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

Okay. Good afternoon, and welcome to the continuation of day 2 of the Barclays Global Healthcare Conference. I'm Steven Valiquette, Managing Director and Health Care Services Analyst here at Barclays. Our next session will be with dental manufacturer, Dentsply Sirona. The stock has performed pretty well this month after the company recently provided a better-than-expected guidance for 2021. So we look forward to having more discussion about the prospects for dental industry recovery in relation to the pandemic. With us from the company, we have Chief Executive Officer, Don Casey; as well as Derek Leckow, who has taken on the Investor Relations role again this year. So this will be a fireside chat. And with that, I guess, we'll dive right in.

So the company reported earnings last week, as I mentioned, gave '21 guidance and included the view of more volume improvement in the second half of the year versus the first half. Well, guidance was communicated last week, it's probably planned and mapped out several weeks, maybe even a month or 2 earlier, just given normal corporate practice. I guess I'm curious, just given the rapid pace of COVID case declines seemingly worldwide in February and early March. And the fact that Dentsply Sirona is truly a global company be able to start with -- perhaps you guys can give a little more of an outlook by major region, U.S., Europe, Asia and our rest of world. And I guess we'll just kick off with that.

All right. Thanks, Steve, and thanks for having us. We always appreciate the opportunity. We had a good solid session this morning. So Steve, again, thank you. Look, we are seeing cases drop in the U.S., Europe is a little further behind. Asia Pacific has been a little closer to normal. There are some spots that we haven't seen the continued improvement, and that's probably the area that we had some concern about as we look at '21, kind of Russia kind of running down Central Eastern Europe, which has been a pretty rapid grower. If you look at Poland, Romania, kind of Croatia down. Middle East and Brazil are not seeing the same kind of snapback that you're seeing in the U.S., but in our pecking order of recovery, Asia Pacific is the furthest along U.S., EMEA, for us, that's basically Europe. And then some of the developing regions are a little slower. Steve, our guidance, yes, obviously, we work on that 4, 6 weeks out. And what we thought was we would see some level of improvement. And if it improved faster, that would just provide topside to what we were going out. We also thought there may have been a little bit of topside that we wanted, to be honest, to have some insurance depending on how fast or slow kind of Russia, India, Middle East and Brazil come back. So the only other color I'd give you based on some of the conversations with investors this morning was the ADA is something that most people kind of look at. And we think the ADA is probably a month behind what we're seeing and tracking. Remember, we turn on our CEREC machines every day. We can see how many are being used in the volumes. So we tend to think the ADA, while directionally correct, maybe a little bit slower and just a little bit more pessimistic than what we're seeing in the market.

Yes. I would agree with that based on some of those CEREC results, and maybe we'll touch on that a little bit later. I want to shift gears here a little bit, though. For the conference call last week, you guys talked about increasing the R&D spend from $115 million last year to $160 million this year. I guess I'm curious to maybe dive in a little bit deeper on where the incremental R&D dollars will be spent. Whether it's related more to bring in more late-stage development projects across the finish line within R&D? Or is it more about just broadening the scope of projects the company is working on at earlier stages?

It's a little bit of both, Steve, but I'm not trying to give a -- equivocate on the answer. Look, our strategy has been how do we really do a good job around diagnostic excellence. So we start with -- let's get great diagnosis. Let's get treatment planning moving that we use our consumables to deliver against that. So if you took implants per se, whether it's a digital impression or whether it's X-ray then you move in, hopefully, to SIMPLANT, then you're going to pick an Astra implant system, use ATLANTIS which is another digital kind of technology for custom abutment. And then in a totally perfect world, you would mill a single unit crown on your Primemill. So if you go through that as a workflow, we've said implant clear aligners, restore -- restoration and the dontics are our primary areas of workflow importance. And if you look at that, as I just kind of outlined those steps of diagnosis, treatment planning and then using the great consumables we have to deliver the restoratives, you can see where we're going to highlight. We're going to highlight those kind of 4 big workflows. I would say probably more money is going to flow into the software aspects of this. We're learning increasingly that the machines are great, but the -- having progressively easier software to use is important. So that's actually the biggest spending priority. We mentioned in the call, Steve, that we're going to -- we have a pretty good portfolio. Of things we're going to launch in the back half of this year around particularly the restorative and the implant franchises. So that's why I say it's a little bit of both with the implant resto, it's kind of get the 510(k) filed and getting that across the finish going globally. But as we think about workflows, that tends to be a little bit more software and digitally oriented. And then we opened up an innovation -- we're in the process of opening up an innovation center. We made that announcement last week. We're opening close to 100,000 square feet of innovation center, which will be actually very forward looking. It's like material development and a bunch of technologies we think will impact cross dent. We'll have that open in 2021. So it's a little bit of both.

Okay. All right. Great. Also within the P&L, one of the areas where the company normally doesn't give as much color, but it's understandable, just around the gross margins and I asked a little bit about that on the call. But I guess I'm just curious, just more color maybe on just the pure pricing dynamics within this. Investors that follow all the public companies, there's always -- seems like a never-ending circular discussion around the manufacturers and the distributors around promotional activity and rebates or lack of rebates. Just curious, the question really is, how much control do you really have over your promotional activity that may impact your margins? And how much are you thinking about the gross margin component of the P&L?

Well, I'd like to think we've got a lot of control over, Steve. And we've exercised a fair amount on that. But when you talk about gross margin look, the 2 biggest drivers in that are really what's the mix, how much is T&E versus Consumables. Consumables tend to have a slightly higher gross margin. So what does mix look like, part one, part two is what's the absorption. Obviously, in Q4 when we delivered what we jokingly referred to as a tax number, $1,040 million in revenue. That's obviously better than if it's $900 million. So obviously, you get gross margin moving when you see more absorption. And then the third is some of the dealer rebates show up in gross margin. We think we've got a fair amount of control over that. And we have said and just to put a finer point on it. One of the reasons we saw U.S. fourth quarter consumables move in the right direction is we have really focused on putting direct-to-dentist promotions, things like the One DS program. And we've been working through that over the course of the year, which means we're spending more money there than you might see in traditional rebates and other things. And as we've had conversations with the Benco Schein, Pattersons of the world is like, look, we want to pay you time, just sell our products, help us gain share, and we'd like to think we put a slightly bigger carrot out there and put less emphasis on more wholesale activities. And we've kind of gotten through that cycle in the U.S. We're about halfway through that cycle in Europe. But ultimately, if we can level load retail demand, it's not as if dental procedures spike during the year. They're pretty even. Slightly higher in the fourth quarter when people, particularly in North America, are spending against their savings accounts. But if we can level on that, we think that's obviously a benefit to not only our manufacturing because we can level out things, but also that puts more margin back on our side of the ledger.

Okay. And somewhat tying into that. Investors still ask us from time to time whether it makes sense for you guys to self-distribute products. Yes. Yes. Clearly, you have a global franchise. This question usually comes more for the U.S., but curious if there's other markets, too, where you're not doing this currently? Where you're either partnering it or does it make sense to toggle to that self-distribution model on a larger scale in any of your major markets?

Yes, Steve, I think things are a little bit more nuanced than the question kind of lends itself to. I mean, one of the frustrating things, at least for me, is everyone focuses on like consumables in North America because Envista, Schein and Patterson report them at. Well, less than 40% of my business is in the U.S. and less than half of that is in consumables. So as goes this little piece -- an important piece, don't get me wrong, goes the whole thing. And it's just -- it's not necessarily accurate. I would point out a couple of things. First, 30% of our business is direct today. So our -- the bulk of our Endo business, implant business as well as clear aligners, all go direct today. So that's 30% plus of our business that's direct. The second issue is, as the DSOs become bigger and more prominent, they're beginning to rearrange the landscape as it suits them. And we're agnostic as to how they want to participate. So some of them come directly to us and say, "Hey, look, in the big categories, resto or implants or endo," they're going to tell the dealers, they're going to negotiate directly with the big companies, Astra, Envista, 3M or whoever. And they're going to tell us what distributor to go through. That's fine. In other cases, some of them go to the dealers and say, "Hey, put together the best bundle you can." What we've done, Steve, is we've moved to a price for DSOs. If it's a big DSO defined as 850 storefronts, if you will, or more, that's the price. It's a volume-based price. And we don't favor one dealer over another. And we're transparent with what the -- what those prices are to the DSOs. So -- but ultimately, as we go through it and where we've had, we think, a pretty good run with Patterson in China and these guys. There's 5 things that these guys do: they do order to cash; they do financing; they do the logistics of it; they do a fair amount of servicing; and they do do some demand creation. We're less reliant on the demand creation, their salespeople out selling than we were before. But at this point, we don't see ourselves getting in the -- putting 800 trucks on the road to go service CEREC systems, and that's something we want to pay the dealers to do. The order-to-cash system, that's pretty efficient. And they do a fair amount of the financing of technology and equipment that we help defer that. But those are businesses that we don't want to get into. So it's a little more nuanced than are we direct or are we indirect?

Okay. Got it. Okay. So obviously, a big part of the bull case for Dentsply Sirona, for sure, is the margin expansion opportunities, and you guys have laid that out over the last year or 2. SG&A is definitely a big component of that for sure. And just to generalize, in 2020, it seemed like during the COVID pandemic, there was a lot of opportunity to curtail SG&A. That was a big part of the earnings success. And then as we kind of flip to '21, some of that normalizes or comes back in. But really, the question is, because of the pandemic, has this caused you to really rethink the entire return on investment matrix on SG&A spend by category of marketing spend in the post-COVID environment. And has that led you to any major changes on how you're marketing across the board?

Yes. I mean, Steve, what -- all of us probably did some reassessment based upon the pandemic and a lot of things like where do we work from. But here's just an easy kind of thought, and I know you've a pretty sophisticated model. We -- when we did the restructuring, we said, "Hey, look, we're going to get to 22 in 2022." And we have been making pretty exact progress on that. We were sitting in '20 when the pandemic hit. We hit 19 and '19, we're 18.75 or whatever, we were sitting distance. And so you almost want to draw a straight line. That's the structural improvements that we made in the business, whether it was shutting down manufacturing facilities, closing down legal entities or consolidating legal entities. We've had a huge enterprise modernization program. So underneath -- that's the structural improvement. The bump you saw when -- like if you look at our fourth quarter, we were 23.2 that area over the straight-line curve represents what the pandemic is. I think there's a lot of learnings from the pandemic that we're starting to apply, which, in my opinion, should accelerate how fast we're able to get to the 22. And look, I think our -- the bull case, I'm not going to call a bull case, I'm going to call it the optimist case is how do we get organic growth, we move from 3 to 4 to 4 to 5 but how does that look more like 6 to 7. And if you kind of get that kind of sales performance, what kind of leverage you're going to get in the rest of the P&L? And is that SG&A? How much of that is variable SG&A and how much of it is fixed? So our thought process is if we can get the flywheel moving a little bit faster, there is going to be leveraged beyond the 22. And then -- and as you structure that, that's why we're pretty comfortable talking about double-digit EPS for this foreseeable future based on that formula. I think one of the opportunities we have going forward, though, is where is that trade-off right now between the margin -- should we push the margin of 24 -- 24, 25 and see growth sit there at 4%? Or would that equation be better balanced at 22 to 23 with 6% to 7%? So that's kind of the internal dynamic that we're having today. I believe as we're scaling the business, and Jorge Gomez, our CFO, is actually in charge of our overall like IT QA/RA as well as finance and reporting all that enterprise modernization scale work in the back is if we get that done the right way, if we get our manufacturing footprint from 29 to say, 22, 21, it should enable us to get a little bit more leverage even with those higher growth rates.

Okay. Got it. All right. Shifting gears here a little bit, some of your more specific products So the BYTE acquisition gives you a greater footprint in clear aligners at a pretty critical time point in the market evolution from my perspective. It seems like case volume growth is really accelerating in both practitioner-directed and consumer-directed case starts. You guys have a lot of runway on both sides of that. I guess I'm curious, if you had to look out 3 to 5 years from now, do you think the company's sales of the practitioner-directed clear aligners or consumer-directed clear aligners will be greater as we look out over an extended period of time?

In a perfect world, they're pretty close. I would just say the head start that BYTE has is if you put it 5 years out, it will be hard for -- SureSmile almost it's a double, double, double and then you've got to see kind of BYTE sitting at 20% growth. The lines wouldn't cross for a couple of years out, just given the relevant size of disparity today. But Steve, look, I think the direct-to-consumer numbers are probably -- that category in the U.S. has probably grown 20%. I think the dentist-directed clear aligner business is probably a little faster than that. I tend to think that's more in the 20% to 25% range. So I tend to think that's where the trajectory looks. I think one of the reasons the DTC space is a little bit slower. I think 2 of the bigger players there and I don't want to speak for them at all. But SmileDirect and Candid were faced with the challenge. During COVID, they had a retail -- a significant retail presence that they had to kind of shift into becoming digitally native. So that's a pretty big swing, whereas BYTE was created right from ground zero and never have a retail presence, and we don't anticipate it. We believe that BYTE can grow in a couple of different ways, which, again, I'd love to see SureSmile catch up. But as we look at BYTE, it's early days in terms of penetration. We tend to think the number of people who would be eligible for a Class I ortho treatment that could go direct to consumer. We think that penetration is well in single digits. I don't know if it's 5 or 10 but it's not 50. So the penetration there is, we think, in front of us. We believe we have a great opportunity. We're going to see a 1 million BYTE unique visitors this year, half of them are going to be eligible for BYTE. How do we translate that rest of that patient traffic into our dental network, preferably to CEREC doctors. So we think about that as by Pro. And then how do we think about international, I mean, cumulatively today, I couldn't even pay for my 32-ounce chip for lay cup with what we're selling in Australia and the U.K., and we think we have an opportunity to push that well beyond where it is today. On the SureSmile side, look, we're really going. We don't have a nighttime product. We don't have a whitening product. We're going to look to bring hyper fight over onto the SureSmile side for vibration technology and other things. So that is -- SureSmile right now is only in 2 countries. We'll have that in 10 by the end of the year. So we think that there's a pretty good set of tailwinds behind SureSmile with geographic expansion, new product. And just -- we think we've got a very good formula, which is focus SureSmile on the CEREC doctor or somebody who's bought technology and equipment for us that isn't selling clear aligners today. So yes. I'd love to say that we're having a fight between the 2 of them for the -- we'll call it, the Derek Leckow cup of who wins the bigger side. But in the short term, we think that there's distinct tailwind behind them, but there are tailwinds that should allow us to grow significantly on both sides of that equation.

Okay. That's definitely very helpful. Maybe shifting over to the equipment side. It sounds like Primescan and Primemill starting pretty good uptake. You mentioned a lot of success on the back of the virtual DS World. At the same time, you had some tax implications for the fourth quarter. So kind of blending 2 questions into one. I guess I'm curious, if I created some backlog as you go into early calendar '21. So I'm curious if there's any updates on just uptake of Primescan and Primemill in early '21 as we kind of flip the calendar year just related to the tax stuff. And also, is there any sort of ratio you're seeing that's evolving now as far as Primescan units sold versus Primemill units sold? I mean they're not necessarily related to each other as much out as you would have had as CEREC components previously. But just curious if there's any ratio you're seeing as far as the unit sales of the 2, if you even look at it that way.

So the 2 questions there, Steve. We're not as big a believer as others about the tax deferment spilling into Q1. And again, not trying to tell you what Q1 looks like. We're pretty happy with how things are going. But I didn't necessarily look at that as a backlog associated with tax. With the virtual DS World, we're thinking it's a longer tail. And if you've been to the DS World, there's a lot of incentives, excitement. Let's do this now and what we're seeing on the virtual events. We're very happy with how it played out, but it's playing out over a longer time period. So one of the reasons I think we're comfortable with what we're seeing around CEREC, in particular, is this more associated with how we're approaching DS World and selling that afterwards. If there is people wanting to defer equipment purchases, so you get the depreciation and a higher tax year that -- maybe it's there. It's not something we're tracking specifically. And then on the ratio of scan to mill. Yes, typically, you'd see 50% of the CEREC machines would upgrade into a mill. I mean if you go back to Bluecam, Redcam and then the MCXL series, you typically -- you see a ratio where they'll update the cameras more than they'll update the mills, but we really haven't had a new mill in 8 years. And the kind of the bummer for us was we were at Chicago mid-winter. And actually, one of the things we saw. We were milling -- we were scanning people's teeth and then milling them right there, and people wouldn't wait for it to come off the sintering of it, and they get a 400-degree crown in their hand. Which usually resulted in somebody reflexibly throwing the crown out somewhere in the crowd. But we had just launched mill, and that kind of got shut down. So we're treating 2021 Q1 is the relaunch of Primemill because we have really good manufacturing capacity. We're very early stages. Where -- somebody asked me in a baseball inning, Steve, where -- I think the umpire just said play ball. We're early in the first inning on that, just based on -- we didn't even launch it in all the countries around the world. When COVID hit, we kind of pulled back. So it has not been a global launch, and it is now. So -- I mean, we're pretty excited about what Primemill can mean to us as we go through this year.

Okay. I think we're 1 minute into over time, so I'll ask maybe just one final question. Actually, 2 questions kind of blended together. So I mean, obviously, you guys -- there were some businesses that you voluntarily decided to exit. It's been all document over the last several quarters. Curious if there's any other product areas where XRAY may still do some pruning? And then also on a summit related topic, is there any possibility you may still sell or monetize the medical business that you purchased as part of the Astra Tech implant deal from several years ago?

Yes. We're not done portfolio pruning, Steve. I mean we're always going to be after that. And we have a chart in my office each of the SBU leaders now. I mean are you accretive from growth in profit? If you're up in that right side, you're blessed would never happen to talk to me or Jorge. If you're on the bottom left, however, and you're in the bottom left for 2 or 3 years, you get bothered by Jorge and I and then you get soaked. So we're always going to be remaking the business and look, it is -- you almost -- and Steve, in the prepared questions, you're exactly right. I mean, we exited roughly $170-plus million of business. We added almost the same back, but the growth profile and the margin profiles are dramatically different. So I still think there's a fair amount of room there in terms of how we look at remaking Dentsply Sirona going forward. In terms of the Wellspect business, which is the health care business, we're pretty happy. We think we're a good owner for that business right now. We continue to investing in it. Nothing -- we're not going out and buying Convatec, but we're certainly, we've invested around the edges. And without giving a huge amount of detail, we've been able to accelerate the growth and improve the profit margin. We think there's still room to do that. And we've got a good management team. I really like where that business is from a new product perspective, and we'll -- we like that business.

All right. Great. And with that, I think we're 5 minutes over, so I appreciate you guys taking the extra couple of minutes here to hit the last few questions. So thank you for your time today, and everyone, enjoy the rest of the conference.

Okay. Thanks so much, Steve.

Thanks.