Envista Q2 2024 Earnings Call Transcript

Quartr
Provided by Quartr
August 7, 2024

There are 10 speakers on the call.

Operator

Please standby. Your program is about to begin. My name is Stephanie, and I'll be your conference call facilitator this afternoon.

Operator

At this time, I'd like to welcome everyone to Avista Holdings Corporation's 2nd Quarter 2024 Earnings Results Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question and answer session. I will now turn the conference over to Mr. Stephen Keller, Principal Financial Officer of Invista Holdings.

Operator

Mr. Keller, you may begin.

Speaker 1

Good afternoon, and thanks for joining the call. With me today is Paul Kiel, our President and Chief Executive Officer and Eric Hammes, who will assume the position of Chief Financial Officer tomorrow. Paul and I will be leading the call today and will handle the Q and A at the end of the prepared remarks. I want to point out that our earnings release, the slide presentation supplementing today's call and the reconciliations and other information required by SEC Regulation G relating to any non GAAP financial measures provided during the call are all available on the Investors section of our website, www.investico.com. The audio portion of this call will be archived on the Investors section of our website later today under the heading Events and Presentations.

Speaker 1

It will remain archived until our next quarterly call. During the presentation, we will describe of the more significant factors that impacted year over year performance. The supplemental materials describe additional factors that impacted our year over year performance. Unless otherwise noted, references in these remarks to company specific financial metrics relate to the Q2 of 2024 and references to period to period increases or decreases in financial metrics are year over year. During the call, we may describe certain products and devices that have applications submitted and pending certain regulatory approvals or are available only in certain markets.

Speaker 1

We will also make forward looking statements within the meaning of the federal securities laws, including statements regarding events or developments that we believe, anticipate or may occur in the future. These forward looking statements are subject to a number of risks and uncertainties, including those set forth in our SEC filings, and actual results might differ materially from any forward looking statements that we make today. These forward looking statements speak only as of the date they are made, and we do not assume any obligation to update any forward looking statements except as required by law. With that, I'd like to turn the call over to Paul.

Speaker 2

Thank you, Stephen. Good afternoon and welcome to Invista's Q2 2024 Earnings Call. We appreciate you taking the time to join us today. We'll cover 3 items in the next 30 minutes or so and then reserve the last half hour for Q and A. I'll start with some opening thoughts on the quarter, on my first 90 days with Invissta and on the broader dental market.

Speaker 2

I'll then turn it over to Stephen to walk us through the numbers and we'll come back later in the presentation with a strategic update and outlook for 2024. Four thoughts by way of introduction. 1st, Envista is a fundamentally good business with significant unmet global demand, dental has proven to be a secularly growing market over time. And Envista is well positioned to serve this demand, holding a top 3 position in the most attractive segments. As a former Danaher business, we have a high performing continuous improvement culture, which is evident in our strong operations and talented people.

Speaker 2

Having spent most of my career in other structurally advantaged companies, I know what they look like and can see that this company is built on a very solid foundation. With that as a starting point, I would also say that our recent performance does not reflect our full capabilities, much less our vast potential. While free cash flow was strong in the quarter, up 41%, our core growth of negative 3% and adjusted EBITDA margin of 10% was below expectations. As Stephen will explain in a moment, these include a number of one time and non cash charges. Excluding the impact of these items, we believe this implies an underlying performance of the business in line with Q1.

Speaker 2

Even at these levels though, we are capable of more. And as such, we are swiftly taking action to position our company for better performance moving forward. To that end, we filled 3 critical executive roles in Q2. We're making important investments in Spark Manufacturing Technology to improve profitability and support long term growth. We're drawing down channel inventory in our distribution businesses, connecting us even more closely to end user demand and we're continuing to make growth investments in our largest and most profitable business, Nobel Biocare.

Speaker 2

We're excited by the return potential of these investments. On the back of all this, we are reinstating full year guidance of negative 1% to negative 4% core growth and 10% to 12% adjusted EBITDA margins. The P and L impact of the actions I mentioned are concentrated in Q2 and Q3 and we expect to return to growth in Q4. Absent one time and non cash charges that Stephen will detail later, we believe that the underlying performance of our business will be more in line with modest growth and low teens margins on a full year basis. As you will recall, I joined Envista on May 2nd and my 1st 90 days with the business have been both productive and encouraging.

Speaker 2

As I previewed on our Q1 earnings call, I focused the lion's share of my time over the past few months in 3 primary areas: customers, colleagues and operations. With respect to the first, I've had the pleasure to meet with dozens of customers, key opinion leaders and business partners. With close to 2 thirds of our business sold direct, our customer connectivity is strong and the quality of our portfolio is well recognized. Stakeholders know that Envista is a great company and they want and expect even more from us. Regarding my colleagues, I've connected with nearly all of our top 150 leaders as well as many of our frontline teams.

Speaker 2

They also know how strong their company is and are similarly eager and committed to performing up to our potential. Ours is a continuous improvement culture, which means we know we must be better tomorrow than we are today. The opportunities I've seen in just the 1st 90 days are both meaningful and actionable. For as far as this and our predecessors have come across our 100 plus year history, our brightest days are still ahead. Finally, in terms of operations, I expected to find a capable organization and have not been disappointed.

Speaker 2

I have visited most of our largest sites around the world already and the benefits of the Invista business system are readily apparent. EBS is an important differentiator for us. However, even here, there remains opportunities to extend the impact of EBS across our global footprint. There is more we can do to convert our capabilities into consistently strong results. This is what good companies do.

Speaker 2

And most of what I've seen across my 1st 90 days supports what I said on the previous slide. Envista is a fundamentally good company. Before I turn it over to Steven, let me say a few words about the dental market as well as our relative performance within it. In total, we estimate that the global dental market grew low single digits in the quarter. Compared to its longer term growth, this relative market softness that we and others have commented on continued in Q2, driven by macro factors like higher interest rates, moderate consumer confidence and rebalancing of demand following the post COVID market surge in late 2022 and 2023.

Speaker 2

On the positive, patient traffic remained steady and several of our larger customers enjoyed solid growth in the quarter. Looking at sector specific conditions, the implant market was flat to slightly positive in Q2 with value outperforming premium and single tooth procedures bearing better than full arch. While we underperformed the market in the Q2, we took steps to improve our overall performance. We have significantly increased our local training programs aimed at supporting our top customers and their referral networks, delivering more than 800 local training courses in H1 alone. In addition, year to date, we've had more than 5,000 customers participate in national events aimed at attracting and developing new doctors.

Speaker 2

We believe these investments are starting to pay off. In North America, our performance relative to the market also improved. Our new customer win rate in Nobel is up and sales from new customers grew both year over year as well as sequentially. Still more on a global basis, our value implants business grew for a 2nd consecutive quarter as we continue to build momentum in this important segment. The orthodontics and dental consumables market also saw flat to low single digit growth in Q2 and we gained share in both of these segments.

Speaker 2

On the ortho side, our traditional bracket and wire business saw a solid uptick with particular strength in emerging markets. Reported sales growth for Spark slowed in the quarter as we're now deferring a larger portion of case revenues. As described in our filing, we recognize a portion of Spark revenue at the start of the case and the balance over the treatment time. This change in deferral has no impact on the cash flows or true economics of the business. Indeed, we believe our case starts grew above market in the quarter.

Speaker 2

Diagnostics was the only major dental market segment experiencing a contraction in Q2, down mid single digits impacted by the higher interest rate environment I mentioned earlier. Our business contracted high single digits in the quarter as we saw the continued impact of exiting some lower priority, more price sensitive geographic markets. In summary, it's been an encouraging 1st 3 months for me at Invista. I'm pleased with our ability to attract world class talent and impressed with how quickly the organization is moving to enact the changes needed to improve our trajectory moving forward. We still have much to do, but we're off to a promising start.

Speaker 2

With that as an overview, I'll turn it over to Stephen to take us through the numbers.

Speaker 1

Thanks, Paul. Before reviewing our 2nd quarter results in detail, I would like to comment on a non cash impairment charge related to goodwill and intangible assets that we recorded in the Q2. As Paul mentioned, the general market softening driven in part by higher interest rates and moderate consumer confidence has contributed to reduced revenue, operating margins and expectations for future cash flows. These effects, coupled with the decline in our stock price, have resulted in the estimated fair value of certain parts of our businesses to fall below their carrying value. Therefore, we recorded a $1,200,000,000 non cash charge for goodwill and intangible impairments in the quarter.

Speaker 1

Turning to our results in the Q2, we delivered sales of $633,000,000 Adjusting for the impact of currency exchange rates, core sales for the quarter declined 3.2%. This reflects growth in our Specialty Products and Technology segment, offset by a 10 point decline in our Equipment and Consumables segment. Segment. Outside of typical business drivers, sales in the quarter were also impacted by 2 unusual dynamics. 1st, as Paul mentioned earlier, we have increased the proportion of revenue we are deferring on new spark cases.

Speaker 1

The increase in deferral is based on our current best estimate of aligner usage rates and the timing of future shipments. As a number of completed Spark cases continues to grow, we empirically adjusted our estimates to reflect actual experience, better matching revenue and aligning use by our customers. It's important to note that this change only impacts the timing of revenue, creating near term impact on reported results. This change does not impact the underlying performance of the business, nor does it impact the timing of cash flows associated with cases sold to doctors. 2nd, in addition to the changes in Spark's deferred revenue, Q2's reported revenue was also impacted by a strategic decision to reduce consumable inventory in the North American distribution channel.

Speaker 1

Over the last few years, we have worked to reduce the number of weeks on hand with our distribution partners. Given our strong operational performance and consistently high customer service rates, we took the decision to further reduce inventory in the channel and believe that this is better for both our own business and our distribution partners. We closed Q2 with North American channel inventory at roughly half the levels we had in the peak of 2023. While this creates a near term impact on growth and margin, it positions Envista for better performance moving forward. Geographically, our developed markets declined mid single digits with both North America and Europe declining in the quarter.

Speaker 1

Nearly all of the decline was driven by the increase in spark deferrals and the realignment of dealer inventory. Excluding these impacts, developed markets grew modestly. Our emerging market business grew low single digits in the quarter. Russia delivered high double digit growth versus sanction impact in Q2 of 2023. China declined low single digits against a very strong second quarter in the prior year.

Speaker 1

While there has been near term volatility in China and Russia, these are good markets for us. We have been serving customers here for a long time and we are well positioned for continued long term profitable growth in these critical markets. Our 2nd quarter adjusted gross margin was 54.2%, a decrease of 370 basis points compared to the prior year. The decline was driven by lower volumes associated with channel inventory reduction, less favorable mix and one time costs associated with technology investments in Spark Manufacturing. Our adjusted EBITDA margin for the quarter was 10%, which was 9 10 basis points lower than in Q2 of 2023.

Speaker 1

I will walk you through the components of this in a moment. Our 2nd quarter adjusted diluted EPS was $0.11 compared to $0.43 in the comparable period of the prior year. Our free cash flow in the quarter was a bright spot as we delivered $86,300,000 of free cash flow, a 40% increase versus prior year. Given the unusual dynamics in both our core growth and adjusted EBITDA margins, we have added 2 additional bridges to provide further transparency regarding our quarterly results. From a reported revenue perspective, the increase in Spark deferrals negatively impacted top line results in the quarter by $11,000,000 or roughly 107 basis points.

Speaker 1

We expect to recognize all the deferred revenue over the next 18 months. Commercially and operationally, we continue to make progress in Spark. In the quarter, we saw a greater than 20% increase in the number of active Spark doctors and year to date we have launched Spark in 6 additional countries. We expect Spark to continue to be a growth engine for Envista over the long term. When it comes to the realignment of dealer inventory, the impact reduced our sales volumes by $317,000,000 in the quarter as compared to last year.

Speaker 1

With channel inventory levels now less than half of where they peaked in 2023, we expect to see sequential growth in consumable sell in as we move through the second half. Further, long term, we expect sell in to match sell out more closely, leading to more consistent growth and the opportunity for additional share gains. Outside of these two major dynamics, we saw a solid contribution to growth driven by pricing in the quarter. As you can see from the bridge, our adjusted EBITDA margins in the quarter were down 9 10 basis points year over year. A little over a third of this reduction was driven by one time costs that are not expected to repeat.

Speaker 1

As mentioned, these included investments to further improve where unit cost declined double digits in the quarter. After another roughly onethree of the impact was driven by the increase in spark revenue deferrals and the decrease in dealer inventory. In the case of dealer inventory, we do not anticipate further drawdowns moving forward, although there will be a year over year impact in Q3 relative to higher levels of 2023. Similarly, while Spark deferral will result in further P and L headwind in the near term, it provides an equal and offsetting tailwind down the road. Deferred Spark revenue will be recognized fully over the next 18 months and consumable sell in should normalize in line with sell out of our products.

Speaker 1

As discussed on previous calls, we continue to make strategic investments, particularly in the implant business. The investments are centered on training education, sales and marketing and R and D and all are aimed at accelerating growth. Provided we are successful in this regard, the high margin profile of this business should result in attractive returns for these investments. A few other items of note. We delivered 100 basis points of margin expansion from price in the quarter and delivered 100 basis points of net productivity.

Speaker 1

Turning now to segment performance. Core revenue in Specialty Products and Technologies increased by 0.9% compared to the Q2 of 2023. Our orthodontic business grew mid single digits with Spark delivering growth despite the increase in deferred revenue. Our brackets and wire business grew solid mid single digits as we saw robust growth in Russia and China, balanced with more tepid demand in other parts of

Speaker 3

the world. Implants

Speaker 1

declined low single digits in the 2nd quarter. Our value implant business posted modest growth, a continuation of improving performance that we saw in Q1. Our premium business was impacted by the continued market weakness in full arch implant restorations and continued underperformance in the North American market. However, as Paul mentioned, we are starting to see benefits from the investments we are making. Our performance relative to the market has improved and we continue to protect existing customers and win new business at an accelerating rate.

Speaker 1

For the Q2, our Specialty Products and Technologies segment had an adjusted operating profit of 9.1%. This was down 9 60 basis points versus the same period in the prior year, driven by the impact of investments, one time cost and deferred revenues described previously. Core sales in our equipment consumables segment in the 2nd quarter decreased by 10.1% compared to the Q2 of 2023. Our diagnostics business declined high single digits. The decline was primarily driven by weakness outside North America.

Speaker 1

Encouragingly, our North American business grew as demand is stabilizing. Emerging markets saw a large decline in the quarter driven by the combined effect of the muted macro conditions and our deemphasizing of non strategic geographies and solutions. With these efforts, we continue to refine our focus and concentrate our energy in markets where we can build and maintain sustainable competitive advantage. Our consumables business declined double digits in the quarter, driven by the drawdown in channel inventory in North America. As discussed, patient demand remains resilient and we continue to strengthen our partnership with our distributors to drive sellout.

Speaker 1

Equipment and Consumables adjusted operating profit margin was 16.1% in the Q2 of 2024 versus 25.7% in Q2 of 2023. Most of the decline was directly related to volume and mix along with some discrete investments in our distribution partnerships and in diagnostics marketing. We expect equipment and consumables growth and margins in Q3 to remain challenged due to the year over year comparisons. Conversely, Q4 should show a marked improvement with both year over year and sequentially as we position our E and C business to deliver growth in 2025 and beyond. In the Q2, we generated free cash flow of $86,300,000 a 41% improvement versus prior year.

Speaker 1

Our increased cash flow was driven primarily by improved collections and better vendor management, and we believe that our improving free cash flow is indicative of the solid underlying performance of our business. I'll now turn the call over to Paul for a strategic update.

Speaker 2

Thank you, Stephen. Over the next few slides, I'll share additional background on our recent executive appointment, highlight areas of particular focus for us in H2 and go into a bit more detail on the full year guidance I sketched out earlier. On July 15, we announced 3 new members of our executive team, Eric Hammes as CFO, Stefan Nielsen as the President of Nobel Biocare and Veronika Accurio as President of Orthodontics. Eric joins us from Rockwell Automation, where he served as Vice President of FP and A. Prior to Rockwell, Eric spent over 25 years at 3 ms, where he held a variety of senior financial and operational leadership roles, including Chief Accounting Officer, CFO of 3 ms Healthcare Business, Director of Finance for 3 ms's Orthodontics Division and SVP of Finance for 3 ms International, which represents roughly 2 thirds of the company's revenue.

Speaker 2

In addition to his deep finance and accounting experience, Eric has also held several senior operating roles, including EVP of Business Transformation, Chief Country Governance Officer and EVP of Enterprise Operations, with responsibility spanning 170 manufacturing sites and over $30,000,000,000 in annual production. Relevant to Envista, Eric's entire career has been in businesses with a focus on growth and a continuous improvement culture. His experience is global, having lived and worked in the U. S, Europe and Asia, and he knows our dental markets well, having worked in and around them for many years. At the same time that we welcome Eric to Envista, I would like to express my deepest gratitude to Stephen Keller, who capably served in an interim capacity while we searched for a permanent CFO.

Speaker 2

As Eric is with us today on the call, I'll ask him to say a few words of introduction prior to his appointment as CFO tomorrow. Eric, welcome to Envista.

Speaker 4

Thanks, Paul. I'm thrilled to join Envista at such an exciting time for the company. Our leading brands in the most attractive segments of dental coupled with the strength of our people, create the foundation to compete, grow and win. Like so many of you, I see the unique opportunity at this time in Envista's decorated history to create real value for all of our stakeholders. In the weeks months to come, I look forward to meeting our partners and customers, my colleagues and our shareholders.

Speaker 2

Thank you, Eric. Moving forward, Stefan Nielsen joins us from Coliseum Dental working with CEO for over 5 years. Under his leadership, Coliseum more than doubled in revenues growing to be Europe's largest dental service organization. Envista is highly customer centric and few are as well positioned to understand the needs of our customers as Stephane, who was one himself for many years. He knows firsthand the distinctive strengths on which we're building as well as specific opportunities for us to be even more competitive.

Speaker 2

Prior to Coliseum, Stephane was CEO of Grand Vision in Brazil, a leading optical service provider. And before that he spent over 18 years at Nestle in a variety of operations marketing and general management roles around the world. Like Eric, Stephane brings relevant breadth and depth to Invista. Underpinning our global reach, Eric and Veronica will be based at Invista's headquarters here in Southern California, while Stephane will be based at Nobel's HQ in Zurich. Veronica Accurio brings to Envista more than 30 years of dental and medtech experience.

Speaker 2

She was most recently President of 3 ms's largest business, the roughly $5,000,000,000 Medical Solutions division. Prior to that, she held various commercial, operational and business leadership roles of increasing responsibility, including SVP of 3 ms Healthcare in the Greater China Region, Managing Director of 3 ms Taiwan, VP of Business Development for 3 ms Healthcare in Latin America and Global Business Director of 3 ms Oral Care's Restorative Business. Like Eric and Stephane, she's lived and worked all over the world, including the U. S, Asia and Latin America. Like Stephane and Eric, Veronica knows dental specifically and medtech more broadly.

Speaker 2

And like Eric and Stephane, she has consistently demonstrated the commercial, financial and operational excellence needed to realize the exciting potential we all see here at Envista. Having touched on our progress in Q2, let's now look forward to the second half where we'll intensify our focus in 3 particular areas: growth, operations and people. Growth remains our first priority. With the high margins that accompany our leading positions, accelerating top line growth is the key to even faster expansion in earnings and cash flow. We'll see this play out in general consumables as we expect to return to selling growth in Q4 with meaningfully lower channel inventory.

Speaker 2

We'll see the same in implants as the investments we are making continue to pay off and we'll see this in our fastest growing business Spark, where our attention remains squarely focused on expanding the number of ordering clinicians and associated case volumes. Moving on to operations, we have more opportunity to optimize our cost structure continuing to save where we can so we can invest where we want. As Spark is still highly dilutive to overall margins, the faster it has grown, the more margin compression we've absorbed. As Spark continues to scale, this margin headwind will eventually shift to accretion. A good part of this is driven by volume and we are amplifying the benefit through the technology investments mentioned earlier.

Speaker 2

And most importantly, people make all the progress possible. The sustained success of Envista will hinge on our ability to further advance our culture of performance, inclusion and continuous improvement. The fact that we are able to so quickly attract world class leaders point to the enormous upside in this company that the Envista team will unlock together. And this all begins with delivering on our updated 2024 commitments. So let's turn to those now.

Speaker 2

As mentioned at the outset, we are reinstating full year guidance of negative 1% to negative 4% core growth and 10% to 12% adjusted EBITDA margins, inclusive of the one time and non cash charges that Stephen detailed earlier. We're acting now to position Envista for improved performance moving forward. The P and L impact of the actions covered on today's call will be even larger in Q3 before a projected return to growth in Q4. Excluding the impact of the one time and non cash charges, we would expect modest core growth and low teens EBITDA margins for the year. We will build on this momentum as we move into 2025.

Speaker 2

Four closing thoughts before we open it up for your questions. 1st, I'll underline again that dental is an attractive market with proven long term growth drivers. We're seeing a short term softening here in 2024, but over any meaningful period of time, this market has grown at stable GDP plus rates. 2nd, Envista has built leading indefensible positions in the most exciting segments of the dental market. Our portfolio is well balanced both by category as well as by geography.

Speaker 2

And the business has high margins and strong cash flow characteristics, allowing us to self fund a steady growth embedded structurally in our markets. 3rd, we need to do more to access this opportunity and we are swiftly taking the actions needed to accelerate top and bottom line growth. The actions taken in Q2 and Q3 should allow us to return to growth in Q4 and then carry them in the momentum forward into 2025. Finally, and most importantly, we are propelled by the significant opportunity we clearly see in front of us to create even more value for our key stakeholders. I applaud my colleagues for the encouraging progress we've made together in my 1st 3 months.

Speaker 2

And in the same way, we're grateful for the strong support we enjoy from our customers, partners and shareholders.

Speaker 1

Thank you, Paul. That concludes our formal comments. Paul and I will now take your questions.

Operator

Thank you. At this time, we will open the floor for questions. And our first question will come from Elizabeth Anderson with Evercore ISI.

Speaker 5

Hi, guys. Thanks so much for the question and congrats on starting altogether as we go through the rest of the year. Can you talk to me a little bit about the like actual run rate of the business? Because I'm doing the math here. It looks like the EBITDA the midpoint of the EBITDA that you're guiding to for the back half of the year is something like $125,000,000 in the range like $100,000,000 $150 ish on my math.

Speaker 5

Like is that the right actual like run rate of the business as we think about that? I know that there are a number of one time items in the quarter, but I'm thinking more as we think about like the back half of the year and forward. Thank you.

Speaker 2

Thanks for the question, Elizabeth. And it is the right place to start. So let me recap. There were, as you said, a number of moving pieces in the quarter. We announced reported core growth of negative 3% and reported EBITDA margins of 10%.

Speaker 2

If we adjust for the one time and non cash impacts, underlying performance was more like positive 1% core growth and 14% EBITDA margin in the quarter, pretty similar to what we announced in Q1. Now on a full year basis, we've reinstated guidance of negative 1% to negative 4% core growth and 10% to 12% EBITDA on a reported basis. But on a similar normalized basis, excluding the one time and non cash effects, we expect to deliver a similar 1 ish percent core growth and 14 ish percent EBITDA margin for the full year. Now looking at the second half by quarter, I'd again underline that the impact of the one times will be larger in Q3 than Q2 and this will show in the Q3 reported results. Conversely, the impact will be less in the final quarter, so we expect to return to growth in Q4 allowing us to build momentum heading into 2025.

Speaker 2

And most importantly, I'd go back to where I began, Envista is a fundamentally strong company With our underlying performance, in the quarter above our reported results, it was still below our demonstrated capabilities. So we have clear line of sight to what improvements are required to improve our trajectory and many of those actions are underway already. We have work to do here, but we're pointed in the right direction.

Speaker 5

Got it. That's super helpful context. Thank you. So I guess on that math, gives you an implied like 200 jump off point, which is helpful. How do we think about like as we go look forward and you guys particularly on the implant business, what are the sort of key actions you guys are thinking about on a short term basis versus things you're thinking about that might be a couple year kind of trajectory?

Speaker 5

I know obviously the macro is whatever the macro is. But like where do you see those things as kind of like the near term and maybe longer term priorities on that business in particular?

Speaker 2

Also a good So with implants, you have to begin with the underlying market and margin characteristics of the business. So this is a proven growth category. Right now, the premium growth has slowed, in particular for the full arch procedures, and value has done a little bit better. We expect both of those to accelerate moving forward. And as we noted, we're seeing improvement on both sides of our business.

Speaker 2

Our gap to overall market growth on the premium side, shrunk in the quarter and we had a second consecutive period of growth on the value side. 2nd part of that equation, of course, is margins. One of the things we all like about these businesses is that as you accelerate growth, it has an incremental effect on the growth of earnings, expanding margins. So we'll continue to make the investments that began in Q1 and continue to cross Q2 to accelerate growth in implants. That's about $6,000,000 a quarter.

Speaker 2

And while that has a near term impact on margins, we've all seen this enough. We'll know over time when you get the growth, it more than pays for itself.

Speaker 5

Got it. Thanks so much.

Operator

Thank you. Our next question will come from Erin Wright with Morgan Stanley.

Speaker 6

Great. Thanks. You mentioned a few times that you think the long term growth rate in dental is like a GDP plus type of rate. I guess, how are you thinking about the market getting to there? And then in terms of how you're thinking about getting to growth in sort of the Q4, I guess, what does that entail in terms of underlying market growth for the balance of the year here near term?

Speaker 2

Yes. I mean, as you guys know, I've been in and around the dental market for, I'll call it 20 years now. And so we have seen macro ups and downs during that time. In fact, 2 of the more pronounced contractions that hopefully we'll witness in our lifetimes happen in that period. And so from that, we know dental is not immune to the macro, but it is less sensitive than other categories.

Speaker 2

And I think you're seeing the same thing currently. Now with respect to the second half, our return to growth in the Q4 is mostly a function of how the one times we talked about play out. It's not dependent on any improvement in the macro. I would expect 2025 to be, from a market perspective, a bit better than 2024 and we'll be we'll benefit from that as well. That's how it's played out in the long term drivers of growth in dental, just have not changed.

Speaker 6

Okay. And then if I could ask one follow-up just on Spark. And could you talk about what underlying normalized growth would be kind of for Spark for you and kind of just underlying kind of traction in the market competitive dynamics that you can speak to in the various different markets that you participate from a geography perspective? Thanks.

Speaker 2

Yes. For Spark, I mean, the clear aligner category is a high single digit grower. We've been growing better than the category over time. In the next couple of quarters, that'll be a bit clouded for us because of the impact in reported results related to the increased deferred revenue. But the underlying growth of the business won't be impacted.

Speaker 2

For example, we look in addition to the core growth, we look at the number of ordering clinicians and we look at the number of submitted cases. The number of ordering clinicians for us was up strong double digits in the quarter and then the growth of submitted cases was up high single digits. So we believe we'll continue to have good growth on the Spark side, accretive growth for Envista. The second comment on Spark is around profitability. Now that remains highly dilutive to us from a margin perspective.

Speaker 2

So conversely, Spark grows for us, we've absorbed more margin compression. We had good progress in the quarter in terms of our unit costs. Unit costs or aligner per aligner costs were down double digits in the quarter. Eventually, that will turn to accretive. And over the past several years, we have entirely funded building the Spark business out of operating income and cash flow.

Speaker 2

And that will turn to a tailwind here as that business becomes accretive.

Speaker 6

Okay. Thank you.

Operator

Thank you. Our next question will come from Jon Block with Stifel.

Speaker 7

Great. Thanks guys. Good afternoon. Yuval, it seems like there are some data points that suggest that Invisa's implants, the division improved, growth was closer to that in market relative to what you guys experienced in past quarters. So I guess the question is, do you feel confident you have the portfolio to get back to market growth, portfolio being the right mix of premium value?

Speaker 7

Are you confident that the current investments are sufficient to get back to market growth? And maybe if so, the timeline in which you hope to achieve something like that?

Speaker 2

Hey, John, thanks for the question. So first on portfolio, yes, the combination of Nobel and our 2 value businesses, these are good portfolios. We're well positioned to compete globally in both categories. Second thing I would say is, my view, having been working in the business now for 3 months is that, we did not invest sufficiently previously in either of these businesses. And that's what caused the management team to start putting money back in Q1, continue it in Q2, and we intend to do the same here across the back half of the year.

Speaker 2

You pointed to the leading indicators we're also looking at that give us confidence that those investments are starting to pay off. But we got to now convert that into the results that we share with you guys. In terms of timing, I don't know we're yet in a position where I can call when that will turn to positive, but we hope to make sequential improvement across the second half and again carry that momentum into 2025.

Speaker 7

Got it. Very helpful. And maybe just to shift gears a little bit. I thought I heard you in the commentary sort of allude to for Envista modest growth in mid teens margins. And when you think about the 2024 numbers, you might think, hey, that's far away.

Speaker 7

But to your point, when you normalize the numbers this year, I think you called out 1% top line and 14% EBITDA margin. So that modest growth, call it, in mid teens, is that something that we don't have to look too far down the road for? In other words, is that something where use the normalized numbers for 2024 and we might land there for 2025 when we think about things? Thanks for your time.

Speaker 2

So let me take it in steps. So yes, I did say the 1% core growth normalized and 14% EBITDA fairly characterized our underlying performance. That's about what we reported in Q1, it's normalized in Q2. And if you work through the math, that's about what we're guiding to for the full year, again adjusting for the one time and non cash expenses. So that's point number 1.

Speaker 2

Point number 2 is, we're not yet giving guidance for 2025. We'll come on to that. But our goal here in the second half is to get back to growth in Q4. I want to again emphasize Q3 reported results will be difficult and then carry that momentum into 2025 and hopefully do better consistent with our kind of continuous improvement culture.

Speaker 7

Thank you.

Operator

Thank you. Our next question will come from Jeff Johnson with Baird.

Speaker 3

Thank you. Good afternoon, guys. Paul, maybe going back to some of the value implant comments you made earlier. We don't talk about that part of your business very often. We don't get much insight into it.

Speaker 3

My understanding has been some of that alpha product has come off the market given MDR issues in Europe a couple of years ago. In the U. S, I think your implant direct business is a lot of older style implants that the market has maybe started moving somewhat away from over the last 5 years or so. So do you think you have the right value implant portfolio today? And how do you kind of beef that up, I guess, over the next few years if that's the way the market's at least starting to trend in some areas?

Speaker 3

Thanks.

Speaker 2

Yes. It's an important segment for us. So let me unpack your questions. You had a question about ImplantDirect and Alphabio currently and then whether we think we'd benefit from bolstering that portfolio moving forward. So first, with respect to Alphabio, it's actually performing quite well for us.

Speaker 2

I'm looking at Stephen, I want to say high single digit, low double digit grower right now.

Speaker 1

Yes.

Speaker 2

And you're correct on ImplantDirect. That has been the slower grower of our two businesses. Implant Direct is mostly North America. Alphabio is mostly outside of North America. So that's question number 1.

Speaker 2

Question number 2 with respect to our value implant portfolio, it's a good category right now, one of the faster growing in dental and we'd certainly like to make it bigger. Our first look is to build organically on the nice platform that we already have in place. But as you guys know, we've had some good luck over the years with accretive M and A. So that will remain in the toolkit as well.

Speaker 3

All right. That's helpful. And then just back over on the Spark business, on the increased deferrals, we've got it very, very ballpark, maybe an extra $150 a month or sorry, per case that you're deferring. Are we somewhat in the ballpark there? And then when we've seen these changes in deferral rates in the past, it's usually because acuity is going up, maybe you're doing tougher and tougher cases.

Speaker 3

And as you do those tougher cases, you have to defer some revenue for added refinements down the road and all that. Just what's the driver of the increased deferment, I guess, number 1? And 2, boy, I forgot my second question. My second question, how far does that increased deferral rate maybe push profitability breakeven out on the Spark business? I think at one point we thought you could get to breakeven on Spark maybe by end of 'twenty five.

Speaker 3

Does this push it out a year or further than that beyond the end of 'twenty five? Thanks.

Speaker 2

This is Steven's last call in the hot seat. So I'm not going to let him get off too easy. I'm going to pitch that one to Steven.

Speaker 1

Yes. I mean, Jeff, I mean different products, but I mean, you're in the right ballpark in terms of the additional deferral. That's about the right amount. And you're also right about what's driving the deferral. I mean, the increased deferral is really 2 things.

Speaker 1

It's basically us having more data monitoring kind of overall usage rates, but then more importantly projecting out kind of the mix that we expect going forward. Obviously, we focus more on the orthodontic segment, so we do get more comprehensive cases. And as we look where we're growing, we do think it'll be it's prudent to defer a little bit more revenue for the cases that we expect in the future. So that is where we're at. In terms of profitability, look, this does have a obviously, it does have a short term impact on profitability.

Speaker 1

I think again, I think what you will see us continue to improve profitability as we kind of lap some of these impacts on the deferral rate. I think in terms of really laying out the long term profitability and the long term growth of Spark, I think we're going to wrap that up with our Capital Markets Day that we're planning to do in Q1 of next year where we can really talk through the long term outlook for the growth of overall in Vista portfolio and the relative profitability of the different segments. Fair enough. Thank you.

Operator

Thank you. Our next question will come from Brandon Vazquez with William Blair.

Speaker 8

Everyone, thanks for taking the question. Maybe first, can we just talk a little bit about the kind of normalized EBITDA margins that you guys are talking about? I think you're talking about a 14% kind of normalized EBITDA margin in the quarter versus the 10% reported. Can you just bridge us what those four points are? There's a very helpful slide on the EBITDA margin bridge, but a lot of points in there.

Speaker 8

So what are the four points you guys would consider get you to a normalized EBITDA margin range as we think about the run rate, especially going into 2025?

Speaker 1

I mean, look, it's really you can really break it into 3 the things that we need normalized for really 3 big buckets. There is just one time cost that in the quarter that will not repeat. We made some investments to accelerate our spark manufacturing, kind of accelerate technology that we're using. There's some bad debt except there's a few kind of one time non repeat costs. That's about a third of the issue.

Speaker 1

Then as we called on the slides about 300 basis points that's related to the profitability on loss and increased Spark revenue deferral as well as the dealer inventory reduction. And then you have this kind of these longer term investments that we've kind of flagged that we're making that are in specifically in Nobel North American Implants, not everywhere, but in some other but specifically there. Those are we made decision to invest ahead of getting increased sales because we know it's the margin profile of the business. This is the good investment to make. So when you normalize for those kind of three things, that's where you're kind of come out with around the 14% EBITDA margin.

Speaker 1

Obviously, it's a little bit of hard work when you're kind of trying to

Speaker 8

Yes, understood. I'll ask a follow-up to that and another one just put them together here. As you're talking about the 300 basis points there Spark margin headwind, You also mentioned that that needs to annualize, right, that will be next year. So do we think of that as 300 basis points of EBITDA margin headwind every quarter for the next couple of quarters until it annualizes. Then other follow-up question is just like the specialty and technology section op margins are kind of half of what they used to be a year ago.

Speaker 8

What gets those back up more meaningfully? I think we're about 9% right now. What gets that to a mid to high teens number again in the next couple of years? Thank you.

Speaker 1

So just to be clear, 300 basis points is not only related to Spark, it's related to dealer inventory reduction. So as Paul called out during the prepared remarks, Q3 will be a little bit more challenged from a reported adjusted EBITDA margin related to some of these dynamics. But fundamentally, as you go into Q4, they start to normal those both those issues start to normalize and get more towards that kind of underlying performance. The sorry,

Speaker 2

the other question was? Related to SP and T margins.

Speaker 1

Yes. The SP margins, a lot of these costs specifically around the one time costs and also the investments that we're making are disproportionately impacting the SPT segment. And so again, the one time cost will not repeat, and then the investments will pay for themselves over time. So we should expect a reasonable recovery in SP and T margins. But again, with Q3 being a little bit more challenged across the portfolio, but then going into Q4 getting closer to the getting more normalized.

Operator

Thank you. Our next question will come from Kevin Caliendo with UBS.

Speaker 9

Thank you very much. First question here, as you talk to those investments that you made in Nobel this past quarter, it seems like most of it was on the sales and marketing side. I'm just wondering from a product perspective, do you feel that the Nobel products that you have today are sufficient to carry you to look at premium market long term growth rate or perhaps more R and D investment in 25 is going to take you there?

Speaker 2

Yes. The $6,000,000 or so per quarter into Nobel covers both new product development, R and D as well as sales and marketing. And so a good portion of that is to strengthen the new product pipeline. Again, similar to the earlier question, writ large, the implant portfolio is good. We compete globally with what we have, but it's a dynamic category, highly evidence driven and with a lot of involvement from clinicians.

Speaker 2

So it's always moving forward. And I think what we found over the last couple of years that is as we weren't investing enough in that, the market kept moving forward and we didn't move forward as quickly. So we're trying to rectify that imbalance.

Speaker 3

Thank you. Helpful. And then as a follow-up,

Speaker 9

kind of switching gears, about Fair Your Business, you work with dealers. How do you feel where you sit today in those relationships? Do you think those relationships are mutually beneficial? Or do you see anything in those partnerships you'd like to change?

Speaker 2

Yes. I mean, I think you started in the right place. 2 thirds of our business is in the specialty categories, which tend to go direct. So the general topic is less central to Invistam than it is to some of our peers. But specific to the 1 third that does go to distribution, we don't call them distribution partners likely.

Speaker 2

We really mean that. We've been working with these folks for decades and where we go to market with our channel partners, we're glad we do. We see real value from what they bring And I think they tell you this as part of my onboarding reconnecting with the industry, I spoke my counterpart at all of our large partners. And I was encouraged by the collaborative relationship between the two organizations.

Speaker 3

Thank you. Very helpful.

Operator

Thank you. Our next question comes from Michael Cherny with Leerink Partners.

Speaker 9

Great. Thank you. This is Dan Clark on for Mike. Just wanted to circle back to the implant again here. For starters, Paul, you haven't been here for very long and yet you're already talking about an uptick in some new customer wins off of your rechange in the sales strategy.

Speaker 9

Like how should we think about the pace of that going forward given that you're starting to see some improvement here early

Speaker 2

on? I mean, this is how that that's how you accelerate growth in a high margin category like implants. One of the good and the bad things about specialty dental is that it tends to be pretty sticky. If you have a customer and you treat them well, you often have them for decades. But the flip side of that is if you do lose a customer, it's a little bit more work getting them back on your side of the ledger.

Speaker 2

So that's why we spoke about the uptick in new product wins or in new customer wins, because it has an impact in the quarter, but it's also a longer term proven indicator that your underlying business is improving. So listen, we're very far from declaring victory in premium implants in North America. What I meant to signal on this call was 2 things. 1, we're continuing to invest in it payoff and 2, we see green shoots that it's starting to yield benefit.

Speaker 1

Got it. Thank you. And then just

Speaker 9

as we think about some of the R and D investments here you're making in Nobel implants? Like what sort of a timeline for where we might see these improvements come to market? Thank you.

Speaker 2

Yes. I think I am going to take a pass on the details of that right now. For competitive reasons, we're not going to talk through the timing of our new product pipeline. But I'd say broadly, it's in a cloud. So first, digitization of workflows and implants, well understood.

Speaker 2

We're fortunate in that we have both a diagnostics business as well as a specialty business. We make both sides of the equation, but connecting the 2, I think is an opportunity for us. So we're spending time on that. Second, we talked a little bit about the mix between premium and value. We are under indexed in value.

Speaker 2

So that's a second category that we're focused on. And then the third is the prosthetic part of this, we also participate in the crown and bridge part of it. And we think that's another area where we could probably do more. Again, we're unique in being across all pieces of the solution there.

Operator

Thank you. Our next question comes from Jason Bednar with Piper Sandler.

Speaker 9

Hey, good afternoon. Thanks for taking the questions. Paul, wanted to start on the pricing side. Good to see just the pricing that you're taking across the organization, the benefits you saw here in 2Q. You've been around the market for a long time, the dental market that is.

Speaker 9

You've seen the evolution of pricing, the shifts in pricing power in the industry over the last couple of decades. Just be interested to hear your perspective, your high level view of like where do you see pricing going within the portfolio you have and feel free to comment whether it's SP and T or E and C?

Speaker 2

Yes. Thanks for the question. So again, just to kind of recap, we had, I'll call it, $8,500,000 of positive price in the quarter. That's a little better than a point of growth for us. It differed by segment.

Speaker 2

We got more price in ortho and in consumables. We got less in implants and diagnostics. But for the most part, pricing was in a tight band around that, I call it, point of positive that I mentioned. My experience in the category is that it tends to be less price sensitive, certainly than other investment categories and less price sensitive than other medtech categories. So I'm just trying to learn whether that's still the case as I kind of reconnect.

Speaker 2

But the underlying sort of drivers of why that relative price inelasticity

Speaker 1

still

Speaker 2

for us to capture more price. And of course, that's a kind of multivariate equation, how you get to that and probably a longer conversation than this call. But the core of your question is correct. I think there's more we can do here.

Speaker 9

Okay. That's helpful. And then just as a follow-up, I wanted to focus a little bit on the Spark Manufacturing investments that you're making. And just maybe you can give us some flavor of the benefits or the contributions from those investments. Any details on what exactly you're doing that's hitting the P and L and not just CapEx?

Speaker 9

How much cost are you taking out of the process with these investments? And I don't know if you'll be willing to provide it or not, but just quantitatively, what do these actions mean for Spark gross margins if we're sitting here 12 or 18 months from now?

Speaker 2

Yes. So let's see, 3 parts to your question. The first is just a reminder, we're building this business for long term success. We built this organically entirely out of operating income and cash flow and we put in place a foundation for a very large and lasting business. We have a global manufacturing footprint in place.

Speaker 2

Second thing I would say is that, I visited 2 of those facilities so far on 2 different continents and have been impressed with the trajectory of the improvement, both the scale up of capacity as well as the drive down of unit costs and I referenced that in my prepared comments. Now specific to your question about how does that play out in the P and L, we had a double digit decrease in unit costs in our Spark business in just the quarter. So this business on a gross margin perspective is profitable. But we still need to cover at the operating income level that large investment I mentioned in the global supply chain. And that's what's causing us to continue focusing on reducing unit costs.

Speaker 2

So the shifts from being margin dilutive to margin accretive.

Speaker 9

Okay. Thank you.

Operator

Thank you. That does conclude the time we have questions today. I would like to now turn it back to our presenters for any closing remarks.

Speaker 2

Thank you. As we noted in our prepared comments and echoed in the Q and A, this is a good business with leading positions in the best segments of a pretty attractive dental market. We have high gross margins, good cash flow and a strong balance sheet. Underpinning all of this, we have a positive culture centered on performance, inclusion and continuous improvement. So from my perspective, most of the foundational elements of success are already in place at Envista.

Speaker 2

Our focus now is on generating better and more consistent performance from this strong foundation. And we're moving swiftly in this direction as evidenced in Q2 with the executive hires, the growth investments and the one time actions. While the P and L impact of this work will continue across Q3, the positive benefits should become more apparent in Q4, allowing us to build momentum as we roll into 2025. Thanks everyone for joining us on the call and for your continued help and support.

Operator

Thank you, ladies and gentlemen. This does conclude today's presentation. You may now disconnect.

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Earnings Conference Call
Envista Q2 2024
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