in order to make other products so that once we have product available they can access that. So it's daily management, it's weekly management, it's root cause Pareto, and it's certainly helping us a lot in terms of being able to serve customers. We think better than our competition through this period, but we're looking forward to the time when we'll get those CBS tools driving productivity and margin expansion in the business versus helping the teams to scramble for supply. Thanks so much. Thanks, Andrew.

and our next question is from joe giordano with cowan and company go ahead please hey good morning this is uh robert in for joe um just on esau i wonder if you could talk about the implications of lower steel prices and how fast you all might have to you know give back some of the price increases that you've um potentially made recently

Yeah, thanks for that question, Robert. What we are seeing in the marketplace is that steel prices have been relatively stable. And so we'll see where the prices go. I think we've spoken about this before. Our intention is we do expect when steel prices go down, they will give some price back. But then we have other tools in our toolkit with CBS where we talk about value, different strategies around product lines, streamlining, et cetera, that will help us continue to hold some amount of that price as we go through the years. So what I do expect is that we'll have some innovations, some new pricing, as well as some givebacks related to steel prices declining.

Okay, that's helpful. Thank you. And then just on the med tech business, just wondered, you know, how have procedure rates in the ambulatory procedures trended versus, like, the hospital-based procedures? Like, is there any difference there? And do you feel like you've picked up some share gains

Yeah, there is, you know, as we move through COVID, the hospitals accelerated the pace of moving things into an ambulatory environment and the percent of procedures done in an ambulatory environment expanded, at least temporarily. And, you know, I think the expectation is that that balances back a little and then the ASC continues to outgrow. You know, we've tracked our business and a portion of it that's in that ambulatory environment And, you know, we believe that our portion of the ambulatory environment is more than the average industry amount and that it's been growing faster. And so we do think that success in that ambulatory environment has contributed to our share gains. And we've got, you know, strategies aimed at making sure that, you know, over time we've got the right solutions, not just our implants, which set up well for the ambulatory environment, but also the full solution in terms of the workflow for that surgeon that helps them to efficiently do the procedure in a small footprint space and helps us to keep using that as a part of how we gain share in the market.

That's great. Thanks so much for taking my questions. Yep. Thanks, Robert.

And the next question is from Chris Snyder with UBS. Go ahead, please.

Thank you. So the company has talked to kind of high single-digit normalized organic growth from MedTech. But I was hoping for some more color or any maybe targets the company has on expected total growth, you know, as commentary and actions, you know, suggest you guys will continue to be active on M&A. And then I guess, you know, maybe a different way to ask the same question is, is there any kind of timeframe for the expected, you know, kind of $3 billion MedTech revenue target, which the company has spoken to?

Yeah, thanks, Chris. Well, I think first what I'd say is we've talked about being able to drive to $2 billion pretty quickly. And a lot of that's going to come from organic growth, just starting from our pro forma coming out of this year and then a couple years of good, strong organic growth will get us a good ways toward that $2 billion number. And we certainly see ample bolt-ons and adjacencies that would be – opportunities to fill in the gap there and to grow double digits through the coming years and get to that 2 billion pretty quickly. In terms of how we get from 2 to 3 billion, we certainly have the opportunity to grow nicely organically with the portfolio that we've been shaping and the strategies that we've been driving. We have an opportunity to continue to do bolt-ons and adjacencies like the ones that we've been doing And then there are some larger possibilities to think about within the orthopedic space, some large attractive areas that we're still not in and also adjacent to the orthopedic space that could be a part of how we make that journey from two to three billion. Always with a focus on making sure that we're getting great businesses, that we are shaping our organic growth upwards to solidify that high single-digit consistent organic growth, and we're shaping our gross margins upward. Because, you know, if we've got the organic growth and we've got the gross margins, we are very confident that we can drive the EBITDA margins up over time.

I appreciate that, and that kind of, I guess, leads into my follow-up on MedTech margins. You know, I certainly understand that COVID was a a pretty material drag in the quarter, and M&A has been a margin headwind all year, you know, as expected. But, you know, the legacy DJO business is running down year on year despite similar top line and down pretty materially in 2019 despite higher top line, you know, at least by my math. I know you guys called out supply chain as a headwind, but is there something else, you know, going on there that we should take note of that's driving that compression?

Yeah, you know, beyond the acquisitions that you mentioned that are, you know, we try to isolate that so you can see the temporary impact of those acquisitions, and we've already talked about how those are going to scale over time and some of the synergies on the math side. So if you set aside the acquisition impact, there's really three factors there. One, we made some meaningful investments back as we worked through 19 that we've talked about to really get this business positioned for the future and get it prepared to drive the kind of growth that that we're driving relative to the industry now. Second, operating leverage is important in this business. And when we grow above mid-single digits and in that high single digits organic range over time, there's a healthy amount of operating leverage that's going to contribute to margins. And through the past couple years, we've had limited growth there. And take that operating leverage you know, out of the equation and in shorter periods of time, like recently, you know, when we expect to be at one level and then we wind up at a lower level, it, you know, can be, you know, a real headwind. And then third, you know, COVID-driven inefficiencies. You know, we're seeing, you know, inflation. We're seeing a lot of extra costs from expediting. The inflation is not just product, but also freight, and some of it is you know, outbound freight to customers, and we can look at how we pass through through policy, etc. But some of it also, all the escalation in global freight rates related to supply chain pressures, and those are expected to subside over time. But in the meantime, you know, that's extra cost coming through the system. And beyond the inflation and expediting, our, you know, production has been quite inefficient. When, you know, I talked earlier about the challenge of week to week figuring out what are we going to make based on which supplies have not come in the way they were supposed to. And that really has a pretty significant impact on the efficiency of how the plants run. And again, we've chosen to focus on keeping customer service up and bear the cost that go with that. And so those are the three big factors that are affecting margins. You know, we think about the past, the 25% going forward. So, yeah, we've got a little lower starting place than we talked about earlier in the year. When we think about the past, the 25%, we've got an opportunity to recover that COVID impact over time, you know, in terms of being able to, you know, manufacture more efficiently in terms of, you know, not having the excess expediting costs and things and recovering that inflation one way or the other, whether we get it all through price or over time it subsides some. Second, we've got a chance to get that operating leverage and also productivity through CBS as we grow, and that will be a meaningful contributor as well. And third, we've got opportunities to scale our SG&A and to streamline our SG&A. We've had projects underway, different initiatives streamlining our SG&A, and we'll continue to focus there as well to make sure that that overall journey to 25 percent is secure. And we're confident that it is. As I said, we've got the gross margin. we'll be increasing that over time, and we've also got the growth coming over time, and so we'll make sure that the bottom line comes with it.

I appreciate all that, Collar. Thank you.

All right, and next we have Jeff Hammond with KeyBank. I'm sorry, KeyBank Cap Markets. Please go ahead.

Yeah, good morning. Yes, Sean, good to have you on the call. Maybe I'll ask you a question and go the other way on price. Can you just talk about You know, if steel kind of stabilizes here, what do you think the wraparound pricing is for ESOP into 22?

You know, what I'd say to you is that we don't predict, obviously, what happens with steel. But what you know very well is that we've had a strong process in play. we know exactly what to do and react to when steel goes up or down. And so my view on that particular piece is, as I said earlier, that steel is stabilized. In some regions, it's still going up. We've got strong processes in place to react to that. And then going forward, what I expect is that for that price-cost piece to continue to be neutral as we move forward.

Okay, and then... You know, Matt, maybe just on, you know, if we assume that there's kind of no re-spikes in COVID into 22, like, what do you think is a reasonable kind of growth rate to think about for P&R and recon individually as you move into 22?

Yeah, so our recon business, you know, was... So, again, you know, maybe focus on the core growth. Our recon business was growing... you know, healthy double digits before we came into COVID. And so we expect it to be able to come out the other side, you know, growing in healthy double digits. And then as we, you know, the foot and ankle businesses are businesses that can grow double digits as well. And we've talked about the Mathis business as a business that will build from its mid-single digit history up to double digits. And so, you know, we do expect that overall recon portfolio to be able to grow in that direction. in that double digits range, you know, as we come out and over time. And on the P&R side, you know, those are markets, you know, that, you know, grow kind of in the 3% kind of range. You know, we've been shaping the portfolio a little, like the Lycure acquisition shapes us a little bit in a positive way, and we'll look for other ways to do that with bolt-ons. But, you know, we do think that P&R business has been shaped up to where You know, it's growing better than the market now, you know, right through COVID. And so we do think on the other side, you know, we're positioned to at least grow at market rates in that business and, you know, potentially higher than market rates. And so if you put those together, you certainly get to mid single digits plus and potentially high single digits growth already on the other side of COVID, you know, versus a little bit further forward.

Okay, and then just cooking for Chris, you know, we're getting closer to the split. Any thoughts on tax rates or tax structure for each of the businesses individually?

Yeah, thanks, Jeff. So we're continuing to work through all the tax structuring that it takes to enact the tax-free separation of the company, and we've got really two great tax teams that are developing now, to focus on where we can drive those rates longer term. So it's a little early for us to make definitive comments on that, but I can tell you that absent any legislative change in the U.S., our teams are going to be focused on maintaining rates at or below the sort of current levels.

Okay, thanks.

Okay, and we now have a question from Nathan Jones of Stifel. Go ahead, please.

Good morning, everyone. I wanted to ask a question on the pricing in MedTech. I think, Matt, during your prepared remarks, you said there were places you could get pricing, places that you can't get pricing. I assume that that's got to do with insurance reimbursement rates, but maybe for the industrial analysts on the call who don't understand those mechanisms as well, you could describe a little bit about the process for getting those reimbursement rates increased as inflation goes through, how long that might take, et cetera?

Yeah, sure. Yeah, there is a portion of the business, there's a portion where we are the biller, and so we get the reimbursement rates. And then there's areas where our direct customer is the biller. And, you know, over time in the industry, you know, there's, you know, constant reassessment, you know, within Medicare of what the right reimbursement rates are. And historically when there have been inflationary periods, you know, sometimes those rates, you know, have then been increased or sometimes, you know, some of the ongoing kind of yearly changes. reductions that come through. And some of the product lines have stabilized for a few years before that continued. And in some cases, that's something that the industry lobbies for and gives information for. In some cases, it's a normal process where they go through that. But there is certainly a you know, an opportunity for some of those reimbursement rates to change over time, and we think that, you know, will be part of the equation. But then there is also another portion of this that is, you know, GPO contracts with hospitals, and those GPO contracts, you know, open up, you know, at different periods of time for different pieces of the business. And again, you know, the kind of historical trend on some of those GPO contracts is that they typically... go down each time that they open up, and that's why this industry has a little bit of price down every year. But, again, in inflationary periods in the past, those GPO contracts, you know, sometimes, you know, stabilize or even go up for a period of time based on, you know, the arguments that players are able to make about the inflationary environment. And so those are some of the other mechanisms beyond the straight price mechanism that will be coming through as we work through the next couple years. And so... I would expect that the overall price-cost equation for this business for the next couple years is better than it is in normal years as we're pulling back what's happened over the course of these past two years.

So you think it takes like a year to two years for this to normalize?

Yeah, I mean, what I'd say, we're certainly focused on trying to make sure that we get, you know, as much price through the systems as we can as fast as possible and offset as much as possible of the inflationary impact that we've borne. But I'd also say that on the inflation part within products, if the product costs don't go back down, you know, it'll take a couple years to fully normalize. Now, there are other inflationary things, you know, like you know, expediting costs and higher freight costs that could change, you know, could change very quickly, you know, if things stabilize in the global supply chains and if there's then more excess in terms of freight and logistics, you could see, you know, as we work through next year, you could see a sharper fall off in some of these freight and logistics costs, you know, that could be a, you know, a faster path through.

Thanks for that. And then one for Chris. You mentioned in-quarter timing in Fabtech during the quarter. Can you give us some more details on what that was?

Yeah, sure, Nathan. Back in 2020, we had some customer distribution challenges that we had to reserve for and to consider for, and some of that, of course, happening in the middle of all the COVID timing there, and our teams did a really good job of working through the related issues and getting to a good answer, and our expectations that we'd get to the other side of that more closer to the end of the year, and the good news is we got there a little bit more quickly. And so we wanted to highlight that just because it put a little bit of extra positive impact on the Fabtech margins in the third quarter that you wouldn't expect to see as we progress into Q4. Having said that, we have every expectation that Q4 margins and ESOP are going to be attractive relative to prior performance. Great. Thanks.

I'll pass it up.

Okay. And we now have Steve Tussa with J.P. Morgan. Go ahead, please.

Hey, guys. Good morning. Good morning. Hey, Steve. Can you just talk about what you're kind of seeing in international markets in the Fabtech business? Anything kind of out of China or anything like that that you could talk about?

Yeah, thanks for that question, Steve. I think what I mentioned in my comments earlier as well was we saw a really fast recovery in Asia as we came out of the COVID period and restrictions. What we are seeing is a stabilization in the growth rates, and China is no different on that particular front. But other regions in Asia continue to seem to have a really strong growth profile, specifically as we speak about India and some of the other geographies there. But we are seeing a bit of a stabilization in our growth rates in China.

And how do you see that playing out in the fourth quarter and then going into next year?

Yeah, and so what we have said is that our play in China has been really in places where our innovation is appreciated and where we add significant value. What we are seeing is that in the places that we play, there continues to be some tailwind and momentum on that particular side, so we're not seeing any downside in our position in China. As you know, we play basically on the top tier of that particular marketplace in China.

Okay, great.

Thanks a lot.

And that concludes our Q&A session. I will now turn the call back to Mike Masek for closing remarks. Go ahead, please.

Thanks, everybody, for joining our call today. We look forward to catching up with you guys individually, and have a good afternoon and day. Thanks, everyone.

Thank you, ladies and gentlemen. This concludes today's conference. Thank you for participating. You may now disconnect.