Envista Holdings Corporation (NVST) Earnings Call Transcript & Summary

All right. Good afternoon. I think that's our cue to get started. So why don't we get started? My name is Jeff Johnson. I'm the senior medical technology analyst at Baird, and our next presentation this afternoon is from Envista, leading manufacturer of dental products, including an high-growth area such as dental implants, orthodontics and dental imaging. With us today from Envista, we're very happy to have CEO, Amir Aghdaei; Chief Financial Officer, Howard Yu; and VP of Investor Relations, John Moten. Amir, I'll turn it over to you. I think you have a few minutes of prepared remarks you'd like to make, and then we'll move straight into Q&A. So thanks.

Yes. Thank you so much, Jeff, for having us. I want to paint the picture for you on the past 2 years' journey. September '18 is exactly 2 years since separation from Danaher and becoming a publicly traded company. Here in the IPO, we talked about building a company that is differentiated, higher growth, higher margin with M&A as a tool that we can use to really continue to build a differentiated company over time that creates value for shareholders, but also have a positive impact in the industry. In the past 2 years, during the COVID, we were able to increase our core margin by over 300 basis points by exiting some of the businesses that they were really not growing, had a limited impact in our margin. We moved the business from a flat to a mid-single-digit growth, as you have seen in the past several quarters. We have shifted our portfolio from what it was at the time of IPO, which was 50% Equipment & Consumable indirect and 50% is Specialty, which was purely direct with the higher margin to a 60-40 format, 60% of the business now is Specialty and direct. We now have a business that over 85% is consumable related. Even on our hardware product that they're less than $5,000 that they can be purchased directly, and we are positioning ourselves to be a higher growth, higher-margin business with an incredible cash position that gives us an opportunity to participate in inorganic activities. We feel really good about what we have accomplished in the past 2 years and posed to be able to continue making progress as we go forward. Jeff, with that, let me pass -- hand it back to you for any exchange or questions you have for us.

Yes, sure. And there's a few things in there, Amir, that you mentioned that I want to dig into here in a few minutes. But let me start with some of the short-term focus stuff just to get it out of the way. I apologize, it's stuff I kind of have to ask in these kind of settings, but I'm going to ask anyway. In the second quarter, your core revenue grew nearly 9% in Specialty. I think it was up a few points in E&C, and that's on a 2-year basis relative to pre-COVID times. That blends somewhere between 5% and 6% on a 2-year growth rate for the company. So when I think about when you reported 2Q ran through June, obviously, Delta variant risk has kind of grown since then. We've seen that spread throughout the country. We've seen especially in the Midwest and especially the South, some pressures on hospitalizations and what have you. Is that having much of an impact as you're seeing it on dental consumption? Because obviously, we're hearing it a lot in hips and knees and things that get done in a hospital setting, but help us understand what that's doing maybe to dental consumption.

Yes. About 90% of our business is in North America, Western Europe and China. And honestly, if you look at it today, we are back to pre-COVID. Volume are exactly as they are, and in fact, average spending per patient is a little bit higher than what we saw in 2019. The other 10% are more on emerging markets, Brazil, India, other geographies that we really do not expect a return to normalities, maybe second half of 2022. But in that 90%, Delta variant as well as other things that we are noticing, it really hasn't had that much of an impact in our business. The dentists, they have learned how to deal with the realities. They have become a lot more effective in sanitization, in the spacing and managing things. They have become a lot more productive. Most dentists, they see more patients now than they did in 2019. And if anything, the past 2 years have taught them that how to do a better time-asset utilization realities that they're fixing. So we're not seeing -- short answer, Jeff, we're not seeing any major change. Freight, distribution, trade, supply chain challenges continue to be there. You all know that. I'm not telling you anything that -- a cost of a container movement compared to a year ago is 4x higher. Supply chains are continuing to be an issue, but these are realities that everybody is dealing with. In dental, in our end market, we're not seeing a major change of trajectory.

Yes. And just on that supply chain question, I had it for later in the list, but I'll ask it now since you brought it up. I mean how much pricing power do you have in dentistry today? Can you pass half of that on to the end customer? I know some of the stuff that goes through distribution. They tend to be price takers. Whatever you push the price at, they will then raise their price as well. But as the manufacturer, how much pricing power do you have in dentistry?

Yes. We could -- depend on the product category, specifically when your differentiate it. We got product that your -- we people want it. You have an opportunity, you have to be thoughtful and careful. As an example, Jeff, last year, in the middle of pandemic, we really didn't change our infection prevention prices. We wanted to be a good citizen. We wanted to make sure that industry back on its feet. So we didn't change any of it, despite the fact that there was a shortage. Today, given what the realities are in the market, we are trying to really adjust to it. Everybody understands the distribution costs, and I don't mean that through distribution. Logistic costs, we're trying to pass some of those expenses, some of those costs back to the customers, and they do understand it. 60% of our business is actually direct that gives us an opportunity where we are differentiated past some of those prices. We're trying to be really selective on when we do that, how we do that, not to impact abilities of the industry to get back on its feet, but where it's justified to take advantage of investment that we have made in R&D, the differentiation that we have created.

All right. That's helpful. And then as I think about the last couple of quarters, there's been a little movement in that 2-year growth rate, but in general, kind of around mid-single digits. Sounds like volumes are kind of staying fairly stable in that. Do you think 2022 -- and I know you're not guiding to '22, I'm not even trying to sneak a question in on '22 guidance here. But as we think about '22, can next year be a year where we go back to just thinking about kind of normal year-over-year growth rates, we can get away from all this discussion on how we're comparing things? And is your business positioned -- again, whether mid-single digits means 4 or 6 or somewhere off of that range? Can we think about just kind of year-over-year core growth for Envista being somewhere in that kind of mid-ish single digits?

Yes. So we are committed to a mid-single-digit growth, and I think you can count on it, that's what we're going to deliver as we stand today. There are a whole certain new elements in here. If I put acquisition aside, the more we focus on Specialty, the more that piece, that 60% is growing a lot faster. You look at the ortho, combination bracket and wire as well as our aligner, it's growing double digit. Look at prosthetic imaging impact combined together, that's growing high single digit. 60% of business is set up in a format that it is high single digit. That of 40% back to normal. The normal situation on Equipment & Consumable is low single-digit growth. And you put that together, mid-single-digit growth for us should be the base, should be [ not ]. We're not happy with it. We're not satisfied with it. We want to get it to grow mid-single-digit plus as we go forward. We have made a commitment, 50 to 75 basis point of a margin in an ongoing basis. The latest transaction that we have done, the divestiture of treatment in [ instrument ] should give us another 100 basis point of core growth on the remaining part, 30 to 40 basis points of margin improvement. You add that on top of it, plus the investment that we are making on Spark, on N1, other categories, I think the prospect over the next 3 to 4 years is going to be very different than what we got today. Today, that's what we are saying, but we expect that to continue to rise over time, quarter after quarter. We want to build credibility. We want to deliver on it. We want to make sure that we're not pegged as a mid-single-digit, high teens EBITDA. That's a starting point for us, and we have high aspiration to change that over time.

Okay. So a lot to unpack there. So let me kind of move around a little bit and kind of abandon my script here for a second and just kind of try to go off what you're saying. So mid-single digits, you're basically saying you wouldn't be satisfied with that? In my mind, there's 2 ways to get there. One way is just that it's kind of the 5- to 10-year path, which is your Specialty stuff continues to grow at 10%. It goes from 60% to 63% to 66% to whatever, and just mix kind of just shifts. There's also the M&A path there, the inorganic path. One, in the absence of acquisitions, how much faster can that Specialty grow? And do you foresee Specialty being 65%, 70% of the company-wide business in the next couple few years? Are you going to go that fast, that big?

Yes. Lot on math you just -- exactly what you did, Jeff. If I just follow that, I would see us to be in a 2/3, 1/3 Specialty versus the Equipment & Consumable. And then we're reshaping the business a little bit. Our traditional equipment business has been a stand-alone business by itself, but there is an opportunity to really bring that together with our implant -- diagnostic, planning, implant, prosthetic. That can be another vector that changes the dynamic of our equipment. If you take a look at some of our product categories like infection prevention. We have been going through a standard channel. Just imagine, if we give an opportunity to have more people, the segment that we are not advising today have access to it. So combination of this access, commercial, technology and integration that gives us an opportunity to change the organic approach, rather than 60% to 61%, 62%, go a little bit faster in that area. And we're going to do all of that, go faster. Now add a little bit of acquisition power on top of it. Getting the best financial position, our balance sheet has never been as good as it is today. You add that power to it, you're going to see a different approach, different model as we go forward.

Okay. And maybe 2 follow-up questions there. The 60% going from 60% to 66%, 67%, is that under the core definition of how we thought of you in the past and you -- maybe this is what you were trying to allude to, but is that implants and orthodontics? Because when I look to your point, the infection control stuff is in E&C, but it's a high growth potential. The imaging is in E&C, but if you get the workflow efficiencies and solutions right, that's not really the old style of E&C we used to think of as low growth, it could actually be a good growth driver. So do we even conceptually think of your company maybe by its old definition of Specialty in E&C, 60-40, but already, you're like 70-30 with you put like a new definition of how to think about digital future drivers versus analog old stuff?

Yes, Jeff, in the long run. So we've got a short-term type of thing that we got to do, and we're committed to that mid-single-digit growth. We're committed to that high teens and all that. But if I look at us and say, okay, if I want to paint a picture for what the next [ 3 ] years is going to look like, and I think that's what you're getting at. There are 3 segments that we like to be a major player. Ortho segment. Ortho segment is a combination of clear aligner plus bracket and wire. You add those 2 pieces together, that's about a $5 billion, $5.5 billion market, growing double digit. We want to be the clear #2 player in that space and the clear #1 player when it comes to high-end orthodontics [indiscernible] piece. That's one key segment. Today, we have Ormco, we have Spark and both of them are growing and puts us in a position to be able to do that. The second segment, I define it in this format, imaging diagnostic. Planning, software, all kind of capabilities around AI, placing an implant, implant itself, which includes robotics, prosthetic and all this stuff that goes to lab. That's an $8 billion market and is growing high single digit. We have about a $1.5 billion business in that market. We have a hole in our portfolio, but gives us an opportunity to really optimize that in the long run. That's the second segment. The third segment is our traditional consumable. We've got a really good position in there. We want to extend the access. So we're not changing the definition of what we are reporting, we're not doing any Equipment & Consumable versus a Specialty, but I'm trying to describe what the possibilities could look like. An $8 billion segment that is going double digit, an $8 billion segment that is growing high single digit, another $5 billion or $6 billion market that is growing low single digit by high margin with a huge access. We can position ourselves to be a key player in every one of these segments. And then any grade our capability, so we are truly differentiated in each segment. This is a 3- to 5-year transition, Jeff. It's not something we're going to do on January 1. We would do it through organic activities, and M&A is going to really help us to make that transition happen quarter after quarter after we build credibility, after deliver one after another, and after we do an acquisition that really make that really pronounced and visible.

Yes. All right. Well, Howard, let me get you involved here on a couple of questions. One being, after the announcement on treatment units, you're going to net a little north of $400 million in cash. I guess, more than that if you get the earn-outs in that, obviously. What's your total capacity right now? Somewhere $1.5 billion to $2 billion, is that kind of total balance sheet capacity post that cash coming in the door? And -- one. And two, do we see some of that deployed even before year-end? Or do you think this is more of a 2022 and beyond strategy?

So Jeff, I think this transaction will close at the tail end of this year. And so the numbers that you're putting out there, I think, are pretty reasonable. We should be at 2x debt leverage by the end of this year, which frees up a considerable amount of acquisition capacity and for us to deploy capital. It could be upwards of 1.5, north of that as well in terms of when we can do better, how much we have. As it relates to when, we have an active funnel continuously. We've had it even before we spun off from Danaher. We continue to review it. Amir, myself and other members of management look at that on a very consistent basis. We're cultivating constantly as well. And so we will look to deploy that capital for the right assets at the right time. I mean we want to make sure that we're being prudent and disciplined about that approach as well. As you know, Jeff, we have hurdle rates that we need to meet as it relates to returns. And generally, we look to get to double-digit cash-on-cash returns in the 3- to 5-year window and certainly, a little bit more patient for larger transformative type of deals. And so we're going to stay disciplined in that process, whether that happens this year or whether it happens sometime in 2022.

Okay. And I just want to understand, Howard, from your side, one other point. Amir, you said a couple of times high-teens EBITDA margins. And I just -- that's why I opened my model when you saw me looking over to the side here for a couple of times. I've got you at 19% plus EBITDA margins this year going to somewhere around 20% next year. What am I misunderstanding there? Because I thought the margin profile would be higher, especially at 50 to 70 basis points per year of expansion over the next few years. So is high EBITDA or is high teens EBIT or EBITDA?

It's EBITDA. It's adjusted EBITDA, Jeff. And the guidance that we provided in our second quarter earnings call was that for the full year 2021 that we would be at high teens adjusted EBITDA. What that means is that's a 300 to 400 basis point improvement from where we were in 2019, a 30% increase in absolute dollars. And so that's what we think. We will be investing here in the second half. And there are some temporary costs that were saved during this pandemic that will unwind a bit when we think about face-to-face meetings with customers and training and education and things of that nature as well. And we'll continue to invest. And so we feel comfortable with the high teens EBITDA margins on an adjusted basis here for the full year 2021.

Yes, I got that. Amir, maybe I misunderstood you. Though, again, I thought you were saying a high teens EBITDA margin business going forward, like for the next 3 to 5 years. So you're saying that for the starting off point this year, and then you're still comfortable with that 50 to 75 bps a year?

Exactly. Exactly. Exactly, that's the guidance.

Okay. And then -- yes. And one other thing. I just want -- I've had a ton -- since you guys announced the divested -- the planned divestiture of the treatment units business, had a ton of calls with investors or a ton of questions from investors. I think everybody feels good about that strategy, but the one thing I want to level set and make sure I understand from you guys, you sold that business at a little over 1x revenue. The stuff you're wanting to get into is going to be a bigger multiple. I mean, you're not going to acquire good growth assets at 1x revenue. So let's say, it's 3, 4, 5x revenue, whatever higher than that, those deals don't tend to be accretive initially. So to me, there could still be a bit of a gap next year from an earnings perspective that you sold a business that probably was generating, I don't know, $0.15 of earnings a year or something like that of EPS. You're going to redeploy that into higher-growth assets. But should we all be thinking like want to focus on the long term and that's all great, but next year, have to take into account that you might have a little dilution from the early stages of this repositioning of the portfolio?

I think, Jeff, that's the right way to look at it. I mean we are going to have as many divestitures do have a little bit of short-term dilution, we anticipate that. We feel really good about what we've been able to do with that [ COBO ] business over the last couple of years and positions us well to go ahead and sell it and so we have. I think, short term, there is going to be some dilution. But certainly, when we look at long term, as Amir has outlined, I mean we're going to get a growth profile that improves 50 to 100 basis points with this divestiture and that our margin should expand nominally somewhere in the 30 to 50 bps range as well longer term. And so we feel really good about that prospect.

Okay. Okay. And then Howard, just last question on the M&A strategy. Are there any boxes that you absolutely have to check. It has to be growth accretive? Or does it have to be margin accretive out of the box? I mean, what would be you won't even look at it if it's not XYZ? Are there any hard and fast rules?

I think overall, Jeff, Amir has outlined specifically in terms of, hey, we want to make sure that we have a very attractive industry and that means growing faster with better margins overall and more direct businesses. And so that's the way that we think about it. Certainly, if there is certain areas where short term, it may not be as accretive immediately, we're going to take the long view. This is not a business that we're setting up for next year or the next 2023, we want to make sure that we're delivering consistent execution and growth, both top line as well as profitability on a consistent basis year-over-year.

Okay. And Amir, maybe category-wise, how do you feel about dental implants, orthodontics, those kind of things? At least within implants, I guess, we can think about some value implants in some of the international markets where you might have some product gaps. But how do you feel about capital acquisitions versus consumable or more Specialty consumable type acquisitions? Because you mentioned robotics and [ prosthetic ], and there are a couple of assets out there that do robotic driven kind of implant placement. There's other kind of capital businesses that have been floating around in Specialty areas the last few years, things like that. How do you feel about capital equipment, adding more to that and the lumpiness that can bring versus the recurring revenue stream of Specialty consumables?

Yes. The answer to that, Jeff, is we want to see more implant placed because the margin profile of implant. We want to see more ortho cases done because the margin profile of that. So you know that very well. Last year, 20 million implants were placed worldwide on 12 million people. 60 million cases are for ortho. Just imagine whatever robotic AI software regenerative value implant that we can add to increase the number of placements. Obviously, we'd like to get a big part of that increase coming to us. The margin profile justified for us to make investment in AI, in capital, in robotics, in iOS, in regenerative, it justifies that level of investment because that combination really gives us the margin and growth that we're looking for. So we want to make sure these acquisitions, this investment either organically, inorganically line up with these strategic priorities around ortho, on implant. Implant from diagnostics all the way to prosthetics. That's where we're going to put most of our energy. We have done all of that organically in the past couple of years, and we're going to continue to do that internally as well as through partnership and through acquisition. So no preference. We're not against buying capital equipment if it gives us an opportunity, robotics that allows us to place 5 implants versus 4.

Okay. That makes sense. And then just a couple of other questions real quickly here. Just on the DSO front, the comfort you have and your positioning there. Is your positioning continuing to improve? Obviously, we saw the Aspen deal. Aspen is going after some value stuff for a whole host of reasons we can talk about offline that you probably know even better than I do, that's understandable. But you do have the value implant line here in the U.S. So is value implants an area of focus? Are you all in on kind of focusing N1 and premium implants? Just help us think about your focus on premium versus value on the implant side as well.

Yes, happy to talk. We -- both of them are focus area for us. The customer base of a premium is really different than the value. And the way we look at it and say, now, let's take an average single implant placement of $4,000. You pay $300 for premium. You pay $150 for value. So if you look at the percentage of that versus the overall, it's pretty small. So why would you go after the premium? Because you got a reputation, you want to use software, you want to use strain and education. You want to have this halo effect about the best-in-class implant for life, and you want to build your network so other people can continue to do that or surgeon that they are really best-in-class. Value implant is very different market segments. And some DSOs, they are using both of them. Some, it is just one of a kind, one time. You come through, you place that, and all you're looking, you're looking for that point solution. You're not expecting robotics. You're not expecting guided surgery. You're not expecting any of those things. And there is a significant market for it. And we think inside U.S., we're a pretty good place. We want to continue to extend that going in other geographies. We are a really good and strong position on premium. We are under index and value outside the U.S., and we want to make sure both of them continue to grow. $2 billion, $2.25 billion market on each segment, the value is growing a little bit faster. Prices are dropping. Premium is growing mid-single digit and prices are hanging in there. And we're actually getting price increases in those areas. So this hypothesis that one is going to replace the other one, it just really hasn't proven to be correct.

Okay. Fair enough. On N1, just as we talk about premium, we have been hearing kind of -- I think this might even go back pre-COVID when we were able to talk to some European surgeons, but about a 15% price premium or so versus Nobel Active. Is that about the right way to be thinking about it? Are you getting any pushback on that premium, number two? And three, any update on the regulatory pathway in the U.S.?

We're not getting any push back on it. The people who are using it, they really like what they're seeing. And the reason for it is because of the entire system, the damage to bone and tissue is a lot less. You can get a lot more -- the healing time is a lot faster. The chair time is a lot lower. So yes, you can pay 15% more, but you can save significant amount of time on chair time and on the healing time. So we're not getting pushback on it. The COVID has put a little bit of damper on it because you have to bring people into the OR, you have to teach them, they have to place an implant. And it's difficult to get more than 3 or 4 people in a place versus before we could get 50 people in a setup and train them. FDA continues to go through a process. This is not a incremental improvement, this is a complete new system that has to go through the entire 5 day process. They want clinical information. They want to have information about bone loss, tissue damage on a case by case. So we have to give them that clinical data. They ask questions, we provide that information to them. We are hopeful. End of this year, hopefully go through that, but we can't really count on it. It wasn't part of our financial. We're thinking about it more in 2022, 2023 is going to be a major factor. Upon saying that, our premium implant continued to perform a mid-single digit information available in the market, as says, we are beginning to gain share in specific geographies in Europe and other places. We've got work to do in here, but our current capabilities, current portfolio is more than justified for us to continue to gain share and move forward.

Okay. And one last question on implants. I'm not sure, unfortunately, we'll have time to talk about Spark, but on implants, we've started to hear a little bit of runways about VBP in China. I've tried to size your implant exposure in China, maybe $30 million to $40 million, something like that. One, am I at least ballpark accurate there? And two, we did see the hip and knee VBP tenders announced this morning at down 82%. That's -- I've been thinking down 40% to 50%. So is my $30 million to $35 million, $30 million to $40 million exposure correct? And is there any reason to think dental implants may not be treated any differently than hips and knees, and we have to think of kind of a bigger [indiscernible] cut maybe even a week ago, we were thinking?

So Jeff, 2 things. One, the number is on the high side, it's less than that. And then the other part is, the premium implant in China, there are only 4 major players. Most of those are international. There is no local players. So that makes a difference. And the market is not that big, like the [ Scorthicks ] and other. The other thing to think about, over 75% of our business under premium implant is on the private segment. So there is an impact. I'm not dismissing it, but it is not as pronounced. And given what the growth looked like on the private plus other parts of it, we think we can manage that moving forward.

Yes. And 90% of hips and knees are public in China. So completely opposite from where you guys are at. Okay, that make sense.

Yes.

Spark -- we're down to literally 1 minute, Amir. So I'm just going to throw us off all at. Tell us how good Spark is doing, your comfort level with that over the next couple of years.

Yes. We said we're going to get to $100 million. We're well on our way to get to that run rate in 2022. 40% increase is the number of dentists that they place a case with us every 4 weeks, quarter after quarter. So you get that run rate product by itself, Jeff, you know that better than anybody else. It's a really good product. It stand on its own. We think this is the combination of bracket and wire, and at Spark, it's going to put us in a position of advantage in this $7 billion or $8 billion market in the long run. We are really happy with what it's doing, and the team is really rallying around it and making a huge difference in there in the industry.

Yes. Fair enough. All right. Well, with that, Amir, our time is up. So thank you all 3 of you for a wonderful overview here of Envista. As a reminder, next presentation is set to begin at 3:10 p.m. Eastern Time, include Tabula Rasa Healthcare, HealthEquity, Avio Pharmaceuticals and VistaGen Therapeutics. All right. Thanks, guys. I appreciate the time as always. Take care.

Thank you.

Thank you, Jeff.