Enovis Corp

NYSE:ENOV

Earnings Call Transcript 2020-Q1

[Operator]

Ladies and gentlemen, thank you for standing by, and welcome to the Colfax First Quarter 2020 Earnings Call. [Operator Instructions]

Please be advised today's call is being recorded. [Operator Instructions]

I would now like to hand the conference over to your speaker, Mike Macek. Please go ahead.

[Michael Macek, executive]

Thank you, and good morning, everyone. Thank you for joining us. I am 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 on the Investors section of 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 our SEC filings. Actual results might differ materially from any forward-looking statements that we make today. The forward-looking statements speak only as of today, and we do not assume any obligation or intend to update them except as required by law. With respect to any non-GAAP financial measures made during the call today, the accompanying reconciliation information related to those measures can be found in our earnings press release and today's slide presentation.

Now I'd like to turn it over to Matt, who will start on Slide 3.

[Matthew Trerotola, executive]

Thanks, Mike, and good morning, everyone. Thank you, everyone, for joining us today, and I hope you and your families are safe and healthy.

We're all experiencing unprecedented challenges related to the COVID-19 global pandemic. And although there is uncertainty over the timing of the recovery, we remain confident in our strategy for compounding value creation. We have 2 strong global business platforms, a proven business system for driving continuous improvement and a team of talented and resilient associates. As the pandemic abates, we intend to resume the strong momentum that we've built throughout last year and continued through March.

In the first quarter, we earned $0.38 per share, $0.01 higher than the prior year but lower than expected, due to COVID impacts on our revenues in March. We also delivered $27 million of free cash flow in the quarter, a good start to 2020. Because of the uncertainty of customer demand related to the pandemic, we are suspending our previously provided financial outlook for the year.

Safety is our top priority, and we took quick action to protect our associates around the world. Many of our associates are working from home and adapting with the help of technology and increased communications and engagement. I think I've been on more video calls in the last month that in my entire life combined.

We've been working very hard at our manufacturing and distribution sites to protect our associates through social distancing, quarantine protocols and protective equipment. We're incredibly proud of these teams and our field service teams for the work that they continue to do to support our customers and patients with essential products during this crisis.

We also quickly and thoughtfully flexed down our costs to protect our financial strength and partly mitigate the COVID effects on revenue. We expect that Q2 will be the demand trough, and we will continue to align costs and revenue as demand recovers. We have significant liquidity to continue to invest for growth, and we expect to come out of the other side of this crisis stronger than ever.

Slide 4 shows that we came into 2020 with the same momentum that we created last year. Our FabTech business drove margin expansion again, and most markets around the world were growing or seemed headed towards second half growth. MedTech revenue momentum continued with daily sales growth through February of about 8% and a clear path to mid-single digits or better for Q1.

Reconstructive product line sales continued to take share with strong double-digit growth, and Prevention and Rehabilitation sales reached about market growth levels. Overall, we were on track to deliver share gain, margin improvement and solid cash flow conversion. We expect to return to these performance levels after we've worked through the crisis.

Slide 5 provides an overview of the long-term drivers of our businesses and current market dynamics. Our orthopedic products provide relief from pain, improve injury recovery and support increased mobility and activity levels. As a result, our MedTech business is well positioned to benefit from overall population growth, aging of the population with related diseases, health and wellness trends and increasing access to health care.

We continue to see the global market growing at 3% to 4% per year over time and believe our business will grow more quickly due to innovation, commercial process and operating execution. There is nothing that suggests that the current crisis will permanently change the market growth drivers; in fact, some continue to advance in the background.

The largest driver of the business is surgeries to address pain or treat an injury. Most of our Reconstructive products are used directly in surgeries, primarily in the U.S., and our Prevention and Rehabilitation products are partly used for pre- and postsurgical treatment, which connects a portion of their demand to elective surgery as well. These products are also driven by nonsurgical pain and injuries from diseases like osteoarthritis and diabetes and from sports and recreation, athletic training and repetitive motion injuries. The Prevention and Rehabilitation products serve a diverse set of global applications and are typically delivered through clinics.

The most significant impact of the crisis on our MedTech business is the shutdown of elective surgery to allow the hospitals to temporarily focus their resources on COVID-19 and other life-threatening illnesses. We've also been impacted by the stay-at-home and social distancing policies that have shut down organized sports, limited recreational activity and reduced workplace hours.

Restrictions have also limited the operation of clinics where patients access our solutions. All of this has pressured the industry, including our MedTech business. I'll talk later about the factors that will lead to recovery.

Our FabTech business supplies welding and cutting equipment and consumables to a wide range of applications around the world. Over time, the industry tends to grow with global industrial production and infrastructure investment. We have the largest exposure among our peers to faster-growing emerging markets, positioning us to benefit from infrastructure buildouts around the globe.

Government-driven restrictions have also affected this business. In some cases, such as China in mid-February and India in April, governments have chosen to completely close their economies and shutter all business establishments. In most other countries, there are selective constraints on industry and demand reduction from lack of economic activity. Our business is affected, like other short-cycle industrial businesses, with a sharp decline in sales in many segments and an increase in products serving medical applications.

Slide 6 shows the short-term impact in April on our company. We believe this will likely be the month with the largest impact, with policy-driven efforts at their peak and amplified by customers defensively cutting spending. In our MedTech business, organic daily sales were down almost 60% in April. Reconstructive sales dropped further due to a roughly 90% reduction in elective procedures in served markets. Prevention and Rehabilitation declined at a lesser rate, impacted by fewer surgeries, fewer injuries on sports fields and workplaces and overall lower recreational activity levels. This segment has more diversified end uses and is more global, so the demand decline is a bit dampened and recovery will be impacted by a broader range of factors.

The return to growth starts with elective surgery. Hospitals and surgeons have a powerful financial incentive to get this going again as soon as they can safely do so, and many patients are in pain awaiting surgery. These are called elective surgeries, but for many of the patients that are waiting for an implant, it is only elective for a period of time that they could stand the pain. Many surgeons are making plans for backlog catch-up by working longer hours or weekends. However, this will be paced by state-by-state and country-specific policy as well as the practical challenges of safely performing the surgeries.

The other key growth regulators in MedTech will be the pace that clinics reopen, that people get back to work, that recreational activities resume and that organized sports return. We're already seeing some improvement from April trough levels. U.S. states are beginning to resume elective surgery. And economic, social, workplace and sports restrictions are slowly being lifted around the world. We have active discussions with reconstructive -- recon and sports medicine surgeons about their patient backlog, scheduling plans and needs. Our MedTech daily sales levels have improved over the past couple of weeks, and we will continue to watch for other positive signs and stay ready to meet increasing demand from customers.

FabTech April daily sales were down about 30% organically versus the prior year. The drop was a bit higher in the U.S. and Europe, and we had healthy growth in Asia and our GCE gas control business. We expect some modest improvements as we progress through the quarter and more countries get back to work.

In addition to the benefit from reopened facilities, we expect the easing of certain restrictions will improve sales levels in this business as we move through the quarter, but the pace is uncertain. As we make progress in certain regions and economic sectors, there is a risk that others could be restricted. But overall, we expect each month in Q2 to improve, and we expect the Q3 decline to be less than in Q2. The rate of improvement in Q3 and Q4 will depend on the success of stimuli and overcoming the residual economic drag from Q2.

We have a very positive example in China included in the appendix. Our ESAB China business had strong growth in April and is now up year-to-date. We expect some countries will have similar bounce back. However, some countries may take longer to recover or even take steps backwards if the risk increases again.

MedTech Q1 results are included on Slide 7. We were on a strong growth trajectory until mid-March, and pro forma sales of $291 million ultimately landed at about the same level as last year with the benefit of a few extra selling days that will reverse in the fourth quarter. We believe the business lost $25 million or more of revenue in March due to COVID.

Lower revenues and the follow-on effect on operating efficiency contributed to reduced EBITA and margins in the quarter. The cost actions that were developed in March are now fully deployed, and business leaders have thoughtfully reprioritized spending to protect growth investments, including key product launches later this year.

In response to the virus, DJO has accelerated release of some technologies and products to allow practitioners to work remotely with patients and accelerate the movement of surgeries into the ambulatory service center environment. We have had some great feedback about how surgeons will use our OaraScore software to help manage the risk of higher levels of outpatient procedures.

Turning to Slide 8. Our Fabrication Technology business again outperformed our primary competitors with better top line performance. The organic sales decline of 2.2% includes the few extra days that will reverse in Q4. Volume levels were impacted by the drop in demand that started in the second half of March, mostly in Europe, North America and countries affected by shutdowns. Lower organic sales translated into slightly lower profit with margins expanding 70 basis points year-over-year due to effective price/cost management and continuous productivity improvements. Restructuring projects initiated late last year remain on track with expected in-year benefits of at least $20 million.

Looking ahead to Slide 9, we summarize our priorities. First and foremost, we're focused on the health and safety of our associates. This includes thousands of associates around the world working in our manufacturing sites, hundreds of service associates and the remainder of our team who are mostly working from home.

Second, we're focused on continuity of supply for our customers and patients at this time when they need essential products from us. Third, we're taking proactive action to keep our company financially strong and healthy. And finally, we're protecting key investments and making plans to go on offense as markets recover.

In tough times, you learn a lot about the capabilities of your associates. I'm extremely proud of our leaders around the world for the way that they're stepping up to these priorities. We've worked very hard on talent development as a corporate strategic priority, and in times like these it really pays off.

Slide 10 provides some additional benefits about our associate safety and supply chain efforts. We've always put the safety of our associates first, and this situation is no different. We learned from the experience of bringing our Chinese facilities back up in February and have put in place extensive measures to minimize the risk of illness across our manufacturing and logistics network. These include the recommendations of CDC and other health organizations and governments as well as additional ideas from extensive benchmarking.

We have not been untouched by this virus, but we've managed to limit the impact to a small number of employees around the world. Early in Q1, we worked hard to adapt our supply chain as Chinese suppliers were closed down. The strength of our local manufacturing positions and agility of our team helped us to avoid customer disruptions. More recently, we're using our CBS toolkit to flex costs and inventory while retaining agility to respond as demand returns. At this point, about 90% of our sites are operational at some level, and we expect all to be operating later in the quarter.

Our company is also helping to fight the coronavirus by supplying needed products and solutions, as shown on Slide 11. DJO's connected medicine platform, MotionMD, now includes telehealth. This offering allows practitioners to compliantly and securely deliver DJO product to patients through a contactless process.

Recent evidence suggests that 1/3 of COVID patients suffer from blood clots, and DJO's Venaflow compression devices can be effective in mitigating this risk. The GCE business in ESAB is manufacturing portable oxygen concentrators and critical control valves for oxygen delivery applications. And in addition to our standard products, we're converting some of our supply chain capacity to supply masks and hand sanitizer in limited quantities. We're using the first supply of these for our own teams and also supporting our channel and customers.

We're very proud of the initiative that our team has taken to do their part wherever possible. A guiding principle for us is to maintain our financial strength and avoid operationally increasing our debt. Many of us have been through several downturns and know the importance of swift, decisive actions that create time and space for fine-tuning of investments and structural changes to prepare for a strong and profitable recovery, whatever the shape.

Slide 12 summarizes how we've significantly flexed our costs in Q2 to maintain our financial strength. Our existing restructuring plans remain on track for execution this year, driving over $20 million of cost savings to ESAB plus operating improvements at DJO to support further revenue growth. In addition, we've implemented wide-ranging temporary measures to reduce our planned second quarter P&L cost by $80 million to $90 million. About $20 million of this is variable selling cost, an advantage of our MedTech selling model.

To reduce our employment costs, our Board and executive team agreed to temporary pay reductions, and nearly every associate has been furloughed or taking a temporary pay reduction. Investments have been prioritized, and discretionary spending has also been restricted. Overall, we expect to keep decremental margins in Q2 in the 25% to 30% range.

To further help with cash flow, we reprioritized our capital spending to push some of it into 2021 while accelerating targeted growth and health-related investments that will keep us well positioned to regain our momentum as the pandemic passes.

Earlier, I mentioned how we're using CBS to help us dynamically manage our supply chain to keep inventory at levels that support current demand but also ready to support business recovery. We're also using CBS to better manage customer collections and more tightly drive cash flow. All together, we believe our actions will reduce more than $100 million of cash outlays in Q2.

We believe the current mix of restructuring and temporary actions address the Q2 business environment. If sales levels sequentially improve throughout Q2 and into Q3, we'll dial back some of the temporary actions. If conditions remain closer to trough levels in either business, we can decide on the right mix of temporary versus new restructuring programs. In every case, we will protect our cash flow and ability to invest for growth and outperform customers.

Before I hand it over to Chris, I'll wrap up on Slide 13. As I mentioned, most of us have been through tough challenges like this in the past. We know how to execute the defensive playbook: protect the investments, manage costs, reduce risks and be ready when markets improve. In this crisis, there is also the additional challenge of protecting employees from the health risks.

I've been spending a lot of time recently talking with our teams about dynamic offense. We're doing everything we can in Q2 to build goodwill with customers and prepare for strong share gain during the recovery. We're reshaping our CBS growth plans for where the growth will be. We're prioritizing new product efforts to cater to what customers will need and value the most later this year, and we're fast-tracking some solutions that have a window of opportunity to cross the chasm of adoption.

The telehealth solution I mentioned earlier is a great example. We had that on the road map, and the team pulled it forward to quickly get an offering in the market at the critical time of customer need. We already have over 150 customer adoptions.

We've maintained our investments for growth, including targeted inventory to quickly respond as markets recover. We're also preparing to align sales incentives with recovery scenarios to maintain high levels of motivation and engagement. With travel restricted, our teams are finding creative virtual ways to stay close to our customers and end users, adding value however we can today and planting seeds of opportunity for the future.

We've also repurposed about half of our annual strategic process to focus on the initiatives that will help us to gain competitive advantage in a post-COVID market environment. With a healthy workforce, supply chain, innovation engine and balance sheet, we will be positioned to regain our momentum as the COVID pandemic passes.

Now I'll turn it over to Chris, starting on Slide 14.

[Christopher Hix, executive]

Thanks, Matt. As Matt mentioned earlier, we have a strong balance sheet with significant liquidity. At the end of the quarter we had $366 million of cash and over $900 million of borrowing capacity, for total liquidity of nearly $1.3 billion. A large amount of the cash balance resulted from a proactive draw during the early stages of COVID in March.

With the financial systems now firmly supported by central banks, we intend to flow those funds back against our revolver and finish the second quarter with $75 million or less in cash. With the actions taken to control costs and cash flow, we expect free cash flow in Q2 to be neutral or better and total liquidity to remain at current levels.

In response to COVID, we recently amended our credit agreement to allow for temporarily elevated leverage levels. We agreed with the banks on very conservative limits, but we don't expect to use them. This change gives us the flexibility to continue to execute our strategy despite the pandemic.

Slide 15 is an overview of our first quarter consolidated performance. The amounts on the page are as reported. Consolidated sales and profit were higher than the prior year due to including an entire quarter of DJO performance this year versus only March in last year's first quarter. As a reminder, March is a 5-week month and is the most profitable month of the first quarter for DJO. Colfax was tracking to deliver higher sales and profit before the effects of COVID changed the picture. On a pro forma basis, core sales declined about 1% more after adjusting for the 4% to 5% benefit from extra selling days.

Pro forma gross margins increased 90 basis points due to ESAB's price/cost management and continued productivity improvements. The sharp drop in sales late in the quarter created negative operating leverage and lower pro forma EBITA margins. As Matt mentioned earlier, we expect to control decremental margins in Q2 to 25% to 30% due to the significant cost actions taken.

Current exchange rates would create an approximate 4% year-over-year headwind on sales and EBITA in the second quarter. We expect interest costs to remain in the $25 million to $30 million range in Q2. Because of the uncertainty surrounding COVID, we expect the tax rate to be volatile during periods of lower profitability, possibly spiking into the high 20%s or above.

This quarter, we recognized the full dilution from the mandatory converts or TEUs. As our share price sustainably recovers above $25, you will see these incremental 3.7 million shares drop away. Overall, we believe we are likely to achieve positive adjusted earnings per share during trough revenue periods.

Q1 free cash flow of $27 million was in line with expectations and consistent with our full year plans for $250 million or more. As Matt outlined, we took significant actions that will reduce second quarter cash flow outlays by at least $100 million. Now despite these actions, we believe COVID impacts on revenue and profit will considerably reduce our cash flow this year. Due to material uncertainties caused by the pandemic, we are withdrawing all guidance for 2020, including cash flow.

Slide 16 summarizes the views expressed throughout this call on the possible shape of the recovery in each of our businesses. We believe April will be the most difficult month with some easing starting in May and June. Most MedTech scenarios reflect a Q3 ramp to recovery as health care access is expanded and the backlog of cases begins to be addressed. The industry has a powerful incentive to service patients, attack its building backlog of deferred procedures and resume its revenue streams, and we believe demand drivers support a return to a more normal environment for certain product lines this year and the overall business in 2021.

The industrial scenarios have a wide band. Improvements in Q3 and Q4 seem likely, but pacing depends on a number of policy and economic factors. We expect fewer shutdowns, positive government stimuli and easing restrictions to reduce some of the current drag, which should move us out of trough levels. But we cannot predict when demand lulls will return to healthy levels, and we'll remain ready to manage through any scenario.

Wrapping up on Slide 17. We demonstrated our resilience, the strength of our teams and the power of our business system by responding quickly to the pandemic. We are protecting the health of our associates and the company's financial strength while continuing to supply essential products to customers. We are already anticipating the eventual recoveries in our markets, and we'll be ready to play offense and resume our momentum of growth, margin expansion and healthy cash flow.

That concludes our prepared remarks. Sydney, let's open up the call for questions.

[Operator]

[Operator Instructions] And our first question comes from Jeff Hammond with KeyBanc Capital Markets.

[Christopher Hix, executive]

Jeff, we can't hear you.

[Operator]

And our next question comes from the line of Nathan Jones with Stifel.

Our next question comes from Joe Giordano.

[Technical Difficulty]

[Christopher Hix, executive]

Okay. We may have a technical problem here that we're investigating.

Well, let's call an audible here. Why don't we have questions e-mailed to me, and we'll try to address them as best we can.

[Operator]

Joe Giordano's line is open now.

[Joseph Giordano, analyst]

Can you hear me, guys?

[Matthew Trerotola, executive]

Joe? Yes, we can.

[Joseph Giordano, analyst]

So -- okay. Let me start here then. Has this situation with DJO being like shut down effectively, has it like allowed you to have different conversations with opinion leaders in the space? And kind of related to that, can you just touch on your ability to kind of keep critical sales force in place during this?

[Matthew Trerotola, executive]

Yes. Yes, absolutely. Thanks for the question. Yes, so of course, certainly, DJO has not shut down completely. We've got all of our facilities running and some key parts of the business running at pretty reasonable levels. But it is a fact that elective surgery -- I think there's a lot of public data out there that orthopedic elective surgery is down about 90% from the expected levels, or was at least going back a couple of weeks.

And you're absolutely right. So on the one hand, that creates a lull in procedures and the demand that comes with them, but it has created a unique opportunity for dialogue with surgeons who are usually extremely busy. And our teams have been taking full advantage of that, ranging from working with those surgeons to get input about future products, working with those surgeons and their staffs to educate them about products that we've got coming through the pipeline this year, collaborating with them on how we're going to help them to ramp more in the ASC environment as they try to do more of that on the other side of the pandemic.

So it hasn't been -- and not just in DJO, but in both of our businesses, we're finding that there's a unique opportunity in time now where users who are usually extremely busy are highly available. And our sales teams and our technical teams and our leaders are taking full advantage of that in this period. And as you said, I think it's very insightful, for the sales team, this is great for them because they're used to being out in the field, and many of them are not able to get out in the field right now. And instead of just kind of sitting around, they are very, very actively connecting with customers, connecting with end users, making [indiscernible] right now. But I will say -- we're getting some background noise in here. Okay. I will say that the surgeons are very eager to talk about how we're going to support them because they're getting back to work now and they're planning on ramping as fast as they possibly can.

[Operator]

And our next question comes from the line of Joe Ritchie.

[Joseph Ritchie, analyst]

Can you guys hear me okay?

[Michael Macek, executive]

Yes. We got you, Joe.

[Joseph Ritchie, analyst]

All right. Okay. Great. Well, thanks for -- appreciate all the details today. Just maybe starting off, I'd be curious, is there a way to maybe size or frame kind of like the backlog of potential patients that are waiting for reconstructive surgeries? And then just thinking about this a little bit longer term, is this going to -- do you think that the whole pandemic is going to accelerate the shift to outpatient surgeries? I know you guys are well positioned there. So any thoughts around those 2 would be helpful.

[Matthew Trerotola, executive]

Yes. So first, to comment on the backlog. There's been a number of surveys done that have tried to look at this. And I think, certainly, one I looked at -- recently that's credible and consistent with some of the discussions that we've been having is that in these -- 2/3 of the backlog is going to be worked off reasonably quickly. And then -- and there might be, say, 1/3 of it that will be delayed a little bit further out.

And so what that means is that there are the patients that were already scheduled to be done in the coming months, plus maybe 2/3 of the backlog that was deferred in late March and April. And so certainly what that creates for the surgeons and the hospitals is a challenge to say how can we run above normal rates to get caught up, and that's what they're trying to do. Now the practicality of that is something that we're trying to be ready for, but at the same time not count on because they're going to have to kind of work their way through all the details of how they do that safely, how they do that logistically. And we're trying to make sure we're ready to support that from a supply standpoint and a service standpoint, but we're also cognizant that it may take a number of months for that ramp to get back up to normal or high rates.

As far as the ASC, yes, there's -- I mean there's no question that part of how they can get caught up is by trying to do more things in the ambulatory surgery environment, and that's the game plan for some of the hospitals, some of the people that we work with. But there's still the majority of surgeries that are done in a hospital environment. And in those environments, they're looking more at how they can partition off the elective stuff as quickly as possible, get comfortable that they've got ample supply of all that they need to do those things safely and then make sure that they know how they're going to protect everybody in the operating theater and go. And we've had lots -- we've had kind of a meaningful uptick in our surgical business in the last couple of weeks as we've started to see a lot of doctors get back to work.

[Joseph Ritchie, analyst]

Okay. No, that's helpful. And if I can maybe just have maybe one follow-on question. As you're thinking about the rest of the year, you mentioned 25% to 30% decrementals in Q2. Is the expectation that you're going to try to hold to kind of like a 25% to 30% decremental if things get a little bit more prolonged? And then I guess also, just from a cash flow standpoint, you guys mentioned being at least cash flow neutral by Q2. Is that -- is it an expectation that you're going to try to remain at least cash flow positive throughout the year?

[Christopher Hix, executive]

Yes. On the decremental margins, we think we found the sweet spot for Q2 by flexing the costs, as Matt had indicated in his commentary there. We've got the flexibility there to continue to manage the temporary cost reductions and really try to pace those with the revenue recovery that we think will be coming here in the May, June and then the Q3 time frame. So whether or not we hit exactly the 25% to 30%, we think we're going to manage those costs in line with that revenue pacing.

The other comment I want to make is that we're making sure at the same time that we preserve the investments that are going to make sure that we maintain the momentum that we had and the market share gains as we come out of this. So it's important that we both preserve the right growth investments and also the financial health of the company, which leads to the question on cash flow. We do believe that we've got the capability as a company to manage the cash flow and support both the growth investments that need to be made on the capital side and on the R&D side to keep the innovation engines running while, at the same time, toggling the spending and the working capital to remain cash flow positive. Now if we decide that we've got to lean a little bit harder into some of the growth initiatives or some of the safety spending that we need to do to address the pandemic, we think that's a healthy trade that we would need to evaluate as we go through the rest of the year.

[Operator]

And our next question comes from the line of Nathan Jones.

[Nathan Jones, analyst]

Maybe -- I don't know, Matt, whether or not you have enough information to potentially comment on what you're expecting in the MedTech business in May. It's obviously down a lot in April. I don't think anybody is surprised to see that, but you did say that you've seen a pickup in that business in the last couple of weeks. Is there any kind of help you can give us with the trajectory of that business as you head into May?

[Matthew Trerotola, executive]

Yes. I mean I think what I would say is that it appears highly likely that the surgical part of that business will be a good step higher in May than it was in April. Now April was very low for that part of the business. But it seems highly likely. We're already seeing the weekly trend. We can see the scheduled surgeries. We've got the forecast from the doctors. And so we expect a step up in the surgical business in May from April.

That will be pretty meaningful, but it's hard to call the rest of the business at this point. There is some parts that will have a little bit of delayed effect from the surgery. It may take a couple more months to bounce back up. And there's some other parts, as I commented, that are a little more related to all the different activities that have been shut down, whether it's sports or recreation or the activities that cause trauma and things like that. And the pace at which those come back is something that we're going to watch unfold in the coming months.

[Nathan Jones, analyst]

Okay. A little bit of a longer-term question on the MedTech business. It would seem to me that you should get most of the implant stuff back at some point. It's not like that permanently shifts to the right. There should be a catch-up there. And there's also going to be on the prevention and rehab side, related to elective surgery, a catch-up that you should get there.

Now you clearly won't get all of it back because I haven't been able to go skiing and blow out my knee for the last couple of months, but there should be a good chunk of that, that the business does catch up and that is just deferred into the future. Do you think this stuff that is deferred into the future rather than is lost is caught up by the end of this year, the end of next year? What's your expectation around that?

[Matthew Trerotola, executive]

Yes. So first, I think your comments are exactly right, that a large portion of the demand in the MedTech business is being deferred versus going away, right? The diseases that are leading people to have the pain that makes them need to have the elective surgery or need the different rehabilitation and treatment, those diseases have not stopped, they are continuing. And so arguably, the demand continues to build. And even a lot of the activities that cause injuries, there's a lot of people exercising at home and things like that, so those haven't stopped either.

And so a good portion of the demand has just been pushed to the right with an opportunity to catch up. And then as you said, there is a portion that has just gone away from these particular months because the injuries aren't happening or things like that.

Now how much of that -- and so that's really good news in terms of, hey, eventually, you come back to probably the same place or better and then work from there. And it's just a question of how far out is that.

The second thing is, okay, how much catch up do you get as you're working through that. And as I said before, there's a powerful motivator for the implant surgeon, the recon surgeons to catch up as much of it as possible as fast as possible because it's a huge economic impact on the hospitals and the surgeons from what's been going on for the last month or so.

And so I think it's fair to say that there's going to be a lot of catch-up here in Q3 and Q4 in terms of the things that weren't done in Q2. And it's just a question of how does that balance up against the rate at which all the activities come back in the economy and at what point does the regular demand plus catch-up exceed whatever drag there is from activities that are still shut down and then at what point do you kind of clear all that and get back to a normal place. Most views of the industry are showing a pretty quick recovery through the quarters of this year and a pretty healthy place in Q4. And we're certainly prepared for that, but we're trying to also be cautious that we're ready for other scenarios as well.

[Operator]

And our next question comes from the line of Julian Mitchell.

[Julian Mitchell, analyst]

Maybe just the first question around the balance sheet. I don't think it's come up yet in the Q&A. Maybe just clarify what was the leverage level at the end of the quarter and also, I guess, how you see the leverage playing out over the balance of the year and what the updated thoughts are on the pace of delevering?

[Christopher Hix, executive]

So we ended the quarter with net leverage of less than 3.8x and -- I think somewhere between 3.7x and 3.8x. So we're very much on the path that we expected to have as we execute the playbook to get the leverage back long term into the 2 to 3x range. As we project forward, it's difficult to say with certainty given the uncertainties around revenue and profit and all that.

We know that it's a priority for the company to not add to its debt levels operationally as we go through this pandemic, through the trough and then through the recovery as we progress throughout this year. So our main objective is keep the debt levels at or below where they're at today, keep the company financially healthy. As EBITDA levels rebuild, we see ourselves getting back to the current debt or leverage levels. And then as we generate cash from that point forward, we'll, of course, continue to drive it down.

[Julian Mitchell, analyst]

That's helpful. And then my second question, just a quick one around the free cash flow. Normally, in Q2, you do have, seasonally, a very good positive free cash flow. Understand that it's maybe flattish or slightly positive in Q2 of this year. I just wanted to clarify that that's including the $100 million of short-term cash tailwinds in the quarter. So is the balance, the headwind on the other side simply the decline in earnings? Just wanted to check that.

And maybe help us understand how you see working capital trending, let's say, in Q2 and how you see it playing out as revenues fall. Should we expect a big working cap cash tailwind? Or are you keeping working capital kind of on hand in preparation for what could be a sharp recovery in MedTech?

[Christopher Hix, executive]

Yes. So the cash flow commentary that we've had was net of the benefit of the $100 million of delayed cash flow outlays in Q2. So we have the revenue and profit pressure that's coming, and then the tool that we have to offset that are -- is taking the cost actions that we've taken, rephasing some of the capital spending and then, to your point, addressing some of the working capital opportunities. We've really, I think, done an excellent job among our teams of deploying CBS even more assertively, firming up some of our processes here to make sure that we can manage inventory, both for the -- to get to the right financial answer but also to be ready to continue to serve customers as this recovery starts to take shape.

So we think there's an opportunity here for inventory levels to flatten and decline a bit. Receivables, our teams have really done an excellent job working closely with customers to make sure that we keep collections coming in. At the same time, we understand that the DSO levels are likely to come up a little bit. Some of our customers deal with their own financial situation. And then on the -- we're working closely with our suppliers to match up our payables processes with the receivables there, just so that as we see some of the DSO increases occurring that we've got a natural offset, at least partial offset, by driving the DPO out. So net-net, you'll see, I think, working capital will be a bit of a tailwind early in the quarter here, especially as we begin to recover. Of course, we'll see that naturally turn into a little bit of a headwind but with the benefit of the improved processes that we've built in the last couple of quarters.

[Operator]

And our next question comes from Nicole DeBlase.

[Nicole DeBlase, analyst]

So with respect to the decremental margins that you guys are targeting, the 25% to 30% in the second quarter, is there any -- is there a material difference between what you would expect to see in DJO relative to FabTech?

[Christopher Hix, executive]

Well, naturally, given the higher-margin profile of DJO versus ESAB, we'd expect to see the decrementals be a little bit higher for DJO versus ESAB.

[Nicole DeBlase, analyst]

Okay. Got it. And then just on the FabTech pricing, saw some deceleration from 2% last quarter to flattish this quarter. Is the expectation now because cost inflation has become much less of a factor this year that you kind of maintain that flattish pricing level throughout the next few quarters?

[Christopher Hix, executive]

Yes, Nicole. There's been a lot of good work done on price versus cost in that business, and we think we're in a sustainable place there. In different regions around the world, there has been some steel escalation in some areas that's being addressed, but in many places, steel is coming down. And we feel like the current price levels are sustainable.

[Operator]

And our next question...

[Matthew Trerotola, executive]

Jeff Hammond, if you're not able to get in, you could send Chris an e-mail. I know you were the first one on the list. And we don't know if you've tried to get in and can't, but you can send Chris an e-mail if you want.

[Operator]

[Operator Instructions] Our next question comes from Josh Pokrzywinski.

[Joshua Pokrzywinski, analyst]

So following up on the incremental margin comment -- or, I guess, decremental margin comment. How should we think about those on the other side? Presumably some of the temporary cost actions come back and eat into some of the leverage. But same incremental coming out as the decremental going in or is there something else to appreciate?

[Christopher Hix, executive]

Well, generally, the incremental/decrementals in these businesses are in the sort of 50s for DJO and the 40s for ESAB. We would expect that these temporary cost measures would come back into the business, but it's not a -- we don't have a deferred spending that will create a bubble that needs to be caught up. It's just those costs will naturally flow back into the business. So I would expect, as the business recovers and we get back into sort of real growth down the road, that the incremental/decrementals are going to be likely to be closer to those sort of mid-50s and low 40s; mid-50s for DJO, low 40s for ESAB.

Now having said that, there are growth investments that we continue to make in these businesses. And so naturally, there's a little bit of a pull down on that. There always has been typically at ESAB 10 points of pull down as we've been supporting the innovation engine. And you could expect in DJO that we'll continue to be making the growth investments, the improvement in the operations that provides a little bit of a natural tug on the sort of mid-50s incremental margins.

[Joshua Pokrzywinski, analyst]

Got it. That's helpful. And then, Chris, I apologize if you said it and I missed it. How should we think about any costs that were associated with the covenant reset? It doesn't really look like there was a lot of movement in the interest rate. Any other line item that gets kind of trued up or costs that get amortized through the life of the facility?

[Christopher Hix, executive]

Yes. There was a minor work fee that we paid to the banks of about 0.25 point, so just a few million dollars to support the amendment there. And to your point, it gets deferred amortized over the life of the agreement through 2024, so just -- so immaterial effect on the P&L.

[Matthew Trerotola, executive]

Yes. I'm going to jump in. We have -- Mike Halloran, who was the first one that got some kind of technical limitation, e-mailed us a question -- or 2 questions, one around ESAB trends by region and one around whether we think there's any destocking effects.

The ESAB sales per region, we talked about a little bit there. You've got a pretty wide range there. Of course, you've got at the positive end China and Asia that were up here in April pretty healthy, which is a little bit of a bounce back from some of the earlier in the quarter drags, and we think that there's a potential for that region to stay in a positive range. You've got the kind of larger North America and European regions in kind of the 35% to 45% down. And then you've got some -- a few places that are down very large amounts because the whole country was shut for most of the month, like India. So it's a range, and we expect that picture to shape slightly to the positive in the next couple of months.

As far as destocking, we don't do large amounts of destocking and stocking in either business. Sure, there might have been a little bit of stocking in North America, say, coming down the stretch in March, but not enough to create some large residual drag.

[Operator]

And our next question comes from Walter Liptak.

[Walter Liptak, analyst]

So I wanted to ask about your -- the reopenings in China and if you think that -- just talk a little bit about the trajectories, I guess, with the ramp rates in MedTech and FabTech getting better and if you think that there's something special about China or if we could see the similar kind of ramp rates as Europe and the U.S. start to reopen.

[Matthew Trerotola, executive]

Yes. I mean that's kind of the million-dollar question here. And I think I'll say what I can about it, but I think that's something that we're going to have to watch unfold. I think we certainly have a data point that says that China has been able to get back to growth pretty quickly on the back side of this, and some other places. Our whole Asia business in ESAB is up pretty healthy in April. So we've got some data points there that would say that there's a potential to get back to growth pretty quickly.

Now it remains to be seen whether those areas are going to sustain growth in the coming months or whether they're going to have any kind of issues. And then as you look at other regions, we really think it's going to be case by case in different countries and even industries within countries in terms of the parts that are able to quickly recover to growth because it's really just been a constriction that was causing the issue in April and in Q2 versus the places that are going to take longer to recover because there's been some real financial and economic impact that it takes more time to restore.

So we're going to be watching that closely, as we said. And we've really taken a scenario-based approach to the FabTech business in terms of being kind of prepared for the better end of the spectrum on recovery, which is a real possibility, but also fully prepared for the lower end of the spectrum on recovery, which is also a possibility. We think the band on MedTech is likely a narrower one, and it's more likely that there will be a swifter recovery there. But in both businesses, we're trying to be ready for multiple scenarios.

[Walter Liptak, analyst]

Okay. Great. The other thing, you mentioned in FabTech that you did a little bit better than your competition. I think that some of your competition in welding was down about 40%, you were down about 30% in April. Do you think that's a regional thing, that you have more international? Or do you think there's something else that's going on that's helping you to outperform the competition?

[Matthew Trerotola, executive]

Yes. So 2 thoughts on that, Walter. So the first is we look hard at the quarter-by-quarter performance of the business, both from quarterly results as well as a lot of other sources. And we feel confident that we again had a good strong quarter in Q1 on a relative basis in terms of relative growth performance, and that's on the back of many strong quarters before that.

As far as the April results, I think, sure, we're probably seeing a little bit of that continuing on, but we also have a globally more balanced business, and we've been working hard to reduce the cyclicality of the business through some of the investments we've made and some of the strategies that we've driven in the business. And I think you probably see that reading through a little bit as well, global mix and product mix, in the month that is showing a more dampened effect in April for us.

[Operator]

And our next question comes from Andrew Obin.

[Andrew Obin, analyst]

Can you hear me?

[Matthew Trerotola, executive]

Yes, we can hear you fine, Andrew.

[Andrew Obin, analyst]

So lots of discussion around the reconstruction part of DJO. I wanted to ask about prevention and rehab. DJO has good insights with the software you have for clinics. Are they also expecting some backlog effects in late second quarter and third quarter?

[Matthew Trerotola, executive]

Yes. So prevention and rehab, as I said, has more balanced demand drivers, but there's definitely a part of -- a meaningful part of that business that is driven off of surgery, some related to implant surgery and a larger amount related to sports medicine surgery. And so there's no question that there have been surgeries that have been deferred that need to be caught up that ultimately impact prevention and rehab.

But that business has a more diverse set of drivers than just surgery and therefore has had less of a short-term impact, a more dampened short-term impact. And while we do expect there to be some recovery from the missed surgeries, we also think there'll be a range of other drivers that will be falling off as well into a little bit more balanced recovery than what should be a sharper recovery for surgical.

[Andrew Obin, analyst]

And a follow-up question for me. How do you guys think about sort of leverage going forward as it relates to your M&A model? Based on your conversation with banks, what's the thinking about the appropriate leverage, structural leverage going -- I'm talking about not you managing the debt right now, which you seem to be doing great, but as you -- as things calm down and you start doing more acquisitions, can you run the company at the current leverage rate, or do you have to take it down? Like what are the banks telling you?

[Christopher Hix, executive]

Yes. Our objective remains as we've stated before, and that is, long term, to get the leverage back where we had it before, which is down in that sort of 2 to 3x zone. And we've got flexibility about how we manage around that. But we felt that going into this year that we had the right sort of profile for cash flow and other actions that we're taking to both deleverage the company and also to support the M&A program, and although the pandemic will push that out a little bit for us, we think that it's still very much in our wheelhouse to get back to the deleveraging path and also support the M&A activity that we have. And right now, our focus is dealing with the pandemic, and that's keeping people safe and serving our customers, staying financially healthy and all that. So we still will continue to have M&A activity at lower levels, given the focus that we've got on the operational side right now. But over time, I expect the EBITDA levels will be restored, and you'll see the M&A investments expand.

[Andrew Obin, analyst]

Yes. I guess my question was more about -- because I think investors would love to pay for more deals like DJO. So I'm actually thinking more about down the line, can you go back to high levels of leverage to do the right structural -- to do the right strategic deal. That's what I was asking actually.

[Christopher Hix, executive]

Yes, I got you. Look, we've got -- I think we have a very supportive bank group. They supported us as we made the portfolio transformation. They've demonstrated their support again recently for the company. So we believe we've got adequate access to leverage to continue to drive the strategy, both strategically and operationally. And there's plenty of opportunities there as we build out the MedTech platform and, of course, continue to make the selective investments on the FabTech side.

[Matthew Trerotola, executive]

Yes. And one thing I'd add there is one of the things we really liked about the DJO acquisition and the entry into the orthopedics and the broader MedTech space was that we saw lots of potential for very attractive bolt-ons and adjacencies that would continue to improve the quality of our portfolio and the organic growth capability and the margin profile, but be able to do it in a more step-by-step way than the size of the DJO deal that we did.

And so in the short term, we're definitely focused on kind of very small stuff because of the other things we've got going on. As we move into next year, we feel like we can look at some of these attractive bolt-ons and adjacencies. And in the coming years, we could see attractive things that we can do that strengthen and expand the platform but are not as -- anywhere near as sizable as the DJO acquisition that we did.

[Operator]

And our next question comes from Chris Dankert.

[Chris Dankert, analyst]

Can you hear me all right?

[Matthew Trerotola, executive]

Yes.

[Christopher Hix, executive]

Yes.

[Chris Dankert, analyst]

Just want to circle back a little bit on the FabTech margin here in the first quarter, nice performance there. Obviously, pricing was a bit more flattish, fuel costs are down, but good portion of that increase in the margin has to be cost. I mean how much of that is short term in nature? And kind of which sort of expense rebound should we expect next year in 1Q for FabTech?

[Matthew Trerotola, executive]

Yes. That business has been working very hard for years now on sustainable improvements in margins from a combination of value-based pricing, productivity, improving the mix, structural moves that enhance the cost structure of both the supply chain and the fixed cost structure of the business. So this has been, as you know, a multiyear journey. And the business has been getting better and better and better, and it really is a sustainable path.

It's not to say that any given quarter, we couldn't have a little bit of pressure here and there, but we don't feel like there's anything about the performance in Q1 that is unusually high for that business. And it's something that -- the business, as we talked about, already had a restructuring program underway for this year and next year to continue to create space for the continued improvement in margins over time.

[Chris Dankert, analyst]

Got it, got it. I guess speaking to that structural portion, operating 32 plants globally. Were there any plans for closures during 2020 before the downturn? Just any comments on those bigger structural initiatives would be great.

[Matthew Trerotola, executive]

Yes. We've been working through a program that has generally included 1 or 2 sites per year, and this year was no different than -- we typically -- sometimes, in tougher times, we've leaned in and maybe been a little more aggressive on sites coming out. And in other times, we backed off a little bit. But this year was continuing on with that program, and now we'll be looking at whether there's any of that that we should pull forward in the back half of the year.

But the program was also very much aimed at streamlining the operating expenses of the business in sustainable ways, so not cutting sales costs out of the business but actually rethinking how the fixed cost structure of that business works, things like further kind of outsourcing and automation of the back-office processes into our shared service centers and things like that. And so the business is working through that multiyear program, and we expect it continue to benefit the supply chain but also to enable the fixed cost structure of that business to scale that as it grows.

[Operator]

And our next question comes from Nathan Jones.

[Nathan Jones, analyst]

I don't know why I'm back in the queue. I already asked my question so you can just pass it on to the next.

[Operator]

Okay. And I'm not showing any further questions at this time. I'd now like to turn the call back to your speakers for any closing remarks.

[Matthew Trerotola, executive]

Okay. Mike?

[Michael Macek, executive]

Listen, thank you all for joining us. Sorry for the technical difficulties here. We appreciate your continued support and interest in the company, and we'll look forward to providing you another update here after the second quarter. Thank you all.

[Operator]

Ladies and gentlemen, this concludes today's conference call. Thank you for your participation. You may all disconnect. Everyone, have a great day.