Envista Holdings Corporation (NVST) Earnings Call Transcript & Summary

Hi, everybody. Thanks for jumping on. Steve Beuchaw here from Wolfe Research. We're doing the virtual thing, of course, here with our conference here in year 2. As you may know, I'm 1 of 5 Wolfe analysts, and we're really happy -- in health care that is. And we're really happy about the lineup that we have this year as we've gone to a 2-day setup. And we're having a lot of fun with it. Our first company within my broader coverage here at the conference is Envista, which has been a fascinating story in terms of the way that they've managed through 2020. We have the full brain trust with us. We have Amir Aghdaei, the CEO; Howard Yu, CFO of company; and John Bedford, who runs IR and has a dual mandate, including some FP&A as well. So thanks, everybody, for being here and for managing to pull 3 laptops together into a single conference room to accommodate our software. Really appreciate that.

Well, what I thought I might do to start given how much has happened this year is give you a chance to just frame up how do you introduce Envista to investors given how much has changed this year. We all went through this exercise about a year ago -- a little bit more than a year ago as Envista was becoming a public company. And for many of us, we knew Envista for quite a long time given Envista's visibility from within Danaher. What I thought you might want to do, though, is just start and say, okay, now that we know more a year later about how the product portfolio is shaping up and what we've been able to do on the margin front given the restructuring, how do you introduce Envista as an investment opportunity to someone who's newer to the story?

Yes. Thank you, Steve. Appreciate the invitation and getting very creative, having the social distance amongst us and 3 different laptops. So September of last year, as you said, was the beginning of the formation of Envista independently traded company. At the time, we talked about 3 dimensions. We thought this new company would have better growth momentum, higher margin and a portfolio that is different than what we had before. And the rationale behind it was the independence gives us an opportunity to make decision a lot faster, respond to the realities of the market. And then the free cash flow that we had in the past gives us an opportunity to do M&A in a smaller segment. In a $3 billion company, that $100 million acquisition would then make a huge difference a lot faster. So as you well know, we've been dealing with the past 6 or 7 months the pandemic. But what we did -- nothing really about the thesis of the company has changed. So we started by looking at the portfolio to begin with. We said there are pieces of this portfolio that really don't fit into the integrated workflow. They're not growing. It is -- the margin really doesn't help us in the long run. So it took about 5% of our treatment unit primarily in North America, Pelton & Crane as well as in Brazil and kind of shut that down over time. And that process is almost complete. The last orders came through in Q2 and basically exited that business. About 5% of the portfolio and a little bit more in some of the categories that had the same sort of characteristic, low margin, low growth, commodity type. Think about it in this format, about $100 million worth of business that has -- was declining and basically had no margin in helping us from a portfolio aspect of the company. We exited that segment. We're able to take a look at the cost structure of the company, and we wanted to make sure that we take advantage of the opportunity, set ourselves up, close the gap versus our nearest competitors, but also invest in the growth opportunities. Unfortunately, but the realities of the business, we were able to -- about 10% of the sales force -- I'm sorry, 10% of the entire company exited through that process. We made a commitment of saving about $100 million permanent cost in 2020. In the Q3, we have accomplished about $80 million of that, and there is more to be done in Q4. So exiting that portion of the business, reducing the overall cost structure really put us in a better position that we could invest in the growth initiatives. What growth initiatives we have been focused on? The #1 priority is, specifically during pandemic, has been the infection prevention business for us. Just to set the frame, that's about $150 million to $200 million business in 2019. We made significant investment in that area, doubled the capacity, has been growing over 30% in -- throughout the year. And we have significant backlog. Just to give you again a little bit of feel, at the beginning of Q4, we had about $30 million of backlog in that space. So infection prevention is a big part of the growth, about 200 basis point of the growth opportunity. We invested in Spark Clear Aligner, it's about 100 basis point of a growth for us in second half and wrapping up really quickly, really fast, and that's really a positive story for us. And then on implant, purely through introduction of a new generation of implant, we call it N1 that is introduced in Europe, ramped that up as well. So combination of a growth initiative, the intention of getting us to mid-single digit over time is exactly what we have been able to accomplish. The margin, as you have seen in Q2 and Q3, we've been able to get ourselves in high teens. And that's what we wanted to do with EBITDA close to about 20% in Q3. And then the portfolio management, creation of a better portfolio that's integrated as well as having the opportunity to start doing more and more acquisition as we go forward. We highlighted that back in September. 14 months later, we can look back and say we have done a lot of things that we said we were going to do. And we are in a really good place to continue to execute going forward. Putting it all together, I think as hard as this pandemic has been, really accelerated a lot of things that we wanted to do. So we feel good about our position, we think there is a lot more to come in here.

So just to put a finer point on it, I'm going to want to talk to Howard a little bit about the margin outlook. But before we go into some of these details, if I think about the progression over the last year, when you were giving your perspective about what the top line growth outlook might be, you hadn't really seen the full Spark launch yet. You weren't yet working with 3Shape, you hadn't made the change with Pelton & Crane and you hadn't seen some of the traction with N1. So you know a lot more now than you did then. I wonder, has your top line sustainable growth perspective changed at all? Or is it still basically in line with where we were circa 12 months ago?

So obviously, the environment that we have been going through has been a really dynamic and difficult to predict it. We were minus 48% in Q3 and minus 1.2% in Q3 -- I'm sorry, in Q4, minus 48%; and in Q3, minus 1.2%. We saw a progression improvement month after month, starting in April. April was a bottom at minus 80%. We saw progression taking place, and that has continued. And we have seen that progression continue through Q4. The challenge, Steve, is the uncertainty that we are dealing with. You hear a lot of information about rise of cases. What we see, what we know is offices continue to stay open. People are cautiously optimistic about what is taking place. To answer the question about what we can control, what we can and manage control, we have been able to do that. What is happening in our environment is something that is really difficult to predict and forecast. We're trying to kind of set ourselves up on the things that we can control, continue to manage our investment about growth and deal with whatever situation is in the next several quarters. But as I said, if we go back to every one of these product categories that you touched on. Spark, we have 50% higher capacity. We have 500 doctors that they're submitting cases. We are now in Europe and continue to build momentum going forward. N1 is now in the hands of over 100 dentists in Europe, and we are ramping that up going forward. And we think infection prevention has momentum over time. China has got back to a double-digit growth for us in second half. So putting it all together, we think that what we would have in a normal situation, we will have a much better growth momentum than what we have had in the past.

Okay. Got it. So then let's go into some of the details. Maybe I'll start with Spark. I thought it was interesting that within just a matter of weeks of each other, both Envista and Dentsply Sirona, decided to get a little bit more -- I don't know if it was more optimistic necessarily, but be a little bit more explicit about expectations for their clear aligners. And so I wonder if you could speak a little bit -- in a little bit more detail about what you saw that led to the decision to be a little bit punchier in the messaging there. It's an interesting time, right? It does seem like orthodontics is faring better than many other categories. Your clear aligner, of course, is relatively new and launching into a somewhat untapped market, perhaps the Damon users. And there's a question -- I think it's still not fully answered. But there's a question as to whether clear aligners do better than brackets in an environment where people are looking for low-touch solutions. Can you just talk through your thinking on those points and how you decided to get -- to tweak the messaging around Spark?

Yes. So I can't speak on behalf of other companies, but I can tell you what our position has been and continues to be. We have about a $400 million in 2019. We had about $400 million of bracket and wire business on a bracket and wire industry that is about $2 billion and low single-digit growth. We look at the number of cases, number of starts, in 2019, that number was about 15 million. To get the penetration, the people who need it, the people who can afford it, 15 million was a combination of clear aligner and bracket and wire. We think about 500 million people that can really afford it and need it. So you take a look at that, that penetration is less than 5%. So this is a significant opportunity in both of these spaces. And you have seen, obviously, the clear aligner continues to get momentum going forward. So that's one piece of this puzzle that says plenty of runway in this space. Now let's come back to bracket and wire versus clear aligner. We are focused on a very specific segment of the market. Orthodontists, difficult cases, people who really focus on doing -- primarily dealing with individuals that they want to get the best possible solution yet. In Q3, our bracket and wire business -- and it has been like that, not only Q3, it has been growing mid-single digits and continues to grow mid-single digits. Combination of clear aligner and bracket and wire in Q3 was double-digit growth for us. So you wonder why does the bracket and wire continue to grow. Three reasons. It is -- 70% of this business is outside the United States. A lot of training and education takes place across the world for us to kind of continue to teach people how to use it. China has been a great example. Russia, another one. We continue to put energy around it, training and education, leaders teaching other people, and they keep ramping up. New product. About 20% of the revenue of Ormco today comes from product that is less than 3 years or so. So continuously upgraded, putting more and more product categories in hands of orthodontics that they can provide the best possible solution. And then continued investment in the commercial activities, resources, support, educational activities across the world. We think that business is going to continue. From what we know, our own customers are telling us the case start is ramping up. Yes, they're using clear aligner, but they're not switching one versus the other. They're ramping both of them up. Where we see the best opportunities of the same customer that you touched on, the Damon, passive self-ligation customers. It's saying now they have option. They have option of bracket and wire. They have an option of clear aligner. They can use it in the best possible format to answer the need of their customers. So our current customers are ramping this up. So as we said, we have become a lot more direct because now we have the capacity. Now we have people that they're really signed up and they're telling us that we are winning to put cases in place. 5 case a month is something that we are looking for to see continuity. At a one-time use, small number, keep repeating that and keep adding to it going forward. And we have built a significant amount of capacity. What we have today, the capacity we have today can satisfy what we need to do in 2021 and potentially in 2022. We think we can get to about $100 million business over the next few years. It's what we have created. Product is outstanding. That's what they tell us. Capacity is in place. Service and support is really good. Software is something that people are familiar. And the organization is the same organization that they trust and they have worked with for decades. That's our point to be on it, and we want to make sure that this works hand-in-hand together.

Jus one follow-up on Spark. How much further can you go pushing the commercial organization, scaling it around the aligner? And do you feel like you're in a good spot in terms of the integration between the aligner, the DTX Suite overall, and your partner 3Shape?

Yes. So let me answer the commercial piece. So we have 1 organization, 1 sales force that covers a the zipco geography. Goes to the doctor, dentist, offer them clear aligners as well as bracket and wire. So we don't have different organization. And then we have specialists that they are able to answer software question, ramp up and all of this. So that's the number one. We have agreement both with a company called Medit as well as 3Shape. And -- but it's not an exclusive thing. We can accept file from any iOS. As long as they're willing to send it to us, we can provide support. So we have an open architecture that we have built, but we are offering the iOS as people need it, either the Medit solution as well as the 3Shape solution, not only on the ortho area, but also on implanted space. Now on DTX and the software piece. Our intervention all along has been to create a seamless workflow that obviously work with our own system but is an open environment that you can connect any kind of diagnostic tools, imaging tools, be it 2D, 3D, as well as iOS, sensors and any other. Connect to it, get that information create this database of information and then create planning capabilities and then execution. We have it for the implant system. It's working very well, and we are adding other discipline to it. Spark would be the next thing that we will be adding to it as we go forward. So that capability, that ecosystem, think about it as an operating system, continue to expand -- that platform continue to expand as we go forward. And we have put it into all of our imaging devices. So anytime you wire one of our imaging, we are the largest imaging company in the world, they can get that in DTX as part of it. So that gives them an opportunity to use it, experience it, and then we can add to it as we go forward.

Okay. We're past the halfway point here with Envista. If anyone has questions, feel free to pop them into the box in the webcast interface or send me one by e-mail, I got my e-mail up here on the side of the screen. Howard, next man up. So in simple terms, you guys put up a very clear and transparent view back during the process a year ago as to where you thought the margins in this business could go. But of course, that didn't contemplate the ability to accelerate savings this year. And it didn't contemplate some of the learnings of the COVID era. So I think a simplistic view would say, okay, they accelerated those cost savings. We maybe have some additional T&E savings. We've made a couple of changes on portfolio, some with the upside with new growth drivers, some removing downside with a bit of divestiture activity. I mean my bias would be to say, my margins in '22, '23 post-COVID era are going to be higher than I would have modeled a year ago. Would you try to talk me out of that perspective?

No, Steve. I mean I think -- listen, we've always been transparent in this regard that we're looking to get to and close the gap with some of our peers longer term to get to that high teens, low 20s in EBITDA margin. I think that statement fundamentally stays intact. I think, clearly, with the pandemic, we've had an opportunity to go ahead and implement some short-term temporary cost measures. A lot of those we did in Q2 and rolled into a little bit of Q3 here. And then we backed off a large portion of those here in Q4 as it relates to the furlough, salary cuts, other benefit type of cost savings that we put in place. But as Amir indicated, we've done some pretty substantial restructuring around head count, organizational structure. And here in Q4, we're starting to see the benefit of some of the footprint consolidation as well. And you mentioned some of the learnings coming out of the pandemic or going into the pandemic. That's also a reality for us. And so right now, we want to make sure that the $80 million-plus that we talked about in Q3, that we see those savings stay in and are a healthy contribution for us. We're going to go through our budgeting process as we always do here. And then ultimately, we'll see how this pandemic rolls out, but we feel like we're in a good place coming out of the pandemic to drive those margins, close the gap to peers, get into those high teens and low '20 EBITDA margins longer term.

Okay. On a time line that's still roughly in line with what we would have talked about a year ago?

Yes, I think so. I mean we will certainly look at opportunities to accelerate where appropriate, but I think that the commitment stays true.

So how do you think about striking a balance? This is a question for you, Howard, but also for the full group. Between putting a pedal down on commercial investments as well as trying to drive margins. I would imagine -- I'd love to hear, Amir, what you think on this point that you've had an opportunity to take share by being an org that can drive surety of supply during a time when many had difficulty with supply. I know it's a complicated multilayer question, but how do you think of the intersection between accessing that opportunity? Have you seen that identifiable share gains? And how do you think about the balance between making those investments and margins?