Envista Holdings Corporation (NVST) Earnings Call Transcript & Summary

I think we're going to get started here. My name is Jeff Johnson. I'm the senior medical technology analyst at Baird and our next presentation this morning is from Envista Holdings, a leading manufacturer of dental consumables and equipment with a top 3 share position across implants, orthodontics, dental imaging and general consumables. With us today from Envista, we're happy to have Chief Executive Officer, Amir Aghdaei and Principal Financial Officer -- is that -- I forgot the title already -- incoming CFO as well, [ Steven Kelly ]. Amir, I'll turn it over to you if you have a few comments you want to make, and we'll go right into Q&A.

Great. Thank you for having us in here. September '19 is 4 years since we have become an independent company. Just for -- most of you probably know us a little bit about our history, but Envista came about as an outcome of 30 acquisition over a 10-year time period. These acquisitions reported Danaher between 2004 and 2014. We spent over $7 billion buying these companies in various segments. Starting 2015, we started consolidating them under one umbrella and by 2019, we created an independent company, Envista. Just to give you ground us a little bit. We have 4 different businesses, and we reported in 2 different segments. We have a consumable business, #2, #3 positions and it has 4 elements into it, is endo, resto, infection prevention and small devices. We're in over 90% of all dental offices worldwide. All of that is shorter distribution. We have an imaging business that has, again, 3 pieces into it. It's 2D, 3D inter-oral scanner with a software umbrella that connects all of that. That combination is our equipment and consumable business, over 40% of our business. The imaging part is our #1 position in the world with over 160,000 installed base. So we feel really good about those 2 segments. What we have done since separation, refined the portfolio. We put it -- positioned it in higher growth, higher margin and they're performing. Both of those are proxies, market proxies or above it on both of those businesses. That brings us to our specialty business. We have an ortho business for our practical purposes. We are the #2 player under ortho as a whole. This is a combination of bracket and wire and clear aligner. We've been growing double digit for the past several years. We started from basically nothing in 2017, a clear liner and now we are the fastest-growing clear aligner. Our focus purely is on orthodontists, both on our bracket and wire and our clear aligner. We feel really good about that segment of our business, growing double digit, and it's improving margin continuously. The last piece of our business is the implant. That's the area that we are going through a transformation. We are making series of changes, and this is -- we have done that in other 3 businesses, and we're going through the same process on the implant side. Our goal is to get that back to proxies or above proxies by 2024, 2025. You put that combination together, 2 segments, 60% direct higher-margin growth areas that are 40% for distributors. And if you wonder why do we have all these pieces together, the way we look at dentistry is it's an opportunity to really digitize this industry, take a lot of waste out of it. In order to do that, you have to start with diagnostics when a patient walks in. If you have all the modalities, if you have software that you can pool all these different pictures together, then it gives you an opportunity to develop a treatment planning. We can do endo, ortho implant. That's what we got. And then our consumable basically gives us an opportunity to open the door and answer a lot of needs that dentists have worldwide. Since the separation, what we have been able to accomplish is about 450-basis-point of margin improvement, changed the portfolio, about 100 basis point. As a whole, the portfolio is growth compared to the industry. We have changed it. So long-term growth is about 100 basis points, better than it was about 4 years ago compared to proxies. And in the past 3 years, the compound annual growth rate has been about 4%. This year, it's a little bit challenging. But our goal is, if you look at 2026, our goal is to get this business to be mid-single digit plus high-single digit with 22.5% EBITDA, and we feel really good about being able to get there based on the activities that we are undertaking. It gives -- hopefully, it gives you a little bit of a feel about 12,000 employees. Almost every geography you can imagine we are in with the great set of brands. And this is a holding company. So at the hand of dentists, you don't see any Envista product. You see all Kerr, Sybron Endo, Nobel and many other brands. Hopefully, that gives you a little bit of a feel for starting who we are and what we do to begin.

Yes. You knocked out the first few of my questions, though, with that. So let me try to rephrase here a couple of my questions. But you have done a fantastic job of repositioning the company into those high-margin, high-growth areas and deemphasizing the lower margin, lower growth areas. Is there anything more that needs to be done on portfolio management at this point? Any gaps or any areas left to deemphasize either direction, I guess?

Portfolio management is certainly -- this is a little bit of a -- I worked for Danaher for quite some time before we became Envista and managed 2 different platform. Portfolio management is a standard process. We do that in an ongoing basis. We have an M&A committee that looks at all the target on a monthly basis. And I think what we needed to do -- the fundamental pieces we needed to do, we have done, but we're going to continue to look at opportunities to reset, reposition ourselves. So just give you one specific example. In the past 12 months, we take a look at imaging as a whole, and say where is the competitive advantage? Where do we have a position that we can ask for premium prices but also add value? As an outcome of it, we decided we're going to probably exit about 10% of the business. Lower, more of a commodity. Margin is not there. And really, we're not competing. We're not a cost position player. So we decided we're going to exit out of those geographies and double down. We have spent about $1 billion, I would say, in the last 4 years in acquiring companies, early investment, and we have exited about $400 million -- we sold about $400 million, but also proactively exited probably about $150 million to $200 million, just we exited without really spending a whole lot of energy on it. And the outcome, portfolio has become where it is. Moving forward, we have a gap in our portfolio, very specific areas, but we wanted to make sure the fundamentals in place. We feel good about it before we go at another $1 billion worth of acquisition over the next 3 or 4 years.

On those gaps, I mean, an obvious one might be 3D printing, what else -- any others that you...

So on the 3D printing, it's really interesting. You hear a lot about it. We know the installed base, we know where it is. So you are a much better judge of this than I am. It took about -- probably about 15 years for clear aligner become more of a standard treatment procedures. IOS, probably 5 years and this is earlier stages. Still with all of that, it is less than 30% penetrated. 3D printing at this point is a technology that has yet to become mature, purely is because of resin, it's because of component and material. If we get to a point that you can really print same-day crown, then you can see the breakthrough. So we are working with the SprintRay very closely. We have bundled our IOS to it. But today, what you can do is barriers, night guards and things -- temporary crown. I think in the next 3 to 5 years, this is going to become an important part of the overall offering. If you want to digitize your office, you really need to have that IOS and you need to have a 3D printing. But if you put that aside, where we think that there is significant opportunity for -- I mean we're not just an acquisition for the sake of acquisition. We are trying to simplify the workflow in here. To me, I'm an industrial engineer, dental offices is one of the most underutilized asset in this country. You take a look at 30 hours, you've got $1 million worth of asset in there. A lot of waste has been through the process. People are sitting there waiting, you pick stuff from one system to the next. So productivity is what we are after. How do we create productivity; software, AI, connecting solution from one piece to another, that's where we are putting a lot of energy. And then from a component perspective, if you look at the impact, the prosthetic part, the permanent crown is really disconnected from the rest of the process. CEREC did a great job in solving one specific problem around chairside, but the opportunity is much broader, bigger. If I may, I answer one more thing in this. If you look at clear aligner, what is it about the clear aligner that really has changed the industry? Digitization. Digitization gave the GP opportunity to provide procedures that otherwise they wouldn't have been able to do. You get an IOS, you have a file, you send it somebody design it for you, send it back. And through that process, now you see 6 million, 7 million clear aligners that are being produced, $4 billion market has been created. You got about 100 million 3-unit bridges and you look at the number of implants compared to 3-unit bridges as well as other solutions, the reason we haven't been able to break through that, that digitization as simplification hasn't happened. So anything that we can do in that area to make that a standard procedure -- implant to be a standard procedure, I think that would be a breakthrough for industry as well as for us. So value implant, add to it AI, prosthetic design, service capabilities, prosthetic that really happens throughout the process, 3D printing, guided and navigate surgery. Combine all of that to simplify it, I think you would have a breakthrough on the implant side similar to what we have done on that side.

Do you make that a closed system. I mean, just as I hear that -- my struggle has always been this digital pathway that you and some of your other peers are talking about, makes a ton of sense. And I totally agree with you on the inefficiency in the dental office. The problem is monetizing it. And if it's not going to be directly tied to, you have to use your implant, your prosthetic, your abutment or everything, your IOS and nobody likes closed systems. So it's like the dual-edge sword there, right? And that's the challenge, is how do you monetize these digital pathways?

Okay. So let's take the aligner as an example to see what has happened...

Which is an iterative process, you're making 60 aligners. So that -- the digitization of a clear aligner to me makes a ton of sense because it simplifies pretreatment planning. A GP doesn't have to do anything. Get a send-in, aligner show up at their door, right? Not even a GP for you guys in Ortho. Yes. But in the others, that's where I struggle a little bit more.

So let's take diagnostic or acceptance as a simple process. One out of every 4 -- best of the best, is 30%, average 25%. People walk into the DSOs. They do a diagnostics, they walk out. So acceptance rate is about 25% to 30%. So how do you change that? In order to change it is you have to do visualization. You have to be able to show what the system is telling you, you have to do simulation. So when we look at the DSOs as a whole, or any GPs, I'm not latching on. If you have that kind of capability right in front of you, it improves acceptance rate. Acceptance rate in the United States, every 1% is $4 billion.

So in-face visualization, video visualization...

Exact -- simulation. Yes. Okay. So when that happens, we said, well, how do you monetize it? I monetize it through -- today, we have a whole set of SLA capabilities around our imaging. If I add AI to it, if I add visualization to it, that gives me an opportunity to monetize on the software. It gives us an opportunity to monetize on whatever mix is going to happen through that treatment planning. But you got to make some investment to make that happen. You can't just go in and say -- you mentioned closed system. We are subscribed to this open architecture. Up to about 9 months ago, we didn't get a single case from our own IOS. All of them came from everybody else, and we haven't changed anything. We continued to accept cases and aligner from every system, every solution. Same thing on the imaging side. When we are building this infrastructure, we're not forcing people to just go to our OP 3D or use it, but if you use ours, it's simpler, it's easier. That's a method we are putting in place.

All right. Fair enough. Well, let's move on to a couple of product segments that I think you're right. The ortho business has been on this very consistent strong growth path. I think we all feel as investors, we can just kind of lock in 3, 3.5 points to company-wide growth from ortho. If it's 20% of revenue, growing 15% is kind of the simple math on getting 3% growth or something the company wide. Is there anything with the Spark business that we should have on our radar screen? I know it's not going to double every year the way it has been off the smaller base. But is that still the right number? You talk about double digits? Kind of -- is it right to think about brackets and wires kind of low mid-single digits over time, maybe not right in this macro, but low mid-singles and Spark still growing at a very strong rate. So kind of the overall ortho into that low to mid-ish teens kind of range?

Yes. Yes, absolutely. You absolutely have it correct. And I think the bracket number -- so we had mid-single-digit growth for 4, 5 years before we came to the Covid area. Now that we have the bracket -- now that we have a really clear aligner that it is best in class in the market, we can give people opportunity for a combination treatment. Some of the things that we have seen in the past, probably 6 months or so. You talked about cannibalization. It's not a cannibalization of the bracket and wire. It is our ability to really give people opportunity to use one versus the other. So what else can you expect? We are going to -- in Q4, we're going to open a new factory in Europe. And that gives us an opportunity to deliver within 5 working days in Europe, which is one of our fastest growing area.

For Spark?

For Spark, right. And then our goal is -- and we have been in investment mode for 4 years now, and we're going to continue to do that. But the margin -- spot margin is below fleet average. And it's becoming a bigger and bigger part of our equation. We expect that margin to -- and it has been improving every quarter. We expect that to get to fleet average by end of next year. That, by itself, a combination of growth plus the margin change. It really changes the dynamic of our portfolio. So you're going to say, why are you confident in 2026 number? A big part of it is because of this margin change.

And do I need to think about just thinking about my model and thinking about when Align has opened a facility in China when they opened their Polish manufacturing facility. Gross margins come down initially for the first 6 months or so and then come up as efficiencies and scale build in that factory. Is that -- just I think about the gating of my '24 margin, will a European Spark facility be enough that I need to take a little down and then up in the first center?

So the investment of the European facility went in place last. So -- because some of the [indiscernible] item, it takes like 9 to 12 months. If we signed a facility, we got the approval for it and it's actually coming in production in October. And what we have done is the more automation we put in place, the less labor we need. And labor is the most important part of that growth -- the gross margin equation. So just to give you a feel on our factory in Mexicali. In the middle of Covid, we built a factory in 9 months, we hired 2,000 people. We haven't added anybody to Mexicali. But as we have done automation, we have added more lights. Same model is playing itself as we go through our factory in Eastern Europe. There's going to be an impact. I'm not telling you -- but it's on the CapEx side. But we think the incremental volume plus logistics. Logistic is such an important of this equation. We don't have to ship it from China or Mexicali, we can ship it from Europe. That was going to save us a ton in the past.

And still confident -- last question on ortho -- still confident that the brackets and wires, especially into those emerging markets where you've got kind of a developing middle class that can afford ortho, but probably can't afford clear aligners yet. Is that still the kind of growth driver of brackets and wires even in a market where we're seeing increasing clear aligner penetration?

There is a little bit of a hiccup in Russia, as we all know. But outside of that, think about it as 1/3, 1/3, 1/3 -- 1/3 North America, 1/3 Europe, 1/3 everywhere else. That 1/3 everywhere else has been growing double digit. So even if the other 2/3 is flat, that's how the growth has -- that model has worked for 5, 6 years. A little bit of a step down this year because of -- VBP because of Russia. But the model that we have in mind is it's going to continue low single digit. And this year, if we can get it to flat, that would be great. But that combination that gives us a really good position to be differentiated in the market.

Okay. So that's the 20% of your business that's ortho. If we move on to -- hopefully, this is going to be a quick 1.5 minutes. The 40% of your business, that's the general consumables and equipment. What do you call that division?

Equipment and consumable.

E&C, yes, knew, like I was blanking on E&C. Your E&C segment. Any update -- any latest thoughts on kind of market? I always think of that business for you is going to grow at maybe a little bit below right now with some of your emerging market stuff, but actually at slightly above. So is market kind of still in that 2% to 3%, 3% to 4%, and you kind of be somewhere ballpark-ish over time?

Yes, I've been looking at this. Actually, you gave me some indication many years ago, 5, 6 years ago. So what is driving that? It's GDP, GDP plus. Correlation, in case -- I am a math major. If you look at correlation causation, GDP plus, you look at every geography, look at what the GDP look like. Equipment and consumer lines up specifically with that. And GDP is in a good place, it's going well. When interest rates are high, equipment is a little bit impacted, but the overall market looks the same. But if I look at it in a longer-term horizon, we get that to a mid-low single-digit above fleet average. You've got 40% of the business. That is, everyday use, low single-digit, above fleet average margin or at fleet average, I think it's a great add-on to the overall thing. So I got 60% faster growth, higher margin; 40%, low single-digit growth at proxies...

But consistent...

Consistently, we can deliver. Now, we've got a really good combination. The only thing -- this year, the only thing is equipment. We got to see what happens in the next 3 months or so about interest rate. I don't expect anything radically it's going to change. But the tax -- at the end of the year, because of the tax relief, a lot of people buy equipment at the end of the year. So we're hoping that will repeat itself. So we will see a bump on the equipment side. But consumable is pretty consistent, sell-out, sell-in, you can see it. Inventory being managed very carefully. I'm not expecting any radical change in that space.

Anything from a Russia standpoint on relief on some of the import issues in that?

This is one of the most complicated thing we have ever dealt with. They put a whole set of new guidance in place. We got licenses in some areas. We're trying to decipher what that means that you can ship stuff to. So we got licenses in some of the products because we expected to get that in September. We got it last week. We are trying to decipher to specifically figure out what would that look like. We said it's going to have an impact and it had a less impact than what we expected in Q2, less than $10 million. We're hoping that we can get that in Q3. We have yet to see it, but we are working through it to see if we can clear that up going forward. That's only on a specific segment of our business, mostly bracket and wire, a little bit implant.

No, that's right. I always think it's on the E&C side, but it's not.

No.

But just to complete that Russia thought, if it doesn't fall into the third quarter, still confident, it comes back in the fourth quarter though?

We haven't lost any of it because we -- the inventory is underground, people had enough of it. And we have found all kinds of various logistic way to get to Russia. If you go through Mexicali, if you go from Sweden, which is one of our factories, they don't fall into the American produced product. So we can get in some products specifically. It's just kind of for now. You got to get a license for it to get it there.

Okay. And on the implant side, that's where there's been some -- a little bit of hiccup on VBP, although that seems like it's turning the corner, volumes are starting to outgrow the price headwinds there. So I still think that China can actually by the back half of this year and into next year be a grower in implants? Is that still a fair comment?

I was in China 4 weeks ago -- 4, 5 weeks ago. And I went visited a bunch of our DSOs and one of the largest public hospital. So the volume has ramped up significantly. And you wonder what happened, all of a sudden, everybody is placed an implant. It was a little bit of a subdued demand prior to that. But 2 other factors in here that is really interesting. The price of a 3-unit bridge is almost becoming similar to the implant. And a lot of people are thinking, why would I do this when I can do that. The second part, the price difference between value and premium has closed. So as an outcome, I can put a German made, Swiss made, American made, why would I do this other one because the price difference is not that much. So you got to -- we normally talk about who's winning. Let's figure out who's losing in this process. A lot of people who were stuck in the middle between value and premium, they're having a hard time now. The premium guys are getting a lot more business. We had a small business on the value side with [indiscernible]. That has been accepted in the hospital, but the volume is increasing rapidly to a format that is really substituting the VBP 35%, 40% price. But, Jeff, I'd be foolish if I assume that China is going to get back to normal. You've got so many different wearable in place, consumer confidence, the housing, the interest, people are not spending money. And that's what we heard over and over and over in hospital, DSOs, private practices. Right now, it looks awesome. I can't tell you what the next 3, 6 months is going to look like.

Fair enough. Fair enough. And then on the other part of your implant business, primarily thinking about North America, maybe some of these issues have bled a little bit into Europe as well. But we know that you guys are a big player in full arch, All-on-4 cases, things like that. That I think is where we're hearing in our checks, you have had some challenges because of high interest rates and $30,000 case cost than that. So that I would expect just macro-wise, is going to be tied more macro-wise when the macro improves, that part of your business can improve. On the other part of your single implant business, what have trends look like there? It feels like you've kind of undergrown the market the last couple of quarters on the single implant side? What's the pathway to turning -- getting that back to at least market?

So the reason I talked about the other 3 pieces, I want to tell you a story of what we have done in order to really get those businesses on track. You've got to have a clear value proposition and strategy. I can walk you through imaging, consumable or ortho part that this is our strategy, combination treatment, point of entry and diagnostic consumable everywhere, expansion of the channel. The heritage of Nobel was around innovation. They came in and said, "Well, we created the market. We innovated. We..." Great. Thank you. What's the next thing you need to do there? If there is a segment of the market that values that premium and is willing to pay 2x the price, how big is that segment? And are we providing premium service to that segment? That's the process that we're going to try to kind of understand. Because what has happened -- specifically in North America. Look at the number of players that have come in. They have closed the gap, providing good service, good product at a much lower cost. This is not premium going becoming value. This is -- prices are high, but the level of service that they provide, the training, education and so. You got to create enough of a differentiation that say it is worth doing that. Where is that differentiation? Is around innovation, training education, customer support, prosthetic. We have had gaps in our execution in various places. We get the business. When we go to get prosthetic, there is a breakdown in there as an outcome after 1x or 2x individual practitioners. So, "Okay, I'm paying that much money, I want to get that service." So we're doing a deep dive into every aspect of this. I'm hoping -- I'm not hoping, I'm working on it, we're working on it to get this back on track and we started getting back on the proxies by 2024. By the way, you say, why do I believe you? I'm asking you to take a look at what we did on consumable and we have done that. That's our heritage, of going back, take a look at it, understand it, put the standard processes in place, turn a corner and start performing. The other thing about -- I mean, the dental industry, very slow transition. So even if you come up with the best and greatest, you got to be thoughtful about. I'm going to put it in place, prove the concept, yet have some people to kind of play a missionary role, tell everybody else and start transitioning it. Same thing has happened with N1 as an example. We have put it out there. People love it, but there is not enough -- it hasn't had enough of an impact in the industry to transition a whole lot of people over. We're just going to be thoughtful about this. We're not in it for next quarter. Obviously, we got to deliver. But in the long run, we feel really good about being able to turn that around.

All right. So in the last 1.5 minutes, let me just ask 2 questions. I know you haven't guided on 2024 yet. I know you're not going to give me 2024 guidance here. But let me ask 2 questions. One is as we talk about kind of this multi-quarter turnaround in the dental implant business, China is still some uncertainty once we get past this initial kind of bump back in volume and that Street is hanging out at 6.5% growth next year, feels to me a little aggressive, relative. I think I'm sitting at a little over 5%. Just at 6.5% growth, that is closer to, I think, your 2026 goal. Would you recommend Street kind of reassess how they're looking at next year?

Look, I may advise to have that conversation with all of you one-on-one, but we haven't guided for 2024, and we're not ready to do that. But what I can tell you is 3 segments is doing extremely well. I'm hoping that given what is happening, we're going to continue to maintain that. And our intention is to turn the implant business around and start seeing better performance in 2024.

Yes. And from an EBITDA perspective, you're still comfortable, I think, I don't want to put words in your mouth, but still comfortable on the 20% guidance for this year. 22.5% is the 2026 goal. Should we be straight lining from here to there? Is there a little more back-end load as you talk about kind of eventually getting Spark up there, getting the implant business maybe later next year, turned around, things like that.

Yes, we said 50 to 75 basis points per year. Spark is going to play a really important role in here to get us that bump. We're going to see it in the second half of 2024. So I think we're going to have a much better margin structure as we come out of 2024. And then in 2025, 2026, we will get to exactly what we have committed.

So still some improvement, maybe next year, again, not putting words in the mouth, but think about a little steepening of that ramp as you get into [ '25, '26 ].

In 2025, 2026. As soon as we turn that around, that's the biggest factor. IOS is coming -- beginning to start getting momentum. IOS has a higher margin than the rest. And then we're deemphasizing some of the exits that we have done, proxies that are going to level off in 2024 because we exited almost 10% of our imaging business over the past 20 -- the past 4 quarters.

All right. Well, I think we're a little bit over here. So, we'll end there. But thank you, Amir, for the time.

You're welcome.

It was always great to talk to you.

I appreciate it.