This week’s bond review looks to the healthcare sector. DJO Global is a designer and manufacturer of products designed to help patients move – hip and knee replacement / implants, braces for rehabilitation, products to assist in pain management and physical therapy products, just to name a few. Since the beginning of 2017, the company has been undergoing a transformation, focusing on reducing costs and increasing efficiencies across all areas of its operations. Over a year into this process, the company’s results for its first quarter 2018 look promising.
- Operating income increased by 501.9% to 33.5 million from $6.7 million in the prior year period.
- Adjusted EBITDA increased by 13.2% year-over-year, to $64.8 million.
- Business transformation objectives are on track to deliver 7% to 10% annual cost reductions by the end of 2018.
- DJO’s International segment’s revenues grew 13.3% in the first quarter.
- Revenues for the Surgical Implant segment grew 8.1%.
DJO management expects to build revenue momentum as the year progresses, with several new product launches planned in the upcoming quarters. With healthcare being an essential service, companies associated with the healthcare industry tend to be less reactive to overall economic cycles. For this reason, diversification into the healthcare industry makes sense. DJO Global’s 2020 bonds offer diversification into the essential healthcare industry and make an ideal addition to Durig Capital’s Fixed Income 2 (FX2) Managed Income Portfolio, the most recent performance of which is shown below.
Business Transformation Under New Management
In November 2016, DJO Global hired Mike Eklund as the new Chief Financial Officer and Chief Operating Officer. Mr. Eklund came from Dell, where he very effectively identified $3 billion of productivity improvements and executed on cost savings totaling over $300 million. In 2017 and up through the first quarter of 2018, DJO has made significant progress on its Business Transformation goals, namely to streamline and reduce costs. From its latest quarterly results (three months ending March 31, 2018), the company reported that it is on track to deliver 7% to 10% annual cost reductions by the end of 2018. Additionally, transformation actions taken to date (since the start of 2017) are expected to contribute $21.8 million in savings over the next four quarters.
About the Issuer
DJO Global is a leading global provider of medical technologies designed to get and keep people moving. The company’s products address the continuum of patient care from injury prevention to rehabilitation after surgery, injury or from degenerative disease, enabling people to regain or maintain their natural motion. Its products are used by orthopedic specialists, spine surgeons, primary care physicians, pain management specialists, physical therapists, podiatrists, chiropractors, athletic trainers and other healthcare professionals. In addition, many of the company’s medical devices and related accessories are used by athletes and patients for injury prevention and at-home physical therapy treatment. The company’s product lines include rigid and soft orthopedic bracing, hot and cold therapy, bone growth stimulators, vascular therapy systems and compression garments, therapeutic shoes and inserts, electrical stimulators used for pain management and physical therapy products. The company’s surgical division offers a comprehensive suite of reconstructive joint products for the hip, knee and shoulder.
For its most recent fiscal year ending December 31, 2017, DJO Global’s revenues were broken down as follows:
As shown above, DJO Global’s largest revenue generator is its Bracing and Vascular business segment. Over the next 4 or 5 years, the market for orthopedic braces is projected to expand globally. A recent study by Fact MR projects that the global orthopedic braces market will grow at a CAGR of 5.1% between 2017 and 2022, to reach USD $3.0 billion by the end of 2022. The main drivers for growth in this market is the increasing demand for orthopedic braces among the geriatric population, rising occurrences of bone-degenerative disease, increasing levels of obesity, rising participation in sports, consumer access to braces through e-commerce websites and increased adoption of orthopedic braces for preventative care. North America is the largest market for braces, followed by Europe.
Surgical Implant Segment’s Growing Sales Share
DJO’s Surgical Implant business segment has grown significantly as a percentage of total revenues. In 2012, Surgical Implant made up 6.5% of total net sales. As shown in the above chart, that share has now nearly tripled to 17%, with the Surgical Implant division often showing the highest year-over-year increases. In its most recent quarter (Q1 2018), DJO’s Surgical Implant segment grew 8.1% over Q1 2017, reflecting more than 20% growth in the company’s shoulder implant product line. In DJO’s most recent earnings call, Brady Shirley, DJO’s President and CEO, revealed that the company will launch seven new products within its surgical implant segment in 2018 and that management expects double digit growth in sales of its hip and knee surgical products in 2018.
Interest Coverage and Liquidity
DJO Global had operating income in its latest quarter of $ 61.1 million (this is without the effect of depreciation /amortization). In Q1, the company had $43.9 million of interest expense. Interest coverage for the most recent quarter was 1.4x. Although this ratio is on the lower end, DJO Global has good growth prospects and a good chance to improve their financials moving forward. Historically, Q1 is the slowest quarter of the year for the company. With that said, investors should look for increasing revenues as the year progresses.
As of March 31, 2018, DJO Global had cash on hand of $34.6 million and $68.8 million available from the company’s revolving credit facility, for a total liquidity of $103.4 million.
The default risk for bondholders is whether DJO can fulfill its Business Transformation goals of cost reductions, continue to grow revenues through new product launches and improve efficiencies in customer service and operational excellence. For the last few quarters, the company has stated that it is tracking toward producing 7% to 10% in annual cost reduction by the end of 2018. The year over year increases in Q1 of adjusted EBITDA and operating income are both positive signs. The seven new product launches just in the Surgical segment for 2018, should continue to drive interest and sales in DJO’s products. The company continues to streamline processes in its ordering and distribution systems to better serve its customers. Lastly, with the large, aging population in the United States as well as increasing obesity rates, demand for the products produced by DJO Global will continue to increase. Therefore, the over 11.5% yield-to-maturity on DJO’s 2020 bonds appears to outweigh the risks identified.
Summary and Conclusion
DJO is in the midst of a Business Transformation. Results from first quarter 2018 look promising, with a massive increase in operating income, along with double digit increases in adjusted EBITDA and international sales. The company states it is on track to deliver annual cost reductions of 7% to 10% by the end of this year. And the surgical implant division has nearly tripled as a percentage of total net sales over the past few years and should continue to show healthy gains as the number of hip, shoulder, and knee replacements increase in the American population. With the country’s aging population as well as increases in the rates of obesity, the market for DJO’s products is growing. These short 22-month bonds have a healthy yield-to-maturity of more than 11.5% and includes diversification into the thriving healthcare products industry. As such, these 2020 bonds, couponed at 10.75% are an ideal addition to Durig Capital’s FX2 Managed Income Portfolio.
Issuer: DJO Finance LLC
Ratings: Caa3 / CCC
Yield to Maturity: ~11.67%
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Disclosure: Durig Capital and certain clients may hold positions in DJO’s April 2020 bonds.
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