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

Good morning, everyone. Welcome to day 2 of the William Blair Growth Stock conference. Our next session is Dentsply Sirona. So thank you all for joining us. I am John Kreger, the analyst at William Blair that covers Dentsply. And I am required to tell you that if you want to see a list of our conflicts or any other disclosures, feel free to check out williamblair.com. From the company, we have Jorge Gomez, the CFO; and Andrea Daley, the Head of Investor Relations. We're going to do this in a 30 minute, generally a Q&A format, but Jorge is going to give a few minutes of overview for those of you that might not be as familiar with the company. So Jorge, I'll turn it over to you.

John, thank you, and good morning, everybody. It is a pleasure to be here to share a few thoughts about where we are as a company, and of course answer a number of questions that some of you may have. So we thought we would start by providing a quick overview of our strategy and the key components of our overall corporate direction, if you will. So starting with our direction from a strategic standpoint, we are -- we have a pretty big portfolio that is evolving. And growth for us is one of the most important things we're working on. And so as you see on this slide, our strategy starts with growing revenues, and investing for the top line is something that we are doing on a pretty consistent basis. We are focusing our efforts on key areas in dentistry, particularly those which are growing the fastest. And within those, we have now a very strong clear aligners platform, franchise. We continue to have very good products in the digital imaging space. Our implants business is very robust, and we're spending a lot of time on that business to make sure that it grows at market rates. We have also, as many of you know, a very strong consumables portfolio. We have done a lot of work optimizing that portfolio, shedding assets that are either not growing or have low profitability, and investing for growth, adding more capacity into our clear aligner business, investing into adjacencies in the implants business. So top line growth is paramount to us. At the same time, we want to have profitable growth, and improving margins is extremely important to us. We have demonstrated a good track record on delivering on the targets that we have set for ourselves. If you go back a number of years, our operating profit margins were in the mid-teens, 15%, 16%. We have made good progress, and we exited 2020 at close to a 20% operating profit margin level. For '21, we're expecting to be, on average, about 21% for sure, exit '21 at 21%. We had a good first quarter, showing that type of profit margin rate. And then by '22, we expect to get to the 22% level. We are doing a lot of work to enable that type of margin in terms of simplifying the organization and making sure that we manage our balance sheet in a very effective way. We have -- we embarked on a very ambitious restructuring plan that is going to yield savings in the $250 million level by the end of next year, and we are very much on track to achieving those savings. From a capital structure perspective, we're very much focused on cash flow conversion, and we have delivered on average cash flow conversion in excess of 100% for the last several quarters. We have a strong credit rating in the BBB -- strong BBB area with low leverage. And from a capital allocation perspective to enable the growth to improve margins, we have been very clear in terms of how we want to deploy our capital. And the key tenets of that capital allocation policy include, we're targeting to spend about 4% of our revenue in R&D, primarily in the categories that I indicated before that will fuel the growth. We are also targeting to spend about 4% of revenues in capital expenditures. And in addition to that, we have a solid return to -- cash return to shareholders policy. We have a dividend that we just recently increased by 10% last week. And we use excess cash to buy back shares as appropriate. At the same time, with our free cash flow, we try to invest in areas that are strategic to us, and that will provide growth, sustainable growth. In the last several months, we have completed 2 important acquisitions. We completed BYTE, a $1 billion acquisition. We completed Datum, which is an important acquisition, much smaller size, in the implants business, bone regeneration. And those acquisitions are going well. Integration is tracking well. So that is in a nutshell what we are trying to do. The second point -- this is the strategy, and we feel really good about our industry. And so a couple of points on the next page that I want to highlight, dentistry, the dental space, is a very resilient category. It's an industry that has recovered well from the pandemic. And as we could -- as we experienced in the first quarter, we saw volumes approach now what we would consider normal levels, using 2019 as a reference point. And big markets like the U.S., I think most people would agree, volume is now trending at around the 95% level. And perhaps for some areas, close to 100%. Patient confidence has increased dramatically. And in many markets things are almost back to normal. From a long-term perspective, we feel really good about this industry, the market fundamentals, aging population, rising economies and new technology is a reason to be really excited about the industry. Software and technology is changing the game, and we are very active in that space in terms of working on integrated workflows. That is critical for the future of the industry. And we are performing well against those trends and feel good about the future. I think we provided a guidance for 2021 that is consistent with those views. So with that, John, let me pause there, turn it back to you and tell us where to go.

All right. That's great, Jorge. Great overview. I think maybe the next one is a nice little segue from the overview that you just gave. You've been at the company a couple of years, Don a bit longer. Can you just talk about what you found when you got there? And what's maybe the biggest thing left that you want to accomplish from a sort of a restructuring standpoint?

Yes. It was -- I made a very conscious decision to come to this company because I thought there were great opportunities. And so when I got here, I found a few things that were not total surprises, because they had come up in my conversations with the Board and due diligence and so forth. But when I got here, it has struck me that I probably had underestimated the potential from those things. And those 2 things are, one is the breadth of our portfolio and the global scale that we have. We have a tremendous, very large installed base. And we have tremendous untapped opportunities to integrate that installed base and to take advantage of the scale that we have. The best opportunity we have is integrating better all of our products. And we're doing that in multiple ways. One, new software, new technology is really enabling the seamless workflows that we are beginning to see in multiple procedures in dentistry. Probably the best example right now is the integration between scanners and clear aligners. And we have multiple examples where that seamless interaction is creating a lot of demand and productivity and is driving top line growth for us. To that effect, we announced yesterday a very important partnership with 3Shape, basically allowing them to have access in a seamless way to our clear aligners business. They're a great competitor. They are a great company. We respect each other up, and we believe this is going to be a win-win opportunity for us. We will have access to dentists that use a different technology from a scanning perspective, and they will have the ability to offer clear aligners or give their clients or customers the opportunity to have access to a great clear aligner technology. So that is a good example. So technology is enabling that integration. The second point is from a commercial standpoint, how we are coming together as a 1 company, 1 enterprise through more -- through smarter promotional opportunities, and trying to improve the share of wallet. One of the striking things for me when I got here was the fact that we had very strong penetration with the given dentists in 1 particular category, and then very low in other parts of our portfolio. So one of the things we're trying to do is we want to expand our share of wallet across our entire offering. And that is that we have a significant opportunity there that we are just beginning to tap. The second thing that was clear from the beginning, but when I got here also I thought there was more opportunity, was having better processes and infrastructure. And that is something that we have been doing a lot of work on. And I think that is reflected on -- the outcome from that work is reflected on the margin trajectory that we have seen. Years ago, as many of you know, the company was very decentralized. And the integration between Dentsply and Sirona never really happened until Don got to the company about 3.5 years ago. And we were very committed to doing that. We're still doing that. We are not done, but we're seeing tremendous efficiencies. We're seeing how our margins are improving, more importantly. Customer experience is getting better. And to my earlier point about better share of wallet with customers having an integrated platform, going to customers as 1 company is really important in that regard. So those are 2 things that we continue to work on and have been very important for me since I got here.

Great. Let's dig into the Sirona situation a little bit. As you said, it seemed like the early days of that combination were tough. What is left to accomplish from your perspective on integrating those 2 high-quality but very different assets?

I think we have some work to do in terms of making that integration more seamless, but all the components are there. Starting with the cultural integration, which is something that is not inconsequential, it's something that takes a number of years. And since Don got here, he's emphasized that tremendously. And as a management team, when I look around the table, most of the members of the management team are post -- or came to the company post merger. And so from that standpoint, we are all very neutral and objective, right? We want the best for the entire company. And that has permeated throughout the organization, and now we really act as 1 company. What is left to accomplish is making sure that the new processes that we have implemented are now enabled by good data, good technology -- technology from an infrastructure perspective. And then finally, that the commercial organization is able to take the benefit from that great platform and use it to be more effective as we go to our customers. I think there is fine-tuning that we can do commercially from an incentive perspective. And then I think the ultimate test of the integration is to have seamless integrated workflows across procedures, where all the pieces of our portfolio can go into those procedures coming from one single company. I think that is the next phase, and we are already embarked on that journey.

Great. Just to follow-up on that, our impression of Sirona was they had great technology but didn't have a lot of recurring revenues. I'm curious if you agree with that perception? And if so, how do you fix it?

Yes. My understanding is similar to yours. And I think we have already taken a number of steps over the last several years to improve that cadence and, to your point, to make revenues more predictable, more recurrent. First step in that journey is we completely revamped the R&D organization. So we made the R&D spend and strategy a lot more cohesive, more clear. And we established frameworks to really assess the return on investment on those projects with the intention of, again, being more predictable with respect to launches, for example. And I think investors in general probably have seen how, over the last 3 years, our -- the number of launches we have brought to the market has increased. There's a nice chart that we normally show during the earnings -- in our earnings presentation, I show the progression of launches over the last 3 years. And that is a clear demonstration of the fact that the R&D engine is working better. And by doing that, our top line trajectory is going to be more predictable. The other thing is sales force effectiveness. So you need to have great products, right pricing and then the right sales organization to be able to deploy those products across our customers, going back to a point I made before about share of wallet. We want to make sure that the entire portfolio is available to each of our customers always, so that we can sell, cross-sell and really leverage the power of the enterprise.

Sounds good. Let's go back to the 3Shape partnership that you mentioned. I know it's brand new. Can you just elaborate a little bit on how it's going to work? Is it global or is it specific to a certain region? Is it active right away, or will it take time for some integration work to be accomplished before you can flip the switch, so to speak?

So first, it's going to take a little while before it goes live because of the -- essentially software engineers and commercial people of the 2 organizations need to come together and develop the integration of our softwares, which is essentially what this partnership is about, is today -- and the reason we're doing this partnership with 3Shape is because both companies believe in the importance, the power, the benefits of having open ecosystems. So our scanners are open to any customer, any other technology, and 3Shape believes in the same philosophy. Right now, you could use their scanner with our clear aligners, but there's a lot of manual intervention, downloading files, uploading other files. What we want to do is to make sure that we have the imaging software from their scanner talk to our treatment plan, our SureSmile treatment plan, so the clear aligner software with the imaging software are connecting seamlessly. That is the purpose of this collaboration. And we will be deploying this in all the markets where we have SureSmile and all the markets where we overlap over time. Of course, we'll focus on the bigger markets initially, but the intention is to -- because once we have that integration of software, it's relatively simple to replicate that in multiple markets. So we'll roll that out over time to the markets that matter the most.

All right. Sounds good. Let's switch to macro conditions. What are the latest bits of feedback you're getting from the sales force about how demand trends are going?

Yes. I mean, we talked a lot about this when we did our earnings call for Q1, and everybody is very optimistic. I think the fact that Q1 was as strong as it was in terms of revenue is a clear demonstration of views of the future. And I think what happened in Q1, and the reason why we had a strong quarter, and frankly, other people had a strong quarter, was because as we were wrapping up 2020, markets began to open up, the rollout of the vaccine gained a lot of traction, confidence levels went up. And as a result, there was a kind of, across the board, a replenishment of supply chains. So for example, take Dentsply Sirona. My inventory levels of raw materials, work in progress, finished products in Q4 were much lower than what they were in Q1. Why? Because my projections for the rest of the year, which we share in the form of our guidance, show a significant growth this year. And so we had to buy more to make more. And it's highly possible that that type of transition was happening across the entire supply chain. Distributors, dentists, the level -- the views about future demand were more positive, and so everybody was buying more. I think that -- I don't have any reason to believe that has changed since we announced earnings. And the trends for the most part are good. I don't think we are totally out of the woods. I think we've seen examples of situations that were looking good and then they got more difficult. We still have a few markets, not the most important markets for us, but a few markets are still pretty impacted by COVID; you have examples in Latin America, India, although -- again, India, for example, is immaterial for us. But I don't think we can claim that we are done with COVID. But for the most part, there's a good -- the trends are good.

Great. So if we think about last year, sticking on the same topic, generally I think we would agree that volumes were down, but sort of spending per visit was up quite a bit, which allowed the industry to do quite well from a revenue standpoint, even with lower volumes. So as we lap the pandemic, do you think that higher spend per volume -- or per visit trend can persist as we move through the year, or would you expect more of a normalization of some of the kind of classic hygiene visits come back?