Enovis Corporation

Ladies and gentlemen, thank you for standing by, and welcome to the Colfax Third Quarter 2020 Earnings Call. At this time, all participants are in 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 further assistance, please press star 0. It is now my pleasure to turn the conference over to your speaker today, Mr. Mike Masek. Sir, please go ahead.

Thank you. Good morning, everyone, and thank you for joining us. I'm Mike Masek, Vice President of Finance. Joining me on the call today are Matt Terrell, 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 on our website, colfaxcorp.com. We will 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 State 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 as required by law. With respect to any non-GAAP financial measures made during the call today, 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, and we'll 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 around the world. Thank you, team Colfax. Our results this quarter demonstrate that we have worked past the worst of the pandemic's effects. We achieved very strong sequential improvements during Q3. Organic sales improved 30% from the second quarter, declining only 3% year over year. Both businesses are quickly recovering with lines of sight to regaining our pre-COVID momentum. We again outperformed our competitors, driven by strong commercial execution and growing innovation. I am pleased with our financial results this quarter. We delivered 41 cents per share of adjusted earnings and $49 million of free cash flow. These are strong sequential improvements over Q2. and we expect further strengthening in Q4. We also announced the signing of an acquisition that will strategically broaden our MedTech reconstructive business. We are regaining our positive momentum with a clear strategy for compounding value creation. Slide 4 updates the pace of recovery and underlying customer demand. All markets strongly improved from Q2 lows this quarter, and many returned to growth. Our MedTech business grew 1% with a little help from non-recurring PPE sales. Elective surgical procedures in the U.S. are nearly back to pre-COVID levels, and many organized sports activities and other injury drivers have resumed. Clinics in our CERV markets are operating much closer to pre-COVID levels, increasing demand for non-surgical products, and recreating the pipeline for our reconstructive products. With markets in the range of 90 to 95% recovered, we expect sales per day growth to stabilize at these flattish levels in Q4. The short-term range of outcomes will be influenced by continued positive activity and treatment trends versus reactions to COVID case escalation in some geographies. We believe that our markets should return to healthy growth in 2021, over 2019 demand levels. Our Fabtech business rebounded sharply in the quarter, only down 6% versus 25% in the second quarter. Developing regions are mostly back to growth, again demonstrating the strength of this business's global reach. Our improving trend continued in September and October, giving us a good start to Q4. We are forecasting growth to be on par or better than Q3, depending on the short-term risks from COVID reemergence in Europe and the U.S. elections. This overall positive trending gives us confidence in a return to 2019 demand levels at some point in 2021. MedTech business results are included on slide five. Q3 sales increased 2% to $314 million, including a 1% FX benefit, and 2% from personal protective equipment sales that are not expected to repeat. This rapid and substantial rebound from Q2 shows the strength and resilience of our MedTech portfolio. Reconstructive product lines returned to fast growth, 9% above last year, as we extended our multi-year record of taking share in surgical. Prevention and rehabilitation product line sales also recovered strongly off of Q2 lows, declining only 2% year-over-year for the period. This part of the business is more global and impacted by a broader range of factors than just elective surgeries. We expect growth to return to PNR upon the full return to sports and general recreation that drive normal orthopedic clinic activity. The sales rebound in the quarter contributed to a strong improvement in profitability that narrowed the gap to prior year performance. We incurred about $5 million of higher supply chain costs in Q3 to overcome COVID-related challenges and maintain customer service during a period of quickly recovering demand in MedTech. We expect margins to improve sequentially in Q4 and have a clear focus on driving further improvements. We continue to make good progress using CDF to strengthen the P&R supply chain and innovation engine to drive above-market growth and margin improvement in the future. We're also making key supply chain and technology investments to scale our fast-growing surgical business, enabling continued future share gain and productivity. Moving to slide six, we signed an agreement this month to acquire the star total ankle placement business and certain finger implants from Stryker Corporation that should close in the fourth quarter. We're excited to complete our first strategic acquisition since acquiring DJO, and the DJO team is ready to use our proven CVS toolkit to integrate these product lines. The acquisition complements our fast-growing, reconstructive product line with an entry into a billion-dollar-plus foot and ankle surgery market that consistently grows mid to high single digits. The total ankle replacement segment is a strategic entry point given its high growth, strong gross margins, and importance to the surgeons. The STAR angle is a great technology with compelling outcomes data and many loyal surgeons. We are confident that we can apply our proven DJO surgical playbook to drive above-market organic growth over time. In addition, the fragmentation of the foot and ankle space presents multiple paths for further acquisition-based expansion into this very attractive adjacent market. On slide seven, fabrication technology organic sales declined 6% and FX pressure contributed three points of additional decline. This represents a strong recovery versus the second quarter and the eighth quarter in a row of outgrowing our primary competitors. All regions improved from the second quarter. Nearly half of our sales come from faster-growing emerging markets that collectively achieved year-on-year growth. Our North American and European regional sales significantly improved, but these markets are still the most affected by government actions to control the spread of COVID virus. Our GCE gas control business achieved another quarter of solid growth due to strong demand for our medical and life sciences solutions. Our Fabtech team achieved another quarter of low 20s decremental margins, significantly mitigating the profit impact from lower sales and achieving margins only 50 basis points less than our strong Q3 margins last year. Restructuring programs remain on track to deliver over $20 million of savings in 2020, with approximately $10 million of follow-on benefits next year. Temporary cost controls are still in place to ensure we meet our spend with recovery, while also supporting growth and innovation spending. ESOP remains well-positioned for strong relative growth, continuous margin improvement, and strong cash conversion going forward. On slide eight, you can see that CDF continues to thrive thrive at Colfax. Our teams have adapted to the virtual work environment in a number of ways to maintain our continuous improvement momentum. While our in-person activities have temporarily declined a bit, the number of virtual activities has exploded. For example, we started the year with a plan to roll out an operations boot camp training with five modules for our operations leaders around the world. When travel became restricted, we revised the curriculum and materials to create interactive online sessions that were effective and very well received. As an added plus, the leaders did not need to travel, and we were able to have most of my team participate directly in the facilitation. Our success this year has changed the way we think about delivering training to our associates, and we expect to make online training an even larger component of our associate development efforts going forward. Our CVS engine is still very active in our supply chain. By year end, we will have completed close to 100 Kaizen around the world. The slide highlights one where the relatively new Colfax team at GC used our 5S and SMED tools to reduce setup time by 60%, improving productivity and liberating additional capacity for the strong growth that business is capturing. Outside of our supply chains, the teams have developed innovative virtual Kaizen approaches. We highlight on the slide the way that the DJO bracing team has adapted voice of the customer processes to keep new product developments on track. Our business system remains alive and well. Our teams are adapting to recent challenges and continue to drive continuous improvement in everything we do, living our company purpose of creating better together. With that, I'll turn it over to Chris. We'll start on slide nine.

Thank you, Matt. We reported 806 million of sales in the quarter, only 3% down organically from the prior year as we get closer to full recovery from the effects of the pandemic on our financial results. Our team successfully flexed variable and fixed costs to control the gross margin impact from the lower sales to only 80 basis points. We continue to control OpEx and execute our restructuring programs while protecting growth and innovation spending. EBITDA margins moved up significantly from Q2 levels and really narrowed the gap to the prior year. Excluding COVID friction costs, we achieved year-over-year decrementals in the low 30s as expected. The tax rate drifted up in the quarter to recognize profit mix and other effects that are not expected to recur and we expect the rate to land back in the low 20s in Q4. Overall, we achieved a very healthy 41 cents of adjusted EPS in the third quarter. I am very pleased with the progress we've made on cash flow this year throughout Colfax. Our teams have strengthened processes to reduce seasonality and improve predictability of future cash flows. We achieved $49 million of free cash flow and 86% conversion in the third quarter, despite a $15 million net headwind for restoring working capital, as we signaled in our last call. We are clearly getting closer to the type of market and operating conditions that support $250 million or more of annual free cash flow at high conversion levels. Earlier, Matt reviewed current market conditions, and our financial outlook on slide 10 reflects these improvements. We expect another sequential increase in sales in the fourth quarter of 1.5% to 2.5%. Excluding the 3% to 4% headwind from fewer selling days, we expect year-over-year core sales growth to be similar to or slightly better than third quarter performance. This reflects a year-over-year MedTech change of flat to down 2% and a FabTech change of down 4% to 6%. Interest costs should be in line with third quarter reported results. Adjusted EPS is forecasted to step up from $0.41 in Q3 to $0.45 to $0.50 in Q4 on sequentially higher sales, margin improvement, and a lower tax rate. We expect free cash flow to sequentially increase to at least $80 million. This range of earnings reflects the current risks to the global economy from COVID and U.S. elections. Our improving profitability and cash flow are also shown on slide 11. Our second half 2020 profit performance should narrow the gap to last year's pre-COVID levels and demonstrate the cash flow potential of our transformed portfolio of businesses. Factoring in expected cash flow in Q4 and annualizing second half performance shows that we would end the year on a run rate of 3.7 times leverage. And this is before the expected additional cash flow and higher EBITDA in 2021 that will drive this metric down even further and create additional capacity to support our strategic growth program. We have a firm financial foundation that strengthens every day. Wrapping up on slide 12, the effects of the pandemic are largely behind us. Our teams demonstrated resilience, continuously outperforming competitors despite COVID pressures. We are closer returning to our pre-COVID momentum of growth in sales, profit, and cash flow, And the fourth quarter should show another positive step. We are again active in sourcing, closing, and integrating acquisitions that strengthen our businesses and increase their growth potential. To summarize, we are executing our strategy of continuous improvement and compounding value creation. With that, Brain, let's open up the call for questions. Sure.

As a reminder, to ask a question, you will need to press star 1 on your telephone TV. To withdraw your question, press the pound key. Your first question comes from Andrew Alpin from Bank of America.

Guys, thank you so much for fitting me in early. So just a question in terms of the impact from COVID on your business model. Can you just talk about shift from hospital to ambulatory surgery centers to How much of it are you seeing, and what's the longer-term impact?

Yeah, thanks, Andrew. So, there's been that ongoing trend from hospitals to ambulatory centers. You know, a lot of shoulders have been done outside the hospital already historically, but knee is the product that's been going through that rapid shift. And, you know, certainly in COVID, there's been some acceleration of that shift. that is a way that the hospitals have been protecting to be sure that they can continue to do elective surgeries even as we continue to have infections. And so we've seen that shift. I think for us, we see that ambulatory shift as a positive thing. It's a part of the market that grows faster. We've got products that set up well for that shift. Our knee product is is one that does well with more active adults and that fits well the kind of patients that are the first ones to be shifted into the ambulatory environment. We provided our oral risk scoring tools to doctors to enable them to help assess the risks around doing surgery in ambulatory. And we've got... you know, relatively simple equipment sets and continue to work on simple fire instrument sets for that ambulatory environment. So we see that as an opportunity for us, and certainly we've been able to continue to have, you know, knee is the product that has grown the least in the COVID. The market has grown the least, but within that, we've continued to grow stronger than the market and have healthy growth in our knee product line.

And just a follow-up question, is there a difference in terms of sort of ability to postpone different kinds of orthopedic surgery? Is there a difference between shoulders, knees, hips? Do they behave differently or it's fairly similar? Thank you.

Yeah, they do. They behave.

It's funny.

We call them elective surgeries. Like I said on the previous call, they're sort of more deferable than elective, most of these surgeries. Typically they're being done because patients are in in a degree of pain to where they feel like they need the surgery or they're having their activities that they used to be able to do in their lives restricted to the point that they really want to get back to being able to do those activities. And so it comes down to deferrals. And what we've seen is that the hip part of the market has come back the most aggressively, I think, because those are situations where the pain is the most and the need for the surgery is it is the most there, and so that's the part of the market that's come back the most.

Thank you. Your next question comes from Joe Giordano from Cohen. Hey, good morning, guys.

Morning, Joe. Hey, Jim. So I'm guessing you're not going to want me to ask about 2021 necessarily, but you guys said that at DJO, the trends support 2021 being above 2019. So if that's the case and that plays out, would you expect margins to be higher as well on a 12-month basis, not different than what you guys reported based on the stub period, but on a 12-year equivalency?

Yeah. So, Joe, we have talked about, you know, from a growth standpoint, you know, if you look at, Q3, where our underlying growth was, you know, just in the range of, you know, flat or minus one. You know, the guide for Q4 being, you know, flat to down a couple in terms of daily growth. You know, we feel like that reflects that even as there continue to be some challenges and risks that are very real, there is also, you know, progress on the fundamental demand drivers of the business and progress on people being more comfortable going in and getting treatments and service. And so we feel like that, you know, that points to a turnover to growth in 2021 and a kind of healthy year of growth in 2021 versus 19. On the more margin front, and I will say in our mid-tech business, our primary focus on that business is to make sure that we can pick back up with the mid-single-digit core growth that we were starting to demonstrate in that business. down the stretch the last quarter of last year, the first couple months of this year, we started to show that mid-single-digit core growth capability of the business that, you know, is important and makes the business very valuable. So that's our first focus on that business. We're also, you know, very focused on making sure that we drive margin improvement, you know, in that business, certainly back from where we are, back to more normalized rates in that business. And where we land on the other side of COVID is, You know, it's going to be a combination of the investments that we've been making in the business, in the supply chain and in R&D and growth engines of the business, you know, up against, you know, the productivity that we've been driving. And we're certainly focused on making sure we get the markets restored and that we have strong and healthy cash flow in that business. But we're also trying to make sure we do the right things, you know, to really solidify that mid-single-digit growth engine.

Fair enough. Yeah, I think it was great to see the deal on the ankle portfolio. I think that people were hoping to see stuff like that coming out of the transaction with Striker. I'm just curious if you're any color on momentum of new talent acquisition in general or as a direct result of the transaction for some people kind of up for grabs, KOL salespeople, things like that.

Yeah, we're certainly very excited about adding the star product line. Great opportunity. It's just a great adjacency. Certainly when we did the, you know, when we were, you know, doing the planning for the acquisition of DJO, we looked at whether there were attractive adjacencies to move into, and foot and ankle was one that had attractive growth, you know, good structure, you know, good possibilities, but it was a, A nice surprise to have the Stryker transaction create this opportunity this early in our ownership of DJO to step into that adjacency and do it at an attractive price. Certainly, any time there's changes like that, there are opportunities, and we're focused on making sure that we retain all the key customers there and that we make sure that we're getting – getting the right channel to be able to strongly, you know, serve that foot and ankle. Some of that will be done through our existing surgical channel. Some of that will be pieces that we pick up. And so we're certainly focused on making sure that we come out of the gate, you know, in good shape with that product line and be able to drive strong growth over time.

If I can just sneak one last one in on Fabtech real quick. I mean, you guys continue to outperform there. It's been a nice story. But how are you kind of, managing the business now maybe preemptively around some of the Europe headlines around potential shutdowns again?

Yeah, certainly we watch the things that are going around the world very carefully. All year in Fabtech, we've tried to make sure that we are being cautious about about what kind of revenue is going to come in that business and the rate of recovery that will come in that business. We've tried to make sure we're being cautious about that. We've taken a lot of structural costs out of that business, as you've seen, and we've got some additional projects that we've talked about that are going to continue to take structural costs out of the business. But then at the same time, we're making the necessary investments to keep that relative growth performance going. And so, you know, we've tried to make sure that we're ready for a range of recovery scenarios in Fabtech. And, you know, to be honest, they look for a little bit like they're like maybe we're heading towards the better end of the spectrum on those recovery scenarios and that the business, you know, might turn over, you know, Q4 or Q1, turn over a growth. And, you know, certainly with a little bit of the slowing down in progress in the U.S. and some of the European things that are going on, you can You can see that we're taking a little more cautious path, that it'll take, you know, a number of quarters before it turns back over. But what we're seeing around the world is that as people are seeing additional waves of COVID, they are being very, very careful to protect the industrial production in the countries. You know, I think, you know, even if you look at what Germany and France have talked about in recent days about their situations, You know, they have, you know, shut down significant portions of their economy, but they have explicitly left open the industrial portions of their economies. And, you know, that means that the constrictions that we saw back in Q2 are not going to reappear in terms of economies being just kind of forced down. But certainly, you know, some of the, you know, kind of limitations in people's behaviors are going to slow the rate of recovery, and we've tried to reflect that in our comments.

Yes, that's very fair. Thank you.

Your next question comes from Jeff Hammond from KeyBank. Your line is open.

Hey, morning, guys. Morning, Jeff. Hey, a couple questions on MedTech margins. One, just in the quarter, you know, I guess if you exclude the COVID costs, you're still down year over year. Is that mix or investments? And then just Talk about the profitability profile of this acquisition.

Yeah, so, you know, the first is, you know, that business, you know, it's got to have a little bit of quarterly variations in the margin levels, you know, for, you know, seasonality factors, you know, whether certain investments are made in certain quarters, et cetera. And so, you know, the specific quarterly margin level that we're confident against, you know, is probably a little on So again, I think there is a little bit of a tougher comp there, but then as we talked about, we did have a pretty significant amount of inefficiencies just from having to quickly turn that business down and quickly turn it back up and really keeping our focus on serving customers as first priority and being willing to take on some of the extra costs to expedite split shipments and do the things that it takes when you're kind of in that kind of a dynamic environment. It certainly took on some extra costs, and we'll still have a little bit of those, you know, as we move through the next couple months here. But, you know, we certainly are focused on getting the margins recovered in that business and making good sequential improvements there. You know, as far as the, you know, the annual business that we got, the growth margins in that business are very attractive. It's, you know, at the upper end of the surgical margins, and so it's an attractive ad, and you know, for sure, you know, we'll be working on, you know, scaling the fixed cost base of that business. And so, you know, it'll add some profit out of the gate. But as the business grows, you know, the total profitability will scale up against those very high gross margins.

Okay. And then just on Fabtech, it looks like your developing markets saw the best results Yeah, I guess the developed markets looks like it accelerated the most. Can you just talk about where you're seeing the best recovery from a geographic and, you know, if you can maybe comment on end markets as well?

Yeah, sure. So most of the developing markets grew in the quarter, and, you know, I think that's consistent with what we talked about even from what we were seeing early on. early in the quarter, and that's consistent across places like Asia and Russia and parts of South America. You know, I think the one developing market that has been slower to recover is India, which is still in the negative because it really, you know, they really locked things down hard back there in Q2 and has taken some time to get that economy restarted. India is making progress, and certainly what we're seeing down there is is resolved from the government and not kind of recreate that total lockdown that hurt their economy so much back in Q2. So we feel like that one will get back to growth, you know, pretty soon here. And then, you know, kind of, you know, the vast majority of developing markets will be in the positive. As you said, developed markets, significant improvement from Q2 to Q3, but those are ones that will take a little bit longer to, in those markets, but we did see very nice improvements in those markets, and we do expect them to be able to continue to improve gradually over time to support that overall back-to-growth for the global welding industry. From a segment standpoint, certainly things on the infrastructure and construction end of things have have come back very quickly. We saw the automotive market, both in the U.S. and Europe, the automotive supply chain start back up. We've got a little less exposure to that, but that's a positive factor as well. And the market is lagging and certainly putting some pressure on the U.S. and a few other places around the world. is oil and gas, and that's one that certainly should recover over time, but that's the one that is lagging the most.

Okay.

Thanks, guys. Your next question comes from Nathan Jones from Spiegel. Your line is open.

Good morning, everyone.

Good morning. Just start with a follow-up on Jeff's question on the DJO margins and specifically on that $5 million of supply chain costs. Can you give us a little more colour around what those costs were? I assume those are temporary things that you should be able to get out of the business. What's the timing on being able to eliminate those from the business? Are they gone in the fourth quarter or should we expect a bit of a drag still from those supply chain costs?

Yeah, Nathan, you know, so there's a couple different sources. You know, one, when we, you know, flexed down fast, you know, we had, you know, certain places in the world where we, you know, we were not able to flex down the label based on, you know, government restrictions on what we could and couldn't do. And so we took, you know, a little bit of extra cost into the product from some of the production in kind of mid to late Q2 that flows through into the things that we that we sell in Q3, and sort of that part of it would, you know, would clear through. You know, second, as we flex, you know, back up, you know, quickly, we have, you know, we've kind of done whatever it's taken in terms of, you know, things like overtime that add some extra cost. And then third, there's been quite a bit of, you know, both inbound and outbound freight expediting and splitting up orders in order to get the customer as much as possible of what they've asked for while we're still waiting to get through the other parts. Those are the operational costs that make up that extra cost in the quarter. A good portion of that is clearing through, but certainly some of the more expediting-related aspects of it will still continue for you know, for another couple of months here and put a little extra cost into the fourth quarter. All indications are that as we move into next year, they should be fully behind us.

Got it.

You know, when we have recessions like this, you normally see industrial revenue shifted permanently to the right. I would think a fair amount of the prevention and rehab revenue is shifted permanently to the right, but the reconstructive revenue isn't pushed permanently to the right. People are still going to get those implants done at some point. Do you feel like that 3Q caught up on some of those deferred out of the second quarter or that there is some pent-up demand here that you still have to work through going forward and any ideas you've got on the timing of that?

Yes, of course, you're absolutely right that our reconstructive business is a business where if it's not coming now, it's predominantly shifting to the right. And a part of our prevention and rehabilitation business is driven off of elective surgery as well. And so for that part of prevention and rehabilitation, if it isn't coming now, most of it is shifting to the right. But as you certainly pointed out, if the activities aren't happening, you know, we kind of miss the demand. And so that's the right way to think about our portfolio. As far as kind of how that dynamic has played out, you know, I think if you look at most published sources, they talk about elective surgery, you know, recovered in the U.S. to kind of a 90% to 95% of pre-COVID kind of range right now. and they talk about clinics being in maybe the 80 to 90 percent of pre-COVID range and improving. And those are the two things that kind of affect that equation, right, because the rate at which we're doing elective surgeries, you know, a few months back was burning down the backlog, and the clinics were at much lower levels. But as those two approach, the difference between the surgeries that are happening today and the ones that are being created for tomorrow, you know, starts to get narrower, and we've kept a close view of that. And so, you know, our view is that the way that we've made our way through the third quarter, you know, certainly left some things in the backlog in terms of surgeries that have been deferred and that were still scheduled, and, you know, that's offset the fact that clinics are not, you know, fully operating and restoring the pipeline and sort of, you know, keep that elective surgery in that 90 to 100% type of range as we move through the fourth quarter. And if elective surgery is in that range, you know, we're having nice growth in our surgical business based on the way that we take share in that business. And then, you know, as we move into next year, at some point there will be a time when when the clinics are fully operating and so we're fully restoring the pipeline. But there may still be a little bit more backlog to burn off over time to make up some of what we lost this year. And whether that comes through next year or whether some of it comes through next year and some of it comes through the following year kind of remains to be seen.

Great. Just one more quick one on the margins. You did about 18% in 2019, high incrementals in here. You're talking about some pretty decent growth in 21 over 19 levels. There's some operational improvement that's gone into the business, but probably some higher investment as well. Is 20% EBITDA margins in 2021 beyond the realms of possibility, or is that a target you have in mind?

Are you talking about the MedTech business or the ESOP? I didn't hear the question.

MedTech. MedTech. And you're talking about EBITDA or EBITDA? EBITDA.

Yeah. You know, I think, you know, we've talked about, you know, trying to make sure in the medtech business that we're focused on, you know, restoring back to, you know, 2019, you know, kind of margins as, you And, you know, the 2019 A to A margins were in that, you know, 17 or so range. The A to D margins were closer to 20. And, you know, as I said earlier in my comments, we're focused on sequential improvement in the MedTech margins, you know, with understanding of different seasonality and things that will come in different quarters. and we're focused on making sure that we have the right balance of making the right investments in that business while at the same time, you know, driving the productivity in the business so we can restore the mid-single-digit growth engine, you know, quickly, get those margins restored to pre-COVID levels, you know, as soon as possible as well, and then build from there both, you know, continue to drive the growth and improve the margins from there.

Great. Thanks for the commentary.

Your next question comes from Walter Liptak from Seaport. Your line is open.

Hey, good morning, guys.

Hey, Walt.

I wanted to ask about, you know, the comment that you made about outperforming the Fabtech peers. And I wanted to get an idea, do you think it's the geographic mix that helps you guys get that little bit better, you know, lower declines? in the last couple of quarters, or do you think there's something with the changes you've made to products or channels that's helping you, you know, gain some market share?

Yeah, well, certainly we take a look at both of those carefully. Most geographies we can get a signal on, you know, specific share gain, and we also, you know, look at the mix and You know, I think what I say is that we've been over time shaping that business both in terms of the geographies we serve, the segments we serve, the type of business model we have, the innovation that we drive to make sure we've got a very strong, healthy business that can have strong growth relative to industry growth and that also can have strong and consistent margins and cash flow. And, you know, I think if you just, you know, look at not just the last couple quarters, but you look at the last, I think you'll see that the growth performance versus industry has been consistently very strong and, you know, that is a combination of having a, you know, healthy footprint to our business in terms of the industry geographies that we serve and how we're executing our growth model and innovation and channels.

Okay, great. Was there any difference in the growth rates or the decline rates for equipment versus consumables this quarter?

Yeah, there was not a significant difference between equipment and consumables.

Okay, great. And the last one for me, I just... You know, I guess with the CVS that you're doing, you know, I guess there's probably a lot of opportunities in the med tech business. And I wonder, you know, what's your experiences now with doing CVS there? Is it supply chain or is it factory work that you can do? You know, how much margin do you think there is?

Yeah, so we have, you know, gotten a lot of good CVS activities going in the DGO business. The team has really embraced the toolkit and the cultural aspects of CVS, and we've certainly been leaning in and helping as well. We've done a lot of work in the supply chain so far already. Most of that supply chain work has been focused on customer service and laying the foundation for productivity improvement over time, which is not unexpected as we step into this and not inconsistent with what I've seen in other businesses over time. We've also been doing quite a bit of CVS work in the innovation engine, particularly the racing rehabilitation or P&R innovation engine within that business. And, you know, that's something that, you know, pays dividends over time in terms of both the productivity of Innovation Engine and the kind of growth contributions and how that helps with price resetting. And so that's something that takes longer, but it's an area that we've done a lot of good work so far, been able to put some resourcing in that they can help with that, that's got some experience in that area. And then third, you know, some of the back office processes and, you know, opportunity for process improvement. And again, our initial work there has been in eliminating restrictions to growth that existed in that reimbursement engine and getting things flowing better on the front end to where we weren't constricting the growth of some of our businesses. But then we've also been laying out a foundation that is going to enable productivity benefits.

Okay. All right. That sounds great. Thank you.

Thanks, all. Your next question comes from Joe Ritchie from Goldman Sachs. Your line is open.

Thanks. Good morning, everyone.

Good morning, Joe.

Hey, Joe. So I just wanted to kind of make sure we're all level set on 2021 and the recovery in MedTech. So if we assume, you know, 2019 had, call it, pro forma revenues of, call it, $1.2, $1.3 billion, and the 17% type EBITDA margins that you talked about, you know, should we then assume the comments around 2021 being above 2019 levels that we're looking at, you know, call it $1.3 billion plus type revenues and EBITDA north of, call it, $210 million in the MedTech business?

Yeah, Joe, I'm really not ready to give specific guidance on next year. I think we've gone pretty far on this call trying to kind of, you know, shake a little how we see the markets recovering and give a, you know, a sense for, you know, how we're working on that. I think, you know, what I'll say, you know, is, you know, on the ESOP side, sub-tech side, I think we've been clear that we've been working hard on making sure that we restore the margins and then some by the time we get back to – get back to 2019 levels. And on the MedTech side, we're trying to make sure that we're getting back to those margins at the right time based on the investments in the business. And I think, you know, that's as far as we're going to go on this call, but certainly not too far down the path here we'll be given much more specific guidance.

Okay. No, it's fair enough. I guess maybe just following on there, though, as we kind of think about the recovery into next year, Just based on what you know today, the backlogs on the, you know, on the surgical side, the elective procedure side versus what you're seeing on the bracing side, do you expect at this point to see some type of like mixed benefit from a margin perspective as we head into next year?

Yeah, again, it's really a little too early to make the call on that. There's a lot of moving parts, you know, beyond just the macro moving parts. And so, you know, I think, again, we'll certainly be happy to share comments like that when we get into our specific guidance, I would say.

Okay. All right, maybe just kind of shifting gears, one last question on this acquisition that you did. still a relatively, you know, small acquisition and what you guys have kind of defined as a potentially, you know, billion-dollar-plus type market. And so maybe just discuss a little bit more about, you know, what this acquisition gets you into this specific market and what the potential opportunities are for bolt-ons, you know, within foot and ankle surgeries.

Yeah, sure. You know, the financial space is a space that is, you know, a billion or a billion dollars to market, but it's got a number of different kind of slices in terms of the specific, you know, challenges the patients have and the procedures that doctors do to address those situations. And it's got great growth, great reimbursement margins, and has a lot of fragmentation that creates that acquisition. a startup that steps us into a portion of that market with a leading product, you know, a good share position, a leading product that's got a ton of historical data and, you know, surgeons that are committed to that product. And it is, you know, we believe the most strategic part of that foot and ankle space because it's a place that for the surgeons that do foot and ankle work, it's, you know, it's the It's a very important procedure for them in terms of the dollar per procedure, the importance to patients. And so we see it as a strategic entry point that gets us that connection in the space. It's a meeting position within that slice of foot and ankle that we can solidify and build from within that slice, but then it also creates that anchor point to then extend organically and or inorganically into other pieces of that foot-ankle space over time, many of which have, you know, those attractive growth dynamics like the TAR.

Okay. Thanks for the color.

Yeah. And, you know, I have an analogy. You know, shoulder is, you know, a little bigger. You know, shoulder is more, you know, a couple billion dollars or so, Mark. But if you kind of roll shoulder back 10 years – Kind of like foot and ankle does today is a way to think about it. There was a lot of fragmentation, still a lot of growth runway, and some different slices in terms of what was being done there. We've got an extremely valuable shoulder franchise within DJO that drives strong growth, high margins, has got a lot of growth runway ahead of it, and now we're adding this where we're going to start out where we're stepping in, but with plenty of opportunities from there.

Yeah, that's encouraging. Thank you.

Your next question comes from Steve Dousa from J.P. Morgan. Your line is open.

Hey, guys. Good morning. Hello, D.C. Can you just talk about how, I mean, I know there's been a lot of M&A activity out there, but how are, you know, valuations and then how are you, you know, basically, you know, modeling the DCFs on these things that you're looking at? You know, what types of multiples are you seeing out there? It's kind of a, you know, high multiples, but a lot of uncertainty is, you know, a bit of a strange time right now. So how do you think about that at a high level?

Yeah, Steve, so sure. There was a period of time where it was tough to do acquisitions because there was so much uncertainty. But as things have started to clear, certainly on the med tech front, as elective surgery has largely recovered and there's kind of more clarity of where we'll probably pick up on the other side of this thing, I think you've seen certainly more deals being done. I think as we look at acquisition opportunities, certainly on the MedFix side, we see a range of opportunities from things that are more straight up bolt-ons of product lines or channels that we can see opportunity to do them at attractive multiples with faster return paths. And then we see adjacency opportunities like like the star ankle, you know, the star we got for a very attractive price given the backdrop of Stryker needing to sell it. But then, you know, we see other ones, you know, that are adjacencies where we might have to, you know, pay a higher multiple, but they're really going to contribute to organic growth in a significant way and strategically strengthen the business and a little longer path to returns. And so there's a range of opportunities. We've got a very full pipeline. We continue to keep focused on our 10% return threshold, but we appropriately flex that. Sometimes we're expecting it a lot sooner, and sometimes we're willing to take the full five years to get to that threshold based on the strategic importance of what we're adding. I've got to say I'm really encouraged. by the amount of opportunities that we've got in the pipeline. I'm excited about the star ankle. I think it creates a great growth vector for us that we'll be able to build out over time.

Great. Thanks a lot.

Thanks, Dave.

Your next question comes from Julian Mitchell from Barclays. Your line is open.

Hey, good morning. This is Trish on for Julian. So just maybe one more question on MedTech margins. I know you mentioned that there's some seasonality there and maybe some supply chain costs are still there, but you expect sequential improvement. These margins were down around 1,000 basis points in Q2 and 250 basis points in Q3. Is it possible to get back to flattish in Q4, or should we still expect them to be down year over year? And then just one more on the acquisition. I think you mentioned high growth margins when we consider kind of selling costs and everything else. Are the operating margins similar to MedTech?

Yeah, so, you know, first of all, Q4, you know, has got less days than last year, which is going to be a, you know, kind of meaningful effect on the margins, and it's also got, you know, some of these costs that we talked about will continue on, and so we're, you know, definitely more We're focused on sequential improvement in Q4 and then being able to roll over and drive to a good healthy 2019 or 2021 overall margin. I think Q4 margins likely will be lower than last year for the reason we talked about here on the call in MedTech. As far as the acquisition, we see the You know, this acquisition and the broader, you know, foot and ankle opportunity over time as, you know, having the opportunity, you know, to have the, you know, the same or stronger margins over time as the rest of our MedTech business. And certainly on an incremental basis, you know, as we can scale a position in that space, it can be accretive to accretive to overall MedTech margins. Some of the gross margins are attractive. And whether it's accretive or not, it's just, you know, how much you invest for growth versus when do you take more margin decisions.

Got it. Thank you. That's very helpful. And then just maybe one more from me on free cash flow. You guys mentioned you're on track for $250 million kind of if we annualize the second half. I think the first half tends to be seasonally weaker in terms of free cash flow for you guys. So has anything changed in terms of what you're expecting for seasonality of free cash flow? And should we not be expecting a big working capital headwind next year as sales recover? And then just one finer point. Last year you talked to kind of the $185 million adjusted base free cash flow. That implies kind of flattish with your guide for this year, but in the slides it looks like we're comparing to GAAP for that second half number. And what's the right base we should be comparing this year's free cash flow list?

Thanks. Okay, that's a lot of questions. Let me – Trish, let me see if I can help you out on that. I think the main point that we want to make is that we've done a lot of good work this year around through all of our teams. to improve the sort of predictability and reduce a little bit the seasonality of the cash flow. What that means is even though we would expect the second half cash flow next year to likely be higher than the first half, we wouldn't expect to have quite as significant of a ramp. And so I think that's an important element there that demonstrates the improvement that we've made. The second half performance that we have this year is certainly indicative of the potential for next year. I do believe it paves a pretty clear path that we can get back to that sort of high conversion rate that we had expected. We talked about previously the amount of cash flow that we would generate. In terms of the current year cash flow, I think we've laid that out transparently. People can see and understand that. Obviously, they understand the impact of COVID. I would say that up until mid-March, we had high conviction that we would get to the $250 million or more in 2020. But obviously, we had to deal with the pandemic and the effects of that. But what's great about the second half, even though we've had a Q3 that had a lot of working capital rebuild, is we've clearly demonstrated that we're back on that path to being able to generate significant cash flow for next year.

Okay, thank you.

Thanks, Chris. Your next question comes from Chris Snyder from UBS.

Your line is open. Thank you. So just following up on previous conversation around 2020 MedTech guidance, the Q4 outlook seems to suggest that the deferred backlog built up in Q2 is being worked through this year. And then so when we look out to 2021, you know, mobility on the margin should be depressed versus 2019, at least early in the year. So what are you guys seeing that gives you confidence around healthy growth next year over 2019 levels?

Yeah, I think there's a range there, you know, by business. So I think you could get into the detail of a guest area, and I'd say, you know, if you go to the, the surgical end of the spectrum, you know, I think there's still going to be some catch-up opportunity next year that I think is likely to, you know, to create some opportunity for a little stronger performance on that reconstructive part of the business versus, you know, as you appropriately point out, if you go more to the part of the PNR business that is not driven by surgical, you know, there, you know, the – Some of the limits on activities and things that are likely to come are going to, you know, put a little pressure on, you know, can you get a full year of growth or not. But even that P&R segment has a combination of surgically driven drivers as well as drivers from those activities. And so, you know, we put that all together and the view is, you know, that 2021, you know, you know, has got, you know, good potential to be, you know, kind of a normal healthy year of growth off of 19. Okay.

I very much appreciate that, Collar. So, you know, I understand the weightings between, you know, reconstructive and P&R. And is that the way we should be thinking about the part of the business that's, you know, that's 30, maybe a 30-70 split between P&R you know, injuries driven by mobility and then just kind of general wear and tear, which is, you know, obviously less impacted by mobility. Is that the fair kind of split across the entire method?

Yeah, no, it's, yeah, it's not actually. So the 30% that is reconstructive is, you know, predominantly driven, like it's surgically driven and that's, predominantly driven from disease, you know, as the primary driver. And so, you know, so I think just an important comment on that is that we can work off the backlog in terms of patients that are scheduled for surgery, but we still have patients that canceled their surgery but still need it. So that's a factor that will come into play next year or the following year as far as, you know, kind of, quote, elective surgery, you know, that kind of factors into that equation. So the 30% of reconstructive is all surgically driven. And then when you go into that PNR section, there is a meaningful portion of it that is surgically driven, either from implant surgery or sports medicine kind of surgeries. Obviously, some sports medicine surgeries are based on conditions that already existed before COVID. Some would be from things that would be created within COVID. A portion of PNR support is surgically driven and then there is a portion of PNR that's actually workplace injury driven and so you get the industrial workplaces and construction workplaces all back. You get a restoration of that and then there's a portion that is created by, um, you know, by sports. And even within sports, you've got organized sports, uh, that have had, uh, had constrictions, uh, or I should say sports and recreation. You've got organized sports that have had constrictions, but then you also have the, you know, the weekend warriors that, that if anything, uh, have, have been doing more exercise, not less exercise. So, you know, I, I think it's, uh, you've got to kind of get down, down into it to get to the pieces and parts. Uh, but, uh, I think you've got the right top-down view that there's a surgical portion that a lot of the direct backlog will be worked off, but don't forget some of this deferred procedures that comes back into the backlog that was pent up. And then you've got kind of an activity-based part that is part from kind of mobility, organized sports, and stuff like that, but it's part from things like just people getting back to work.

Appreciate all that, Collin.

Thanks for the time.

Your next question comes from Nicole DeVlas from Deutsche Bank.

Yeah, thanks for squeezing me in, guys. Good morning.

Hi, Nicole.

Hey there. So I just want to ask a little bit about Fabtech. Decremental margins obviously have been really, really strong for the past two quarters in the low 20s. I mean, when we think about, you know, what's embedded in the fourth quarter outlook, is the expectation that you guys can kind of stay in that low 20s range in that segment, just trying to think about, you know, the impacts of temporary costs come back, all of the moving pieces into next quarter.

Sure. Yeah, Nicole, the team's done a great job of managing the costs and the downturn. As you note, the decrementals. And it really comes from two factors. Number one is some of the temporary cost actions that were taken that, you know, we continue to manage and work. And then as the business improves, you know, some of those will come back into the business and have already started to come back into the business. The second is the restructuring activities that are well underway in the business. that were planned for the year and some of those actions may have been accelerated a little bit as COVID, you know, came to bear earlier in the year. So we have both of those at play and both of those should come together to produce some pretty respectable decrementals again. But I think we should set expectations that, you know, as COVID continues to obey, we continue to have growth in certain regions. We have easing. declines in other regions, that those decrementals should, in fact, you know, start to climb a little bit. That's natural and healthy in the business, and we would expect to see that.

Okay, got it. Understood. That makes sense. And then secondly, I'm not sure if you're willing to comment on this, but you did talk about, you know, encouraging signs of improvement in September and October and I'm focusing on the welding business. I mean, can you give us a sense of the exit rate in Fabtech in September and October, just to give us a sense of, you know, how 4Q is shaping up initially?

Yeah, I'm not going to get specific on that, but more than what we said, which is that we did see, you know, those two months, you know, better than the previous, and we've certainly factored that into, you know, how we've – how we've thought about and are talking about the fourth quarter. But at the same time, you know, we've seen some of these risks that people have asked about on the call, you know, like some of the European resurgences and things. And so we've tried to combine what we've seen the first couple of months with, you know, the best understanding and thinking we have about how the next few would play out and give guidance based on that.

Okay. Fair enough. Thanks. I'll toss it on.

There's no further questions at this time. I'd like to turn the call over back to Mike.

Great. Thank you, everyone, for joining our call today. I look forward to talking to you going forward. With that, we'll end our call. Thanks, everybody.

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