Enovis Corporation (ENOV) Q3 2020 Earnings Report, Transcript and Summary

Ladies and gentlemen, thank you for standing by, and welcome to the Colfax Third Quarter 2020 Earnings Call. [Operator Instructions] Please be advised that today's conference is being recorded. [Operator Instructions] It is now my pleasure to turn the conference over to your speaker today, Mr. Mike Macek. Sir, please go ahead.

Thank you. Good morning, everyone, and thank you for joining us. I'm Mike Macek, Vice President of Finance. Joining me on the call today are Matt Trerotola, President and CEO; and Chris Hix, Executive Vice President and CFO. Our earnings release was issued this morning and is available in the Investors 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 risks and uncertainties, including those set forth in the safe harbor language in today's earnings release and in our filings with the SEC. Actual results 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, who will start on Slide 3.

Thanks, Mike. Good morning, and thanks to 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 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 $0.41 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 in 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 nonrecurring 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 served markets are operating much closer to pre-COVID levels, increasing demand for nonsurgical 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' 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 risk from COVID reemergence in Europe and the U.S. elections. This overall positive trending gives us the confidence -- gives us confidence in a return to 2019 demand levels at some point in 2021. MedTech business results are included on Slide 5. 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 multiyear 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 P&R 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 a bit sequentially in Q4 and have a clear focus on driving further improvements. We continue to make good progress using CBS 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 6. We signed an agreement this month to acquire the STAR total ankle replacement 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 CBS toolkit to integrate these product lines. The acquisition complements our fast-growing reconstructive product line with an entry into $1 billion-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 Ankle 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 7, Fabrication Technology organic sales declined 6%, and FX pressure contributed 3 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 a recovery while also supporting growth and innovation spending. ESAB remains well positioned for strong relative growth, continuous margin improvement and strong cash conversion going forward. On Slide 8, you can see that CBS continues to 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 5 modules for our operations leaders around the world. When travel became restricted, we revised the curriculum of 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 CBS 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 1 where the relatively new Colfax team at GCE used our kaizens and SMED tools to reduce setup times by 60%, improving productivity and liberating additional capacity for the strong growth that business is capturing. Outside of our supply chain, the teams have developed innovative virtual Kaizen approaches. We highlighted on the slide the way 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, who will start on Slide 9.

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 teams 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. EBITA 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 $0.41 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 the expected cash flow in Q4 and annualizing second half performance shows that we would end the year on a run rate of 3.7x 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 close to 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, Brian, let's open up the call for questions.

[Operator Instructions] Your first question comes from Andrew Obin from Bank of America.

So just a question in terms of the impact on COVID on your business model. Can you just talk about shift from hospital to ambulatory surgery centers? How much of that are you seeing? And what's the longer-term impact?

Yes. Thanks, Andrew. So obviously, there's been that ongoing trend from hospitals to ambulatory centers. 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 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 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 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 Oara risk scoring tool to doctors to enable them to help assess the risks around doing surgery and ambulatory. And we've got relatively simple equipment sets and continue to work on simplifying our 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 -- 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 lines.

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?

Yes, they do. They behave -- yes, it's funny. We call them elective surgeries. I think I said on the previous call, they're sort of more deferral than elective, most of these surgeries. Typically, they're being done because patients are 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 be 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 the most there. And so that's the part of the market that's come back the most.

Your next question comes from Joe Giordano from Cowen.

So I'm guessing you do not want me to ask about 2021 necessarily, but you guys said that the 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, different than what you guys reported and based on the stub period, but on a 12-year equivalency?

Yes. So Joe, we have talked about from a growth standpoint. If you look at Q3 where our underlying growth was just in the range of flat to or minus 1%. The guide for Q4 being flat to down a couple in terms of daily growth, we feel like that. That reflects that even as there continue to be some challenges and risks that are very real, there is also progress on the fundamental demand drivers of the business and progress on people being more comfortable going and getting treatments and service. And so we feel like that points to a turnover to growth in 2021 and a kind of healthy year of growth in 2021 versus '19. On the margin front, and I will say in our MedTech 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 to stretch the last quarter of last year, the first couple months of this year, we started to show that that mid-single-digit core growth capability of the business that is important to make the business very, very valuable. So that's our first focus on that business. We're also very focused on making sure that we drive margin improvement 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 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 up against the productivity that we've been driving. And we're certainly focused on making sure we could get the margins restored and then we have strong and healthy cash flow in that business. But we're also trying to make sure we do the right things to really solidify that mid-single-digit growth engine.

Fair enough. Yes, 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 Stryker. Just curious if any color on momentum of new talent acquisition in general or as a direct result of the transaction for some people kind of up pro grabs, KOLs, salespeople, things like that?

Yes. We're certainly very excited about adding the STAR product line. Great opportunity. It's just a great adjacency. Certainly when we did the -- when we were 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, good structure, good possibilities, but it was 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 the right channel to be able to strongly 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 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, 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?

Yes. Well, so certainly, we watch the things that are going around the world very carefully. And all year in FabTech, we have tried to make sure that we are being cautious about what kind of revenue is going to come in that business and the rate of recovery that will come in that business. We try 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 cost 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 we try to make sure that we're ready for a range of recovery scenarios in FabTech. And to be honest, it looked for a little bit like here like maybe we're headed towards the better end of the spectrum on those recovery scenarios and that the business might turn over -- Q4 or Q1, turn over to growth. And certainly, with a little bit of a slowing down in progress in the U.S. and some of the European things that are going on, you can see that we're taking a little more cautious path that it will take 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. I think even if you look at what Germany and France have talked about in recent days about their situations, they have shut down significant portions of their economy, but they have explicitly left open the industrial portions of their economies. And that means that the constriction that we saw back in Q2 are not going to reappear in terms of economies being just kind of forced down. But certainly, some of the 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.

Your next question comes from Jeff Hammond from KeyBanc.

A couple of questions on MedTech margins. One, just in the quarter, I guess, if you exclude the COVID cost, you're still down year-over-year. Is that mix or investments? And then just talk about the profitability profile of this acquisition?

Yes. So the first is, that business is going to have a little bit of quarterly variations in the margin levels for seasonality factors, whether certain investments are made in certain quarters, et cetera. And so the specific quarterly margin level that we're confident against was probably a little on the high side. You saw our full year number back in '19 was below that. So I think there is a little bit of -- a little bit tougher comp there. But then as we've talked about, we did have a pretty significant amount of inefficiency just from having to quickly turn that business down and then 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 both 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 as we move through the next couple of months here. But we certainly are focused on getting the margins recovered in that business and making good sequential improvements there. As far as the ankle business that we got, the gross margins in that business are very attractive. It's at the upper end of the surgical margins. And so it's an attractive add. And for sure, we'll be working on scaling the fixed cost base of that business. And so it will add some profit out of the gate. But as the business grows, 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 -- I guess, the developed markets looks like accelerated the most. Can you just talk about where you're seeing the best recovery from a geographic? And if you can maybe comment on end markets as well?

Yes, sure. So most of the developing markets grew in the quarter. And I think that's consistent with what we talked about even from what we were seeing early in the quarter. Yes, and that's consistent across places like Asia and Russia and parts of South America. I think the one developing market that has been slower to recover is India, which is still in the negative because it really -- they really lock things down hard back there in Q2 and has taken some -- taken some time to get that economy restarted. India is making progress. And certainly, what we're seeing down there is, is resolve from the government to 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 pretty soon here. And then kind of vast majority of developing markets will be in the positive. As I said, developed markets, significant improvement from Q2 to Q3, but those are ones that will take a little bit longer to go to get back to growth, especially given some of the current pressure 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 come back very, very quickly. We saw the automotive market, both in the U.S. end market 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 that 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.

Your next question comes from Nathan Jones from Stifel.

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 color 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 for the business? Are they gone in the fourth quarter? Or should we expect a bit of a drag still from those supply chain costs?

Yes, Nathan. So there's a couple of different sources. One, when we flex down fast, we had certain places in the world where we were not able to flex down the labor based on government restrictions on what we could and couldn't do. And so we took some -- a little bit 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 sell in Q3 and sort of that part of it would clear through. Second, as we flexed back up quickly, we have -- we've kind of done whatever it's taken in terms of things like overtime that add some extra cost. And then third, there's been quite a bit of both inbound and outbound freight expediting and splitting up orders in order to get the customer as much as possible what they've asked for, while we're still kind of waiting to get through the other parts. So those are the kind of operational costs that make up that extra cost in the quarter. Good portion of that is clearing through. But certainly, some of the more kind of expediting-related aspects of it will still continue 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. When we have recessions like this, you would -- 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. So first, 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 point out that for the rest of our Prevention and Rehabilitation business, if the activities aren't happening, the demand -- we kind of missed the demand. And so it's the right way to think about our portfolio. As far as kind of how that dynamic has played out, I think if you look at most published stores is they talk about elective surgery 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% of pre-COVID range and improving. And those are the 2 things that kind of affect that equation, right? Because the rate at which we're doing elective surgeries a few months back was burning down the backlog and the clinics were at much lower levels. But as those 2 approach, the difference between the surgeries that are happening today and the ones that are being created for tomorrow starts to get narrower, and we've kept a close view of that. And so our view is that the way that we made our way through the third quarter and certainly left some things in the backlog in terms of surgeries that have been deferred and that were still scheduled. And that's enough to kind of offset the fact that clinics are not fully operating and restoring the pipeline and sort of keep that elective surgery in that 90% to 100% type of range as we move through the fourth quarter. And the elective surgeries in that range will have a nice growth in our surgical business based on the way that we take share in that business. And then as we move into next year, at some point, there will be a time 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, some of it comes through the following year, it 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. There's probably some higher investment as well. Is 20% EBITA margins in 2021 beyond the realms of possibility? Or is that a target you have in mind?

Yes. I didn't -- are you talking about the MedTech business or the ESAB? I didn't hear the question. [indiscernible].

MedTech, MedTech.

And you're talking about EBITA or EBITDA?

EBITA.

Yes. I think we've talked about trying to make sure in the MedTech business that we're focused on restoring back to 2019 kind of margins as soon as possible as we come out the other side of COVID and the 2019 EBITA margins were in that 17% or so range. Maybe EBITDA margins were closer to 20%. And as I said earlier in my comments, we continue -- we're focused on sequential improvement in the MedTech margins 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 drive the productivity in the business. So we can restore the mid-single-digit growth engine quickly, get those margins restored to pre-COVID levels as soon as possible as well and then build from there, both continuing to drive the growth and improve the margins from there.

Your next question comes from Walter Liptak from Seaport.

I wanted to ask about the comment that you made about outperforming the FabTech peers. And I want to get an idea. Do you think it's the geographic mix that helps you guys get that little bit better 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 gain some market share?

Yes. Certainly, we take a look at both of those carefully. Most geographies, we can get a signal on specific share gain, and we also look at the mix. And I think what I'd 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 and healthy business that can have strong growth relative to industry growth and that also can have strong and consistent margins and cash flow. And I think if you look at not just the last couple of quarters but if you look at the last 8 quarters, I think you'll see that the growth performance versus industry has been consistently very strong. And that is a combination of having a healthy footprint to our business in terms of the industries and geographies that we serve and how we're executing our growth model in innovation and channels.

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

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

Okay. Great. And then the last one for me, just I guess with the CBS that you're doing, I guess, there's probably a lot of opportunities in the MedTech business. And I wonder what your experience is now with doing CBS there. Is it supply chain? Or is it factory work that you can do? How much margin do you think there is?

Yes. So we have gotten a lot of good CBS activities going in the DJO business. The team has really embraced the toolkit and the cultural aspects of CBS, and we've certainly been leading 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 stepped into this and not inconsistent with what I've seen in other businesses over time. We've also been doing quite a bit of CBS work in the innovation engine, particularly the bracing and rehabilitation or P&R innovation engine within that business. And that's something that pays dividends over time in terms of both the productivity 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, have been able to put some resourcing in that they can help with that, that got some experience in that area. And then third, some of the back-office processes and a specific point to this business is the reimbursement process that's got a lot of opportunity for process improvement. And we've -- again, our initial work there has been in eliminating restrictions to growth that were -- 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 that foundation that is going to enable productivity benefits.

Your next question comes from Joe Ritchie from Goldman Sachs.

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

Yes, Joe, really not ready to give specific guidance on next year. I think we've got pretty far on this call trying to kind of shape a little how we see the markets recovering and give a sense for how we're working on that. I think what I'll say is on the ESAB side, FabTech 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 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 giving much more specific guidance.

Okay. No, that'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 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 mix benefit from a margin perspective as we head into next year?

Yes. Again, it's really a little too early to make the call on that. There's a lot of moving parts beyond just those macro moving parts. And so 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 small acquisition and what you guys have kind of defined as a potentially $1 billion-plus type market. And so maybe just discuss a little bit more about what this acquisition gets you into this specific market and what the potential opportunities are for bolt-ons within foot and ankle surgery.

Yes, sure. That -- the foot and ankle space is a space that is $1 billion or $1 billion-or-so market, but it's got a number of different kind of slices in terms of the specific challenges that 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 runway for us. What started as it steps us into a portion of that market with a leading product, a good share position, a leading product that's got a ton of historical data and surgeons that are committed to that product. And it is -- 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 the -- it's a very important procedure for them in terms of the dollar per procedure or 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 leading 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 and ankle space over time, many of which have those attractive growth dynamics like the TAR. Yes. And an analogy, shoulders go bigger, shoulders more a couple of billion dollars-or-so mark. But if you kind of roll shoulder back 10 years, look kind of like foot and ankle does today is a way to think about it. There was a lot of fragmentation, have a -- still a lot of growth runway and some different slices in terms of what was being done there. And so we've got 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 additional foot and ankle franchise, where we're going to start out where we're stepping in, but with plenty of opportunities from there.

Your next question comes from Steve Tusa from JPMorgan.

Can you just talk about how -- I mean, I know there's been a lot of M&A activity out there. But how are valuations? And then how are you basically modeling the DCFs on these things that you're looking at? What types of multiples are you seeing out there? It's kind of a high multiples, but a lot of uncertainty is a bit of a strange time right now. So how are you trying to think about that at a high level?

Yes. 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 MedTech 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 MedTech 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 kind of faster return pass. And then we see adjacency kind of opportunities like the STAR Ankle. The STAR, we got for a very attractive price, given the backdrop of Stryker needing to sell it. But then we see other ones that are adjacencies where we might have to pay a higher multiple, but they're really going to contribute to organic growth in a significant way and strategically strengthen the business and for the 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 5 years to get to that threshold based on the strategic importance of what we're adding. I 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.

Your next question comes from Julian Mitchell from Barclays.

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 on the acquisition. I think you mentioned high gross margins when we consider kind of selling costs and everything else. Are the operating margins similar to MedTech?

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

Got it. 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 final 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. Kind of what's the right base we should be comparing this year's free cash flow with?

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 think 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 in 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. And obviously, they understand the impact of COVID. I would say that up until mid-March, we were -- 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.

Your next question comes from Chris Snyder from UBS.

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, 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?

Yes, Chris, I think there's a range there by business. So I think when we kind of get into the detail I would get there. I mean I'd say, if we go to the surgical end of the spectrum, I think there's still going to be some catch-up opportunity next year that I think is likely to create some opportunity for a little stronger performance on that Reconstructive part of the business versus, as you appropriately point out, if you go more to the part of the P&R business that is not driven by surgical. There -- some of the limits on activities and things that are likely to come are going to put a little pressure on, 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 we put that all together, and the view is that 2021 should -- has got good potential to be kind of a normal healthy year of growth off of '19.

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

Yes. No, it's -- yes, it's not actually. So the 30% that is Reconstructive is predominantly surgically driven, and that's predominantly driven from disease as the primary driver in. And so I think -- and 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 cancel 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 kind of elective surgery that kind of factors into that equation. So 30% is of Reconstructive is all surgically driven. And then when you go into that P&R 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 needed would be created within COVID. But a portion of P&R sports is surgically driven. And then there is a portion of P&R that's actually workplace injury driven. And so as 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 sports. And even within sports, you've got organized sports that have had constrictions, or I should say, sports and recreation. You've got organized sports that have had constrictions, but then you also have the weekend warriors that, if anything, have been doing more exercise, not less exercise. So I think it's -- you've got to kind of get down into it to get to the pieces and parts. But I think you've got the right top-down view that there is 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 the -- just people getting back to work.

Your next question comes from Nicole DeBlase from Deutsche Bank.

So I just want to ask a little bit about FabTech decremental margins. Obviously, have been really, really strong for the past 2 quarters in the low 20s. I mean when we think about what's embedded in 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 the impacts of temporary costs come back, all of the moving pieces into next quarter.

Sure. Yes, Nicole, the team has done a great job of managing the cost in the downturn. As you note, the decrementals. And it really comes from 2 factors: Number one is some of the temporary cost actions that were taken that we continue to manage and work. And then as the business improves, 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 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, as COVID continues to abate, we continue to have growth in certain regions. We have easing declines in other regions that those decrementals should, in fact, start to climb a little bit. That's natural and healthy 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 encouraging signs of improvement in September and October. 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 how 4Q is shaping up initially?

Yes. Not going to get specific on that, but more than what we said, which is that we did see those 2 months better than the previous and we've certainly factored that into how we've -- how we thought about and are talking about the fourth quarter. But at the same time, we've seen some of these risks that people have asked about on the call, like some of the European resurgences and things that. And so we've tried to combine what we've seen in the first couple of months with the best understanding and thinking we have about how the next few would play out and give guidance based on that.

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

Great. Thank you, everyone, for joining our call today. And 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.