DENTSPLY SIRONA Inc. (XRAY) Q3 2012 Earnings Report, Transcript and Summary

Good day, and welcome to the DENTSPLY International third quarter 2012 earnings call. At this time, I would like to turn the conference over to Mr. Derek Leckow, Vice President of Investor Relations.

Thank you all for joining us this morning to discuss DENTSPLY International's third quarter 2012 results. Joining us on the call today are Bret Wise, Chairman and CEO; Chris Clark, President and COO; and Bill Jellison, Senior Vice President and CFO. We'll have some prepared remarks and then we'll be glad to answer any questions that you may have. I hope you all had a chance to review our press release, which we issued earlier this morning. A copy of the press release is also available for download on our website at www.dentsply.com. We have also provided a set of supplemental slides to accompany this call also available for download under the Investor Relations section. Before we get started it's important to note that this call may include forward-looking statements involving risks and uncertainties. These should be considered in conjunction with the risk factors and uncertainties that are described in our SEC filings. The company undertakes no obligation to update or revise any forward-looking statements to reflect events or circumstances that may arise after the date of this call. A recording of this call in its entirety will be available on our website. As you can see in the release our results this quarter include a number of nonrecurring items under non-GAAP adjustments. Our comments on this call will focus on results including certain adjustments that provide operational insight beyond some distortion from these items. These items are noted on the non-GAAP reconciliation tables contained in the release. You will note that our earnings guidance is also presented on an adjusted basis. With that, I would now like to turn the call over to Chairman and CEO, Bret Wise.

Thank you, Derek. Good morning, everyone. Thanks for joining us on our call this morning. Today we're very pleased to report another record third quarter, with strong sales growth driven by acquisitions, but also internal growth across all of our major regions. Adjusted earnings growth was also double digit, which we viewed as a strong performance in light of a relatively weak global economic environment here. Overall, looking at the market first, in our view, the global dental market in the third quarter was generally comparable to what we saw in the second quarter. The U.S. is stable, but not really robust at this point. Europe continues to be a mix of slow growth in the north and continued contraction in the south. Combined, the European market is probably flat, plus or minus at this point. The rest of world markets, which as you know comprise as many different countries for us continues to be a mix of slow growth in the developed regions that we have in that category, and mid to in some cases double digit growth in most of the developing markets that we include in rest of world. Overall, I'd say the dental market is doing okay at this point, but it's not great. Getting into details a bit, on our sales performance on an organic basis, it was notably better than what we view as the market growth at this point, across most geographic regions and also on most product categories. Our total growth with precious metals was a positive 12.3% and without metal was positive 14.8%. This 14.8% growth was driven by acquisition growth which was a positive 15.4%, but also the internal growth which was positive 4.7%, giving us constant currency growth for the quarter at a little bit over 20%. Our currency…

Thank you Bret, good morning everyone. I'm going to take a few moments and provide some deeper insights into the recovery of our orthodontics business as well as a brief update on the Astra Tech integration efforts. As Bret mentioned that we've now re-launched our orthodontics product line on a global basis, with the U.S. re-launch following that of Europe and the rest of the world. In aggregate, the orthodontics business contributed the 190 basis points of internal growth on a global basis and also solid earnings improvements, both of which were inline with our internal expectations. We are pleased with the number of very loyal customers that have come back to the business as a result of product availability, and by our sequential progression over the past couple of quarters. We've been saying that we expected to recapture about a third of lost share quickly and that is proven to be true and very much inline with our expectations. One highlight that I'd like to mention from the past quarter was our European GAC Symposium in Lisbon last month, which was a significant gathering of our largest European customers and also had record international representation. We were very pleased with the positive tone of the customer base and the excitement regarding our plans and approach including our expanded investments in R&D which I commented on in last quarter's call. Our focus now expands to the next segment of lost customers who will be much more difficult to recapture as a result of the competitive nature of the orthodontics market and also the aggressive actions that we anticipate from our competitors as they try to hold on to these former GAC users. We anticipate an aggressive fight at the street level to gather back our customer base, really a battle…

Thanks Chris. Good morning everyone. Bret already discussed our sales growth within the quarter, but I would like to add a couple of additional comments. We believe the calendar had a negative impact on our sales growth by approximately 1 to 1.5 percentage points in the quarter due to two issues. First, the third quarter of this year had one less selling day than the third quarter last year. But second, the month of September this year had two fewer selling days than it did last year, and September is the only month in the quarter that Astra Tech has included for the calculation of our internal growth. Since that is when it began being included in our consolidated financial statements last year. So we believe on an internal growth that our internal growth rate of closer to 6% or closer to 4%, excluding ortho-Japan is more represented of the performance that we had in the third quarter of this year adjusted for days. This is only an estimate to allow you to better understand our results though for the third quarter. And looking at our geographic mix of sale ex-precious metals in the third quarter of 2012, the U.S. was 36% of our total sales. Europe represented 42% and the rest of the world was 22% of sales. Despite to recent weakening of the dollar within the quarter, we still were negatively impacted by a strong dollar year-over-year in the third quarter by 5.3 percentage points. Our earnings per share were also negatively impacted by FX rates in the quarter, and the impact was probably in the range of about negative $0.01 to a negative $0.02 per share. And on a year-to-date basis it was approximately a negative $0.04 to $0.05 per share. At current exchange rates, we expect…

(Operator Instructions) We'll go first to Brandon Couillard from Jefferies.

Bret or Bill, what was the core implant revenue growth experience, excluding the effects of the shipping day variances? And if you could comment just on the trend you saw by geography, I guess on a core basis that would be helpful? And then, I know one of your competitors called out pretty abrupt market issue in Japan. How did your business fair in that region, and could quantify the size of your implant revenue in that market?

Core implant growth for us was slightly negative as we said. If you'd looked at days adjusted it would have been flat maybe slightly positive. I think the trends are that the U.S. market continues to grow, the European market probably is not growing at this point, and then the rest of world category kind of varies by country. And also a lot of those markets sell products by tender, so there can be kind of one large time sales that can be disruptive. Looking at the trends for us, the U.S. was our best market, Europe was next, rest of the world was the slowest market for us, but as you point out here that includes Japan where the market was disrupted by several events. Japan's not particularly large for us, probably Japan for the whole company is 4% of our revenue, and in our implant business it's probably around that plus or minus a percentage point or so. So they did have an impact on us in the rest of world category, but it's not really that significant as a percent of the total implant business.

And then, Bill, could you give us an update on operating cash flow and CapEx expectations for the year, and should we anticipate CapEx to step down materially next year? And then, just what are your thoughts about capital redeployment in near term?

On the CapEx side of equation, I think that originally at the beginning of the year we said that CapEx spending was probably going to be in the $100 million to maybe a $120 million range. I think we've obviously looked at in number of those projects and some of that has been just taking time to actually get into the system and getting actually spent. I'd say that instead of that range, it's probably going to be in maybe the $90 million to a $100 million range at this year. But some of those projects are obviously still in the scope. They'll probably get spent next year. I believe that if you look at kind of spend level, it's probably going to be incrementally, again, higher than it is this year. So probably closer to maybe the $110 million to $120 million level next year, although we've not really given any specific guidance on the yearend or our CapEx. As it relates to cash flow, I think that we've got some good projects that are continuing to progress forward. We've built the inventories this year which have obviously had a negative impact on cash flow early on for a couple of specific reasons. I think that that's probably going to be reduced as we move forward over the next few quarters, as we ultimately get a couple of those areas back down to a level that we think is more appropriate. And I think that as we move toward the end of this year, we'll probably have again a strong fourth quarter cash flow.

We'll go next to Glen Santangelo from Credit Suisse.

Bret, I just want to kind of follow-up with some of your opening remarks. You seem to talk about the U.S. dental businesses sort of continuing to grow at a relatively anemic pace and you talk about Europe being flat. And yet, I kind of look at the same-store results or internal growth numbers, constant currency that you guys have put up and days adjusted, it seems like it's close to the mid-single digit. And so I was wondering if you could just help us reconcile maybe what's enabling DENTSPLY to kind of grow, let's call it 300 to 500 basis points faster than the market. Is it a market share issue or is it something within your customer base? Any sort of color would be helpful?

When you look at our internal growth this quarter at 4.7%, a 190 basis point of that is orthodontic, so something in the 2.5% to 3% range is kind of the organic growth rate. It would be higher on this days adjusted basis, but let's call it 2% to 3%. I do believe that the global dental market is growing a little bit slower than that. Certainly, Europe is a little bit slower than that. But our business has been taking share in Europe for numerous quarters in a row. I'm not sure how far back I should go, but I think ex-orthodontics we've been positive 11 quarters in a row, which is in many ways remarkable, given the economic circumstances there. Going back to 2008, 2009, we did increase and make some important investments in R&D. And we had been pretty transparent with investment community that was going to result in more new products coming out. Those products shipped in 2011, early 2012. They've been performing very well. I think they've been driving market share gains for us. So we have been performing above the market across numerous regions, I didn't really give the U.S. here, but U.S., Europe and also rest of world categories, because of those new product launches as they've rolled out. So even as we anniversary those, we're still growing above market and I think it's still attributable to the new innovation we've brought out, not only 2011, but 2012 and what we're going bring out in 2013.

Bill, if I can maybe just follow-up with you regarding the FX commentary you made. I think you suggested in 4Q that you saw that FX would have about a negative 2 to 3 percentage point impact on the topline and earnings. Could you just give us a sense for what some of your currency expectations are that you're using than you're existing model to come to those assumptions?

Generally, when we make comments on the currencies moving forward, at least from a street perspective, we're talking about rates that are consistent with kind of where they're running right now. So that would include something in the euro range that's in the 1.29 to 1.32 kind of range, and I think that that's probably consistent. That will allow us to be about half of the impact roughly. We had a little over 5% of a negative impact in the third quarter that should reduce that to close to half of that level by the fourth quarter if those rates hold up.

We'll go next to Steve Beuchaw from Morgan Stanley.

Given that we've heard the commentary, it sounds a little bit more conservative in the last quarter. I wonder if you could give us an update on what you're seeing there with the regional breakout. Is this still a fairly isolated Southern European issue? Have you seen anything incrementally in the northern countries, some of the more centralized countries?

I wouldn't characterize a commentary difference than they were before, if they came across that way, it wasn't intended. We're kind of seeing the same market development in Europe that we've been seeing for the last several quarters. The third quarter is always a little tough for Europe, because there is some extended vacation periods and so forth, so the entire market seasonally slows down in the third quarter. So you kind of focus your view on what happens in September in that market. But we haven't seen really any dramatic change there. We see the countries in the North continue to perform reasonably well in that environment, not robust growth, but growing, and we see the countries in the south still contracting. So that market appears to be stable, but not a great level right now. And as I said before or on our prepared remarks, U.S. seems to be comparable to what we saw in the second quarter as well. So the global developed market, part of the global dental market seems to be pretty stable.

And one, on your comments around the med-tech tax is it still the view that we think we can pass that through here in the U.S. with some sort of adjusted approach to the market going into 2013?

The med-tech tax the timing of this is getting close here, the law goes into effect January 1, 2013. There's been no guidance on implementation yet issued by the administration, and some guidance is needed here. But we're kind of operating under the belief that it will go live, despite there is some pretty widespread opposition in Congress due to the impact on job creation and innovation. And of course, there is always some chance that something will happen in the lame-duck session. But we're doing our planning as if that's going to go live. We're going to be implementing price increases January 1. We think those price increases were largely offset the medical device tax. I mean, there maybe some small leakage in one-line or another, but I don't think so this point. And we fully believe that our competitors will do the same thing and that cost, although it's small compared to the dentist, total cost will get pass through to the dentist. So we're starting to belief that it will go effective and that probably go effective without implementation guidance by the way. It will go effective, and we're going to implement price increases January 1.

We'll go next to John Kreger from William Blair.

I realize you don't normally give former guidance for '13, until the fourth quarter call. But any kind of early thoughts if you think about the puts and takes. It seems like maybe a tougher macro-environment but also a better contribution from orthodontics, and perhaps Astra integration. Do you think you will be able to deliver better earnings growth perhaps in '13 versus what it looks like you'll get in '12?

Well, John, as you noted in beginning of your comment, we're just entering our planning stage for next year. We do our budget planning throughout November, and we kind of arrived at an outcome and targets for next year, kind of, mid-December. So I don't want to bypass that process anyway. You did raise couple issues in your comments here. The orthodontics will be a factor next year, because it was the pretty large drag in the first half of 2012, although, we're getting earnings growth from orthodontics now in the back half. And the integration, of course, will be proceeding perhaps even at an accelerated pace as we enter 2013. So those are both important points for us to consider. Also important is our new product launches coming up, as well as, whatever currency impact we'll have on the business in 2013. I don't know Bill, do you have any thing to add at this point on the planning for next year.

No, I mean I think at this stage we obviously don't give any kind of directional guidance for next year until we release earnings. So I think Bret's comments are solid. There is obviously a number of things that we believe that we have at least driving our business that should allow us to continue to get growth above and beyond broader market level growths. And we think that those positive factors should hopefully have some benefits for us as we move forward, but we won't give any kind of official guidance until we get into the next year.

Maybe as a follow-up can you just expand a bit more on what you're seeing in the orthodontics market as you fully re-launch your product line. Have you seen slowing in that broader market environment given the tough macro-environment or has that held up better than the implant market and what sort of pricing changes are you seeing from your competitors as they try to hold on to that share that they took from you guys in the past year?

In terms of us having a read on the case start trend if you will, I'm not sure we're going to be the best parameter of that, because again obviously any change in that is going to pretty well muted on based on what we see in the context of our numbers with the recovery of bringing the most loyal customers back that we've gotten over the last couple of quarters. I mean, my sense is that it probably is a bit slower directionally, but in terms of real read on that, I think there is so much noise probably in our orthodontics numbers that that's going to be tough for us to tell or get more specific on. In terms of pricing, I think, maybe as I characterize my comments, we've gotten really the first third if you go back, pretty much as expected, maybe a little bit faster than expected. We do think that the next third is going to be more challenging in part, because of pricing and promotional activities from competition and there is no doubt that we're going to have to be aggressive to go after that. So I think that we're viewing this really as a prolonged street battle, and again, I think our team is up to it, but I think it's going to take us a while here for this next stage.

We'll go next to Jeff Johnson from Robert Baird.

Brett, I know you don't want to go 2013 guidance, let me just ask a couple of questions here on maybe fourth quarter guidance. You come up against your first of a couple of very tough U.S. organic growth comps. I've talked to you guys over the last few months, it sounds like those new products that launched a year ago, kind of build a new base in business, so should we be looking at that U.S. organic comp as a big headwind or you should still be able to grow inline or above market after the higher base of those new product sales?

We are coming up against two quarters where we are above 7% growth in the U.S., so we do have a very strong base there. But as you point out, the portfolio is expanded with these new products, and that's why we had that accelerating growth last year. So these products are now still growing albeit not quite at the pace they were then obviously. So it is a high baseline but we believe we can grow over that baseline and continue to deliver above market growth despite having a very tough comp to come up against for the next several quarters.

And Bill, I know you don't typically or you don't you like to guide on the margin at all, but the fourth quarter last year was kind of the big margin hit down the 16% on adjusted operating basis. It was down I think 400 basis points, if I remember. Good margin this quarter even with Astra Tech in there, you were able to go up year-over-year by 10 bips. Should we be thinking about a strong like 100 to150 basis points expansion next quarter or am I too aggressive in those thoughts?

You're right, Jeff. We really don't get into kind of the specific operating margin improvements on a quarterly basis, but I think that we're obviously with our year end guidance. You know exactly what our guidance must be now for the quarter itself. So I think that you can probably kind of build into that based on kind of the expected growth levels that we're going to have for the overall business. But I think it's at least fair to say that we've had a couple of different comparisons that are in those numbers, both with orthodontic business as well as with not having Astra Tech in our base. So at least now on a comparable basis year-over-year period, you should at least get a better picture of kind of what that's looking like and how we're positioned moving forward.

I would add to that we're very focused on operating margin expansion. And you saw that in our prepared remarks here, despite not having Astra Tech in filling the base, this is the first quarter we got some operating margin expansion post acquisition. And in our prepared remarks we intended to indicate that we're very focused on operating margin expansion going forward. So it's high on our list to priorities at this point.

Then last two, just quick follow-ups here for me. One, on the Japan dental implant issue, is that just an extension as we've heard of some of the issues in Korea about a year ago or so, just the media reports and things like that, or is there something structurally that could really suppress Japanese dental implant market for an extended period of time. And then last question, just on the med-tech tax, and I've heard from a few of my guys out there in the field that there could be a chance here that dental gets excluded completely from the med-tech tax. There is some legislative effort to at least underway on that. And I refer to this high as maybe as 50% chance that's happening or that could happen, any thoughts from your end?

Jeff, first on the Japanese issue there was a little bit of a media flurry that was kind of anti-dental implants. And that did impact the growth here in the short term. I expect that to play its way through like that as happening in other markets with other products. There is inherently dangerous about dental implants, but it is a market where you need good research, you need some good clinical evidence. It takes a lot of clinical education which is expensive and many times it takes a direct sales force that can support the doctor. We have heard theories that dental implants don't no longer require that support and thus people should just cutout the customer support and drop the price. I don't think that's a formula for success in this market. This is a complicated surgery, and it requires that clinical support for the customer with the doctor to get good patient outcomes. So as far as Japan we think it will place it way through, but it might reinforce the need for good, strong clinical education behind these brands, behind these products. With respect to the med-tech tax, I don't want to go too deeply into that but there is always a possibility that there could be carve out for dental. I mean, dental wasn't covered in the coverage of the new healthcare law yet, isn't enough paying the tax which is kind of a disconnect. Other areas of healthcare that didn't have coverage in the act like hearing or vision were exempted, from the tax. So there is a lot of talk in Washington about getting something done on that. Getting things done in Washington in not easy even in a normal environment. I think it's particularly difficult right now. We'll have to see what happens in lame-duck session.

We'll go next to Robert Jones from Goldman Sachs.

I just want to ask with regards to the implant market, what you've seen, how this is done globally? And what are your just general expectations for the implant market going forward?

I think the implant market has probably slowed a bit. We've only got two competitors that have reported, one did a pre-release report. And so we're still waiting on a couple of companies to report to really have a full view of what the market is, but our guess is that market has slowed kind of sequentially here. Third quarter was not a great quarter to evaluate it, because dental implant market is more mature in Europe and Europe takes extended vacations in the third quarter. But if we had to guess, we'd say it's slowed a little bit. It is an expensive procedure. It's a discretionary procedure, and it's entirely possible that as the economy recovers that dental implants will start to grow more rapidly. We saw that in the early signs of recovery, maybe a year ago dental implant accelerated. And I think that would be true again if we saw some economic improvement over the coming months or quarters that we would see the same thing happening at dental implants.

Just to ask also, I see the U.S. sales were very strong internally this quarter. I just wanted to know are those sustainable? Do you think that those can be that robust going forward?

Our U.S. sales growth I think was 3.9. I think that's actually in some ways a little bit slower than we had like, for instance fourth quarter last year and first quarter this year. U.S. market to us looks like its performing pretty stable with what we saw in the second quarter. We'll know more of course, when the distributors report in the coming weeks. But I think from our perspective, we see the portfolio we have and we see how the products are performing versus the market. We're continuing to take share in that market in the U.S. market. And thus, we believe basically whatever happens with the market we can continue to grow at a premium to that.

We'll go to Scott Green from Bank of America Merrill Lynch.

First, I had one on the med-tech tax. So are you assuming any pre-buying ahead of that, normally you get some pre-buying ahead of normal rate increases, and maybe this one is even more in the news, just curious about your thoughts there?

It's entirely possible that as we communicate our price increases to the distributor channels, entirely possible that some distributors will want to buy ahead of that price increase, and thus have that margin enhancement program or opportunity for them. It's too early for us to tell. We've kind of incorporated in our range. We're sitting over the $0.05 range for the fourth quarter, which is a little broader than we normally have. So with the high end of that range, that would probably encompass some buy-ahead on the med-tech tax issue and the price increase issue that we're going to implement. But at this stage, I think it's too early to tell. We probably won't know for sure what that's going to look like till we get well into December.

And then can you elaborate on implant growth, just curious, you talked about you've re-launched the new DENTSPLY implants brand earlier in U.S. and Spain, and now Italy, U.K. What impact of that have when you re-launch on growth in those markets. Are you seeing a positive benefit from that, just on that new brand campaign?

No, I wouldn't characterize it that way. I am going to make a comment, and Chris has been closer to this than I, so he may have some further comments. But when we launched DENTSPLY implant, what it means is we're launching the integration meaning bringing the two organizations together. Frankly, that's more disruptive than helpful versus market growth. We end up changing rep territory. We pull reps out of the field to train them. We end up changing the product packaging et cetera and the CE set up changes as well. The clinical education setup kind of changes as well. So I think what you see with this launching DENTSPLY implants meaning from market-to-market, it's not really a boost to growth. It's almost more of an interruption, but that's where we're getting the synergies. That's where we're bringing the organization together to try to harvest the synergies from the acquisition. So I think its important stuff. Chris, I don't know if you have anything to add to that.

I characterize it, Scott, as a kind of short term distraction. The necessary short term distraction for the reasons Bret mentioned. I mean, you've got the new reps with new things in their bag, new product in the bag, but they have to learn new territories, in many cases new boss, new managers in many cases. But the fact you kind of go thorough that because of the significant potential, obviously with mine organization. I think that what we're really excited about is just the positive reaction of our people, but also of our customer base to that combined portfolio and that combined business. And so again, I think that the necessary distraction, the short term to get the long term gain or medium term gains, and it's pretty much playing out very much as we expected.

And then I think the last quarter you suggested that inventories would decline in the back half for the year, and I think they were up again modestly in the third quarter. Just curious if you could update us on that and how you see inventories in the field as well, that the dentists are holding?

Sure. I think two things there. So first of, in the quarter-to-quarter, at the end of the second quarter we had about 111 days. We actually still had about 111 days at the end of the third quarter. We're still obviously kind of in the midst of ortho re-launch and obviously some of the integration activities, and some of the new ones that Chris, just talked about. I'd say that it's probably still going to take us a few quarters to get the inventory backed down to kind of where we'd really like to have to in place. From a dealer perspective or the amount of inventory asset dealer levels, actually that inventory level is down year-over-year somewhat. So there is no increase in dealer inventory levels over the last year.

And lastly is there a way you could characterize 2013 in terms of product launches as stronger than normal or an average year or right at the normal?

The 2013 is IDS year, so in March we'll have the International Dental Show Germany. That's usually a show where we kind of accelerate product launches, for because we have access to that group every two years. So 2013 could be kind of slightly better than a normally year, I would say.

At this time we have no further questions. Mr. Leckow, I would like to turn the call back over to you for any additional or closing comments.

Well, thank you everyone. That concludes our conference call today. Thank you for your interest in DENTSPLY. If you have any follow-up questions, please contact Investor Relations. Good bye.

That does conclude today's conference. We thank you for your participation.