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

All right. Good afternoon, everybody. Thanks for being here and welcome to the Jefferies 2022 London Healthcare Conference. I'm Brandon Couillard. I cover the dental space here at the firm. It's my pleasure to have Dentsply Sirona with us at the conference this year. Two new faces, CEO; Simon Campion; and CFO, Glenn Coleman, thank you both for being here.

Thank you for having us.

Thank you for having us.

Obviously, both of you have joined the company fairly recently. I would like to just hear why you decided to take on this task? And on the surface, it would seem that both of your respective backgrounds would transfer well to Dentsply's portfolio and current situation, right? You ran Becton's medical business, very diversified, global product portfolio. Glenn, you came from Integra, which is kind of a bit of a roll-up. What parallels would you draw from your experiences there that you think would comport to Dentsply's current situation? Maybe start with you, Simon.

Yes. So firstly, thanks for having us here. Dentsply Sirona is a good business working in a good space that's got reasonably attractive growth, reasonably attractive margins. And the Dentsply Sirona portfolio is pretty robust across its entire spectrum from capital to consumables. And obviously, we've had challenges this past year, which we're pleased that are now behind us, and we can look forward with confidence, and we shared some thoughts on that at our last earnings call. I think to your specific question about what in our backgrounds help us move this organization forward, I think we both come from a very operator-type environment. And I think that type of experience is what Dentsply Sirona needs where we're going to bring more discipline and more process across the whole spectrum of the organization from commercial execution to R&D, R&D investments and to operational efficiency. And our collective experience in those areas will help us advance the cause and enhance the hygiene, so to speak, around the organization. So we have plenty of opportunity to bring our experience to bear on the organization, and we've already kicked off many of those processes.

Yes. And I would just add from my perspective, one of the reasons why I joined the company was the huge opportunity I see ahead. If you look at where we are today and where we think we could be in 5 years from now, I think there's a huge opportunity, and that was a big attraction point for me coming to the company. In terms of my background, I think a couple of things are very relevant to what I've done in the past to what we're going to be doing at Dentsply. So I think first and foremost, I'd highlight M&A, did over 10 acquisitions at Integra, multiple divestitures. And it doesn't mean we're going to be doing a lot of M&A in the short term. I think we've got a lot of work to do to clean up our own house right now. But as we look out a year from now, 18 months from now, I would expect we're going to be doing some accretive M&A deals. But probably more importantly, why I wanted to bring it up is I've been involved in some of the most complicated integrations one can do. I'd highlight the carve-out of J&J's Codman business as one of those, which took us 2 years to actually integrate, but it was a very complicated transaction, huge amount of integration, and that one was done really well. We have work to do on the integration front still at Dentsply, specifically around the Sirona acquisition and some of the previous deals. And so, I think I bring a strong capability to make those integrations work successfully moving forward. You're going to hear Simon and I talk a lot about organization simplification, SKU rationalization, these are all things that we've done in our past and done them really well. And so, I think those are very relevant to what we've done in the past to what we're going to be doing in the future. And then one of my priorities is obviously working to come up with a next-generation ERP system. Today, we have multiple ERP systems. When I started at Integra, we had about 25 ERP systems and ultimately got down to one after 5 years of heavy lifting. So my immediate priority as it relates to IT is getting a plan in place to get to one ERP system and we'll talk more about that as we make progress towards it. But those are just some of the experiences from the past that I think can be very relevant to what we're going to be doing moving forward at Dentsply.

Since you mentioned that, how complex is kind of the IT infrastructure, the systems that Dentsply has maybe compared to Integra?

Yes, I think it's not as complicated as when I started at Integra. But when I left, just as an example, we had capability to get daily sales reporting down to the order level across every part of our business. I don't have that capability today at Dentsply. I think we can get there in a couple of years, make some progress towards doing that. But we get a lot of relevant information, but the timeliness, the comprehensive nature of it, and how it comes together manually versus to a system is things that have to get improved here. And so I would say, it's not as complicated as when I walked in the door at Integra, but certainly, there's a lot of work to be done to get it to where it needs to be.

Just in terms of diagnosing Dentsply's current situation, would you characterize it as a turnaround? Or is it more of a fixer-upper?

I think it's somewhere in the middle, as I answered in the first part of your first question. I think the bones of our organization, to summarize it, are pretty good. There's a robust portfolio. There's good, I would say, clinical knowledge and savviness within our commercial teams. And there's a robust R&D portfolio. Where I would say we need enhanced focus is general discipline, processes around, as I said, R&D and operations. We've already diagnosed some of the challenges that we faced in the North America region, and we're beginning to invest. We've already started to invest in the North America commercial region. And the work that we alluded to on Monday's call, around organizational transformation and identifying what a winning portfolio looks like, that is the type of hygiene work that I mentioned in my first answer that needs to be undertaken. So the bones are good. We just need to improve the hygiene of our organization in many respects, and that's work that has already commenced. And we will share more with everyone during the Q4 earnings in February.

You, on the call, talked about needing to, I guess, backfill some positions in North America, that being a seemingly one near-term priority. What would be the other top three things that you're focused on specifically in, say, the first 60, 90 days?

Yes. So I think my last answer is probably the same answer again. North America performance clearly has been a drag on our organization for a while. Notwithstanding North America, Europe has performed. LatAm has performed, and Asia Pacific ex-China has performed very well for us. So it's a North America commercial execution challenge that we are faced. The winning portfolio and the SKU rationalization is key moving forward. It will help increase our operations efficiency, it will help with cash flow, it will help with prioritization of such things as R&D projects and how we go about that. And then the third thing I would say is there's organizational transformation work that's underway. We have to set ourselves up for agility and for sustainable success and to begin to really integrate, Glenn said it earlier, really integrate Dentsply and Sirona. Dentsply and Sirona came up with separate organizations that grew through acquisitions of a variety of shapes and sizes and in the merger formed this super dental company as it were. But there's a lot of work to be done still around integrating the organizations from a cultural and systems perspective. And so they are the key priorities that we have moving forward from an organizational perspective.

Yes, I'd just say on the finance side, obviously, I mentioned the IT plan and next-generation IT system plan is top priority. But keep in mind, my first 6 weeks were getting all of our SEC filings up to date and the investigations closed out. And so that was a huge amount of focused effort that's now done. This IT plan is top of the list. And then playing into what Simon just said, all of the work we're doing around organizational structure, efficiency, SKU rationalization, building a really good credible 2023 operating plan, which will be shared on the February call, and obviously, we'll lay out more details around that. But I want to make sure what we communicate, we deliver and overdeliver upon as we go into next year. And we've got real operating plans supporting our financial forecast.

I think the biggest surprise out of the recent update is just the fourth quarter guidance. And to what degree is it just an abundant amount of conservatism given you guys have just kind of come onboard. First, is it reflecting some more troubling issues with the business in the portfolio? I mean you talked about fourth quarter core revenue growth being down mid- to high single digits, and that's with 3 points of pricing. So how did we go from being kind of flat organic year-to-date to the fourth quarter being kind of down mid- to high singles?

Yes. So I think when we look at the forecast for Q4, what we said was organic growth -- organic absolute dollars would be essentially flat to up low single digits. So the base business we're saying is going to be stable or grow slightly when you look at the organic business itself. Year-over-year, though, that represents a decline in the mid-single-digit range. So we're still dealing obviously with a lot of FX headwinds. 2/3 of our business comes from outside the U.S. So a stronger dollar has a significant impact on our top line and our reported numbers. And while that doesn't impact organic growth, it obviously impacts our profitability and our EPS numbers. And so we called out some of those impacts on our earnings call. As we look at the forecast, so listen, we're still expecting to see some challenges in China in the fourth quarter, combination of the zero-COVID policies, COVID lockdowns, and also VBP, so that's obviously impacting our China business. North America, while we've put plans in place, we're making the investments, as Simon called out, it's going to take us some time to get back to a better level of performance in North America, coupled with the fact that we had higher inventory at our distributors as we exited 2021. So we're bleeding down and burning through a lot of the inventory at our dealers and distributors. And so, we're expecting to be at really good levels entering into 2023, but that means it's probably going to be a bit more pain here in the fourth quarter. So on the whole, I think it's appropriately conservative when you consider those factors, the macroeconomic factors, seeing a potential slowdown in elective procedures, which would impact our orthodontics business, impact our implants business. And so we are being cautious in our comments. I think some of our distributors, some of our peers are being a bit more bullish, that's fine. But we want to make sure that we're being appropriately conservative in our comments.

About just on the operating line, Glenn, I think you pointed to maybe the fourth quarter being sub-15% operating margin. Is that the right jump-off point to think about for next year?

Yes. I think when we look at our operating margins, we didn't give specific guidance, but if you plug the model between the third quarter year-to-date numbers and full year, you come up with a sequential decline in our operating margins. And I do think that that's probably at or close to the low watermark as we go into next year. And the reason why I say that is we are going to be taking some actions. We'll roll more of those out in terms of what the specific plans are in February. But we're going to do the things we need to do and things that we can control to improve operating margins going into next year. And then hopefully, as the macro environment improves, we'll see that acceleration point in terms of our operating margins. But the latter part of that is still a question mark, but I think the things we can control, we're actually going to action on and do it with a sense of urgency.

You mentioned, Simon, needed to fill out some of the North America team and some investments there. In general, do you need to grow OpEx dollars in order to kind of restore the business back to sustainable long-term growth? Or should we think about OpEx kind of being relatively flattish moving forward?

What we said on Monday is the investments that we need to make in North America and in some of these functional areas, they're going to be OpEx neutral. We won't be driving up OpEx to drive those investments that we need to make to ensure the hygiene of the organization.

Maybe, Glenn, in general, maybe there's not a specific answer to this, but like how quickly can we get back to kind of a more normalized level of profitability? Is this a 5-year journey? Is it 3 years?

So when you say normal, what do you characterize as normal, just so I have the right...

Well, like, you know, like high teens, 20% type.

Yes. I think first and foremost, we want to stabilize our margins, which have been declining sequentially. So we first want to stabilize before we talk about moving back up. I do think with the actions that we're taking in 2023, with some tailwinds coming from the macro environment, whenever that is, so you can use whatever projection you want to use on the macro environment, the combination of those two start to get us back to an upward trajectory on our operating margins and we should start to approach those levels that you're talking about. But I think we'll do the things we need to do internally in 2023. And then the macro environment should get us to a further margin expansion because, listen, there's a lot of opportunity from a leverage perspective once we see the top line growing. And hopefully, the FX headwinds, which we've seen, dissipate and actually become a tailwind for us at some point. But it's been significant. Just to give you context, I mean, for this year alone, we're looking at a $300 million impact to the top line and $0.30 of EPS, which is a sizable number for a business our size. So obviously, that's impacting us negatively. And I think at some point, that goes away. And the combination of the other things should put us on a better path getting towards the numbers that you are quoting.

Simon, as you look across the portfolio, what are the areas of strength? And what areas, product lines or verticals, need work, either from a product positioning point of view or in terms of margin perspective?

Yes. So I think -- we have a broad portfolio, as you know, and I think we're pretty strong in the digital capital equipment piece. I think one of the areas that we are going to focus on moving forward, to answer your question in a slightly different way, is how are we spending our R&D money, so to get at your question in a different way. And we're now just beginning to get visibility to where our R&D money is allocated. So not to pick any specific group, but if I'm investing R&D dollars in a part of my business that the market is growing at 2%, is fully penetrated, and there's less or no opportunity for differentiation, then I have to question why will I be spending R&D money there. So that's the type of work that's underway right now to build out this lake of data that we need to get to these answers. And I would say that, that is a process that we're having to generate right now because the data hasn't existed up to this point. So we're kind of backing into it. But we spend in excess of 4% on R&D every year. The funnel is pretty robust. We just need to ensure that the funnel is robust in the areas that it should be robust in, in the areas that have got high [indiscernible], in the areas that have attractive GPs, and in areas where we can truly differentiate ourselves going forward.

Are divestitures at all on the table? Or is it something that could be likely or you might consider?

Yes. Listen, we're taking a complete look at our portfolio from divestitures to SKU rationalization to family. So I would say there is nothing that is off the table right now. We're halfway through, I would say, a comprehensive review of the strategic fit of some aspects of our portfolio and the SKU optimization piece. And as Glenn said earlier in one of his statements, both he and I have got experience on the SKU piece and the benefits that I can confirm on the organization with respect to cash, with respect to network optimization, with respect to manufacturing efficiency, and indeed with respect to the clarity of discussions between a sales rep and their customer or ourselves and a distributor. So there are lots of benefits to optimizing the portfolio.

I'd like to just ask you specifically about the Byte business. Obviously, it predated you guys coming onboard. Are you committed to that market, the DTC aligner market? And if so, like what's the pathway to sort of profitability?

Yes. So while we weren't part of the acquisition, we do feel that having a full portfolio on both axes of continua in the dental market is important. So we're a full line supplier to the dentist in terms of all the options that they need and addressing the patient. No matter how they come into dental care, we think it is something that we can leverage. I think also importantly is, we do feel, and when we began to work on it, that Byte can bring more people into dental practices to improve their oral health generally and to expose them to more treatment options that they may need, such as preventative or restorative or whatever. So we've began a process to partner with the dental community in relation to Byte itself. And in relation to profitability?

No, I'd just say, first and foremost, both of these businesses that we have, Byte and SureSmile are performing well. We've got good momentum. Each of the businesses actually grew sequentially each quarter in 2022. SureSmile, which is our in-office product, has had double-digit growth each quarter in 2022. And we expect to see another strong quarter here in the fourth quarter. Byte demonstrated year-over-year double-digit growth in the third quarter. For the first time this year, we saw that type of growth year-over-year because we had first half of the year tough comps. But we do feel good about the progress we're making and momentum in both parts of our business. And together, they are becoming a more meaningful part of our overall portfolio. Our ortho business today is around $300 million when you annualize the sales between the two product families. So I think you hit the nail on the head, how do you make these businesses more profitable and accretive versus dilutive to our operating margins. And I think there's opportunities that we're looking at to make that happen. But for now, I would just say they're core to what we do. Very attractive from a top line perspective. These are underpenetrated markets. And so the growth rates are very attractive.

Just in terms of the split on that, how does that break down between SureSmile and Byte, rough number?

I mean roughly, Byte is a little bit larger than SureSmile on the $300 million.

Okay. That's helpful. It would be helpful maybe just touch on China, just size that market overall and then your exposure to VBP and implants?

Yes. So China, and I'll use the 2021 reference point. We said it was 5% of our consolidated sales. So on $4 billion, call it $200 million. Our implants business, which is the business that's vulnerable to VBP is about 25% of sales in China. So call it $50 million. And then there's some subset of that that's not impacted by VBP. So I would say, from a revenue perspective, about $40 million to $45 million is going to get impacted by VBP. We predominantly sell through the private market, not the public market, but we still think that there's probably a haircut coming that's 40% to 50% on the top line. A portion of that will be borne by our dealers. We're expecting to bear about 30% or so of the haircut. So if we do 30% on, call it, $40 million, we think it's somewhere between a $10 million to $15 million top line impact. And obviously, that flows through to the bottom line since it's all price. I think on the positive side, we do expect to get more volume as we go forward. So we don't know exactly what that looks like. Can we fully offset the price reduction? Don't know yet. It's too early, but there should be some positive coming once we get to the bidding process and actually increasing our volumes in China.

You mentioned earlier that obviously, we entered this year with a ton of excess inventory in the channel. What's the current view on channel inventories right now? Are they balanced? Are there still more to burn off?

Yes. So when we talk about our inventories at our distributors, we really talk about CAD/CAM equipment and we mentioned at the end of 2021, we had about $50 million of higher inventory levels at our distributors for CAD/CAM equipment. We have, throughout this year, taken down that level of inventory. So if I look at where we are at the end of September versus end of the year, we're down $30 million. I think it translates to about 60 days on hand lower. And we're continually taking that number down. We did see a slight sequential increase from Q2 to Q3, largely in anticipation of DS World. But we expect to see our inventory levels continue to come down here in Q4. And I think the good news is as we go into 2023, we're going to be in a really good place relative to our overall distributor inventories on CAD/CAM. The way to think about it is a lot of the retail sales that our distributors are seeing, we're not seeing because we're not putting more inventory through the channel, right? We're going to wait for these inventory levels to come down to very low levels before we do that. And that should happen really in 2023.

Once again, just touch on capital allocation. I mean, you've got, I think, $700 million left on the buyback plan. Should we expect you to be active on that right now? Or any anticipated changes to the capital allocation framework?

Yes. No, thanks for the question. We have $740 million of authorization under our share repurchase program. When I think about capital allocation, I think, first and foremost, we've got to figure out how to generate more cash flow for the business. I think this business is a very healthy cash flow business, even with some of the challenges we've had short term. But there's more opportunity to do better when I look at profitability, inventory turns, CapEx reductions and moving past one-time cash outlays associated with the investigation and all that. So I do think there's, first and foremost, more opportunity to generate better cash flow and generate on a year-to-year basis 100% free cash flow conversion using our adjusted net income numbers. In terms of the allocation itself, I think our first priority is to make sure we're providing the right level of investment organically and North America sales will be a great example, R&D, et cetera. But we do expect to return at least 50% of our cash flows to shareholders through dividends and through share repurchases each year. And so that's the way we've looked at our capital allocation strategy, and that will continue as we move forward. And given where the share price is at right now, it looks quite attractive. We'll have to figure out whether it makes sense to do more. But I think for now, no change to what the previously communicated capital allocation strategy is. I think the only message I would highlight is we need to do more around further improving our cash flows, which have been quite good, but I think there's more opportunity.

Great. Well, unfortunately, we're out of time. So I'll have to leave it there. Look forward to all the progress next year, and thanks for being here.

Thanks for having us.

Thank you.