DENTSPLY SIRONA Inc. (NASDAQ:XRAY) Q2 2023 Earnings Call Transcript

DENTSPLY SIRONA Inc. (NASDAQ:XRAY) Q2 2023 Earnings Call Transcript August 3, 2023

Operator: Good day and thank you for standing by. Welcome to the Dentsply Sirona Second Quarter Earnings Conference Call. At this time, all participants are in a listen-only mode. After the speakers’ presentation, there will be a question-and-answer session. [Operator Instructions] Please be advised that today’s conference is being recorded. I would now like to hand the conference over to your speaker today, Andrea Daley; Vice President of Investor Relations.

Andrea Daley: Thank you, operator, and good morning, everyone. Welcome to the Dentsply Sirona Second Quarter 2023 Earnings Call. Joining me for today’s call is Simon Campion, Chief Executive Officer, and Glenn Coleman, Chief Financial Officer. I’d like to remind you that an earnings press release and slide presentation related to the call are available in the Investors section of our website at www.dentsplysirona.com. Additionally historical financial data for our new segment is also available on our website. Yesterday, we announced that the company identified a material weakness in internal control over financial reporting, which did not result in a material misstatement of the company’s previously issued financial statements.

For more information, refer to Item 801 of the company’s current report on Form 8-K filed on August 2, 2023. Before we begin, please take a moment to read the forward-looking statements in our earnings press release. During today’s call, we may make certain predictive statements that reflect our current views about the future performance and financial results. We base these statements and certain assumptions and expectations on future events that are subject to risks and uncertainties. Our most recently filed Form 10-K and any updating information in subsequent SEC filings lists some of the most important risk factors that could cause actual results to differ from our predictions. Additionally on today’s call, our remarks will be based on non-GAAP financial results.

We believe that non-GAAP financial measures provide investors with useful supplemental information about financial performance of our business, enable the comparison of financial results between periods where certain items may vary independently our business performance and allow for greater transparency with respect to key metrics used by management in operating our business. Please refer to our press release for the reconciliation between GAAP and non-GAAP results. Comparisons provided are to the prior year quarter unless otherwise noted. A webcast replay of today’s call will be available on the Investor section of the company’s website following the call. And with that, I will now turn the call over to Simon.

Simon Campion: Thank you, Andrea, and thank you all for joining us this morning for our Q2 2023 Earnings Call. Today, I’ll start by providing an overview of our recent performance. Glenn will cover Q2 results and the updated 2023 outlook and then I will finish by providing a strategic operating update. Starting on Slide 4. We were pleased with the second quarter results, delivering more than 2% organic sales growth. These results rounded out a strong first half of the year in which we exceeded our commitments and delivered over 3% organic growth, well above our expectations. Fulfilling our commitments, financial and otherwise, both internally and externally remains a top priority for this leadership team. Q2 performance was highlighted by organic growth in all four new segments.

Based on the momentum in the first half of the year and our increasing confidence in the back half of the year, we are raising the full year 2023 outlook for net sales, organic sales and adjusted EPS, which Glenn will cover in a moment. We continue to execute on our transformational and strategic initiatives. The progress we are making is beginning to take shape in our results. We believe we are on the right path, driving improvement and transforming the business to deliver sustainable performance over the long term. As previously shared, we had received several inquiries about our Wellspect healthcare business from interested parties. After a thorough review of these and other alternatives, we have decided to keep the Wellspect business in the Dentsply Sirona portfolio as the options explored did not adequately reflect the value of the business.

We have now commenced the incorporation of Wellspect into the operating model and we’ll share performance data as part of our investor updates. We have initiated quarterly business reviews with our second one recently held in Europe to discuss performance and strategy for each country and business group. While there, we reviewed the Connected Technology Solutions R&D pipeline, which we feel is robust. Spending time with our local teams also plays a critical role in building an accountable, high performance culture. These meetings give us the opportunity to dive deeper into the business and engage with employees and customers. Additionally, in Europe, we continue to engage in productive and positive conversations with the Workers Councils regarding the restructuring plan.

We are also continuing to deliver on our sustainability commitments. We have developed and launched the first sustainability educational curriculum for dentistry through the Dentsply Sirona Academy. The curriculum was developed in response to an international study Dentsply Sorona conducted in 2022 on sustainability. To complement the course, the team developed a Sustainability in Dentistry resource Kit to assist dentists in their effort. And now I’ll turn it over to Glenn to discuss our second quarter results in greater detail. Glenn?

Glenn Coleman: Thanks, Simon. Good morning and thank you all for joining us. Today, I’ll provide more detail on our second quarter results and an update on our 2023 outlook. As Simon mentioned, we delivered top and bottom line results above expectations. The second quarter performance was highlighted by organic growth in all four segments, which coupled with favorable margins and a lower tax rate, drove better than expected adjusted EPS. Notably, the second quarter represents another quarter of delivering on our commitments. Let’s begin on Slide 5. Our second quarter revenue was $1.028 billion, representing reported sales growth of 0.5%. Foreign currency negatively impacted sales by $18 million and was larger than expected due to the strengthening of the U.S. dollar versus the Japanese yen and Russian ruble.

On a constant currency basis, sales grew 2.3% led by continued double digit growth in our Aligners business and broad based strength in Asia Pacific led by China which grew 25%. EBITDA margins were 17.7% and were better than expected driven by leverage from higher sales and effective cost management. Year-over-year EBITDA margins were lower due to continued inflationary headwinds impacting our cost of goods sold, the higher commercial and infrastructure investments, partially offset by price increases and cost reductions from our restructuring program. Adjusted EPS in the second quarter was $0.51 and was well above expectations despite a $0.2 FX headwind. On a year-over-year basis, adjusted EPS declined by $0.18 largely due to lower operating margins.

Operating cash flow was $104 million as compared to $173 million in the prior year quarter. The decline was primarily due to changes in working capital, which was impacted by the timing of AR and AP compared to the prior year and higher operating expenses associated with commercial and infrastructure investments. In the second quarter, we returned $30 million to shareholders through dividends with a total of $207 million returned year-to-date through a combination of dividends and share repurchases. Let me now turn to our second quarter segment performance on Slide 6. Starting with the Connected Technology Solutions segment or CTS, organic sales grew 2.8% primarily due to improvements in the supply chain and shorter lead times for certain high tech equipment, partially offset by softer demand in Europe.

Within CTS, our CAD/CAM business declined by mid-single digits driven by lower demand in Europe, particularly in Germany along with broader macroeconomic challenges across the region. That said, underlying retail demand in the U.S. improved sequentially. The Equipment & Instruments business grew high single digits, driven by improvements in treatment centers and imaging in Europe. As well as solid demand across all product categories in Asia Pacific. Organic sales in the Essential Dental Solutions segment, which includes Endo, Resto and preventive products grew 0.7%, driven by stable patient traffic in the U.S., partially offset by softer demand in Europe. We attribute a portion of the softness in Europe to pre-buying activity in the first quarter.

Moving to the Orthodontic and Implant Solutions segment, organic sales grew 3.7%. Aligners grew double digits for the fourth consecutive quarter driven by growth in both SureSmile and Byte. SureSmile grew over 20% and continues to benefit from market share gains, regional expansion, new product offerings and differentiated outcomes. Our direct-to-consumer aligner brand Byte grew high single digits, driven by improved customer conversion rates and lower customer acquisition costs which not only drove higher revenues but also better profitability. On a full year basis, we continued to expect our Aligners business to grow double digits. Implants returned to growth in the quarter, highlighted by demand for value implants as well as growth in China due to VBP volumes and a recovery from COVID related shutdowns.

Our U.S. implants declined in the quarter, but we expect to see gradual improvement for the remainder of the year. And wrapping up with the Wellspect Healthcare segment, organic sales grew 3.1% with growth across all three regions. For Wellspect, we expect to see faster growth in the second half of the year, which will include recent and planned new product launches. Now let’s turn to Slide 7 to discuss second quarter financial performance by region. U.S. organic sales grew 1.1% driven by stable demand in Essential Dental Solutions and double digit growth in Aligners, partially offset by lower sales of imaging equipment and implants. U.S. CAD/CAM distributor inventory levels declined approximately $20 million sequentially in the quarter driven by solid underlying retail demand.

Distributor inventory levels for CAD Cam products remained low at the end of the second quarter relative to historical averages. Because of this, for Q3, we expect to see a sequential increase in U.S. distributor inventory levels in advance of DS World in September. Turning to Europe, organic sales declined 2% due to lower implants in CAD/CAM sales which we attribute to macroeconomic headwinds in the market and unfavorable timing of orders for Essential Dental Solutions. These declines were partially offset by continued SureSmile growth in the region. We also saw more pronounced demand softness in Germany, which is a key market for our business due to recessionary pressures in the country. Rest of world organic sales grew 11% in the quarter, driven by growth in all four segments.

China and Australia posted solid growth and we also saw strong equipment demand across the region. With that, let’s move to Slide 8 to discuss our updated outlook for 2023. We’ve updated our full year outlook to reflect our performance in the first half of the year as well as our increased confidence for the remainder of 2023. While we recognize macro uncertainties cloud the economic outlook in the second half, we are seeing stable to improving patient traffic in most key markets and our execution is improving. We are increasing our outlook for the full year net sales to a new range of $3.98 billion to $4.02 billion. This represents a $75 million increase at the midpoint of the range which is now at $4 billion. We expect organic sales to grow approximately 3% which is an increase compared to our prior range of flat to 2% growth and we expect to show growth in all four of our segments.

We estimate full year EBITDA margin to be greater than 18% unchanged from prior outlook. While we continue to face cost headwinds impacting gross margin we’re seeing these headwinds stabilize and expect gross margins in the second half of the year to be consistent with the first half. Given the better than expected top line performance, we’re also raising our full year adjusted EPS outlook by $0.5 at the midpoint to a new range of $1.92 to $2.02. Keep in mind that the improved outlook also includes a $0.3 FX translation headwind. Overall, we’re pleased to be raising our adjusted EPS outlook for the second consecutive quarter. Our first half performance gives us even more confidence that we’re on the right path towards achieving our target of $3 adjusted EPS in 2026.

For the second half of the year, we expect organic sales growth to be approximately 3% with Q3 growth below 3% and Q4 growth above 3%. For the third quarter, we expect adjusted EPS to grow mid-teens year-over-year but be lower sequentially due to seasonality. A return to earnings growth in the third quarter would mark an important milestone in our turnaround story. With that, I’ll turn the call back over to Simon.

Simon Campion: Thank you, Glenn. Moving on to the strategic update starting on Slide 9. Let me start by reaffirming our strategy, to transform dentistry by digitalizing dental workflows, driving product and service innovation and delivering an exceptional customer and patient experience through an engaged and diverse workforce. In order to fulfill our strategy, we must focus on a simple, more secure and connected workflow experience that our clinic and lab customers trust to deliver better treatment journeys and patient outcomes. We are making meaningful progress executing on the strategy as we remain intently focused on our objectives. Slide 10 shows the 2023 and beyond strategic objectives which I first shared with you at the start of this year.

Our five core tactical and strategic objectives are to, one, deliver on our annual growth and margin commitments, two, enhance and sustain profitability, three, accelerate enterprise digitalization, four, win in Aligners and implants and five, create a high performance culture. We continue to leverage and expand our operating model to regularly monitor and measure performance and drive progress against these objectives, which we believe has already begun to translate into better business performance. Turning to Slide 11 for an update on our objectives. Starting with the goal to achieve our annual growth and margin commitments, we now have consecutive quarters where we have exceeded our commitments and delivered a better than expected first half of the year.

While there is still much work to do, we are increasingly confident in our ability to deliver consistently on our commitments. In February, we announced the new operating model and restructuring plan. We have acted with urgency and have made meaningful progress on the transformation work, with workforce reductions largely complete in regions outside of Europe. Our SKU rationalization plan continues to advance with pilots well underway in Europe and the U.S. and a project team in place to oversee execution. Additionally, there are other opportunities to enhance and sustain profitability through network and operational simplification initiatives with four locations in the U.S. already in the midst of transferring to other locations in our network.

Enterprise digitalization is critical to our success and we remain focused on accelerating it both internally and externally. We are advancing our multi-year ERP implementation project with the internal team assembled and the blueprinting or design phase already underway. We also continue to add capability to DS Core. Over the past two quarters, new functionality has been added to enable more efficient communication between dentists, labs and patients, improve the efficiency of CAD/CAM practice workflows and broaden the range of services to include SureSmile and the Lab. Winning in Aligners and Implants is another important strategic objective. In the new structure, these businesses are now combined into one segment. In Q2, the Aligner business delivered another quarter of double digit growth, highlighting the momentum and traction we have gained in this category.

Byte continued to deliver top line growth and enhanced operational performance with higher customer conversion rates, effective patient engagement and lower customer acquisition cost. SureSmile continues to drive market recognition and growth through our differentiated offering, particularly in the GP channel. Our offering is now available in 55 countries, representing most of our key markets across the globe and we continue to demonstrate the benefits of SureSmile and evaluate investment opportunities to enhance our footprint in certain geographies. In Implants, we have reactivated our investment in clinical education after a prolonged period of underinvestment in this area. In Q2, we hosted the Implant Summit in Athens, Greece, which brought together more than 400 clinicians for three days of hands on peer-to-peer learning and engagement.

Customer feedback from the event was very positive. Additionally, we continue to focus on performance in the Implants business and recognize there is more work to do. In the U.S., we are seeing some green shoots with a number of new accounts coming online in the last quarter. Globally, our value implants offering MIS has shown consistent growth. In China, the Implants business gained strong traction during the VBP program rollout. The incremental volume since implementation has exceeded our expectations and we now expect that volume will more than offset the pricing headwinds for the full year. Lastly and importantly, I would like to touch on the work we are doing to create a high performance culture here at Dentsply Sirona. This is critical to enable achievement of our other strategic objectives and foundational to driving long-term value creation for all stakeholders.

Our new operating model continues to evolve and take shape, providing clarity, efficiency and putting the customer back at the center of everything we do with compliance at the forefront. It gives meaning to the KPIs implemented to diligently run the business and hold ourselves and each other accountable. You can expect to keep hearing these things from us because they stand out as core to our operating model and principles. We’ve also continued to build out the leadership team. Last quarter, I announced that a new SVP of Quality and Regulatory Affairs joined the team, a newly created role elevating quality within the leadership team. Most recently in mid-July, we brought in a new HR leader who along with the rest of the leadership team will play an instrumental role in driving high performance culture throughout Dentsply Sirona.

We also hosted the top 100 DS leaders in Charlotte during the quarter. This meeting, the first since 2019, helped us further align on our operational objectives and transformation, drive our winning culture and reinforce our commitments to ethics and compliance. Now let me close with a few remarks on slide 12. As a reminder, 2023 is a transition year. However, Q2 represented another quarter of improved execution, which provides increased confidence in our outlook. As an organization, we believe we are making significant progress on our transformational and strategic initiatives and we’ll pivot as warranted to pursue our goals. Achievement of the goals, coupled with more normalized marking conditions, will position Dentsply Sirona to grow revenue in line with the market while also increasing profitability.

The combination of these positive factors can position Dentsply Sirona to deliver meaningful earnings improvement with adjusted EPS of $3 targeted in 2026. While we have talked a lot about cutting costs, we recognize the criticality of leveraging some of these released funds to invest smartly in our business with a focus on ROI to drive long-term growth. As I said earlier, it’s not just about bringing great products to the market, we must also actively invest in customer engagement, clinical education and sustainability. As previously announced, our Investor Day will be on November 9th in Charlotte. We look forward to sharing more details about our strategy and road map at this event. And with that, I will open it up for questions.

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Q&A Session

Operator: Thank you. We will now conduct the question-and-answer session. [Operator Instructions] Please stand by while we compile the Q&A roster. Our first question comes from Elizabeth Anderson with Evercore ISI. Please proceed with your question.

Elizabeth Anderson: Hi guys. Congrats on the quarter and thanks so much for the question. I was wondering if you could talk about how you sort of see the progression of the gross margin over the rest of the year? You obviously had a little step up in the quarter. I think you previously talked about maybe 100 basis points for the third quarter. So just sort of if you could talk about maybe or if you can’t talk about it quantitatively if you could sort of talk about the puts and takes on that line? Thank you very much.

Simon Campion: Yes, Elizabeth, thanks for the question. If you look at the first half of the year, gross margins, we did something around 56.7%, a little bit higher sequentially from Q1 to Q2. We expect it to be pretty consistent in the back half of the year. So I would just say second-half of the year very consistent with what we saw in the first half of the year. And we’re still dealing with inflationary pressures. I think the good news is they are starting to subside, but I think we’ll see a better improvement in gross margins moving into next year. On EBITDA margins, we do expect to see a meaningful improvement in our EBITDA margins really in the fourth quarter, so sequentially I’d expect EBITDA margins to go up slightly from Q2 and then a much more meaningful increase in — from Q2 to Q3 and then more meaningful increase in Q4.

So EBITDA margins, we are expecting a much larger jump and that’s because of the restructuring savings kicking in in the back half of the year.

Elizabeth Anderson: Got it. That was very helpful. And as a follow up, can you talk about, I know the macro has been excitingly ever changing this year and I appreciate your comments about China et cetera in the quarter. Can you talk about sort of how July progressed and sort of what you’re seeing currently in the U.S. and Europe and China? I know China obviously had the lockdown, your comments on the rest of the world would also be helpful. Thank you.

Simon Campion: Yes. In terms of July trends, I would just say no significant changes from what we saw in the second quarter. We did have some growth in the month of July, but keep in mind. July sequentially coming off of June is a big drop off, especially in Europe. So when you look at our Q3 guidance, well, it’s up year-over-year in terms of organic growth. We said it’s a little bit less than 3%. Sequentially, we expect Q3 to be down largely driven by the seasonality factor in Europe. So make sure you consider that in your numbers. But July trended exactly in line with our expectations down sequentially but, up slightly year-over-year continue to see stable patient volumes even in spite of a challenging external environment.

I would just say that our Ortho business performed really well in July, so that was good to see. But again it’s still just one month in the quarter and our guidance for Q3 reflects what we saw in the month of July and again guidance for Q3 would suggest less than 3% organic growth down on a sequential basis and if you do the math on that, I would say somewhere on 975 would be the revenue number for Q3. And then EPS, we do expect to see mid-teens growth year-over-year, which is good to see. We’re finally talking about positive numbers year-over-year. And based upon that color, I would just say the EPS number is probably around $0.47 to $0.48. So hopefully that gives you a little bit of color on Q3.

Operator: Please stand by for our next question. Our next question comes from Michael Cherny with Bank of America. Please proceed with your question.

Michael Cherny: All right, good morning and thanks for taking the question. Maybe if I can just start on the segments. I’m not sure if this is too early or something we should wait till Analyst Day for, but is there any color you can give on how we should think about growth across the segments that’s embedded in guidance in the remainder of the year and how we should think about the run rate and I guess the medium term, long term, whatever time frame we want to use outlook for the four new segments?.

Glenn Coleman: Yes, Mike, this is Glenn. I would just say we haven’t given specific guidance on the segments other than, we did make comments that we do expect to see organic growth in each of the four segments. So I would just say, from a color perspective, that’s all we’re willing to say at this point. When you look at the faster growing segments, obviously Implants and Ortho obviously are one of the fastest growing segments. So that would be one where you’d expect to see faster growth. But at this point, we’re seeing positive trends across all four segments. We expect growth and look for Ortho and Implants to probably go a bit faster than the other three segments.

Michael Cherny: Got it. It’s helpful start. And then I guess maybe on the Ortho side, there’s been a lot of variability over the last few quarters now, but especially this quarter in terms of the reported growth rates, obviously off very different bases. How do you see, I’m thinking more on the professional side, but happy to touch on Byte as well, but where the current competitive dynamics lies and I guess the areas where you’re winning the most opportunity versus the areas where you still think you have the most room for further penetration or improvement?