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DENTSPLY SIRONA Inc. (NASDAQ:XRAY) Q4 2022 Earnings Call Transcript

DENTSPLY SIRONA Inc. (NASDAQ:XRAY) Q4 2022 Earnings Call Transcript February 28, 2023

Operator: Good day, and thank you for standing by. Welcome to the Fourth Quarter 2022 Dentsply Sirona Earnings Conference Call. At this time, all participants are in a listen-only mode. After the speaker's presentation, there will be a question-and-answer session. Also be advised that today's conference is being recorded. I would now like to hand the conference over to Andrea Daley, Vice President, Investor Relations. Please go ahead.

Andrea Daley: Thank you, Carmen, and good morning, everyone. Welcome to our Fourth Quarter 2022 Earnings Call. Joining me for today's call is Simon Campion, Dentsply Sirona, 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. 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 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 of 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.

And with that, I would now like to turn the call over to Simon.

Simon Campion: Thank you, Andrea, and thank you all for joining us this morning for our Q4 2022 earnings call. Today, I'll start by providing an overview of our recent performance and the transformation work we have underway. Glenn will cover Q4 and 2022 financial results and also share our 2023 outlook, and then I will finish by providing a strategic operating update. Starting on slide 5. We were pleased to close out 2022 with results much better than expected, exceeding the high end of our prior outlook across key financial metrics. Having led this organization for five months now, I'm energized by the momentum we have and confident that while the macro environment remains challenging, the difficult work we are doing now will aid our ability to navigate it successfully.

We are already seeing the fruits of our efforts with early quick wins such as renewed interest from and with DSOs. While we can't get into the details, it gives us confidence in the progress that we are already making. You may have heard that, we recently announced our organizational restructuring plan to improve operational performance to increase alignment, to drive process and discipline, and to begin to position Dentsply Sirona for improved future performance. We committed to act with urgency, and I feel we are doing just that. We are moving deliberately from discovery to action, and we are confident that this plan and other initiatives will collectively improve performance to deliver long-term shareholder value. Moving to slide 6. Let me take a few minutes to explain the changes we are making.

We are putting into place a new operating model, which will enable the company to better deliver on our strategic objectives while also focusing on our tone at the top that focuses on inclusivity, transparency and importantly, ethics and compliance. The plan consists of the following elements: number one, reducing the global workforce by approximately 8% to 10% while continuing to invest in the global commercial organizations. Number two, implementation of five global business units reporting into one leader, the global business units are designed to drive enterprise integration align our product portfolio to the Company's growth strategy and to drive seamless communication with our commercial teams. Number three, commencement of central functions and infrastructure optimization to support the efficiency of the overall organization.

Number four, hiring a new leader of quality and regulatory to sit on the leadership team, thus elevating the visibility and importance of this critical function within the organization. Number five, simplification of management structure to bring the company in line with industry best practices; and number six, delivering cost savings to fund critical investments in 2023 and beyond to position the company for sustainable future growth. As summarized on slide 7, we expect to achieve at least $200 million in annual cost savings over the next 18 months. And as outlined already, reduced the global workforce by up to 10% of the total employee base but we are not targeting our sales teams. We believe that this plan, along with other actions we have underway will set Dentsply Sirona on the right path to deliver better and more consistent results and, in turn, create significant value for all our stakeholders.

The members of the leadership team have undertaken such work in their respective paths. So this experience, coupled with the partnership of external firms who bring an independent view, industry benchmarking and best practice is benefiting this work. This transformational work is particularly difficult when actions impact our team, and therefore, we have not taken these decisions lightly. We have very talented employees and the leadership team is confident that the changes we are making will unite to the organization for better position Dentsply Sirona for long-term sustainable success. Importantly, we are becoming a more inclusive organization focused on creating and fostering a culture of authenticity, compliance and accountability. This starts with having leaders at the top, who will provide the right tone and foster the right culture, and I feel that this change in tone within the organization is beginning to resonate with our employees.

The most recent North American sales force engagement survey, for example, highlights meaningful arguably significant improvement across the board. In addition to the positive employee momentum, we're also seeing it with our customers globally by leveraging the strength of our clinical education programs. We recently hosted our first-ever DS World, Dubai with more than 800 registered attendees from 47 countries. This was our fourth DS World event in the last six months and enables us to interact with more than 7,000 dental professionals. Before I turn it over to Glenn to discuss the financial performance, let me reiterate that we want to be a company that fulfills our commitments internally and externally, and I feel that the increased engagement we are seeing internally and externally is helping us establish a pathway to be that company.

Glenn?

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Glenn Coleman: Thank you, Simon. Good morning and thank you all for joining us. Today, I'll cover several topics, including our fourth quarter and full year 2022 results as well as our outlook for 2023. Overall, we exceeded the high end of our revenue, operating margin and adjusted EPS outlook ranges that we provided in November and believe this is an important early milestone as we move forward. So let's begin on Slide 9. Our fourth quarter revenue was $983 million, which represented a decline of 10.9% on a reported basis versus the prior year, largely impacted by foreign currency and a stronger US dollar. Organic sales decreased by 2.6%, but if exclude China, sales grew 0.4%. Sequentially, organic revenue grew 5.8% versus Q3.

Operating income was $154 million with operating margin of 15.7%. On a year-over-year basis, operating margin contracted due to continued FX and inflation headwinds, partially offset by price. On a sequential basis versus the third quarter, operating margin improved by 100 basis points, which was much better than expected. Adjusted EPS in the fourth quarter was $0.46 and exceeded the high end of our outlook range by $0.09, largely due to better-than-expected organic revenues and operating margin performance. On a year-over-year basis, adjusted EPS declined by $0.37. We attribute about $0.10 of the EPS decline to foreign currency, with the remainder coming from lower year-over-year organic revenues, inflationary pressures and below-the-line FX expenses.

We also delivered strong operating cash flow in the fourth quarter, which came in at $142 million, translating to adjusted free cash flow conversion of 110%, up from 100% conversion in the prior year. In the quarter, we returned $26 million to shareholders through dividends. Let me now turn to our segment performance in the quarter on Slide 10. Organic sales in Technologies & Equipment, or our T&E segment declined 2.2%, while the consumables segment declined 3.4%. The T&E organic sales decline was primarily due to softer implants volume, partially offset by continued strong demand for aligners. Aligners grew over 25% in the fourth quarter, driven by strong growth in both SureSmile and Byte. This quarter was the second quarter in a row with double-digit growth in this part of our business.

SureSmile continues to benefit from regional expansion, particularly in Europe and new product offerings. Our direct-to-consumer aligner brand, Byte also saw a very strong growth despite slowing consumer spending trends as we're seeing improvement in customer conversion rates. Our CAD/CAM business also returned to growth in Q4, driven by strong demand in Japan and Korea. The Equipment & Instruments business declined by low single digits in the quarter, driven by softening demand and ongoing supply chain constraints. Implants were down double digits versus the prior year quarter due to softer demand in China as well as in the US and Europe. We did see some positives in parts of our implants business as value implants showed year-over-year growth.

Moving to the Consumables segment. Organic sales declined primarily due to lower volume in China. These headwinds were partially offset by modest price increases and recent product launches, including ProTaper Ultimate and CEREC blocks and growth in restorative and preventative products. Excluding China, the Consumables segment grew approximately 1% organically over the prior year fourth quarter. Now, let's turn to slide 11 to discuss fourth quarter financial performance by region. US sales were $369 million, representing an organic sales decline of 1.7%, driven by lower volume in CAD/CAM, implants and lab consumables. These headwinds were partially offset by strong growth in aligners. While CAD/CAM volume was down in the quarter, dealer inventory levels were also reduced by $30 million sequentially.

Turning to Europe. Sales of $376 million were down 3.2% on an organic basis due to lower implants and equipment volume. We attribute the softness in equipment to continued supply constraints, as well as a weaker retail demand environment. Rest of World sales were $238 million and down 3% on an organic basis versus the prior year. In China, as expected, we experienced lower sales across product groups due to COVID shutdowns, as well as headwinds in implants due to the impact of VBP. Excluding China, Rest of World organic sales had a very strong quarter and grew double digits. Moving to slide 12, let me now cover our full year 2022 performance. In 2022, sales were $3.9 billion, representing an organic sales decline of 0.5%. Sales in the year were significantly impacted by foreign currency headwinds, supply chain constraints and regional softness in China and the US, with the US decline largely due to reductions in CAD/CAM dealer inventory.

Despite these headwinds, we are pleased by our performance in Europe, which grew 3% on an organic basis and Rest of World, excluding China, which grew 10%. Notably, our global aligners business, which is a key growth area for the company grew nearly 10% over the prior year. Operating margin for the full year was 16.8%, which exceeded our outlook of margin greater than 15%. As compared to full year 2021, operating margin contracted 350 basis points due to lower volume, unfavorable mix, inflation and foreign exchange headwinds, which was partially offset by price. For the full year, foreign exchange headwinds impacted operating margin by 100 basis points. We delivered full year EPS of $2.09 or $2.44 excluding the impact of FX, compared to $2.82 in the prior year.

The company continues to maintain a strong balance sheet and finished the year with $365 million of cash and cash equivalents on hand with a net debt-to-EBITDA ratio of approximately 2.1 times. For the year, we returned approximately 70% of free cash flow to shareholders through the combination of dividends and share repurchases. And today, we announced a 12% increase to our dividend. This represents three consecutive years of double-digit increases to the dividend and signifies our confidence in our long-term plans. With that, let's now move to slide 14 to discuss our expectations for 2023. Overall, we're reviewing 2023 as a transition year. Significant work is underway to improve the company and fix the internal issues, structure and processes that have hindered recent results and this work will position the company to drive significant shareholder value when the external environment improves.

With that said, we have a credible plan for 2023 that includes cost savings and much needed investments to create and sustain long-term profitable growth in the business. For the full year 2023, we expect organic sales to be in the range of down 1% to up 2%, which represents a net sales range of $3.85 billion to $3.95 billion. Based on current rates, FX will be a 100 basis point headwind to full year net sales. On an FX-neutral basis, we expect the cadence of sales to be fairly balanced over the year with sales slightly larger in the second half of the year as compared to the first half. We anticipate that demand will remain strong in key strategic growth areas. Aligners will continue to benefit from regional expansion and market share gains, and we expect better performance in implants.

We also anticipate, an uplift recently launched CAD/CAM products, including Primeprint, DS Core and Primescan Connect, but we remain cautious on overall equipment demand. Turning to regional dynamics. We expect to see an improvement in the two geographies that were a challenge in 2022, the US and China. In Q4, we made critical investments to our US commercial team, which will continue in the first half of 2023. We also enhanced our commission plans to incentivize growth and address the higher CAD/CAM dealer inventory levels. We expect that, these actions will enable our US business to return to growth in 2023, starting in the first quarter. In China, we expect sales will be flat on an organic basis after a year of significant decline in 2022, but we remain cautious on the demand outlook as significant near-term uncertainty remains.

Additionally, VBP will be a top line headwind due to the 40% price impact we will see in our China implants business. While many uncertainties remain, we are seeing positive signs of recovery. For example, this week, our China commercial team participated in an in-person dental trade show with 50,000 dental professionals in attendance. As we move forward in 2023, we'll be using EBITDA margin as the primary profitability measure to track our operational performance and better align with our peers. For 2023, we expect our EBITDA margin to be greater than 18% which is a decline of 140 basis points from the prior year, but above our fourth quarter run rate of 17.4%. We expect adjusted earnings per share to be in the range of $1.80 to $2 on a full year basis.

Let's turn to slide 15 to discuss the puts and takes in our 2023 EPS outlook. Overall, we anticipate that adjusted EPS will decline from $2.09 in 2022 to $1.90 in 2023 at the midpoint of our outlook range. Cost savings from the restructuring plan are expected to accelerate starting in the second quarter, contributing approximately $0.30 of EPS in 2023, with the full run rate achieved by mid-2024. We anticipate a sequential moderation in raw material inflation throughout 2023, but remain at elevated levels. We will offset a portion of the inflation with price increases, which will net to a $0.20 headwind to earnings. Other items than the FX and interest will net to a $0.04 headwind to EPS. This brings us to EPS of $2.15, up $0.06 versus the prior year, excluding the impact of investments.

We will be making commercial investments and undertaking long overdue integration activities in 2023. These investments are expected to impact EPS by $0.25. On slide 16, we'll cover the risks and opportunities we see in our outlook. Our outlook is based on our most recent view of the dental market and economy today. Overall, we see 2023 as having a healthy balance of risks and opportunities that could enable outperformance. The largest variable to our outlook is the overall health of the economy. Similar to last year, the external environment remains challenging and uncertainty is high. While demand has been largely stable to-date, we believe that recessionary concerns, rising interest rates and high inflation could lead to a change in consumer behavior, which in turn could cause a slowdown in elective procedures and capital equipment purchases.

Beyond the external environment, key opportunities that could drive our performance relative to our outlook include earlier or greater impact from commercial investments and faster sustained supply chain recovery. On the risk side, we acknowledge there is some risk to the timing on realizing savings associated with our organizational restructuring plan. It is a large-scale global program with many variables, which we're closely monitoring as we execute. Turning to slide 17. We've laid out additional details on our expectations for the first quarter, given the visibility that we have at this stage in the quarter. For the first quarter, we expect year-over-year organic sales growth to be approximately 1%, driven by continued strong growth in our aligners business and growth in the US offset by continued headwinds in China, which we expect to gradually improve over the remainder of the year.

US organic growth will benefit from easier comps in CAD/CAM and the favorable timing of dealer orders. Entering the year, dealer inventory has returned to much lower levels and will be largely aligned to retail sales going forward. Having said that, we do expect dealer CAD/CAM inventory to increase sequentially in Q1 and then return to lower levels over the course of the year. We expect the US quarterly performance to be choppy in 2023 with slight growth for the full year. Based on current foreign exchange rates, we anticipate that FX will continue to be a headwind, negatively impacting net sales in the first quarter by approximately $40 million. We expect EBITDA margins will be at least 15% and will sequentially improve each quarter as the realization of the restructuring plan savings accelerate and we begin to see demand recovery in certain regions.

Let me now wrap up on slide 18, and quickly touch on capital allocation priorities. We plan to continue returning at least 50% of free cash flow to shareholders through dividends, which we've increased three consecutive years as well as share repurchases. Our capital deployment strategy is predicated on keeping leverage low with flexibility in the balance sheet while maintaining an investment-grade credit rating. We have a strong balance sheet, a low leverage ratio and healthy cash flow generation and expect full year 2023 free cash flow conversion of approximately 80%, which reflects the expected cash outlays to support our restructuring program. Our goal is to improve conversion to 100% once you move past the one-time cash outlays in 2023 through the organization and portfolio work that we discussed today as well as working capital and supply chain optimization.

And with that, I'll now turn the call back to Simon.

Simon Campion: Thank you, Glenn. Moving on to our strategic update, starting on Slide 20. We are putting our plans into motion as we move the organization forward to address the internal challenges we have faced and lay the right foundation that will enable long-term sustainable performance. The fundamentals of our industry remain attractive, and we are well placed to capitalize on growth opportunities supported by a solid organizational foundation. Our path forward starts with confirmation that our strategy to transform the industry by digitalizing dental workflows, by driving product and service innovation and delivering an exceptional customer and patient experience through an engaged and diverse workforce is the right one.

We are now intensely focused on how we will improve on the delivery of the tactical elements of this strategy in a predictable, repeatable, reliable manner to customers, shareholders and employees. Changing to Slide 21, we have initiated much of this transformational work with heavy lifting is ahead of us. As we embark on this New Year, we are focused on five core tactical and strategic objectives. These objectives are to: number one, deliver on our annual growth and margin commitments that Glenn has just shared. Number two, enhance and sustain our profitability. Number three, accelerate enterprise digitalization. Number four, wind in aligners and implants. And number five, create a high-performance culture. As we make progress on these objectives, we do so with an eye on fulfilling our commitment to return to industry growth and increase profitability.

Turning to Slide 22. I would like to reiterate the key actions we are taking to achieve these objectives. Today, we have provided our 2023 growth and margin outlook, and we are committed to achieving that plan. We will do so by making meaningful progress on the other four objectives that we have laid out. Notably, we have discussed in detail the organizational changes we have underway to implement a new operating model, which will enable us to connect segments and geographies, reallocate capital through the company as needed and eliminate silos to improve the customer and employee experience. In parallel, we are defining our winning portfolio. The strategic intent of our winning portfolio will focus on a simple, secure and connected workflow experience that our dental clinic and lab customers trust for better treatment journeys and patient outcomes.

Related to our portfolio shaping work, a topic of much discussion has been the future of our Wellspect Healthcare business. I can confirm thus far no final decisions about the ultimate status of the significant and profitable part portfolio have been made, we have received several inbound inquiries about this asset. We feel compelled to investigate such inquiries and have commenced engagements with several interested parties. We will not make any further comments on this matter until we have a definitive conclusion to these discussions. Another key aspect of our winning portfolio involves simplification. We are reviewing the company's product offerings on a SKU level basis to inform the size of actions that can be taken to streamline the portfolio and deliver higher returns.

Our early insights indicate that the portfolio is overly complex. For example, we now know that in our consumables business, 12% of the SKUs generate approximately 95% of our revenue in those categories. This complexity adds significant costs to the business and leads to inefficient use of internal resources across functions. Specifically, in Endo, we have over 9, 000 SKUs of different endodontic files with 8% of the SKUs making up 90% of that platforms revenue. While this work is ongoing, we know there is opportunity to simplify and drive improvement in plants and the network efficiencies to unlock further long-term margin expansion. These efforts also yield additional benefits, including reducing operational complexity, optimizing inventory, increasing service levels and sales force effectiveness, reducing risk and improving quality.

Importantly, we see these benefits with the goal of preserving the associated revenue through disciplined execution and effective customer partnerships. The comprehensive review of our business has suffered important areas that need strategic investments to drive overdue integration and enable future growth. Key areas for investment include our global sales teams, our IT systems and in resources to ensure compliance. Many of these investments have already commenced, and we have, for example, made great progress on the US sales force expansion. The vast majority are hired and were recently trained in our North America sales meeting. Investments in our IT systems are necessary to modernize our landscape and further our enterprise integration.

While these types of large-scale ERP endeavors are typically a multiyear journey requiring land investment, they are critical to the business, operating efficiently and most importantly, being able to deliver for customers in an optimal way. We have commenced the process to understand this transformation over the past number of weeks. Compliance is another critically important area. Investing and compliance will support the remediation plan developed in 2022. Operating with the utmost integrity and in a compliant manner in everything we do, is important to us all on the leadership team and on the Board. As such, this investment has the complete support of both groups and is underway. We are confident that with these actions and in more normalized market conditions, Dentsply Sirona can grow revenue at or above our historical long-term targets, while also increasing profitability.

The combination of these positive factors in conjunction with the significant structure of our process changes within our organization can enable Dentsply Sirona to deliver the meaningful earnings improvement expected by the end of 2025, with adjusted earnings per share of $3 targeted in 2026. So let me close with a few remarks on slide 23. We ended 2022 on a positive note by exceeding our prior outlook commitments in the fourth quarter. Importantly, there is a sense of positivity within the commercial teams about the future, driven by the structural changes, our transparency and the commission plan changes. 2023 undoubtedly, will be a transition year as the restructuring plan is put into action against a challenging external environment. However, we are confident in our capability to execute it and establish a clear path forward for the organization, its employees and its investors.

We're committed to taking decisive action at Dentsply Sirona, and I believe we are not only taking decisive action, but taking the right action to improve the company, to improve its performance. We want to capitalize on the opportunity that the dental industry affords an organization like ours and believe that this restructuring enables us to drive internal alignment and accountability, simplified and fund critical growth investments. It is essential to achieving our five key objectives and delivering the meaningful earnings improvement that you expect that we expect. We are embarking on this road confidence in our collective experience, with the support of the Board and with belief that we can transform this organization. And with that, I will open it up for questions.

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