DENTSPLY SIRONA Inc. (XRAY) Earnings Call Transcript & Summary

Good morning, everybody. My name is Erin Wright. I cover the life sciences tools, diagnostics sector at Credit Suisse, and welcome to our 2020 Healthcare Conference. It's the third day of presentations. We hope all have gone well so far. We have Dentsply Sirona with us this morning, so we're excited to have them. This will be a virtual format. If you do have questions following the presentation, you can e-mail me at erin.wright@credit-suisse.com, and we'll feel free -- and we'll be happy to pass those along to management. From Dentsply today, we have CEO, Don Casey; as well as Head of the IR effort, John Sweeney. And I think they will start out with, hopefully, some -- a quick presentation and followed by some Q&A. I'll hand it over to you, Don. Thanks for joining us today.

Thanks so much, Erin. And first, thanks for inviting us. And hopefully, somebody is listening to us if we've got competing with Moderna, who -- we'll try and make up for not having an RNA vaccine. Anyway, just -- we flashed our forward-looking statements. Just want to make sure people had a chance to see those. For those not familiar with Dentsply Sirona, we kind of look at these as our investment highlights. We believe we're the largest provider of dental products, software and services in the world. We're a global leader in a market that we think is pretty attractive. It's got good fundamentals. We always say teeth don't heal themselves. So even during pandemics, people need dentistry. And it's a relatively fragmented and underpenetrated industry in terms of consolidation, whether it's manufacturers or whether it's the providers. We have a very strong profile and capital structure. We believe we're a leader in innovation. And what we're referring to is end-to-end solutions, which means everything from diagnostics -- we believe we have the largest installed digital diagnostic base in the world and how that translates into treatment planning all the way into end treatment, which is where we put our consumables. And then we think we've got sustainable competitive advantages. And we're excited about our prospects to drive and change dentistry because it's a great industry, great fundamentals and we think we're well positioned to take advantage of them. For those of you who are not familiar with us, we compete in 2 segments. The consumables, think of those as everything from like a prophy paste to an endodontic file to a single unit crown to every -- digital dentures and teeth that actually go into dentures. We have a large, as I mentioned earlier, diagnostic. We're #2 in imaging. We're #2 in treatment centers, which are very advanced. Digital assistance in the office. Some people always like to call them dental chairs. We think they're treatment centers. We're #3 in instruments. We're -- we believe a strong leader in digital dentistry. We're the largest CAD/CAM player, which is basically taking a digital impression and pushing that all the way through a mill that's in the dentist office. We have a health care business, which is #2 in urology. The brands there are LoFric and that division we refer to Wellspect. And we're #3-ish -- we like to think we're competitive to the #2 in implants. We have very noteworthy brands with Astra Tech, ANKYLOS, XIVE and MIS as well as a custom abutment service called Atlantis. I mentioned that we think we're well positioned versus industry trends. One of my favorite discoveries in dental -- I'm relatively new in dental -- was that there are countries that actually have mandates about how do we help people retain teeth. My favorite one is Japan, where they want every 80-year old to have at least 20 teeth by 2020 and is an example of how people view and governments and patients view that oral health is predictive of general health, and one of the ways that they view oral health is do I retain my teeth. So -- and as we've seen in the pandemic, retaining teeth and doing lots of Zoom calls -- even though Erin is not smiling, so we can't see her teeth. There we go. Thanks, Erin. It really puts a lot of emphasis on aesthetic dentistry. As dentistry has advanced, we are seeing more and more general practitioners perform specialized procedures, whereas you might see 10 years ago a general dentist would never really think about doing a clear aligner, doing an endodontic procedure or a basic implant procedure. Today, the technology around diagnosis and treatment planning has gotten so good that you're beginning to see more and more generalists and it's a pretty significant trend, be more comfortable taking on these specialized procedures. I mentioned that the industry is relatively unconsolidated. Today, you still see the bulk of the practices around the world in individual dentist offices. But you are starting to see consolidation, whether that's to a group practice, where you might see 5 to 10 to up to 100 offices come together in large group practices to large DSOs, which are dental service organizations. And DSOs are -- the analogy here is a GPO in the medical device space, where you're seeing a consolidation. We have 4 or 5 large players really starting to emerge, where you'll see in excess of 800 to 1,000 offices with -- and we expect that trend to continue over time. Underlying the biggest change in how dentistry is practiced is the adoption of digital technologies, whether that's digital x-rays. I'm old enough to remember the old film and x-rays: "Please hold this in..." And now it's done on panoramic machines that are faster, more accurate; to IOS, what are intraoral scans, which are pictures, digital scanning. And those digital diagnostic technologies have really transformed how dentists communicate to the patient and how they communicate with people like their labs or change their practice by including things like single-visit dentistry, which is you can today go into a dentist office, have an intraoral scan and identify all the steps needed for a complete restoration right up to a single unit crown that can be milled in the dentist office in about an hour. So in these COVID times, where you might see a full restoration -- a Class III, a Class IV restoration take 3 to 4 visits, that can now be done in a single visit. And we think that's very important in a practice flow right now that is a little bit changed because of COVID. And last thing we get really, really excited about. We see -- just like you saw with Epic changing how a patient is managed at the specific doctor's office all the way to the hospital, you're now seeing this in integrated workflows in dentistry, where you're going to see a seamless communication between the dentist, the patient, the lab and putting that all together -- and potentially a specialist, putting that all together through a seamless experience. Again, we're all about sustainable value creation. We think it's an attractive market. If you were to ask me what do I think the dental market grows at, we think it's probably 4% to 6%. There are parts of the category that are growing in high single digits, places like implants and clear aligners, and places that are a little bit slower, which might be the more commodity-oriented consumables. But as we see economies around the world continue generally improving, you see dentistry rising in those places. So we feel pretty good that the category overall has some good solid fundamentals. We believe that there's lots of growth opportunities. We think innovation is really essential to growth and we put a tremendous amount of emphasis on that. We have one of the largest R&D budgets and we've spent a lot of time improving our process around there. And then once we have great products, we have spent the last close to 2 years really trying to improve our overall commercial effectiveness. We have close to 5,000 people on a global basis involved in sales and marketing, which gives us a large global footprint, and we think if we can get that even 5% more effective, it gives us a real sustainable growth opportunity. And we really focus on expanding our margins. We believe that we've set an objective out that's attainable, where we think that we're going to get into the range of margin -- operating margin of 22% by 2022, with pandemic that might shift just a little bit. But we ultimately feel that that's how this business should be operating. And we've taken a number of steps, whether -- things like supply chain integration and plant consolidation to portfolio management. And really looking for a profound way to change how we work that gives us a much more, we think, sustainable head count level and spending efficiencies. So just specific to Dentsply Sirona, we believe that we have an opportunity to take advantage of a unique global breadth and the depth of the Dentsply Sirona portfolio to create more meaningful solutions for dentists. And we think about solutions is dentists -- look, we love to go compete and say a Cavitron is a much better way to do prevention than a manual pick. But we would sit there and say, "Look, we want a dentist to be able to give their patients better dentistry and do it in a way that they are more profitable." So that's when we talk about solutions, where we're going to have great products, but that's going to be provided in a workflow solution that's going to enable better patient care and deliver better economics for the dentist. And we're going to do that based on what we think is best-in-class products. And we're going to differentiate ourselves from a clinical education perspective. Erin is probably tired of hearing this, but I never grow tired of hearing this, which is we have 3 focuses, which is: how do we grow our revenue, how do we improve our margins, and then how do we simplify our organization. Just -- since we announced the restructuring, literally 2 years ago this month -- as a matter of fact, it was 2 years ago to this very day. And we feel that we've made significant progress against all 3 of these initiatives. We talk a lot about innovation. We feel that our productivity from an R&D perspective has really ramped up. We think that we're about halfway through a very, very significant sales force effectiveness overhaul on a global basis. And part of that is: how do we do a better job focusing on countries where the economics will allow us to grow disproportionately. So if you look at the slide right below the grow revenues, you can see that we've seen a pretty consistent journey, where we think that we are growing revenues. This is right up until COVID. COVID has obviously impacted our industry and our company. And -- but we're proud to say that after a very tough second quarter, which is where basically dentistry around world has shown that -- we saw revenues down close to 50%. We're starting to see that business improve on a relatively straightforward basis. And we're optimistic that as we get into 2021, we'll see things return closer to normal. What exactly normal plus or minus looks like is something we're not going to comment on specifically. We are very focused on improving our margins. I mentioned whether it's consolidating our supply chain, whether it's looking at very -- a much more disciplined approach to cost, whether that's in SG&A, whether that's in head count, we feel that we're making a lot of sustainable progress there. And we focused a lot on portfolio shaping. Last quarter, we announced that we were getting out of 2 what were foundational businesses for Dentsply Sirona, in our traditional ortho business as well as our analog lab business. Below, you can see that we've made significant margin -- significant and consistent margin improvement progress and I mentioned we believe we're going to get to a 22% margin. And we said we want to get to 22% by 2022. We continue to believe that number is attainable. We'll have to see whether the pandemic shifts that by a quarter or 2 as we go forward. And just the last issue. We've simplified our operating structure. We had put a goal that we would be completing a 6% to 8% head count reduction. By 2022, we've already exceeded that and we've reduced cost by over $140 million, with line of sight into $250 million by 2022. While margin improvement and head count is a lot of focus, this is what we have fun with, which is this is what our pipeline looks like. As you can see, even in a pandemic year, we've been able to continue focusing on launching things. And as you look out over 2020 and 2021, we believe that we have probably a best-in-class new product portfolio that we will be launching. Some highlights -- why don't we go, John, to the next slide -- would include right now our Axeos wide field of view imaging system. We feel this is a real practice builder. It enables general dentists to incorporate new procedures, whether that's endodontic implants or even looking at a route to crown treatment through clear aligners. But we're very, very excited about this launch. It's in the U.S. today. It will be rolling around the world over the course of the next 2 quarters, and we're getting an excellent, excellent reception to it. And it's also very typical of how we're looking at things going forward. It has our latest software, which is Sidexis 4. It's completely integrated with 200 practice management systems, and we've built a very, very easy to use app that flows right into our SureSmile clear aligner program. I mentioned SureSmile. This is our entry into clear aligners. We purchased a company called OraMetrix about 2 years ago -- 2.5 years ago. We have spent time scaling this and making it ready for prime time, which we now feel it is ready. It offers complete route to crown, which is a little bit different than what goes on in the rest of clear aligners, which tend to be kind of above the gum line. It's seamlessly integrated with Primescan. I joke that I can't even program my iPhone, but I could do a treatment plan for SureSmile with 4 clicks. I still actually haven't figured out how to do widgets on my phone. So that should give you a comparative of how easy this thing is. And we think it's very accurate and effective. And we're very proud to say that our SureSmile expected run rate is going to be over $100 million as we exit 2021. One of the differentiating points for us is clinical education. We believe as we bring out this really strong innovation, it's really incumbent on us to teach the dentists how to use it. It's really interesting. You graduate dental school probably having done one endo procedure and one implant procedure, and we're bringing a lot of technology, which will enable people to do that. We do that through -- we have 59 physical training facilities and academies around the world. I'm coming to you from rainy Charlotte today. Normally, it's beautiful, Charlotte. But we have a training facility that last year we put 10,000 people through in a 28,000 square foot academy down a couple of floors below where we are. We do this in 97 countries. Last year, we touched over 470,000. Our expectation is that we will look at greater than 500,000 people in 2020 as the pandemic really pushed things online. And we did that through over 14,000 courses. Our third quarter performance, which we announced basically a week ago, we were -- total sales of about $895 million. Organic sales for us were down 8.8%. That's a significant improvement sequentially from where we are in the second quarter. Our earnings per share were $0.67 and our operating margin was 22%. We benefited in that margin. There were a lot of both structural activity that's gone on even during the pandemic, but there were also some short-term measures that we put in place to protect the company as we went through the pandemic. Some of those will ramp down over time. And we had a very strong cash flow. Obviously, heading into the pandemic, it was critical for us to make sure that we understood what our receivables and payables was going to look like. And with improving revenues and the cash discipline we demonstrated, we thought we had a very strong cash flow performance. If you look at a financial summary, I mentioned what the sales lines would look like. Three other numbers that I'd highlight on this page. We believe that we took -- we successfully took our manufacturing network, which is in excess of 35 manufacturing facilities, down during the pandemic. We were able to maintain excellent customer service during that. And as we've ramped it up, we were able to bring things online and demonstrate a strong gross profit. Our SG&A -- we believe that we were very focused on maintaining discipline and let's shift with the pandemic, move to more online things. And you can see a 450 basis point improvement in our total SG&A, which led us to the operating margin of 22%. So as you look at the -- kind of our individual segments. Our consumable business -- think of this as our endodontic, our preventive business, our resto business and our lab business. Think of labs as prosthetics, which are like teeth and other things. This business declined about 9.3%. It's important to note, we have some competitors that participate in the consumables segment that have a different makeup, which might be a little bit more oriented to PPE. We do not really participate in a meaningful way in PPE. So this is kind of reflective of what was going on with dental traffic. If you look at our technology and equipment space, again, this is critical for us. And as we kind of entered the pandemic, we thought that this is going to be impacted a little bit more significantly as dentists may be interested in deferring large capital purchases. We really haven't seen that to date. As a matter of fact, during this -- during the pandemic when the dentist office were down -- in fact, we saw a lot of interest in dentists to say, "Hey, I'm going to use this time to revamp how I'm thinking about my practice and what I should be doing." And that's really resulted in what we think has been pretty positive in terms of generating leads and thought processes over the next 6 months about how technology and equipment could perform. Just our -- we mentioned cash flow. Just sequentially if you look, we saw improvement versus a year ago and prior quarter. And our free cash flow at this point of close to $186 million, up 26% versus a year ago, despite seeing a revenue decline of close to 9% shows the discipline that we've been bringing to the company. So in summary, again, we think we're a real player in innovation in the category that -- where innovation is rewarded. We believe that we are a major player in an unconsolidated category with a strong financial balance sheet that should allow us to participate in M&A and L&A as we go forward in the future. And we'll focus on basically trying to transform dentistry by innovative end-to-end solutions. And if we deliver on that, we're going to deliver what we think is sustainable growth and sustainable value for our shareholders. So Erin, with that, we can open it up to Q&A or whatever people would like to discuss.

Great. Thank you so much for the presentation. That was great. So this is a bigger, longer-term sort of question. So sorry, I'm starting out pretty broad here. But since you've come on board, Don, you've had a dedicated effort towards innovation, optimizing the mix here. Sales force incentive structure changes, completed divestitures. There's been a lot of structural improvements. I guess, do you still anticipate long-term growth in that 3% to 4% or maybe closer to 4% to 6% sort of range over the longer term? And then on profitability, you've already hit your long-term target of 22% on an operating margin basis. And is that still the long-term target you expect to sort of achieve here? Or can you speak to kind of underlying margin leverage across your business, particularly as your mix has inherently changed?

Yes. Thanks for the question, Erin. Let's start with growth. I mean, look, we want to target a reliable 3% to 4%. But aspirationally, we like to be much more in the 5% to 6% range. And when we talk about innovation, the investments we're making, we'll spend close to about $130 million this year, $150 million next year in R&D. And that's to: How do we move that from 3% to 4% to 5% to 6%? But right now, we're pretty comfortable saying: "Let's deliver 3% to 4%." I would note that when we get this right, no pun intended on your name -- when we get this right, we'll sit there and say -- 2019 was a pretty emblematic year for us, where we saw growth closer to 6%. But let's -- we'll commit to 3% to 4%. On the 22%, Erin, to be perfectly frank, we don't want people to sit there and say you've already attained it. So let's go get another 300 basis points around that. We think that we've made structural improvements. If you look at where we finished 2019, sitting just a skosh below 19%. That shows kind of -- and when we were talking about we'll get to 20% in 2022, that kind of shows the pace of the structural improvements we're making. We're still very much online to do that. Is it going to bounce around a quarter or 2? It's possible. But when you see a bolus where we kind of pop up to 22%, that's kind of reflective of pandemic management tactics, where we had short work weeks and some other things. But if I -- not that I want to tell people how to model or anything like that. But I think the structural improvements look a little bit more straight-line to 22%. And do we expect to be able to go beyond that? The answer is yes. But short term, if there's some deviations above or below, that might be a little more reflective of the pandemic than the fact that we have on a sustainable basis already hit the 22%.

Okay. That's helpful. And then you obviously had a meaningful step-up or sequential recovery, I guess, I should say over the course of the third quarter. Can you break down the cadence of that recovery during the quarter? What were sort of the exit run rates you were seeing on a monthly basis? And was -- how much would you attribute to a level of pent-up demand versus fundamentals improving? And did October go well for you?

Yes. We've stayed away from commenting around October. But look, basically, what we saw in the third quarter was positive for us. We have said in our call in the second quarter that July was good, and we have seen steady improvement on that. A unique feature in our business right now is in the third quarter of '19, we had a pretty interesting -- 2 interesting comps that to lap becomes a little bit of an issue, where we had a large successful event called DS World, which is by far our largest selling event in our largest categories. And we had that sitting literally right at the end of the quarter. So we're lapping a pretty heavy comp in the technology and equipment space. Also, at that point, we were in the middle of a launch of Primescan and the entry of Primemill. So we're lapping a tough comp. But underlying retail demand, we feel was performing in line with what we thought and we're very, very comfortable that we're seeing consistent level of improvement there. The other comp, which is -- we've talked about and we'll continue talking about is about 9 months ago we made a pretty significant shift in how we view our promotional spend. We've really shifted from what we would say would be more promotional aimed at like 2 for 1s or inventory-oriented events to much more retail-focused events. The program that's really become kind of the standard-bearer is One DS, which is very, very focused on creating end demand at the dentist office, which we think is a long-term differentiator for us. And as a result, we don't participate in quarter-end buys. We're not doing major, "Let's do inventory-oriented promotions." So we're kind of -- that's going to take us a couple of quarters to kind of smooth out. We'll point out the fact that the U.S. is the first place we've tried that, our consumable business was up close to 3% versus prior year. So it'll kind of show you how we think that will play out. And then on the pent-up demand, Erin, it's really interesting. Our endo and implant business performed pretty well. And we believe that's kind of a focus of -- if you need a root canal, you kind of need a root canal. And if you need an implant, those are procedures that -- at some point, the implant is healed and you want to get that restoration done. So we think there was both a mix, where there was kind of a more emphasis put on higher premium procedures during the third quarter, which is one of the reasons we saw revenue come back. On the pent-up demand, I see -- we see some data that suggest there might have been a little bit of a bolus. But as we've kind of looked at the last couple of months, we're not seeing a big dip. I think the biggest dip was dentist office being closed and then the availability of PPE and then how do the dentists manage patient workflow in an environment with new infection protocols. And we're kind of seeing that level out. And again, I'm not going to give you a lot of October. But we're pretty comfortable with how we're seeing our end-user demand through the third quarter heading into the fourth.

Okay. Okay. That's helpful. And then across Europe and international markets, can you parse out some of the trends there, particularly in areas where we've seen further lockdowns? I'm curious if the response has been different across kind of the customer base? And also, can you comment on the more recent trends in China? I think we were a little surprised by that. You also mentioned like Brazil is somewhat weaker. Do you anticipate that those have now stabilized at this point? Curious what your thoughts are there.

Yes. Let's go around the world in 30 seconds. So Europe, Europe looked a lot like the U.S. And it's interesting. As we've now seen lockdowns in the 4 principal countries and travel restrictions, it's something we're obviously watching closely, which is one of the reasons I think you heard us be relatively conservative as we talked about the fourth quarter. To date, we haven't seen any of those countries different than what we saw in the second quarter. We haven't seen any of the countries limit access to health care, which in the second quarter you saw some of the countries lock everything down, which prohibited people from getting dental care. We're not seeing that to date. As we get into China, the interesting issue for us around China: some of our base consumable business got slowed down and we think that was pandemic related. And obviously, as that pandemic changes, we've -- and kind of recedes across not just China, but all of Asia, we feel pretty good about where we are. I mean, China, the comp we were up against -- some of our competitors have a very heavy clear aligner business, which has shown that it's relatively -- demand seems to be relatively inelastic even during a pandemic. And our clear aligner business right now is very U.S. focused. We don't have that offset in Asia. And that's something -- one of the things we're really excited about, SureSmile. We'll have that in 10 countries up and running in the middle of 2021. So we feel good about that. Brazil really -- and why don't we talk a little bit more about Latin America. The pandemic is really raging, whatever word you want to use. The pandemic is impacting Latin America more than any place we've seen. And we've got a pretty big business in Brazil, and it slowed things down. So obviously, what -- again, Erin, we were cautious about how we talked about the fourth quarter, because, again, we don't know what's going to go on in Latin America. We don't know what's going to go on in Asia. So far, what we've seen in the third quarter would tell us that it kind of hits a level. And we're not seeing -- in Brazil, in particular, we're not seeing lockdown of dentist office, although you are seeing the government urge stronger action. So that's one of the reasons we're cautious. But U.S. and Europe look the same. Asia, we see improving. Latin America is still a question mark for us.

Okay. Got it. And then on DS World, since you spoke to it earlier. You talked about the focus more on those retail promotional programs here like One DS. It was launched last year during DS World. What other promotional programs are you considering here? Should we consider some new flashy sort of upgrade cycle launch of some sort at DS World this year? Given its virtual format, it's obviously a little bit different.

Yes. I mean one of the challenges with DS World with us on a virtual event is how do you create the urgency to buy right during that event. And there are some things that will go on at DS World. I mean there's some sweetening of the One DS program. I don't want to be accused of trying to offer our dentists more incentive to come to the virtual DS World. But we're pretty comfortable with what we've worked out with our dealer partners particularly in the technology and equipment area, that there is a good reason to attend DS World. That said, Erin -- I mean it's just like you guys doing conferences. It's -- we're charging -- we are charging dentists to attend DS World, which will be virtual this year. We're getting a pretty solid response. Whether we see the same bolus around technology and equipment, we're not sure. We're just not sure. But we're on our second major iteration of the One DS program. We feel right now we're unconstrained in terms of the ability to deliver Primescan on a global basis right now and we're getting into a similar position with Primemill. The upgrade program is less important for us in the U.S. being that we started that cycle -- it's still a very important cycle. But we still have that in front of us, rest of the world. So we're starting to roll that through Europe and we'll roll that through Asia-Pacific as well as the next couple of quarters roll out, because we -- a year ago, we were more capacity constrained than we are today.