DENTSPLY SIRONA Inc. (XRAY) Q2 2013 Earnings Report, Transcript and Summary

Good day, and welcome to the DENTSPLY International Second Quarter Fiscal 2013 Earnings Call. Today's conference is being recorded. At this time, I would like to turn the conference over to Mr. Derek Leckow, Vice President of Investor Relations. Sir, you may begin.

Thank you, Richele. Good morning, and thank you for joining us to discuss DENTSPLY International's second quarter 2013 results. Joining me today are Bret Wise, Chairman and CEO; Chris Clark, President and CFO; and Jim Mosch, Executive Vice President and COO. We realize there are a number of other earnings reports this morning, so in the interest of time, we'll keep our prepared comments brief. I hope you had a chance to review our press release issued this morning. A copy of the release and the set of slides to accompany this call are also available for download on our website, www.dentsply.com. I'd like to remind everyone that the Safe Harbor language and the U.S. GAAP reconciliation contained in today's press release also pertain to this conference call. Certain statements made on this call are forward-looking statements, as described on Page 1 of the company's 10-K for the fiscal year ended December 31, 2012. 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 the events or circumstances that may arise after the day of this call. With that, I would now like to turn the call over to Bret Wise. Bret?

Yes. Thank you, Derek. Good morning, everyone. Thank you for joining us on our second quarter call this morning. I have some brief comments on the market and our results, and then I'm going to turn it over to Jim and Chris for more in-depth discussion of the results. First, starting with the market. Overall, in Q2, we saw the global market is relatively stable versus what we saw late last year and also in the first quarter this year. U.S. continues to be a growth market, where we are seeing reasonable volume growth at this point. Europe is essentially flat, as we've seen for some time now, and the Rest of World varies, with the emerging market regions really growing nicely and the developed regions in a low-growth stage at this point. So overall, maybe a slight improvement in the U.S. but no other notable change from what we reported on our first quarter call. With respect to our results, we reported 2.5% sales growth, ex PM, for the quarter. This was essentially all internal growth, which came in at 2.7%, and currency was slightly negative. Our internal growth was robust in the U.S., we were up 6.2%; while Europe was positive 1.0%, and that's essentially the same as what we saw in the first quarter; and Rest of World was a positive 0.9%. We've seen good uptake on new product introductions in the U.S., and our specialty businesses were particularly strong this quarter, confirming to us that these businesses, which are targeted at high-end procedures, can really grow in a reasonable economic environment. I'd emphasize that we don't really view the U.S. economy as strong at present, maybe it's growing 2%, yet our specialty businesses in total notched double-digit growth for the quarter, and that was led by…

Thank you, Bret. From an operational perspective, I would like to discuss changes to our U.S. dealer base, comment on Rest of World sales and provide an update on the implant business. As you may be aware, in 2006, we initiated our U.S. strategic partnership program, in which we consolidated our U.S. dealer base, and within the associated terms of the agreement, we received detailed end user data from the strategic dealer growth. We have found the end user data to be highly effective in developing marketing and promotional programs, directing sales activities and monitoring retail versus wholesale performance. Over time, the dealer base is consolidated, leaving us with a fairly concentrated dealer presence in some regions due to both market consolidation and also as a result of our termination of 1 dealer agreement at the beginning of the second quarter. In Q2, we added a net 5 U.S. dealers to the program to support market and customer coverage requirements. This action restores the number of dealers and balances the coverage to a level we've had when we initiated the program in 2006. In the quarter, we did receive stocking orders from the new dealers, but this was more than offset by the impact of the dealer termination, so it was a slight negative to U.S. growth in the quarter. Going forward, of course, we would expect the expansion to add growth over time as these new dealers become effective. As Bret mentioned, our Rest of World growth slowed in Q2 to 0.9% versus prior year. As we have discussed on these calls before, on an ongoing basis, we monitor potential gray market activities, which are generally more prevalent in the Rest of World regions. In Q2, we completed an in-depth assessment and identified some questionable dealer activities. As there…

Thank you, Jim. Good morning, everyone. I'd like to elaborate on our second quarter performance by reviewing key elements of our income statement and also provide some additional color on our balance sheet and cash flow for the quarter. Our sales growth, excluding precious metals, of 2.5% and our non-GAAP earnings per share growth of 6.5% for the period reflect some volume improvements in our U.S. businesses, increased leverage on our operating model and also the impact of synergy benefits. Our internal growth rate of 2.7% for the quarter was negatively impacted by about 60 basis points as a result of the discontinuation of sales to certain dealers in the Middle East. Currency translation was negative 20 basis points or essentially neutral to sales growth for the quarter. Gross profit rate on an adjusted basis in the second quarter was 58.4% of sales, excluding precious metals, which was a 20-basis-point improvement sequentially from the first quarter and 60 basis points below the strong prior year comparison of 59.0%. We estimate that the medical device excise tax in the United States has negatively impacted gross margins by 40 to 50 basis points in the period compared to prior year. So I'm pleased overall with this performance, which is actually above our trailing 4-quarter average despite not having the tax impact in the half -- over half that baseline. SG&A expenses on an adjusted basis were $280.3 million or 39.2% of sales, excluding precious metals. That's down 6/10 of 1% compared to the prior year and also down about a full percentage point on a sequential basis compared to Q1. Expenses as a percentage of sales, excluding precious metals, were down 120 basis points compared to prior year. While we believe we still have some room for further improvement, we're pleased to…

[Operator Instructions] And our first question, we'll hear from Jeff Johnson with Robert W. Baird. Jeffrey D. Johnson - Robert W. Baird & Co. Incorporated, Research Division: So Bret, I want to start with you, just on your assessment of Europe and kind of maybe looking for a little more color there. You talked about the market being pretty stable sequentially. It looks like to me, if I just, for selling days, your growth may have come down 100, 150 basis points sequentially or at least softened 100, 150 basis points. So what gives you the confidence market is stable? And if you could provide any more color on maybe how you think some of the southern European countries versus the core European countries could play out over the next couple of quarters, that would be helpful.

Okay. I'll give that a shot. As far as our assessment of the market, it's based on both our own sales volume and then anecdotal comments from the 10 or 12 people we got in the different regions of Europe running those businesses. We haven't seen a notable change in the market environment, our customer acquisition activity, their buying activities. There's still good uptake on new product introductions, but overall, that market is not growing. In fact, the economy is probably contracting, and the market is perhaps stable, maybe some volume growth in some countries, but that's offset by lower volume in other countries. So overall, we haven't seen a notable change to comment on for the most part. As far as regionally, I think that what we said before, it's still contracting in the South, but I would say we're seeing a little bit of stabilization there. It seems to be bottoming out in southern Europe, and northern Europe is kind of a balance between some markets that are growing slightly and some markets that are contracting slightly. So we have a little bit optimism that maybe by '14, some of the markets can begin to grow again, but we don't really anticipate a large improvement at this point in the back half of the year. And I think probably, entering the year, we had some hope that we would see some improvement in the back half. I don't know, Chris or Jim, do you have anything to add to that?

No, I think that's pretty clear. Jeffrey D. Johnson - Robert W. Baird & Co. Incorporated, Research Division: And Bret, the mid single-digit decline on the dental implant business in Europe is -- you feel like that's kind of in line with market. Is there anything you can do to maybe try to get above market at this point over the next few quarters? Or should we be thinking kind of that mid single-digit decline continues for the next couple?

Well, I think the mid single-digit decline, and Jim may have something to add to this, is in part due to that German integration. And although we saw a notable improvement in our performance in Q2 versus Q1, I think Jim pointed out, it's still negative. I don't know, Jim, do you have anything to add on the European implant business?

Yes, Jeff. I think from our standpoint, we definitely see a situation where our German business continues to improve. France, as an overall market, is doing well. U.K. is doing well. And I think we're seeing some stabilization even in Iberia. Italy tends to still be a little bit challenging. But I think, overall, we're seeing a stabilization, and we do expect some improvement at least from our business perspective in those region -- in that region. Jeffrey D. Johnson - Robert W. Baird & Co. Incorporated, Research Division: That's helpful. And last question for me, Chris. Just on the Rest of World and the dealers, if you lost about 300 to 500 basis points, it seems like -- as you chose to discontinue some of those EMEA or the MEA dealers, was there an EPS impact from that? Does that flow through to the rest of the year? It looks like to me maybe a couple of pennies. I didn't hear you talk about it when you talked about the reasons for trimming the top end of the guidance range, but to me, it had to have been a $0.01 or $0.02 in your guidance if that's going to continue. So just trying to figure that out.

Yes, I would -- I guess I would say, Jeff, certainly had an impact in the second quarter. And as we move forward, we do think we'll get a chunk of that business back through other distributors, and some of it, we obviously believe was gray. So we're going to get some of that back in the developed countries, if you will. But that will take -- sometimes, it takes a little bit of time. So yes, there is certainly a little bit of a headwind built in. Jeffrey D. Johnson - Robert W. Baird & Co. Incorporated, Research Division: Any way to quantify that? Was it $0.01 this quarter, a couple of pennies for the year? Anything?

Yes, you're in the right range. Yes.

And next, we'll move on Robert Willoughby with Bank of America.

Can you talk or elaborate -- sorry, this is Erin Wilson in for Robert Willoughby. But could you elaborate on the, I guess, trends in the U.S. and how sustainable they are? And this is sort of a run rate, I guess, excluding any sort of changes in selling days and such.

Sure, Erin. I'll take a stab at that. I think our performance in the second quarter was really very strong in the U.S. I mean, it's obvious, I don't think the U.S. market is growing 6%, and we had very strong performance in the specialties, in particular, but also in the consumable business was -- had pretty good growth as well. Whether 6% growth is sustainable over a long period of time or not, I'm not sure. I think that would require the market itself to tick up a little bit from where it is today. But our businesses are executing pretty well, and we're pleased with the uptake we're getting on new products in this market. There's volume growth in this market, which we haven't seen for some period of time. And some of the indicators we follow like white-collar employment gains have been pretty steady here for a while, and I think that's helpful to a business like ours.

Okay, great. And then is the integration in Japan, I know you highlighted it in your prepared remarks, but is that going smoothly as initially anticipated?

Yes, absolutely. One of our -- we initially integrated the operational portion of this business, with the consolidation of the 2 businesses to 1 facility. That actually happened in the beginning of June. And then the sales force integration happened at the end of June, and that's gone very well. We're very pleased with the way that has occurred.

And do you have any idea when you can kind of, I guess, regain some of the lost sales due to the gray market distributor in the Middle East?

Yes, Erin, it's Chris. That's going to be gradual. Again, we have other distributors in those regions. We would expect them to pick up obviously a chunk of that initially, but that will probably increase gradually over time. In addition to that, any time we shut off a gray market source, then obviously, that's less product that is getting kind of around our normal distribution channels into the developed markets. So we'd anticipate a gradual increase or a slow impact there as well. I think, again, we'll see it over time. I don't know that it -- it certainly doesn't snap back in a month or necessarily fully in a quarter, but it certainly should come back over time.

And next, we'll hear from Jon Block with Stifel. Jonathan D. Block - Stifel, Nicolaus & Co., Inc., Research Division: Bret, the U.S. specialty market was a really big number, and it seems like it was led by your implant division. Can you talk to the mix shift that you're witnessing in the U.S. dental implant market versus that of what's going on in Europe? And, I guess, in other words, as the delta between the double digit in the U.S. and down mid single digits in Europe, is that all a function of market growth or you're seeing a negative mix shift to lower-end solutions maybe more pronounced in Europe versus what's going on in the U.S.?

Yes, John, this is Jim Mosch. From a standpoint of the U.S. market, I mean, clearly, one of the things that we're seeing in the implant business is how the implant business reacts when the economy improves a little bit. And so, obviously, some of the growth we're seeing is an improved market. However, we absolutely believe that as we've consolidated this organization, it's become more productive and more effective that we are seizing customers and we are growing in this market and we are gaining market share. We definitely believe double-digit growth in North America is an increase in market share in the second quarter. As it relates to Europe, we have definitely had some regions that are under duress and have been for a considerable period of time. So we recognize that implants are not an investment that patients are making. We do not see a huge shift from premium to value. And I think one of the things that we always look at is that we do not see a situation in the marketplace where the cost of treatment to the patient is going down, which we think would be a real driver to that change. We definitely recognize that the value implants are out there. They tend to be local. We know they do a lot of swap between each other, and we monitor that closely. But in the premium segment, we do not see major moves to value in our customer group or -- and then, certainly, our largest customers.

John, it's Chris. I might add that I think the U.S. number kind of underscores that in a reasonable economy. That implant segment really should be accretive and will be accretive to the dental market growth rate. And certainly, what we're seeing in the U.S. and then, obviously, as economic conditions over time improve, I think that has us obviously feeling better in terms of the implant market globally. I would also add, as Jim mentioned, that the U.S. market was the first market that we integrated. So, again, as these integrations go on with time, we get more and more positive momentum, at least that's what we've seen, and obviously, we're pleased with the momentum we have in the U.S., as Jim mentioned. Jonathan D. Block - Stifel, Nicolaus & Co., Inc., Research Division: Okay, that's very helpful. And it actually sort of plays into the next question, which is, how did Japan go on folding together the sales forces? You mentioned a little disruption in Germany last quarter. I guess, did you witness some disruption in Japan? Or was it seamless? And then when we think about Japan being the last market to consolidate in terms of Astra Tech, what should we think about the incremental savings from here? In other words, are there still some things that you can pull down on as we exit '13 and go into '14?

Yes. From a standpoint of the integration in Japan, it went very well. I mean, obviously, you get better over time with experience. The other thing is the Japan business was not nearly the size of, say, Germany or the U.S. So our ability to integrate that seamlessly was very effective. We had a lot of time for those 2 organizations to work together, to get to know each other, to coordinate. And that process, from our perspective, went very, very well, not only from a sales force perspective but also from integration of business systems and things of that nature. So that's gone very well. As far as going forward, certainly, from a standpoint, we recognize synergies from the consolidations that we did. We continue to look for operational synergies as well. And on an going basis, I think there is an element where, as you go through an integration, you have a plan, you execute that plan, you recognize the synergies and then you step back and you take a look at your organization and you say, "Is this aligned with the way I see the business progressing, those strategy that I have in place and you continue to evaluate that?" So from a business perspective, this is an ongoing process for us. Jonathan D. Block - Stifel, Nicolaus & Co., Inc., Research Division: Okay, great. And one more if I can just slip it in. Chris, this one for you, just cash flow-related. It looks like CapEx, I think the range used to be $120 million plus. I think you said closer to $100 million this year. Is that just something from a timing perspective of '13 versus '14 or anything that you're pulling back on from a CapEx standpoint?

Yes, John, it's pretty much just a timing standpoint in terms of we got some initiatives in place, and we really haven't changed the scope of those initiatives but the timing a little bit in terms of phasing on a couple of them.

And next, we'll move to Matt Pascoe [ph] with William Blair.

I know, obviously, you talked about, in aggregate, Europe is -- continues to be weak, but are there any specific products that you guys see that are surprising you?

Well, I would characterize the market in Europe, the consumable market there, meaning the everyday dentistry products, is better than the specialty businesses, which are highly discretionary and a lot of times not reimbursed. So I would say the preventive products and the restorative products are both doing better. We've had some nice product launches there with -- I mean, I'll just throw out some names here, Prime&Bond Elect, the new cement we have; SmartLite, which is a new light we have; TPH Spectra is a new composite we're putting on the market; Protaper NEXT is a new endodontics file. We're getting good uptake in a lot of these newer products, and -- so that everyday dentistry segment is much more stable than the specialty side of the business, I would say, in Europe.

[Operator Instructions] Next, we'll move to Yi-Dan Wang with Deutsche Bank.

First of all, on the dental implant business in Germany, is that a recovery more or less in line with what you were expecting? Or is it progressing a bit slower than expected? Certainly, coming out to the last call, I was expecting it to improve or to start to grow in the second quarter. If you could comment on that, and also when you would expect that business to return to growth, that will be helpful. And then secondly, was the implant business affected by the disruptions that you talked about in the gray market in the Middle East? And then, thirdly, can you give us the sort of sales day adjusted growth for the U.S. and ex U.S. implant business? And yes, that will be helpful. That's all.

Okay. Let me take a couple of these, and then I'll let Jim comment on the German business and the progression of the integration. With respect to the Middle East disruption, that was not implants, that was basic consumable products. Sales adjusted basis, we don't adjust our sales for the days, but if you want to adjust them yourself, you can. I think there was an extra day in the U.S., an extra day in Germany. We were down a day in Sweden. Overall...

Yes. About 60% of our business had an extra day.

Okay. So about 0.6 of a day for the global business was extra this quarter versus last year. With respect to the implant business in Germany and progression of the integration, Jim, do you want to take that?

Absolutely, Bret. From a standpoint of the integration in Germany, I think it's important to recognize that this was, by far, our largest and most complex integration. This is a very large sales force, fairly equally divided between Astra Tech and Friadent organizations. So there was a fair amount of customer transition. They're also moving to a common operating system, common processes, and there's just an element of the business gains confidence and effectiveness over time. We certainly would have hoped that the integration would have gone smoother in the first quarter. We saw a nice improvement in Q2, and we've seen improvement in July. So from my perspective, I see the confidence and effectiveness of this organization improve every month, and we expect it to continue to perform better each month as we go forward. As far as the overall market, the German market is probably, I think, a little bit more challenging than us and our competitors would have anticipated. So that recovery aspect is happening in a market that probably has a little bit of slower growth as well. But I think, over time, as we move through the next couple of quarters, we expect to see some good improvement in that market and that business.

When you say improvements in the next couple of quarters, can we expect it to grow by that time or it's kind of a relative gain in that if the market is becoming more challenging, then you're going against decent headwinds?

Yes, Yi-Dan, we don't really give specific guidance on specific products in specific markets, but we're happy to see that the business is improving sequentially. We expect that to continue. Predicting how 1 market in 1 country around the world is going to progress is a dangerous business, and we don't believe we need to do that. But we're happy with the business. It's progressed nicely from what happened in the first quarter, and we expect to see sequential improvement from here.

Okay. That's helpful. And then last question. On the regional growth in the implant business, can you be a bit more precise on your U.S. and ex U.S. growth? I mean, double digit sounds wonderful. Can you give us some indication on where you are along those lines, whether it's low double-digit, mid-teens, high-teens, and then similarly for the ex U.S. business?

It's low double digits in the U.S., and it's negative in Europe.

And we'll move on to Brandon Couillard with Jefferies.

Bret, curious if you would elaborate on what drove the decision to change the dealer setup in the U.S. market, and if you could quantify the impact to the U.S. growth rate in the second quarter. And then how should we think about that dynamic in the back half of the year?

Okay, Bran, I'll take a stab at this and then if Jim or Chris want to add anything they can. When we -- right after we had done the dealer consolidation, it was late 2006, 2007. We had basically 22 dealers that were strategically picked for coverage in the market and also the way that they transact business with us, meaning they were the most sophisticated and the easiest business partners for us to do business with. They were very efficient, et cetera. Since that time, there has been consolidation of 5 of those dealers. So about 25% of the baseline went away through consolidation, and then in the second quarter -- early in the second quarter, we terminated one of the remaining. It was 17 dealers at that point, so we were down to 16 dealers. We felt that was a little bit too consolidated, so we made the decision to go back out and find 5 or 6 other dealers that we thought would rebalance the portfolio and get us back to kind of a number around 20, 22 dealers to cover all of the U.S., which we think is about the right balance for us. So just -- we expect that there can be industry consolidation, so when we consolidated -- when we brought the dealer -- the number of dealers down before, we knew this might happen. And over the 6 or 7 years since we implemented the program, we had lost 25% of the dealers to consolidation, so we rebalanced the portfolio. This is simply what happened. The effect on the second quarter was that the initial orders from the new dealers to bring their -- put their inventory in was slightly less than the sales we lost to the dealer we cut off. So it was slightly negative to the U.S. growth rate in the quarter. As those dealers become now efficient in areas of the market that maybe we were underrepresented in before, we expect it, of course, to be positive to the balance of the business and the growth of the business.

Got you. And then, Chris, any chance you could quantify the impact of absorption on the gross margin line in the second quarter? And certainly, it sounds like that should trend favorably in the back half of the year as you build inventories. And then, perhaps, if you could call out the impact of mix and currency on the gross margin line in the quarter, that would be helpful.

Sure. Let me start with -- the currency really didn't have much of an impact in the quarter. There's some gives and takes between translation and transaction. From a mix standpoint, mix was slightly negative, with obviously a little bit slower implant growth and also a little bit negative product mix. I would characterize that probably in the -- it was -- appear to be in the -- about the 30-basis-point range. Again, the biggest negative impact for us -- impact in general for us on the gross profit line was the med device excise tax, which was between 40 and 50 basis points of headwind. In terms of absorption, we got a little bit of a lift in absorption but not significant as necessarily in a quarter. As we move forward, I would assume that the inventory level [indiscernible] come up a bit but probably not come up to the degree as much incrementally as they have here in the first -- in the second quarter, at least that would be our expectation. But I don't necessarily see them coming down as rapidly in the back half as historically we have. So I would characterize it probably that way.

Yes. The only thing I might add there, Brandon, is on the currency impact, although it was somewhat neutral in the second quarter, we saw some pretty significant weakening of both emerging markets and some developed markets against the U.S. dollar and the euro. And the reason that's important is, in those markets, we typically buy the inventory in from the U.S. or Europe, and thus, we had a little bit of a headwind -- or more of a headwind than we had when we finished the first quarter with respect to some of those currencies. I don't know, Chris...

Yes. Absolutely. I mean, if you look at it in the quarter, against the Australian dollar, the U.S. dollar strengthened 11%, similar movement against the Brazilian real, similar movement against the Indian rupee. I mean, some of these are smaller organizations force, but there's a lot of them that add up. And, again, as Bret mentioned, these folks are net importers of products, both from U.S. and from Europe in terms of our products. And so as such, as their home currencies weaken, those foreign-sourced products become more expensive for them. And so, obviously, their profits obviously translate to fewer U.S. dollars as well.

And next, we'll hear from Glen Santangelo with Crédit Suisse.

It's actually Diego filling in for Glen. I was just wondering if we could get a quick update on sort of the ortho relaunch. I think where we left it last quarter, the things were tracking well in line with your expectations. Any color around that would be helpful.

Yes. I think we're pretty much -- very much still in line, Diego, relative to what we expected. I would say we kind of characterize it as saying this next phase was going to be a street fight slugging it out, really, customer by customer with competition. I think that ortho Japan together really didn't have a meaningful impact necessarily on our overall growth for the quarter or internal growth for the quarter. We saw some solid customer gains, particularly in the U.S., in the quarter. So we feel good about that. But, again, I think that we're now beginning to run up against kind of the prior year relaunch. We kind of ran up against it in the second quarter in Europe, and now we're going to begin running up against that in the U.S. in terms of some baselines that had customer restocking efforts in it. So -- but, again, the way we're really measuring this is at a customer level in terms of, again, that street fight, and we're pleased with how our teams are doing, particularly in the U.S. right now.

And there are no further questions at this time. I would like to turn the conference back over to Mr. Leckow for any additional or closing remarks.

Well, thank you. Thanks for your interest in DENTSPLY, and thanks for your participation today. That concludes our conference call. If you have any questions, I'm around today for any follow-ups. Thank you.

And that will conclude today's call. We thank you for your participation.