Envista Holdings Corporation (NVST) Earnings Call Transcript & Summary

Good afternoon, everyone. Thanks for joining us. My name is Nathan Rich, and I cover the dental space here at Goldman. We're very pleased to welcome Envista to our conference today. I'm joined for this session by Amir Aghdaei, the company's President and CEO; Howard Yu, CFO; and John Bedford from Investor Relations. Before we jump in, I just wanted to remind everyone in the audience that if anyone would like to ask a question during the session, you can do so through the webcast or you can e-mail me at [email protected], and we'll try to get to your question at the end.

So first, Amir, Howard and John, thanks so much for joining us today. We're really looking forward to the discussion. Amir, maybe to start, yesterday, the ADA put out its latest survey of U.S. dental practice trends. I think it showed that 90% of practices are now open in the U.S. Patient volumes are trending about 53% of pre-COVID levels. It seems like this has improved from where we were in May and certainly where we were in April. I guess since -- in the few weeks since you guys have reported the first quarter, can you maybe just share your view on how you've seen the market progress?

Thank you, Nate. Thank you for inviting us. Headline for us is encouraging. Honestly, if you would have asked us 4 weeks ago, we would have had a very different perspective on it. We are really encouraged with what we are seeing. A gradual recovery much better than what we anticipated. We were prepared and continue to be prepared for worst-case scenario in case if that's in the cart. We're seeing a slow recovery, but we are seeing it around the world. So about 15% of our business is in APAC, including China. That geography is a lot further along in a recovery curve. China saw this a lot faster than anybody else. As you well know, they put a lot of structure around it, and it's getting to more of a normalized range in here. It is a lot more improved from what we saw back in March, and it's a gradual improvement week-after-week, day-after-day in China and in APAC. About 20-some percent of our business is in Western Europe. About half of the businesses in Europe are open today. And they are beginning to open more and more. Some geographies are a little bit ahead of the rest, like in Nordic as well as DACH in Southern Europe that's taken a little bit of a slower transition over time. But even France is much better than 4 weeks ago. U.K. and Southern Europe are the slowest to recover as what we have seen by geographies. In North America, which is about 50% of our businesses, in 48 states, offices are already open. We have a very clear view of geography-by-geography as well as the DSOs. Some of them, up to about 90% of their offices are already open. Patients are coming back slightly. There is enthusiasm on part of dentists to be there as quickly as they need to. They're more than willing and enthusiastic to work after hours, extended hours in order to get back to normal. We're seeing a huge variation by states. In Northeast, a lot less activities than in Central or in South and as well as some pockets of recovery around California. Overall, we have seen a significant increase in demand in the last few weeks. As you recall, we called April to be the trough. It was minus 60% at that point. It was the bottom of what we saw. May was a lot better than April, and we are beginning to see a gradual improvement in the month of June, and we're really encouraged as what we have seen in the past several weeks.

Thanks for that. The detail is really helpful. Going back to Asia Pac, you mentioned that China was a lot further along. I guess, I'd be curious to know kind of where volumes are maybe relative to the pre-COVID baseline in China and for practices that have been open the longest. I mean have you seen volumes continue to build at those practices, the longer they've been open?

Yes. So private practices in China opened a lot quicker than public hospital. Nate, 50-50 is a good ratio to think about. 50% of our business in the market is on the private segment and 50% on the public. And one of the things that we saw on the public side, because a lot of those dentists were deployed to Wuhan providences and a lot more restricted setup, it took a little bit of a longer to open and to recover versus on the private part we saw a quicker recovery. So that's one dimension. The other one was by providence and specific by procedures. So up to about the beginning of May, really there were restriction about placing an implant. After the Chinese National Convention that happens every year, certain new rules were put in place and now implant is beginning to ramp up fairly quickly. In summary, the equipment market is recovering a little bit slower because some of the RFP, some of the investment has been put on hold. The consumable auto implant, restorative, day-to-day activities is ramping up a lot faster. So year-over-year, we are still recovering, but that recovery is gradual and is steady. Now that really is encouraging to see that. That it's not a pent-up demand at one time that goes away, it has been steady, and we are beginning to see that take shape and normalize we are hoping in second half, we'll be in a much better place than what we have seen since the beginning of February.

That's helpful. And you sort of touched on this next one, but whether it's from a category perspective or a procedure perspective, I guess when you've seen the increase in demand, has there been anything to note from either a procedure or a category standpoint?

Yes. So let me just break down our business for you a little bit. About after some of the changes that we have recently done, 85% of our business are considered either consumables or products that have an ASP of less than $5,000 that does not -- they do not require installation. This is a really important factor, Nate. For a dentist to go back to work, for offices to get back to normal, they need to have this set of product on a day-to-day basis. Inventories have been as low as I have ever recalled at the end of Q1. So there is an opportunity for that -- for us to offer a whole set of capabilities, working with our partner, getting these dentists back to work as fast as possible. We think that other 15% that is more of a capital equipment has a slower ramp to recovery. And reason for it, if you need to buy a new treatment unit or a large, expensive 3D image, I think that can wait another month or quarter. But if you need to run your business to take care of your patient, you really need those consumables. You need the implant. You need the ortho product to be able to do that today and as soon as the patients ramp up. The office opening has been a lot faster than what we expected. Now it is all up to the patients how comfortable they feel and what the economical situation look like for that ramp, that recovery to take hold.

That's great. I appreciate all the detail on the current market trends. Maybe taking a step back, I wanted to ask around the long-term framework that you laid out for investors at the time of the IPO. Maybe starting with portfolio optimization, it's been a point of emphasis, something that you've been working on the past several quarters with changes to the treatment center business and in the value implant business. You've also invested more into digital impression. Can you kind of just talk about why these were sort of the right moves to make for the business? And how you see that positioning the company over the next several years? And any other kind of categories that we should kind of keep on the radar for where you could either have a bigger or smaller presence over time?

Yes, pretty good. We outlined a set of principles for the new company. Envista is going to be a company that grows faster, has higher margin and its ability to do M&A. That was the principles and foundation of separation from Danaher. We want to be in the businesses that have higher margin, higher growth and more direct. So you take that and say, okay, I'll look at the portfolio that we have. We have said about 4% to 5% of our business not growing under tremendous amount of pressure, distribution focused and really doesn't have a whole lot of competitive advantage. And we have said, at some point, we wanted to take advantage of the dynamic and rationalize that portfolio. So we have done that now. In the past 4 or 5 months, we have put in place a set of moves that take about $120 million to $130 million of our business that really was not adding a whole lot to our margin, to our EBITDA. It wasn't growing at all and had significant amount of cost structure associated with it. We are exiting that business by end of Q2. We have committed that we're going to take about a $60 million cost out of the system over the next several years. We're going to take $100 million cost out -- permanent cost by end of this year. So you take a look at a simple compare $120 million to $130 million business that had no EBITDA, no margin, about $100 million permanent cost coming out while protecting all the growth initiatives, while being able to position ourselves on a different format. I would like to remind us all that we have been independent for over 5 months since December 18, where Danaher floated the remaining 80% of the shares. Since then, we have joined partnership, multiple of them. We have bought a small company in a regenerative, and we have made some of the decisions that we said that we were going to make. We're going to come out of this a lot stronger. We have continued to invest in N1, in Spark, in infection prevention, while trying to size the company in a different format. I think we are going to be able to close some of the margin challenges and gap that we have at the beginning, and we're going to position ourselves in a much more aggressive format for growth as we go forward with new products as well as changes that we have done in the commercial organization.

That's helpful. Maybe just following up on the margin point, either Amir or Howard. What do you feel like it's going to take to close that margin gap? And when we think about the $100 million of savings, the run rate that you expect to achieve by the end of the year, should we look at that savings amount being incremental to sort of where you ended 2019? And if so, it would seem to imply sort of like a high teens type of EBITDA margin for the business, assuming we're sort of -- we get back to a normalized environment? And obviously, a lot of ifs around how that gap looks. But is that -- in a normalized operating environment, is that the right way to think about the business?

Yes, Nate, this is Howard. Thanks for the question. Yes, I think that is the right way to think about it. One of the things that we talked about before we went public was around closing the margin gap between ourselves and some of our peers as well. And we talked openly about that at that point that, as Amir said, $60 million of takeout over time, we had targeted 2 to 3 years. And what we're really doing here is fast forwarding and getting to the future in 2020. And so taking advantage of this opportunity to go ahead and rightsize the company, substantially improving on the footprint overall with regards to our facilities, reducing some of the complexities that we've had in the organization, span of control and the like so that we can more focus on our customers and our business. And really resulting in, as we talked about during the earnings call, a 10% reduction in our workforce as well. And so I think we are definitely accelerating our efforts to go ahead and close the gap. And as you indicated, if you look at it from a 2019 as a normalized year, that does close the margin gap substantially.

And then, Amir, M&A had been a key part of the story as well. I don't know if it's a little premature to talk about it in this environment. But can you maybe talk about how big of a priority is that for you today? And what areas do you think could be attractive?

Yes, absolutely. So it's a standard process, something we inherited from Danaher, and we're executing moving forward collectively. We started by looking at the market. When I said, what are the market trends? What are unmet needs? And then within that market, we look at all the companies and understand dynamic of each one of them, try to figure out what are added value to them would be, and this cultivation is an ongoing process that we have been doing. I've been doing, Mischa has been doing for the past 5 or 6 years. What we are seeing is an opportunity to really accelerate that. As you can imagine, there is a little bit of a pressure on smaller companies in here. And I think that we will have an opportunity to be a lot more creative in here. And let me talk about that a little bit. We joined partnership in multiple places, early investment as a method for us to really accelerate this M&A moving forward. We think we're going to come out of this not only stronger, but in a much better place in order to be able to add to our portfolio, specifically where the growth trajectories and opportunities are. To be specific, we think that in emerging market, we have opportunity to expand our presence in implant as well as on clear aligner. We have an opportunity to do organic development as we have done, but also do inorganic activities to accelerate the growth. We have the license to do that. We have the right to do it because we are present, we have relationship with customers, we can add to that capability by doing M&A in order to be able to do it a lot faster to create value a lot quicker. It's going to be part of our story as we go forward. We're getting ourselves ready for it. And we're hoping to be able to have a much better portfolio that would allow us to do that a lot quicker as we come out of this.

That's helpful. DSOs was another growth opportunity that you guys have consistently pointed to. You had good performance with kind of the top DSOs in the first quarter. I think that part of the benefit there was some expanded relationships that you've had. So can you maybe just talk about those specifically kind of where you're seeing traction with that customer base?

So as you said, top 10 DSOs, last year, we grew double-digit with them. In Q1, we grew high single-digit with the top 10 DSOs in spite of all the challenges that we have seen. The last 3 largest RFPs and implant, we have been the winner of all 3. And it is not by accident. It is an outcome of significant amount of work and partnership, a team that is dedicated to DSOs, understanding and serving their needs, understanding that they are putting a tremendous amount of investment, opening hundreds of offices, hiring hundreds of dentists, and their intention is to democratize dentistry to bring it to masses. And we think that they have a really good cause that we can be a supportive partner with them, champion their cause and make them successful. So where do we add value? By training, servicing, helping them to expand their already capabilities, improving the approval rate, case approval, doing more services. So as they do more implant and ortho and endo, they can monetize the investment. Improve their retention because those dentists, if they get to do kind of an innovative, creative work that they can expand their skills, the likelihood that they stay is a lot higher. But also offering them creative methods in order for them to be able to not only improve what they do from productivity, but also create more opportunities for the industry as a whole. So going back to the DSOs, what have we been doing with them? A lot of remote training, education, partnering with them around infection prevention so we can help them, teach them to do that a lot faster, a lot quicker. Offering a whole set of back-to-work packages that allow them to ramp up pretty quickly, pretty fast. And continue to show them and teach them and share with them the investment that we are making in innovation around software, around cloud, around integration. I think all of that would come in place. DSOs, they are professional organization. They have procurement, they have distribution, they have IT organization that can bypass many steps in the process. The cost of service for us is a lot lower because we can drop ship in a central warehouse. We can train hundreds of people at once. As an outcome, I think it is going to be an important part of the industry, important part of our partnership with them and important part of our growth going forward.

And it seems like a lot of the traction has been on the specialty side. You mentioned the implant RFPs that you recently won. I mean do those relationships maybe open the door for doing more on the equipment or consumables side? Is that sort of an opportunity to kind of get a kind of bigger share of wallet within these DSO customers?

I'm not sure I mentioned that, we have had RFPs around imaging that we have been the winner as well. Not only the new one, but also replacing some of the older equipment that they have. Yes, absolutely, your assessment is absolutely correct. When you go in there and you act as a partner and your intention is to help them over the next 4 or 5 years, there's a different relationship forms that is different than trying to kind of a show up and win the last deal. We are in discussion, a strategic discussion of what the next 3, 5 years look like. What did they try to accomplish and how we can play and help them, help their people, help their processes, help their tools to become a lot more effective. Build the infrastructure software platform for them that connects all their capabilities together, that they can move 1 patient from 1 office to the next, that they can retain the information of the patient history in 1 place online using the DTX. So it's a lot broader than winning 1 RFP. It's about making each other successful and getting that joint partnership really impact the industry as a whole.

That's helpful. Moving over to the new products that you guys are working on, maybe starting with Spark on the ortho side. You mentioned it driving kind of 50 basis points of growth in the first quarter. That was consistent with sort of the full year outlook that you gave. For the cases that you're doing right now, how are you seeing orthodontists use Spark in their practice? And could you comment on how many docs you have trained on Spark at this point? Or what percent of patients within their practice are maybe treating with Spark right now?

Yes. So they use it for all cases. All the cases that they use, they use Spark today. It addresses all their needs. That combination has been a really important part of bracket and wire in Spark. The number of cases that we get, so just give you a little bit of feel, China got approved both from a clinical perspective as well as from a manufacturing approval took place in December. The number of cases that we are getting today in China, equivalent the number of cases that we got back in January. The number of cases that we are getting outside China is almost the same as the number of cases that we were getting back in January. So we have seen that recovery slowly coming in. We are building capacity to be able to do a lot more as we go forward. At this point, we are building capacity not only for 2020, but also for 2021. As far as the number of dentists, we have talked about a phased approach. We keep signing at 1 phase. We bring them up to speed and make sure they get to the 3 case and then we go to the next phase. Back in February, about 750 of our Ormco customers showed up. This was one of the very last face-to-face meeting that we have had. And a lot of them, they were sharing what they have done with the Spark to their peers. We got dentist that has done over 100 cases of Spark over the past 18 months. They were showing and comparing that versus other cases that they have done. We have a large number of people that they volunteered and they wanted to be part of the program. Unfortunately, the past 2 or 3 months has a slow signing new dentists, but we already know that we can start adding more and expanding this going forward. Nate, I'm not exaggerating if I say that this product stand on its own. It is a product that is as good, if not better, than anything that is in the market. Add service and support, relationship, local presence to that and price competitiveness, then you would see that you got a product in here from a company that you trust, that can -- you can really build the business around it. We're excited about it. We think this is going to be an important part of our growth momentum as we come out of the pandemic.

Yes. No, I mean, it certainly seems like a pretty big longer-term opportunity like you mentioned. I guess, like can you help maybe frame that for investors? I don't know if you could maybe talk about sort of the Ormco user base. And I would think that one of the obvious opportunities is kind of getting them to integrate Spark cases into their practice where you already have the brand name and the recognition with them?

Absolutely, happy to do it. The bracket and wire is about a $2 billion market. It's -- I go back, take a look at the past 3, 4 years, that market is flat to low single-digit growth. In 2018, second half 2018, 2019, our bracket and wire business was growing mid-single digit. The reason for that growth is innovation. The Ormco business in 2017 or so, less than 5% of it came from product that they were less than 3 years' old. At the end of '19, over 20% of our business came from product that's less than 3 years' old. So we put a lot of innovation, revitalizing that portfolio, Damon Q2 and many other products. Education, training and education. The transitional bracket and wire business is a business that you have to teach people how to use. They have to learn it from experts. We did a lot of education, we continue to do that. And then emerging markets, a really important part of this equation. Russia, China, other geographies were fuel to the fire in here, growing the Damon, growing the Ormco bracket and wire business. We have about 17% to 18% market share. Now if we come to clear aligner, $2.5 to $3 billion market, growing double digit, 3 segments. And for the sake of argument, let's assume each one of the segment, the size is equal. 1/3 of that is direct-to-consumer. We're not interested. We're not participating. 1/3 of it is the general practitioner market that they're using clear aligner to expand their market. That's not our target. Our target are orthodontists. That 1/3 of the market that has double-digit growth that they know us. We have relationship with them. Over 90% of our business comes from them. That's what we are going after. We're giving them a choice. From the same company that they know, the same people that they have dealt with, the same people they can trust. That product, that choice is as good, if not better than what they are being offered today. And they are beginning to use that more and more, a small number of customers. We're a lot more interested in a small number of orthodontists doing large number of cases. And that's what we are going to build this business around, that would be our [ B shift ] to continue to expand and grow that. That $1 billion market is growing very rapidly, double digit. Getting a small share of that market is not unfeasible for us. We think this is going to be a big part of our growth vector as we go forward. We're not happy with the 50 to 100 basis point of growth in Spark. That's the starting point. I think this would be a big part of our business, combination of bracket and wire and aligner, that combination is unique plus at some of the imaging software, infection prevention to it, we have a combination that really makes us different than anybody else in the market.

And what's the pricing strategy going to be around Spark? You obviously mentioned it was a premium product. Unlike some players that are out there, you also have the wires and brackets business. I don't know if that creates an opportunity to do bundling. But can you just talk broadly about how you're thinking about pricing that product relative to the other options that are in the market?

So maybe we look at it from a dentist perspective and then I answer that question. Putting somebody through a clear aligner, for a dentist, they would ask the same amount if they put them through a bracket and wire. But what they pay, what a dentist pay is almost 3 to 4x higher for a clear aligner versus bracket and wire. And the reason for that and the time that it takes is 12, 18 months, 24 months for that correction and getting that beautiful smile. The reason is all about [ share ] time. It's all about the number of times that you have to go to office and sit and get support. Clear aligner, every 2 weeks, you can do a virtual consultation. You get a new trade and then you continue that. And once in a while, you go and make sure that you have a true view of what is taking place and if there is any adjustment that you need to do. Under bracket and wire, you've got to continuously go in there and be there. So 3 to 4x price difference, but from a monetization perspective, profitability perspective, an orthodontist makes almost the same amount of money, but their intention is to give you the best possible answer. So from our perspective, the clear aligner add into our portfolio, not replacing it. And when it ramps up, it would have the same sort of margin structure as our clear aligner. It's going to take some time, and we are making investment. But our view is that this is going to be another couple of hundred million dollar business over time over the next 3, 5, 7 years, with similar as a fleet average that would be another growth vector for us.

That's great. I wanted to also hit on implants. Maybe before we get into N1, just starting with the premium portfolio. The performance in the first quarter, I think, was kind of up mid-single digits before COVID hit. I believe that's stronger than the last several quarters. So can you just talk about what drove the improvement there? And specifically, any changes you made around the sales force or how they go to market?

Exactly. So we have done a lot of homework back in 2019. And over and over, we heard the same thing from our customers. A product that is out there, current product, it's as good as any. In fact, some of these products like -- NobelActive has been out there for what, 12 or 13 years, and it's the most used implant in the world, most copied implant in the world. And it's still a premium product that everybody trusts and uses. So we were wondering, then why is it? If the product is not an issue, price is not an issue, it's about customer experience, Nate. We found out more and more as we started digging in. We found out that we have some really challenges around customer experience, around customer service, around training and education. And there are some of the very basic necessities on dealing with the escalation cases. So back in Q3, we recognized that timing is now with N1 coming for us to make those changes. We changed the leadership structure in North America and Western Europe. We brought some of the people that we really trust, proven track record. And we started delayering the organization, started making some changes. On January 1, we put a new president in place. And as we mentioned, in January and February, we had a mid-single-digit growth in North America, Western Europe. During the last 3, 4 months, it has been really apparent that taking care of the customers, answering calls, doing training and education has been really important. Normally on a yearly basis, Nobel symposium attracts about 1,200 or 1,300 people. This year, in spite of that it was virtual, we had 12,000 people attending Nobel symposia. A really good start. A lot of good feedback about opportunity that we can improve this further. And we are beginning to hear and see that, that opportunity is right in front of us with the product that we have already. With N1 coming, we can really change the dynamic of Nobel as we go forward.

And what does the launch process look like for N1? Now that you have the CE approval in Europe, I think you got your first order in Germany last month. How do we think about kind of getting dentists trained on this product and getting them to start doing cases?

We've just talked about Spark, Nate. We brought a small number of orthodontists. We made them part of the process. We use that as a launching pad. There have been tens, if not hundreds, of dentists that they have been using N1 in the past several years. That they have been placing implant, they have been getting the clinical information from them to get that approval to protect the IP. So to begin with, we're going to use this core group of current customers that they are familiar with it. They know what that product is. Those that they have placed order, these are our already current customers. And our view on it is, if you placed in 5 or 6 implant today with N1 because of the ease of use, because of healing time, because of the fear that is going to be lower, you would be able to place 6 or 7 implants. So existing customer would be a starting point. We will start with them. And then we rapidly carry that a step-by-step, at other groups, at the next group and let people come and ask for it and continue to extend it. We are building capacity now to be able to serve Europe. We think this is going to be an important part of our growth story in 2021. And with the approval in the U.S. at the end of 2021, we'll be in a far better place as we go through 2022 growth story around implant, combination of commercial changes we have done, plus new product, add M&A to that equation, I think we would have a powerful implant story as we go forward.

Great. And Howard, I'd be curious to know now that the value implant rationalization is kind of behind you or largely behind you, you're kind of ramping up the premium side. What's the mix within the implant business between premium and value going to look like going forward? And are there any meaningful differences in margins between those 2 businesses?

Yes. I think, Nate, that obviously, the vast majority of our implant business still resides on the premium side. And so in the short term, we don't think that, that's going to change drastically. Clearly, we've committed to both the premium and the value, and we're really excited about this innovation that Amir's talked about in N1 and what that will bring to the premium side and what that might help even as it relates to the pricing specific to that piece as well. As it relates to the margins between value and premium, I think that the margins are fairly similar. Clearly, we do a lot more support services on the premium side. And so by the time you get to the operating margin line for each of these, they're pretty similar and still both better than the fleet average for Envista as a whole.

And last one on implants, Amir, do you see the competitive landscape changing at all? Obviously, during COVID sort of the implant businesses across the board were under pressure. Do you see any change in the competitive landscape coming out of this based on what you've seen so far?

Yes. So the -- I'd just roughly say, half and half. Half of it is premium, half of it is value. Obviously, a lot more volume on the value side. There are very few players on the premium side. There are hundreds of players on the value side. I think you're going to see some consolidation on the value side and some of the smaller players having a little bit more of a difficult time. And maybe more open to some creative ways of managing the business going forward. I think that's what we can expect in the next probably several quarters to see if there are changes. I think it's more likely that it's going to happen on the value side of the business than the premium.

Great. And maybe just one last question as we look to wrap up. Kind of once we get through COVID, could you maybe talk about priorities from like a balance sheet perspective? Howard, where do you see leverage landing? And where -- what would your kind of ideal kind of leverage target be? And how will you guys balance the priorities between taking advantage of M&A opportunities that might come up versus reducing debt and getting to that target leverage?

Yes. So we will certainly take a balanced approach here, Nate. I think that we do have a covenant, basically holiday, until the second quarter of 2021, where we do need to get back to that leverage ratio of 3.75. As a reminder, I mean, our business under normal conditions certainly generate a substantial amount of cash. We talked about over $1 billion of free cash flow over 3 years. And so clearly, that will provide us a lot of flexibility as to whether or not we want to pay down a substantial portion of that debt or whether we want to utilize that, as Amir said, to make some M&A and inorganic activities. And so we certainly are bullish about both those prospects in terms of what we can do. Short term, certainly, we have line of sight to go ahead and get to the covenant and leverage ratios that we need to get to. Even as it relates to paying back or paying down some of that revolver that we have, we'd be looking to do that here over the next quarter or so as well.

Great. Well, thank you guys very much for joining us. We really appreciated the dialogue. And thanks, everyone, in the audience who joined the webcast. Take care.

Thanks, Nate.

Thanks, Nate. Bye-bye.