Enovis Corporation

Ladies and gentlemen, thank you for standing by, and welcome to the Colfax Second Quarter 2020 Earnings Conference Call. At this time, all participant lines are in a listen-only mode. After the speaker's presentation, there will be a question-and-answer session. To ask a question during the session, you will need to press star 1 on your telephone. Please be advised that today's conference is being recorded. If you require any further assistance, please press star 0. I would now like to hand the conference over to your speaker today, Mike Nasik, with Colfax. Thank you. Please go ahead, sir.

Good morning, everyone, and thank you for joining us. I am Mike Masick, Vice President of Finance. Joining me on the call today are Matt Holtol, President and CEO, and Chris Hicks, Executive Vice President and CFO. Our earnings release was issued this morning and is available in the investor section of our website, colfaxcorp.com. We will be using a slide presentation to walk you 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 SEC. 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 required by law. With respect to any non-GAAP financial measures made during the call today, the accompanying reconciliation information relating to those measures can be found in our earnings press release and today's slide presentation. Now I'd like to turn it over to Matt, who will start on slide three.

Thanks, Mike. Good morning and thanks everyone for joining the call. I'd like to start by recognizing our associates for their continued dedication to protecting the health and safety of their colleagues while serving our customers and patients. As I mentioned on our last call, we made COVID-19 safety our top priority for Q2 and took quick actions to protect our associates around the world. At the same time, we successfully navigated a range of challenges to keep most of our supply chains flowing and recover quickly from a few policy-driven shutdowns. We aggressively flexed down our costs to partly mitigate the slowdown in sales and achieve very strong, detrimental margins. We also used an aggressive CBS focus to keep our cash flow positive and protect the overall financial strength of the company. In the second quarter, we earned $0.09 per share on an adjusted basis and generated $18 million of free cash flow, achieving our objective of being earnings and cash flow positive despite a year-over-year sales reduction of about 30%. Sales hit a low point in April, down more than 40%, and then sequentially improved in both May and June as customers worked past the initial pandemic shock. June sales were down 19%, and this positive trend continued in July with both of our businesses, again, sequentially improving. We finished the quarter with ample liquidity and financial flexibility. We protected our key growth investments, even as we reduced overall spending. Our actions this quarter will enable us to regain the strong momentum and relative performance that we had prior to COVID. Slide four shows in more detail the monthly sales progression in our businesses, which played out within our expected range of outcomes. Following a difficult April, our med tech business saw an increasing number of elective procedures, reopening of orthopedic clinics, and increasing levels of organized sports and trauma. Sales improved sequentially from down 60% in April to just down 16% in June. The reconstructive product lines had larger declines early in the quarter due to the nearly complete curtailment of elective procedures in March and April, and as hospitals and ASCs resumed these procedures starting in May, sales quickly improved with June sales down only 3%. Prevention and rehabilitation product lines declined to a lesser extent in April and then improved to down 21% in June. This part of the business has more diversified end uses and is more global, so the recovery is impacted by a broader range of factors than just elective surgeries. Across the total MedTech business, Preliminary July results are consistent with our view that Q3 sales growth will be better than June levels. In Fabtech, sales also improved throughout the quarter. In April, we experienced a decline of just under 30% and improved to down 20% in June. As the quarter progressed, we benefited from reopened facilities, easing of restrictions in many served areas, and sequential demand improvements in almost all regions. Similar to our MedTech business, we expect sequential improvements to continue in Q3. The pace of improvement in both businesses is uncertain, but we believe we will continue to improve through the second half of the year. We are increasingly focused on maintaining and expanding our market advantages and investing for future growth. MedTech business results are included on slide five. Q2 sales of $206 million were down 34% organically. Both segments were down a similar amount and improved through the quarter. As we expected, Reconstructive had a much steeper improvement and had positive growth in July. We are encouraged by the sequential improvements across the business as our teams are working effectively to serve recovering demand. Our temporary cost actions enabled us to deliver positive adjusted EBITDA in the second quarter despite significant volume declines. Given the improving sales, we're rolling back most of our Q2 temporary savings actions and focusing on driving strong sales recovery through commercial processes, strong operating execution, and innovation. We continue to invest in our key growth initiatives and expect to increase overall innovation spending this year versus last. We've highlighted some of our recent launches on slide six. Our fast-growing surgical implants business aligns with great surgeon key opinion leader teams to develop products with superior outcomes. We're building on our product portfolio and filling out the bag where we currently have gaps in our offering. We're about to launch two important new products. First, the Empower Partial Knee expands the number of procedures where patients can benefit from the greater stability and natural knee motion patterns that have made our Empower such a great success. We also recently received FDA approval for the Altivate Anatomic CS Edge, which adds a stemless offering in our shoulder portfolio. These products will help us to penetrate more deeply in existing surgeons and also to continue to attract new surgeons. In prevention and rehabilitation, focused operational improvements along with growing product vitality created significant growth momentum prior to COVID. We recently released two new products under the market-leading Don Joy brand. The X-Rom Post-Op Knee Brace combines excellent range of motion protection with a comfortable, user-friendly design. The VersaRom Hip Brace fills a key product gap in our portfolio. We are expecting to launch several more key bracing products this year, progressing step by step back to the healthy vitality levels that will support consistent above-industry growth. Another part of our innovation strategy is to lead in connected medicine. Connected medicine digitally connects healthcare practitioners to patients in outpatient settings. By capturing more real-time data and driving improved compliance to post-operative protocol, connected medicine can create better patient outcomes and satisfaction with the overall experience. As you can imagine, the COVID crisis has made doctors and patients even more interested in these benefits. This week, we introduced MotionIQ, an innovative new software solution designed to transform the surgical experience by digitally connecting the surgeon, care team, and patient throughout the larger continuum of care. MotionIQ empowers patients to take an active role in their care through a more personalized and informed process while providing the care team with continuous health and activity data. This is another great addition to our overall suite of digital solutions. Turning to slide seven, fabrication technology organic sales declined 25% to $414 million. One of the strengths of our Fabtech business is that it is a truly global business with almost half of our sales coming from faster growing emerging markets. This quarter, these developing regions were down less than developed, and both developed and developing regions showed sequential sales rate improvement through the quarter. Our GCE gas control business grew in the quarter. We acquired GCE several years ago as part of our strategy to improve the margins and growth opportunities within our Fabtech platforms. GCE is a leader in gas equipment, selling in the healthcare space with medical gas systems and other equipment, as well as in more traditional industrial sectors. We significantly mitigated the profit impact from lower Fabtech sales through strong cost control and temporary savings actions, resulting in decrementals of only 21%. Restructuring projects initiated late last year remain on track, with expected in-year benefits of at least $20 million and with higher annualized benefits. We are also playing aggressive offense in Fabtech. By effectively supporting customers, focusing on healthier market sectors, and protecting key growth investments, we're positioned for continued outperformance. Slide 8 highlights some of ESAB's new products. We launched 37 products through the end of Q2 and expect to again top 80 by year end this year. We have a strong and rigorous innovation process in ESAB that reliably creates market leading new products that drive share gain each year. Our Fabtech platform has also been focused on digital solutions. We expanded our digital offering this quarter with the introduction of WeldCloud Notes document management software. This solution adds weld process storage and quality documentation to our industry-leading WeldCloud offering. This quarter, we also launched the Aristo 500iX, a portable power source that is designed to better serve the needs of the heavy industrial market. We also rolled out the MINIARC Rogue ES180i, a portable stick lift TIG inverter that gives us access to a new market segment in high growth markets. We will launch dozens of filler metal and gas control products this year and have highlighted a few key ones from Q2 here. Before turning it over to Chris, I'll summarize our key priorities for the second half of the year on slide nine. The safety of our associates remains our top priority. This includes protecting associates around the world in our manufacturing sites, our field service teams, and those working via technology from home. These teams are focused on continuing to reliably deliver to customers at a time when they need our essential products. At the same time, our teams are driving CVS improvements and advancing our growth strategies. We continue to responsibly flex our costs and are also supporting our customers with strong delivery performance and an expanding number of innovative new products. These new products are being commercialized at a time when markets are improving. We expect to sequentially improve growth and profit in the third quarter and remain cash flow positive. We believe that the rate at which we recover will show clearly the strength of our reshaped portfolio. We also have a healthy acquisition pipeline of strategic bolt-on opportunities and technology investments that can help drive compounding value for our shareholders. I'll close by expressing my sincere gratitude to our associates around the world. Our teams have shown commitment, resilience, and great skill to successfully execute in these challenging times. I am extremely proud of our team and know that we will work through the rest of this crisis together and then resume our winning momentum. Chris will start on slide 10.

Thanks, Matt. Despite the pressure on our revenues in the quarter from COVID, we flexed our total spending down to achieve our objective to generate positive free cash flow. The $18 million we are reporting does not include another $3 million from the sale of assets. We also reduced our operating cash balances to more efficient levels. All of these efforts supported the $300 million revolver repayment in the quarter and kept our liquidity at $1.2 billion. We finished the quarter with 4.2 turns of debt. We are forecasting to be cash flow positive again in Q3 and generate our seasonally highest quarter of cash flow in Q4. Our current view is to end the second half of the year with leverage in the mid-four turns and then to return into the threes as EBITDA levels rebuild in 2021. Slide 11 is an overview of our, as reported, second quarter consolidated performance. Sales declined 32% or 28% organically, as FX headwinds impacted sales just under 4% in the quarter. Based on current exchange rates, we expect this headwind to be lower in Q3 in the range of 2% to 3%. During the quarter, we executed the temporary spending reductions as outlined in our last call. This enabled us to achieve Q2 decrementals of 28% within our expected range. Our outlook is for sales to continue to sequentially strengthen, and we are dialing back many of the temporary cost actions to align with this view. As a result, we expect the decrementals in Q3 to slightly move into the low 30s. Our Q2 operating cash flow of $37 million reflects process improvements that were quickly implemented by our teams throughout the company, in some cases accelerating efforts that would have been completed later in the year. These improvements will also contribute to future performance. As COVID abates after 2020, we expect a return to the $250 million or more of free cash flow and 90% plus conversion that we originally guided for this year. For the rest of 2020, we expect interest costs to track near Q2 levels and the tax rate on adjusted earnings to likely be in the mid-20s. The share count should be mostly in line with this quarter's results. Slide 12 provides a similar view of the recovery in each of our businesses as we provided in our last call. The long-term drivers that we discussed a few months ago remain intact. Our medtech business is well positioned to serve the increasing demand from aging and more active populations and related medical conditions. Our fabtech business remains the only truly global supplier to support infrastructure investments in the developing world. Our MedTech business should benefit from increasing access to health care in our served markets. The industry has a powerful incentive to continue to serve patients and protect revenue. We are already seeing increased activity as surgeons work down their backlogs, and future revenue will also be linked to more patients reentering treatment arenas to seek relief for chronic pain and immobility and for injury prevention. We are expecting flat to down mid-single-digit revenue in Q3, and continued normalization heading into 2021. Our industrial scenarios continue to have a wider band of potential outcomes to reflect the broad number of markets served. We continue to expect sequential progression each month, and preliminary July results are in line with our views. We cannot predict with certainty when demand levels will return to pre-COVID conditions, but see a path for quarterly normalization sometime in 2021. We're pleased at the rate of top-line improvement in our businesses through Q2 and into July. We acknowledge the risks associated with additional waves of infection that continues to influence the wide range of potential recovery outcomes, but we are confident of our path for sequential improvements into the back half of 2020. Wrapping up on slide 13, In the second quarter, we demonstrated our resilience, the strength of our teams, and the power of our business system by responding quickly to the pandemic. We protected our associates and delivered on our Q2 financial objectives of positive earnings and cash flow. Business conditions clearly improved off of April lows, and this momentum has already continued into Q3. Sales and profits should sequentially improve this quarter. Throughout the downturn, we continue to invest for growth to ensure we remain well-positioned to play offense and resume our momentum of growth, margin expansion, and healthy cash flow as COVID abates. That completes our prepared remarks. Let's go ahead and open up the call for Q&A.

As a reminder, to ask a question, you will need to press star 1 on your telephone. To withdraw your question, press the pound key. Please stand by while we compile the Q&A roster. Our first question comes from the line of Scott Davis from Milius Research. Your line is now open.

Hey, good morning, guys. Can you hear me okay?

Yeah, hey, Scott. Good morning, Scott.

Good morning. A couple things sound interesting here. I mean, you made a comment towards the end of the prepared remarks that process improvements accelerated given the pandemic. I mean, can you give us some examples of what you're kind of referring to whether it's factory-based lean or sales, marketing, or kind of all of the above, or just basically anything that you can share with us in that regard.

Yeah, Scott, I mean, the specific comment was related to cash flow, although we're working on process improvements throughout the business. And in cash flow, you had active efforts working on improving inventory management in both of the businesses consistently. as part of our overall CVS focus in the businesses. And, you know, that's an area where, you know, we had already laid quite a bit of foundation in terms of that process work. And as we got early into the crisis, we were able to use that foundation to, you know, very thoughtfully pivot what we're doing on the inventory front across our many facilities around the around the globe and stay in a position where we could serve customers well as the volumes were declining, but where we didn't continue to build up inventory in the business. And so we feel like we've been able to keep ourselves strategically positioned to have the right amount of inventory for the recovery, but at the same time, you know, not have our inventory run up on us as the revenue was coming down.

I would add that we also increase the cycle times in the reviews that we've got in various parts of our operations as well. And as you know, the more frequently you're measuring and improving, generally you're going to be able to drive better results that way as well.

Okay. Helpful. And then just kind of logistically, I mean, you have a few new product rollouts in MedTech that look promising, but how do you get those products out to, you know, how do you educate your customer in times like this and You know, is this the right time, I guess, to launch new products, or is this just part of the regular cycle and it's just going to take a little longer perhaps given the pandemic to really get customers to understand the offering?

Well, interestingly enough, Scott, it's been sort of a great time as long as you're thoughtful about the timing. You know, for a couple of months there in Q2, doctors and their other practitioners were had more time than they've ever had to talk to us. So we took full advantage of that. We had a lot of digital education sessions on a range of issues, including the new product that we had. So we did, with a couple products, we shifted out the timing of the launch by a couple of months to get them out of Q2 when there wasn't as much activity. But then we used that time to do a whole lot of education. And now I think we've got the opportunity to bring those products into the market here in Q3. So I think it was a bit of a unique opportunity on these products that our teams have taken full advantage of.

helpful. Well, good luck to you guys. Thank you very much. Thanks, guys.

Thank you. Our next question comes from the line of Jeff Hammond from KeyBank Capital Markets. Your line is now open.

Hey, good morning, guys. Hey, Jeff. So just wanted to focus on, you know, decremental margins in MedTech. They seemed a little bit weaker than what we were, you know, forecasting. Just can you talk about what you did in terms of temp costs and what comes back and what investments may have kind of weighed and maybe how to think about decrementals between the two segments as we go into 3Q. I know you gave an overall.

Yeah, Jeff, I think we were really pleased with the execution that we had in Q2 in both the businesses. There's obviously a difference in the performance because you've got a different starting point with the margin profile in the businesses. So we would expect the Fabtech business to come in with lower decrementals just as it did. And so we've executed really across the wide range of temporary initiatives that we had which impacted employment levels, you know, compensation, discretionary spend, just really We pulled pretty much all the levers to make sure that we could stay financially healthy. As the quarter progressed and we began to see improving sales levels, it became clear to us that we had the opportunity to match the temporary spending going into Q3 against those improving sales levels. And so we began to turn the knobs a little bit, especially with respect to employees decreasing the furloughs, changing the compensation tactics that we had engaged in. But still, all of that means that we're targeting a level of decrementals in Q3 that's really going to be very similar to Q2. Instead of being in the sort of high 20s, we're saying low 30s. We think that's appropriate given the level of improvement and the fact that we're pivoting the team more and more to playing offense, making sure that we're getting our fair share of the market opportunity.

Okay. And then I think there's been talk of, you know, kind of this catch-up in, you know, the surgical piece. And I'm just wondering, you know, how you think about, you know, I know visibility is tough, but how you're thinking about cadence into 4Q, you know, do these catch-ups all happen in 3Q and then we step back? Or how to think about, you know, some of that catch-up?

Yeah, yeah, Scott. Really from the start of this, or sorry, Jeff, there's been a – I think there's been an understanding that while elective surgery was essentially shut down, there's a backlog that built up. And at the same time, there's less clinic visits that were taking place. And then as elective surgery started to come back initially, we're working off that backlog. But then the clinic visits are building back up the backlog. And so from the start, there's been an understanding that, you know, if the recovery came super fast, then there might be a little bit of a pause after the recovery before you got to normal. And if the recovery came slower, then there probably wouldn't be a pause. And it's just sort of the math equation, you know, between, you know, the backlog and the recreations. of the backlog. And so, you know, as we think about the back half of the year, you know, we're keeping that in frame. As I shared in my comments, our reconstructive business was in a positive zone, positive growth zone in July. That doesn't mean the industry was in a positive growth zone overall because we've been taking share consistently in that industry for a But that positive zone in July, you know, if we stay in a positive zone through the quarter in that business, it just depends how positive we are, right? The stronger we get, the more chance that we might pull back a little late in the quarter or in Q4 once the backlog has been worked off. And if it's a more steady progression through the quarter, then it's more likely that it'll stay in that steady progression. But the good news is that right now this is In the reconstructive business, all the discussion around the range of flat or up a little or down a little, unless something changes in the external scenario versus the significant declines of Q2.

And how's the progression of recovery happening in the rehab side relative to maybe what you would have thought three, four months ago?

Yeah, I think in reconstructive, it's been pretty consistent with what we might have thought. You know, as I said, that business didn't go down as far, and its recovery has been slower. What we see happening there is that there's a significant portion of that business that's driven off of sports medicine elective surgery as well as implants elective surgery. And that part, of course, has come back very quickly with those elective surgeries. But then there's also a significant portion of that business that is, you know, based on a broader range of drivers around the world, you know, sports activities, workplace injuries, trauma, and those are coming back at a more step-by-step pace that, frankly, is more consistent with what we're seeing on the Fabtech business in terms of kind of a step-by-step pace of recovery. And so I'd say the recovery in that business is Consistent with what we've expected, and we're encouraged to see improvement again in July in that business as well, that we think is consistent with what's going on in the outside world as more people are getting back to activities and the clinics are getting more full, et cetera. But at the same time, there's a lot of activities that have not resumed yet, and it's going to take some number of months or a couple of quarters before all of those do. Okay, great. Thanks, guys.

Thanks.

Thank you. Our next question comes from the line of Joe Giordano from Cowan. Your line is now open.

Hey, guys. Morning. Morning. Hey, Joe.

Hey, so, like, I think the color of surgical being up in July is important. I'm just curious, like, is there a wide range of, like, kind of outcomes that you're seeing now in different parts of the country? Like, is it up a lot in the northeast and, like, down or getting worse in, like, California or places that have seen second waves. I'm just curious as to, you know, how do we think about the sustainability and forward direction of that July number?

Yeah, Joe. Well, first, our surgical business is nicely balanced across the country. And, you know, there is no question that there are regional differences, that there are, you know, certain states and cities that came back very, very fast. and then have, you know, have had, you know, some flare-ups in terms of infections that have led to some pullback. And there's other states that have, you know, that took longer to come back, and they're just now really accelerating now. The good news is that there's a degree of diversification there that, you know, they'll have some month-by-month impacts, but not, you know, we're not seeing wide swings. And frankly, it tends to be you know, quite situation specific. Again, if you go back to March, everything stopped, you know, essentially. Things that really had to happen, whereas what's happened here in June, even July, is, you know, you'll have a doctor that starts to see that, you know, because of some local flare-ups, their, you know, their schedule is getting a little bit pulled back, and they'll say, you know what, I haven't taken a vacation in a while, I'm going to go take two weeks. So, we have one of our doctors that we are thinking is going to do a lot, and then they're not, and and we adjust to that, or you have a hospital that starts to get concerned, and so they dial back to only doing things in the in the ambulatory center, and that takes that hospital from 80% or 90% to 60% or 70%. They're more specific case-by-case things that are happening that are causing some of the oscillations in the business. And I think our team, we've got an incredibly agile surgical team, and they're doing a fantastic job adapting to that and making sure that the doctors have what they need to do the surgeries and that we can pivot when someone decides to pull back and someone else decides to do a little more, we're staying very, very close to those docs, and I think doing a great job doing that. And we do feel like that kind of surgical implants business has recovered most of the way and is going to bounce up and down a little. But unless there's some significant unexpected new phenomena, we should be kind of away from the very difficult times in that business.

And apologies if you touched on this. Sorry, I'm kind of juggling a bunch of different things this morning. But have you seen kind of like maybe an accelerated shift towards the ambulatory center? And has it kind of accelerated maybe the uptake of some of your digital offerings for patient scoring and things like that?

Yeah, so there's no question that right now a larger percentage of procedures are being done in an outpatient environment, in multiple types of outpatient environments, not just ASCs. A larger percentage of procedures are being done that way. That's the way the hospitals have dealt with getting back to elective surgery while at the same time having the appropriate separations and things that they need to have. On a temporary basis, there is a meaningfully elevated amount of stuff being done in that outpatient environment. You know, on the back side of that, that will stabilize back, you know, to a more balanced level. But for sure, you know, this kind of trend to more outpatient surgery, you know, has likely been accelerated for good through this. And, yeah, there's some great things that we've been doing there. You know, our aura score is something that we've made available to everyone on a short-term basis so they can – they can use it and see how it helps them to do the risk assessments of which are the right patients to be able to do in that outpatient environment. We've also, you know, our knee product, Empower Knee, is a knee that sets up very well for the type of patient, the active patient that is done in the outpatient environment. And so that creates more in the ASC as an advantage for us. And We've also been continually working on our instrument sets and other workflow for the ASC to make sure that as that trend continues that we can be a real leader there.

And then just last for me, just on Fabtech, obviously you have significant exposure to some parts of the world that have been hit pretty hard too, Brazil, Russia, things like that. Have you seen those markets kind of stabilize at least from a demand standpoint?

Yeah, as I said, most of our regions have accelerated through the quarter, and that includes kind of the various emerging regions like Russia. India is one that – you know, was completely shut down in April and most of May and then, you know, has, you know, reopened in June. It's taken some time to get restarted on the back side of that kind of a shutdown, but all of our facilities reopened late May, early June in India. And, you know, we certainly are seeing that developing part of the business performing better than the developed and, you know, you know, accelerating as well on an ongoing basis. Great. Thanks, guys.

Thank you. Our next question comes from the line of Mike Halloran from Baird. Your line is now open.

Good morning, gentlemen. So... So first on the Fabtech side, a little bit of a continuation from that last question. You know, you think about the guidance in the high single to mid-teen kind of decline range versus 20% decline in June. You know, what informs that improvement? Comps get a little easier, but is this a linear improvement curve, or is it what you're seeing in July across the regions and kind of going normal sequentials off of that or normal seasonality off that? Excuse me. How do we kind of frame how you arrived at a down eight, high single digits to mid-teen type decline range?

Yeah, so, I mean, certainly we tracked very carefully the trends through the quarter and what was driving those trends and, you know, how much the improvements were driven by, you know, factories that we'd had to shut down that we were then able to reopen versus how much was driven by, you know, demand-based economic drivers and, you know, which of those were policy-driven in terms of they were shut down and then reopened versus which of them were activity-driven and maybe they slowed down and then they're restarting at some pace. And we've looked at it, you know, kind of segment by segment. So we looked at how things went through, you know, through the quarter, and then we've taken a, you know, close look at how how June has developed and based on that, you know, have, you know, tried to give our, you know, our best view to you of how we see things going through the quarter. And as you'll notice, you know, it would be a sequential trajectory for us that is quite different from history. We typically are down from Q2 to Q3, you know, based on the summer in Europe and, you know, we're now expecting that we should be up from Q2 to Q3.

The pricing side of Fabtech, slightly positive in the quarter, thoughts on how that dynamic plays out and any kind of price-cost commentary from your perspective?

Yeah, so pricing in the market is pretty stable, and our positive in the quarter is more related to covering inflation in some high-growth areas of the world versus some broader pricing actions. But we are, you know, feeling like there's a good stable price environment in the industry, and we continue to drive, you know, value-based pricing efforts while at the same time being very proactive about, you know, covering inflation when it hits us.

And then last one, when you go back to how you were thinking, talking about the rehabilitation side of things, do how does it correlate to activity levels and the return of reconstruction? Is it pretty coincidental? Is there a lag impact? How are you guys thinking about the timing of that versus the other pieces?

Yeah, so, again, there's a meaningful portion of our prevention and rehab business that is related to elective surgery, and it's pretty closely linked pretty closely linked. As sports medicine surgery restarted around the world, not just in the U.S., we saw a meaningful pickup in a part of our bracing and rehab business that's related to that. And that'd be braces that you use right after getting an ACL. Again, it's this X-ROM brace that we just launched is a brace that'd be used right after you get ACL surgery, but also cold therapy that gets used right after implant surgery or others. So there is a pretty close correlation, you know, with a portion of our bracing business, you know, with that return to elective surgery. But then it's really the rest of the bracing business that, you know, in some cases it was constricted just because people weren't going to clinics. And so they, you know, they would have pain, but they weren't able to, you know, to get to clinics. Some of that came through a consumer channel, but the reality, most of it just didn't come for a little bit there. But there's also, you know, different, you know, sports industries, workplace injuries, you know, trauma, you know, that are the, you know, some of the drivers of the need for prevention and rehabilitation that, you know, we're significantly reduced based on all of the policies around the world of, you know, people sheltering in place and different things like that. And so that's just, you know, as these economies get more and more open and people get more and more active, you know, that should, you know, get the rest of the way back to normal. And, you know, we're not sure if that's going to be, you know, a quarter or, you know, several quarters. But, you know, we do expect the demand route drivers to return, as Chris talked about, as we get into next year.

Appreciate it. Thanks for the time.

Thank you. Our next question comes from the line of Joe Ritchie from Goldman Sachs. Your line is now open.

Thanks. Good morning, guys. Good morning, Joe. Hey, Joe. Hey, can we just talk a little bit about MedTech margins in 3Q? So, you know, if you guys end up doing, let's just call it flat organic in MedTech, so roughly $300 million in revenue, I'm trying to understand, like, whether the EBITDA margins can get back into, like, the mid-teens, because I had them, you know, closer to, like, the high-teens last year, and you do have a mixed benefit. Sorry, that's my dog in the background. Okay. mixed benefit, right, that should be occurring in 3.2 as well.

Yeah, I'll just comment on this, Chris can add, but I think from an overarching standpoint, we certainly are focused on making sure that as our revenue recovers, that our margins are in a healthy place and that we can drive the kind of margin improvements in this business that we talked about you know, since we've acquired the business. And we're confident that that's something that can happen. You know, in any given quarter, there's going to be some to's and fro's in terms of, you know, of what we're selling and what we're investing in and, you know, different aspects of, you know, temporary measures, et cetera. And so, you know, I think we're not going to be, you know, not ready to comment on, you know, specifically quarterly margin comparisons. But what I can say is that we're very focused on making sure that as as the revenue fully recovers, that we have the kind of margins that we should have in that business and then are able to continue to improve from there.

Okay. That's fair enough, Chris. I guess maybe just make sure that I got it straight, though. The expectation is for reconstructive to grow faster than the prevention and rehab business in the second half of the year, and that should be mixed accretive, correct? Correct.

Yeah, that's a dynamic that we've seen for quite some time, and we would expect to see that continue in the back half of the year.

Okay, great. And then maybe just my one quick follow-up on Fabtech. Can you maybe just talk a little bit about what you're seeing geographically and then also what you're seeing on the consumable side of the business versus the equipment side?

Yeah, from a geographic split in Fabtech, as I shared, the developed markets were down more than the emerging markets, but both sets of markets showed healthy acceleration through the quarter. We expect both sets of markets to continue to accelerate as we move into the into the third quarter. And, yeah, obviously on a country-to-country basis, every country is going through things at a little different pace based on policy and other things. But that's what the broad trends are saying. Okay, great. Go ahead.

I think it was a follow-up on the equipment versus consumables there. And in that case there, the experience we had in the quarter was actually pretty similar between the the consumables part of the business and the equipment side. Okay, great. Thanks, guys.

Thank you. Our next question comes from the line of Andrew Obin from BOA. Your line is now open.

Yeah, good morning. Hey, Andrew. Hey, Andrew. Hey, just a couple of questions we've been getting. So the first one, how should we think about the impact of professional sports and college sports on prevention and rehab in in the second half of the year, you know, how should we sort of, you know, quantify the impact and, you know, what kind of impact will it have once college sports resume?

Yeah, so sports, not just professional and college, but also, you know, the broader set of, you know, high school and youth sports activities and other sports activities around the world. you know, are one of the growth drivers of our prevention and rehab business. You know, one of a number of growth drivers, as we've talked about, but certainly one of the growth drivers. And so certainly the declines that we've seen and the rate of recovery that we've had and the rate of recovery that we're talking about is being affected by that driver. And, you know, the assumptions that we've made for the balance of the year is that there is a step-by-step return to sports, you know, that there's not a total lockdown of all sports and that there's not a kind of immediate resumption of all sports, you know, that's going to be sometime next year before all sports are resumed. And, you know, that's kind of what we factored into the high-level trajectory guidance that we're given.

Um, thanks. And, and then the second question, just, uh, thinking about 2021, uh, what would it take for MedTech business to be up over 2019 in 2021? Uh, you know, not asking you for a forecast, but just asking you for a scenario under which, uh, MedTech could actually be up over 2019. Yeah.

So, yes, the scenario that has MedTech above 2019 is, is that, uh, you know, first, uh, elective surgery is, uh, let's say essentially back to normal, right? That we, that, that we clear through this year, uh, you know, the, the return to elective surgery as well as the kind of recreation of the, you know, of, of the backlog and, and that, uh, you know, next year we're, you know, kind of at least close to normal elective, uh, elective surgery levels, uh, you know, is, uh, you know, is the first assumption. And then the second would be that kind of the vast majority of the drags that have existed this year in terms of activities and sports and things like that have, you know, have passed, you know, that, you know, whether it's through a vaccine or through comfort with treatment or through comfort with kind of managing things through PPE and social distancing, et cetera, you know, people have gotten comfortable getting back, you know, sort of close to normal resumption of activities. I think that combination would get us into, you know, positive zone next year, which we think is a very, very reasonable set of assumptions. You know, we're not ready at this point to guide that that's what we think is going to happen, but we think there's certainly a reasonable set of assumptions that would get us to positive in MedTech over 19 and 2021. Thank you so much.

Thank you. Our next question comes from the line of Steve Tusa from JPMorgan. Your line is now open.

Hey, good morning, everyone. Hey, Steve. Just the kind of decremental margin commentary, is there any reason why 4Q would be materially worse or off much from what seems to be kind of a more of a managed kind of stable trend? I mean, I don't I don't think of low 30s as that different than 29%. So it seems like you guys have kind of stabilized things on this front. Any reason why 4Q would, you know, would bounce around at all, assuming, you know, revenues are within a band that we don't, you know, all collapse again by then?

Well, the normal decrementals in the business are, you know, if you think about it, around 40% for Fabtech and over 50% in the MedTech business. So that's our normal operating range. And we tend to flex around that given levels of investment and so forth. So the idea that we're in the 20s and maybe even the low 30s shows that we flexed the cost pretty significantly. As we sequentially improve the business, at some point you're going to see us migrating back toward the more natural levels of decrementals and then eventually converting into incrementals in the business. So I think we've got certainly our hands on the cost levers to be able to manage toward the decrementals here as sales are down. but I would expect to see us migrate over time.

Okay. Over time. Does that mean you're going to be kind of mid-40s in 4Q? Think things play out?

No, I don't think we're in a position to talk a lot about Q4 at this point in time, but I don't think there'd be a reason why we'd have a significant shift in a single quarter in our decrementals.

Right. Okay. That makes sense. And then I guess, You know, I think kind of the real opportunity on margins looks like it, you know, comes at this, you know, the fab tech business. You know, you've got peers, a peer average that's, you know, comfortably above that. You know, you guys said you're working on improving kind of the processes and, you know, perhaps some more structural, you know, more of a structural approach to cost and better ops there. Should we see that materialize? on the way up for that business? I mean, in order to close the gap on margins, you obviously have to, you know, leverage better than, you know, peers on the way up. Is that kind of the goal for Fabtech to, you know, to really, you know, leverage some of the process improvements to deliver better than, you know, better than historical incrementals as this thing recovers over time?

Yes, Steve, I think, you know, First of all, over the last four or five years, we've driven really substantial improvements in the margins of our Fabtech business to where we're now sort of kind of in line with a key peer there versus where we used to be. And that's been a combination of structural as well as CBS-based productivity and innovation and value pricing in the business over time. And we are not done yet. We intend to continue to improve the margins of that business, and you can tell from our comments about some of the structural actions we're taking in that business that we're trying to make sure that in that business, as we get back to 19 kind of revenue levels, that we've made progress on the margin front and that we're also in a position to continue to make progress from there. Now, I will say that, you know, One of our other peers has a structurally different business, and so I've always said it's going to take execution for us to get to the kind of 15% operating profit range and margins in that business, which we were closing in on pre-COVID, but it takes strategy to get us further than that. And we've been working on strategy, both acquisitions that we've made and innovation strategies, et cetera, to kind of lift up the headroom to where 15% operating margins is not the – is not the ceiling for us. And I'm talking operating margins, not EBITDA margins, because that's kind of what we had talked about historically here. But the EBITDA margin that would go with 15% operating margin is about 16.5% EBITDA margin. So we were closing in on that. We're going to close in on it fast on the backside of COVID. But we're also strategically lifting the ceiling, both through restructuring efforts and strategic efforts to make sure that we're not done and we can keep advancing the margins of that business.

Right, right, great. And then one last one on free cash flow. You know, I would hope it would improve sequentially. When you think about kind of the moving parts on working capital, for example, in the back half, maybe I know you don't want to give, like, specific guidance, but maybe just some color on, you know, some of the moving parts in working capital, what what, you know, could get better just seasonally or from, you know, what we're seeing in the revenue trends and, you know, maybe if there are other headwinds that are, you know, discreet when it comes to second half free cash flow directionally because it just seems obviously to get back to 250, you know, I would hope it's not going to be like, you know, really bad in the second half here that there will be, you know, a bit of a pickup on cash in the second half, maybe just some moving parts there.

Sure. Steve, if you think about it, starting in the second quarter, we had obviously the declining revenues, which had a profit impact on our business. And so to counter that, we had two things working for us. In the beginning of the quarter, we had receivables that were working down that provided cash for us there. And then in the back half of the quarter, we had the full benefit of all the spending actions that we were taking, which certainly started earlier in the quarter, but you had the full benefit there. As you roll into Q3 with sales getting sequentially better, now we're going to be in the position where we're rebuilding the receivables. So you've got higher sales, higher profit, but you've got certainly at least in the front end of the quarter or perhaps throughout the quarter, we've got to rebuild the receivables. That's going to take some of that cash. And so as you turn the clock into Q4, what we'd expect to see now is working capital is largely normalized. I'm sure there'll still be some puts and takes. but largely normalized the potential for increasing sequential improvements. And then, as I mentioned in my comments, we'd expect that to be our highest quarter and one that's a little bit more reflective, not fully reflective, but more reflective of the cash flow potential of our company.

So you think the 4Q could be, you know, could close to reflect that kind of 250%?

I'm not prepared to talk about Q4 in specifics, but I think you'll see it being a lot closer to the potential of the business that we had in terms of conversion and longer-term potential. Now, the reason I'm hesitating here is obviously we don't have a full view on Q4. We don't expect a full recovery this year. And then, of course, depending on the rate of improvement, that could be a factor as well. Along the way, Steve, I think I just remind everybody that we've continued to make the investments in our business to support growth. And, you know, that's also a factor this year and an important one that will help us regain our momentum as we work past COVID.

All right. Great call. Thanks a lot, guys. Appreciate it. Thanks, Steve.

Thank you. Our next question comes from the line of Julian Mitchell from Barclays. Your line is now open.

Thank you. And maybe just trying to stick to two questions. My first one would be around the MedTech margins. I understood you're not commenting on Q3, but I guess I wanted to try and gauge how satisfied you were with the Q2 performance. You know, the EBITDA, I think, was down almost 90% year on year. Maybe within that, help us understand what cost savings you realized and whether, once we look ahead to the recovery, if that Q2 performance, how does that inform what type of incremental margins we could expect on the way up once sales return to normal?

Yes, the perspective I have on the margins is we're delighted with the performance. If you think about a business that went through this kind of revenue downturn with the sort of gross margin profile, the high gross margin profile, there was obviously going to be a lot of pressure on the profitability in the business there. And so to maintain the performance that we had with that kind of revenue downturn, you know, caused us to, or, you know, required us to flex our costs pretty heavily. We talked in Q2 about overall getting, you know, flexing our costs in the $80 million plus range across the company. Just given the different size profiles of the business, you know, I think it may have been a little heavier on the Fabtech side, but But we were able to flex costs. Now, some of that comes naturally with the business because it's got a variable cost structure with some of its selling costs. But a lot of the other cost flex came from discretionary spend reductions by having better cost contracts with suppliers, making some changes on the employment side as well. Now, this is a business that's more quickly recovering. And as Matt mentioned, part of this business has returned to growth or demonstrated growth in July. And so we feel it's appropriate that those cost levers are eased back a bit and matched up with the revenue profile, the sort of emerging revenue profile of the business. So I'd say overall quite pleased with that. And as we get closer and closer to revenue matching up to where we've been before, I think that provides a clear path for us to to get our margins back in that neighborhood. As Matt mentioned, there's some puts and takes. Uh, yes, we're working through COVID. You've got extra costs in some places. You've got some inefficiencies that we've, you know, that we continue to work through. But, uh, overall, I think we're quite pleased with the performance and the path that we've got on the margins.

Thanks. And then my second question, um, Just wanted to understand, you gave some color on receivables, but accounts payable fell very sharply sequentially in Q2. And I think that was a big driver behind the free cash flow pressure that you'd seen. Maybe help us understand what happened with that payables number falling a lot more than receivables and inventories and how you see payables playing out over the balance of this year.

Yeah, so the payables performance that we had in Q2 was principally driven by two factors. Number one is we had heavier CapEx spend in Q1, and just given the timing of that, a lot of the actual payment for that CapEx fell into Q2. So that's certainly one factor. And then the second factor is just ensuring that we have a healthy supply chain as we work through COVID. You know, there was a lot of pivoting we had to do to make sure that we maintain the continuity supply for our customers, which we which we did do, and so we had to make sure that we kept the supply chain healthy. Looking forward there, so I think we ended the quarter with a reasonable day's sales in payables there, but I do think there's the potential as we now have increased levels of sales and production that you'll see accounts payable rising up, and that could provide a bit of a source of additional cash in Q3 and Q4.

Thank you.

Thank you. Our next question comes from the line of Walter Liptack from Seaport. Your line is now open.

Hi, good morning, guys. Thanks for taking my questions. Hey, good morning. Hey, Walter. Hey, I just wanted to ask one about the ESAB channel. You guys said your inventories were kind of just right for any kind of improvement. What are you thinking about with the... The channel partners, has there been any sort of a refresh yet? Are your customers starting to hold more inventory as production levels go up?

Yeah, you know, in the e-stop business, we don't, you know, see a lot of channel impacts in that business. You know, there's some modest channel impacts at times as the channel is kind of you know, leaning in a little or leaning, leaning out a little, but, but unlike some other businesses, you know, you know, it's not a business that, you know, that has these kinds of wide springs swings from, from channel stocking or, or D stocking. And, you know, I, I would say, obviously we're a very global business. And so it varies all, all over the world, uh, you know, but, uh, here in, uh, in, in North America, you know, certainly as, as we went through the second quarter, the channel got, you know, more positive over time. And, uh, And July is, you know, starting out, you know, a step forward from June as we've talked about. And so, and we think that's reflective, you know, again, here in North America, it's reflective of the industrial markets and some of the construction markets and some, you know, kind of government-driven infrastructure things like shipbuilding and things like that. You know, those are, you know, leading to some, you know, some healthy progress in the U.S. market. And And then in other markets around the world, you know, the channels are generally cautiously optimistic about the step-by-step progress forward in terms of, you know, more activity as there are less constraints put on industry and then the rebuilding of demand that creates even more activity.

Okay, great. And kind of along those lines, you know, other things besides shipbuilding that might be picking up are like the You know, there's a housing recovery that's going on. Does Fabtech get any benefit from that? And likewise, there's some things that are still, you know, or, you know, auto, you know, maybe that's picking up oil and gas is still weak aerospace. I wonder if we can get a comment on some of the sectors.

Yeah, yeah, that's right. You know, certainly general industrial and construction, not just residential, but all construction sectors. have been positive areas, infrastructure around the world, but also some of the government-driven stuff here in the U.S. Those have all been positive things, and alternative energy has been a positive as well, you know, wind towers and things. But then on the flip side, obviously, you know, oil and gas has been tougher. You know, automotive has been tougher. We're not as exposed to automotive here in the U.S., but playing that supply chain in Europe The automotive has been tougher. Some of the yellow goods has been a bit tougher as well. So it's definitely, you know, everything stopped or everything kind of went slower for a bit there, but, you know, things are coming back at differential rates. And one of our key strategies in the ESOP business has been, you know, to make sure that we are proactively positioning ourselves to succeed with the segments that are coming back the fastest and most successfully and make sure that that contributes to continued outperformance from a growth and share gain standpoint in that business that we've been able to demonstrate now, you know, here for a while.

Okay, great. And the last one is just on M&A. You know, with, you know, any changes on, you know, kind of MedTech focus over, the welding focus and, you know, is it possible even to get deals, uh, you know, to look at in this environment?

Yeah, we've, we've got a, you know, a healthy, uh, M&A funnel rebuilding and, and are encouraged about the opportunities, uh, ahead of us. And, uh, you know, we, we focus on, on M&A, M&A, uh, opportunities in, in both businesses that are going to strategically advance, uh, and strengthen the, the businesses. But, uh, we also have been, been, uh, transparent that we're looking to, you know, overdrive the growth of the MedTech business and disproportionately invest in M&A there in the coming years. But, yeah, there was a period where it was really, you know, not that practical to do any meaningful deals there because the visibility was just really bad. But as visibility is starting to come back, there's, you know, more constructive dialogue happening and processes restarting, et cetera. And I think as we work through the balance of this year and into next year, we're encouraged by the possibilities that we see.

Okay, great. Thank you.

Thank you. At this time, I am showing no further questions. I would like to turn the call back over to Mike Nasik for closing remarks.

Thanks, everybody, for joining our call today. We look forward to speaking with you going forward. Everybody have a good day.

Ladies and gentlemen, this concludes today's conference call. Thank you for participating. You may now disconnect.