Afternoon. Thanks for joining us again at the 23rd Annual Needham Healthcare Conference. I'm Mike Matson, and I lead the MedTech and Diagnostics Equity Research Team at Needham & Company. I'm pleased to introduce Enovis. Presenting for Enovis today, we have CFO Ben Berry. Instead of a standard presentation, we're going to do a Q&A session. If you have any questions you would like to ask, you can submit them electronically through the Needham Conference website, or you can feel free to email them to me at mmatson@needhamco.com, and I'll try to fit them in. With that said, we're going to get started with the Q&A. So, Ben, thanks again for joining us. I wanted to start out with the P&R, Prevention and Recovery business. Can you just give us a kind of an overview of this business?
Sometimes when I talk to investors about it, they have this perception that this business operates in a really commoditized, kind of slow-growth market. But I know that you have some really strong brands here. So can you explain maybe why that perception really isn't right?
Yeah, sure. Thanks. And thanks for having us, Mike. It's good to be with you. You'd be hard-pressed to find kind of someone in orthopedics that didn't know the name DonJoy or the name Aircast. And really, if you think about how we made our name for ourselves as a company, it's really been through strong brands, leveraging kind of capabilities, and kind of building off that over time. And really, through DonJoy, you'll see us kind of on offensive linemen and kind of in 90% of kind of the NFL teams kind of using our product lines on any given Sunday. Aircasts, again, you kind of look around kind of your environment, and you see people in walking boots. And generally, you'll kind of see the name Aircasts.
And really, what we did was we were able to leverage kind of that kind of strong brand power and market position to really help us to kind of create relationships within clinics and hospital settings, and then also kind of take our contracting power within hospitals as we started to emerge with some of the kind of meaningful Recon innovation that we were able to launch over the last several years. So it's really been kind of a key foundation for our business within P&R. We're the global market leader, about $1 billion in a $4-$5 billion market. We're kind of we have a composition of a more diverse set of brands and product lines, bracing and supports where we're the global market leader, rehab technologies and devices where we're also the global market leader.
We have bone growth stimulation devices that help support bone growth post-spinal surgery. We've got a small diabetic footwear business as well. So P&R is a more diverse set of businesses. It's really kind of a strong cash flow generator for us, which helps us to fuel and fund the growth of our recon business, which has been more of our faster-growing portfolio that's been kind of supplemented through a lot of the acquisitions that we've done over the last several years. But it's played a good role in terms of establishing ourselves as a quality player in the industry with strong brands, recognition, and then the ability to generate that cash, like I was saying, to reinvest into our recon portfolio.
Okay. Great. That's a wonderful answer. So Enovis recently launched an osteoarthritis brace called Roam OA. Can you talk more about this product and kind of the market opportunity there? I think this is a category where you were sort of lacking a product. So it's a little more incremental.
Yeah, absolutely. Like I said, we're the global market leader in bracing. But in this category, which was kind of fast-growing and kind of a larger segment within bracing, about a $50 million category, we didn't really have much of a position. We were kind of leveraging some braces to try to compete in that category. But we just launched Roam OA, which, again, kind of allows us to bring a product line that comes into a category where we have a low market share position. It's a single upright OA brace that's very comfortable to wear. And we think that we have an opportunity to really make a name for ourselves in terms of getting our kind of fair share of that size of market kind of with this product line. So we're excited about it. It just launched kind of last year.
We're excited to get it in more customers' hands and look to really solve some of the challenges that patients with OA have.
Okay. Got it. And then are there any other new products in the P&R business that you'd want to highlight? I guess the other one that I saw in one of your slide decks was this Intelect 2 product, but I haven't really heard you talk a lot about it.
Yeah. I think we've got a couple of product lines in the rehab side. Again, strong brand recognition on rehab through the Chattanooga brand. We've got equipment launches of Intelect and Transport 2. I mean, what these really do is kind of bring a freshness to our rehab portfolio, improves kind of the interfaces that customers are kind of working with kind of on the rehab setting. And then just to kind of further kind of help with this, we've got some laser technologies that we've launched over the past couple of years as well that continue to drive some momentum in the rehab space. So those types of things we think are helping us to get to a more kind of sustainable growth in P&R.
If you think about kind of a few years ago, we had to really make some investments to improve our product freshness in this category of the business to get it to more sustainable growth and shape it more towards kind of our goals of a mid-single digit grower. We've been doing that. These are kind of examples of freshening up the portfolio to help us to kind of accelerate some of the growth potential.
Okay. And then I know that you talked about using the cash from P&R to kind of reinvest more on the reconstructive side. But have you done any acquisitions in P&R? And would you ever consider deals there, even if you're prioritizing the reconstructive business?
Yeah, absolutely. I mean, we're always looking at and I use the word shape quite a bit. But we're always looking at how can we continue to shape the portfolio into a stronger business? And when I say stronger business, I mean kind of a profile that comes in accretive from a growth and gross margin and kind of maintains some of the cash flow integrity that we have in some of the other P&R businesses that we have. So a few years ago, we did an acquisition called LiteCure. That brought us laser therapy that's really doing well, growing double-digit, comes with high gross margins.
We look for opportunities that will continue to look kind of like that, which are where we can leverage either channels that we have or capabilities that we have on the P&R side to where we could think about some bolt-on technology or products or companies that could really fit within kind of that mechanics of kind of how our P&R business operates. So it's definitely open. We connect all of our M&A funnel processes to our business strategies. One of our business strategies on the P&R is how do we really shape it towards higher growth and higher profitable growth through gross margin expansion. So we're always looking at opportunities for M&A across all of our businesses connected to strategy. And P&R definitely is in the frame of that.
Okay. Got it. And then moving on to the reconstructive business. So Enovis has been gaining share in this business for years. Can you talk about what's allowed you to capture share, especially since you're going up against some of the bigger companies out there in the medtech sector?
Yeah. I mean, I think it started with kind of a mentality of really thinking about how do we solve challenges through innovation and really kind of address outcomes and patient satisfaction. So it started with us with the product line called AltiVate, which was a reverse shoulder product that was designed in partnership with Dr. Mark Frankle, which was very kind of challenged at the time in terms of kind of the philosophies that were being used in kind of shoulder procedures and really kind of a kind of a polarizing effect sometimes in terms of should you take an anatomic approach? Should you take a reverse approach? Should there kind of be different things to take into account?
So we really kind of pioneered that reverse shoulder through AltiVate, came out over time that it generated really good outcomes, good range of motion, and really established ourselves as kind of a strong player within the shoulder market to where now we're a number 3 global share player with shoulder. It really kind of started with trying to address challenging outcomes with an innovative design in partnership with a strong KOL, which we did with AltiVate. We did the same thing with our Empower Knee platform, which is we saw within total knee arthroplasty that there were outcomes that were pretty good, but satisfaction levels that weren't as good. About 80% of patients are satisfied post-op after they've had their knee replacement. It's not like it's in pain, or it's not like it was a bad outcome.
It was just, it doesn't feel like their normal knee. So we developed a product called the Empower 3D Knee. It's the only product like it that pivots the way that the natural knee pivots, which is a dual pivot action laterally when you walk, medially when you squat. And it mimics kind of the natural kinematics of how a knee actually works, a normal knee. And therefore, we're getting kind of patient satisfaction levels over 90%. I think some of the latest data I saw, 93% patient satisfaction.
So addressing a gap that there was in the market around patient satisfaction and kind of a knee that mimicked and operated like a normal knee. So we leveraged those two technologies to really gain a lot of growth. I mean, they've been growing double digits for over a decade, both kind of product lines.
Then we looked at how do we build out on that, kind of using the same mentality of strong outcomes, but then think about where do we continue to build the portfolio. That's where we really started to open up the aperture with regards to acquisitions. We built a foot and ankle business through acquisition with some really innovative technologies that addressed challenging outcomes, both on a fusion technology standpoint with our DynaNail platform, minimally invasive, which we just acquired through the Novastep acquisition last year. We've created an opportunity for ourselves to really look at how do we drive meaningful innovation into a category, which is large, big total addressable market where we have a relatively low share position and be selective about how we do that, both from internal development and through acquisition capability.
We've been doing that to kind of continue to build out our offering. We're focused on building really strong global KOL teams, good education and training around kind of our products, and then continuing to look at where can we differentiate ourselves to create those diverse growth opportunities in a large market where we're in a low share position. One other thing I just mentioned on that is we've tried to anticipate where the market is going. As you think about shift to clinic settings where we're strong generally, historically, in P&R, we've thought about how do we kind of set ourselves up to be kind of beneficial for when the market shifts to more clinic and outpatient settings. We've created enabling technology that helps with that from an efficiency standpoint, from a patient identification standpoint.
We've streamlined some of our instrumentation to make sure that we're kind of able to manage and do business in that channel in an effective and efficient way. All of these things to think about where do we kind of think of market shifts moving, and how do we lean into that with either technology or innovation to capitalize on that growth potential?
Okay. Got it. And then one question I've had is the bigger companies have kind of gone all in on robotics. And as of right now, at least, Enovis doesn't have a robot. Now, I understand you have other types of enabling technologies like ARVIS. But why hasn't that been a bigger disadvantage to Enovis? And how have you been able to continue to capture share despite the bigger companies all really promoting their robotic systems and kind of using that to try to lock in their customers?
Yeah. I mean, I'd say from our perspective, there's still a lot of market potential for just kind of an implant that performs the way that ours does in terms of solving some of these I wouldn't say unmet needs, but kind of satisfaction gaps that exist in the market when it comes to the Empower Knee, as I was describing. And as I think about enabling technology, it's really first and foremost, it needs to enable an implant that's kind of delivering the right kind of outcomes that you're looking to generate. So first and foremost, we want to make sure that kind of our implant system gets the attention it deserves with regards to kind of the outcomes that it can generate.
Then it's about how do you kind of enable that from a planning, an intraoperative procedure, and then a post-op outcome standpoint.
If you think about that continuum of enabling technology, you've seen different types of attempts to really try to innovate in various areas of kind of the procedural workflow. Our view is that first and foremost, we want to continue to empower our surgeons to kind of be kind of the primary within the procedure, which means they're enabled to have the surgical field visible, that they're able to have what they need in terms of taking their preoperative plan and put that to their use intraoperatively. Then as we think about kind of further iterations, we would think about how do we kind of help them actually do the procedure where they still kind of maintain some of that control.
But at the end of the day, we think that we've started our enabling technology with Arvis, which is an augmented reality navigation device, which takes your preoperative plan, puts it on intraoperatively. So you're in control of where you're kind of positioning your angles to make sure you're implanting your implant in the right location so you're going to generate that good outcome. So at the end of the day, it's really about how do you enable the implant because that's what stays in the body, but at the same time, provide tools, technology, and capabilities to the surgeon to have an effective procedure and think about over time how you connect that workflow. We just started with Arvis. We've got other things that we're continuing to work on as we think about where the market heads over time.
We're not anti-robotic application, but we just want to do it in a way that empowers both the surgeon but then also considers kind of time, kind of the space constraints, and other things that are needed as you're kind of performing surgeries within this space.
Okay. Great. I wanted to talk about a couple of the newer products in the reconstructive business. You've had the Empower Knee for a while, Primary Knee, but now you've launched the Empower Revision System. Can you just talk about the revision opportunity for Enovis and kind of where you're at with that product launch?
Yeah. So I mean, we think revision's probably about 15%-20% of procedures that we weren't participating in given we didn't have a product line. We had the primary but not the revision. So kind of in 2023, we launched the Empower Revision, but it wasn't a full launch with kind of full product line. So one of the things that we get a benefit of this recent acquisition that we did of Lima is we get some titanium cones that we're able to use within that revision system to combine with the Empower System. We also have some other products that are going to be coming as well later this year to kind of help provide kind of a broad range of products to help address complex revisions.
Now we feel like we've kind of built out the portfolio to where we can address the needs of kind of our customers in all their case types. There's an opportunity to go to our current customers that we're using our primary but using someone else's revision. It gives us an opportunity to then go to kind of convert new market share of customers now that we have a full product offering. We're excited about it. It's still relatively early days, but overall, we think it'll build on the strength of what we've seen on the primary side of Empower.
How are you positioning Empower Revision? I think that there's simpler instrumentation or fewer trays or something like that. Is that right, or?
Yeah. We have that, especially in the ASC setting. We have a streamlined kind of set of instrumentation that can be leveraged. And again, what we're trying to do is kind of be very customer-centric in our approach to try to meet the needs of kind of their channel and their procedures to have the right kind of products, the right components, and augments like cones that we're able to provide now to be able to kind of meet kind of their broad needs kind of depending on where they're operating.
Okay. And then Arvis, we talked about that a little bit, but I think you are launching the newest version, Arvis 2.0. So can you just provide an overview of this and talk about the procedures where Arvis can be used?
Yeah, absolutely. So Arvis is augmented reality navigation. So it's essentially a headset kind of that can be worn during the procedure. It provides intraoperative navigation and guidance throughout the case. It's got a battery pack that you put on your waist. It's lightweight, relatively intuitive to use. It helps them have a heads-up display to where they're kind of always on the visual field of the surgery, but then allows them to kind of take that preoperative plan and kind of understand where their position points are for incisions or even to kind of get the angles right on the implant. So all of that to kind of help them execute intraoperatively from a navigation perspective. We just recently launched kind of a 2.0 more broadly near the end of last year in 2023.
That really kind of takes some of the things that we learned through kind of the early stages, added some additional functionality, added registration process of the Empower instruments, added some capabilities around positioning. That's something to get kind of used to around some of the enabling technologies because this is more software-based. It's going to allow us to continue to add incremental functionality over time with kind of a software update versus a massive kind of changeout of hardware that's going to be required. We'll continue to innovate around Arvis, but right now, we're excited about kind of the early feedback that we're getting and the navigation capabilities that it brings to the knee and working on kind of broadening that across kind of other anatomies like shoulder.
Okay. Great. I want to move on. I have a few on the Lima acquisition. So I think you guided to $40 million of cost synergies by year three when you announced the deal. Are you still confident in that number? And how do you expect it to? Is it going to be kind of linear over the three years, or is it more front-end or back-end loaded?
Yeah. Definitely, the work that we've done has validated our excitement about our opportunities of kind of being able to deliver these synergies over the three-year period like we described. So we feel confident that we have line of sight to the $40 million-plus of synergies. What we've said is kind of $10-$15 million in year one, and that kind of ramps up to kind of $40 million over time. So it's not exactly linear, but you can kind of think about year one and year three and kind of do a bit of the math to kind of figure out what that trajectory kind of looks like. But overall, we feel like we've got off to a good start there. We were able to announce the leadership team in mid-December.
We closed the deal in early January, and we're kind of off to the races now of kind of full-fledged integration. So far, so good. But yeah, we see 10-15 year one ramping up to 40 by year three.
Okay. And then so this is kind of the second European-focused orthopedics company that you bought, and your Mathys was the other one. So can you just talk about how the two compare and kind of fit together, I guess?
Yeah. It's interesting because when we went through the process here of trying to figure out how do we really unlock the geographic expansion capabilities of our reconstructive business, we started looking at this kind of earlier back in 2018, 2019, 2020. We were kind of figuring out what was going to be the right move to make there. We were looking at Lima. We were looking at Mathys. We were kind of looking at all the assets in the space. And we felt like a good first step was Mathys because it was kind of a private company, a little bit smaller price tag to get into it.
We knew that it had lower profit margins that we had to get up the scale curve, but we saw some really good capabilities and really limited overlap in terms of some of the cross-selling opportunities that we had with Altivate and Empower. So if you think about Mathys, it was only a European business. They didn't have U.S. business. It was mostly based in Europe, very limited in certain parts of Asia like Japan and Australia. But it was mostly kind of strength and hip. They had their own ceramics capability in terms of captive manufacturing around making ceramics and some good really design history that came along and really good positions in certain European markets. We looked at Lima.
And Lima, kind of a little bit different in terms of where they were a little bit more mixed towards shoulder. About 40% of their business was shoulder.
They did have a little bit of U.S. business, but where they were strong in certain geographies outside the U.S. is where Mathys wasn't as strong. So we found it to be pretty complementary to where there isn't a lot of overlap that's going to create a lot of dyssynergy as we integrate the channel. So we got pretty excited about kind of being able to execute the Lima acquisition, which was a build off of the success that we had of owning Mathys for almost two years and really getting that up the scale curve and building out capabilities to where we had nice complementary products and geographies. And then also now we have an opportunity to capitalize on some synergies as well. So we're really excited about kind of the strength that it gives us outside of the U.S.
It gives us cross-selling opportunities of kind of our stronger portfolio now together. And then it gives us the opportunity to leverage some of their capabilities from a manufacturing side as well to kind of really build out strength for the future, both in how we make products but then also how we design and develop products as well.
Just specifically on the cross-selling opportunities with Lima, so can you just talk about which products could go, I guess, from Lima to the U.S. and which U.S. products they could help sell into Europe and other places?
Yeah. So Lima has a really strong modular shoulder system called the SMR. So we're excited about really leveraging the strength of that as a key product line within our portfolio. They also bring really strong 3D printing capabilities to, where there's customized implants called ProMade, relatively small scale today, but think of application for the future could be pretty strong. So we're excited about the opportunities there to kind of think about broadening ProMade in a more meaningful way down the road. There are things like the cones that I mentioned from a revision standpoint that we get right away that we'll be able to cross-sell in places like the U.S. We got FDA approval to kind of marry that with the Empower 3D system.
Outside the U.S., we're excited about taking Altivate and Empower into the Lima channels as well as kind of leveraging some of the Lima-Mathys where kind of strength versus not strength. There's some opportunities in various countries to leverage hip systems and knee systems and shoulder systems to really broaden out the portfolio in specific geographies. So overall, it's still relatively early because you've got to work through all the product registrations and inventory buildup to really turn on some of those opportunities. But we're excited about the portfolio that we have through these acquisitions and think that we're going to be able to capitalize on it here in the future.
Okay. And then just in terms of the international business, how many countries, I mean, I don't know if you know off the top of your head, but roughly speaking, how many countries are you in? Are you still expanding into more countries, or are you just more focused on penetrating the countries you're already in?
Yeah. I mean, that's really the beauty of kind of the acquisitions that we've done is that we really kind of have the ability to pick and choose where we want to make the effort to grow and then what portfolio we want to capitalize on in some of those geographies. So we're in over 30 countries around the world. Most of those are direct. Some of them are through distributor markets. One of the things that we're trying to make sure that we're thinking about is where are there opportunities for us to really kind of differentiate ourselves either in growth or kind of core financial returns? So areas of the market that we could really lean into to help drive our mix in a beneficial way.
If you think about picking and choosing certain geographies that might come with better pricing structures or anatomies that we could focus on versus others in certain geographies that allow us to mix towards a market growth that's going to be higher than kind of the normal market, that's what we're going to look to do. It's exciting to think about kind of the opportunity now that we have a broader ability to do that with the acquisition of Lima.
Okay. Got it. And then what's your interest or exposure in emerging markets, places like China? Do you think those are attractive opportunities?
Yeah. I think right now, we don't really have a presence in China or India or very small distributor-type business in Brazil. So we're not really exposed to some of those emerging markets. I don't think we're in the current stage of our life cycle. Those markets aren't a priority for us given some of the challenges that come with them to really compete well and some of the concessions that you might need to make to kind of get into those markets. So I think our view is not right now from kind of an attractiveness standpoint because what we're trying to do is, like I said, shape the company towards not only high growth but good profitable growth as well. And some of those markets can put a challenge on doing that.
Okay. All right. And then just a few financial questions to kind of wrap up the discussion. So in 2023, your non-GAAP gross margin was up, I think, by 170 basis points from the prior year. Can you just talk about what drove that? And then was that how much of it was a mix versus just, I guess, scale or leverage and then any other factors?
Yeah. So it was really driven by both sides of the business focusing and executing around our Enovis Growth Excellence business system to really think about how do we continue to get up the curve on overall company margins. And each of that is kind of individualized based on the dynamics at play within the business. So let me start with P&R. P&R, over the last couple of years, we took on a lot of inflation in that supply chain with kind of materials and freight and distribution challenges of kind of procuring materials one part of the world and bringing it in to other parts of the world.
So we had to be very focused on the P&R side around price versus cost and how do we really kind of maximize our opportunity to offset some of that inflation and then even capitalize on some of the deflation as market rates came back to more normalized level, for example, in some of the freight distribution that we were doing. So we were very focused on the P&R side being a little bit more aggressive with some pricing actions in certain parts of the business, being very disciplined in terms of our manufacturing and supply chain, not only driving productivity but kind of capitalizing on commodity pricing and deflation and things like that to really help us make a step in the right direction on P&R gross margins.
And then on the Recon side, it's been around mixing the business in the right way and then scaling the acquisitions in the right way, kind of mixing the right way. Some of the acquisitions come in with higher gross margins than kind of the Recon fleet average when you think about foot and ankle in some of the other businesses. So really kind of that mix is helping. And then we've also been insourcing some of our products. Now that we have a stronger supply chain from some of the acquisitions that we've done, we can make more products in-house and kind of get some returns from that as well. So really kind of both sides of the business helping drive a nice step up in gross margins. And then 2024 will bring in Lima.
Lima is going to help mix us to higher gross margins to where, as a company, we're going to be closer to 60% now that we've got kind of Lima coming into the mold as well.
Okay. And then similarly, looking down the P&L, your operating and adjusted EBITDA margins were up, but they were up less. They were up by, I think, 70 basis points. So you kind of lost the 100 basis points of the gross margin improvement. But I'm assuming that's because of some of the M&A and investments and things like that. But can you maybe just talk about 70 basis points is good, but all the gross margin, I guess, didn't flow through to the bottom line, so.
Yeah. So overall, let me kind of break that down for you a little bit. One is we continue to kind of do outsized investment in R&D, particularly on the Recon side, to really increase our portfolio efforts around enabling technology in general. You mentioned M&A. We have brought in quite a few deals that come in dilutive and high SG&A that we've got to work through integrating, taking cost out, and scaling, which causes a little bit of challenge there in terms of some of the impacts on our cost structure as we do some of those smaller bolt-on acquisitions.
And then the mix of Recon gets us higher gross margin, but all that doesn't flow through to the bottom line because it also comes with higher channel costs as well because it's more of a commission-based sales model that comes a little bit higher SG&A, both with an R&D side and from a SG&A standpoint. So all of that to kind of say we still feel like we've committed to deliver at least 50 basis points or more of core organic margin expansion year-over-year.
We've been able to do that in the face of some pressures with FX exposures and M&A dilution that's brought into the system. And we've got a nice long runway in front of us of margin expansion as well, kind of leveraging our business system across both businesses, scaling our acquisitions, and then really driving productivity and operating leverage as we grow.
Okay. All right. And then just looking at the guidance for 2024, you're seeing much, much stronger EBITDA growth than EPS growth. And I would guess that that's mainly because of the acquisition you did, which is really creative, but then you do have some interest expense because of the debt to finance the deal. So that's hitting your EPS, but that gets backed out for EBITDA. I mean, is that the main difference between those two?
Yeah. Yeah. I mean, there's higher interest expense from the addition of debt that we use to finance Lima. And then there's 100-200 basis points of kind of tax headwinds that are coming from just meaning different geographical mix and Pillar Two headwinds.
Okay. Yeah. That's right. All right. Got it. All right. I think we're almost out of time, so we can wrap up there. But thank you for your time, Ben. I hope you had some good meetings at our conference.
Absolutely. Thanks for having us, Mike. It was a pleasure. And have a good rest of your day.
Okay. Thanks. Bye.