DENTSPLY SIRONA Inc (XRAY) 2005 Q2 法說會逐字稿

Good morning. My name is Lawana (ph) and I will be your conference facilitator today. At this time, I'd like to welcome everyone to the second-quarter earnings release 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 period. (OPERATOR INSTRUCTIONS). Thank you. Mr. Kunkle, you may begin your conference.

Good morning and thank you all for joining the DENTSPLY second-quarter conference call. My name is Gary Kunkle, and I am the Chairman and Chief Executive Officer. Also with me today are Tom Whiting, our President and Chief Operating Officer, and Bill Jellison, Senior Vice President and Chief Financial Officer. I will begin today's call with some overview comments regarding our second-quarter results and the overall business. Then before I turn the call over to Bill, I will conclude with some remarks regarding our outlook for the balance of the year. Bill will then take you through a more detailed review of P&L and balance sheet. Then finally, we will all be pleased to answer any questions that you may have.

Before we get started, it's important to note that this conference call may include forward-looking statements involving risk and uncertainties. This should be considered in conjunction with the risk factors and uncertainties described in the Company's most recent annual report on Form 10-K and its subsequent periodic reports on Form 10-Q filed with the Securities and Exchange Commission. This conference, in its entirety, will be part of an 8-K filing and will be available on our Web site.

By now, each of you should have received a copy of the second-quarter earnings announcement that we released yesterday after the market closed. Our reported sales during the second quarter were $444.8 million; this represents an increase of 4.8% as reported and 7.4% if you exclude the precious metal content. The 7.4% sales gain broke out as follows for the quarter -- base business was up 3.9%; foreign exchange was up 2.2%; and acquisitions contributed 1.3%. Looking at it on a geographic basis, the United States was up 4.7%, Europe was up 1.8%, and the balance of the world was up 6.

While the dental reimbursement issues in Germany continue to have an impact on our European and overall performance, we were really pleased to see the improving trend since we last reported to you. As you may recall from our recent conference calls, beginning in January of '05, Germany replaced their percentage pay reimbursement with a fixed reimbursement for dental work. This new reimbursement scheme also now provides for reimbursement of dental implant procedures and prosthetic procedures using all ceramic materials. It's a very positive change, as these categories were not reimbursable before.

The new reimbursement, however, is proving to be somewhat different from what was originally expected. Communications going into the program implied that the actual amount of the reimbursement under the new program would remain the same as the prior percentage of reimbursements for the same procedure. The significant difference, however, which was not communicated, is that the new program establishes a reimbursement based on a standard of care and not the actual procedure.

Let me give you an example. Last year, a patient was reimbursed approximately 50% for a single crown procedure, whether the restoration was done with a precious metal or a non-precious metal. Thus, a precious metal procedure costing approximately EUR500 would have been reimbursed at EUR250 while the non-precious metal procedure would have had a cost of approximately EUR350 and have a reimbursement of 175. Under the new scheme, the non-precious metal procedure is considered the standard of care for single crowns. Therefore, the fixed reimbursement would be 175, the amount previously given for non-precious metal crowns. This is the amount of reimbursement whether you use a precious metal or non-precious metal in the procedure. This caused some initial confusion in the marketplace but is gaining a better understanding. It also has generated a number of complaints. This is leading politicians to push for further reform that would provide more equity between the new program and the former reimbursements.

On a more positive note, now that the administrative start-up problems are resolved, we are experiencing double-digit growth in both Cercon products and our dental implant products in Germany. Both of these categories are positively influenced now that they're being included in the new reimbursement program.

The year-to-date internal growth in Europe is negative 5.3, but if you exclude the businesses that are being affected by the German reimbursement, the balance of Europe has year-to-date internal growth of plus 7.5. We're very pleased with our performance in our non-German markets in Europe and quite frankly, we give our German organizations great credit for their contributions and results in what we consider a very challenging environment in Germany.

Moving on to the United States, we're pleased with the continued strong growth in the U.S. of 4.7 overall. This is following a first-quarter internal growth in the U.S. of 7%. We had exceptionally strong sales in our chairside businesses; those are the products sold to dental offices. This was led by double-digit growth in orthodontics, implants and anesthetics, which was fully driven by Oraqix. The strong performance of our chairside products was offset by weak sales in labs. Within the U.S. lab business, Cercon products are growing at a double-digit rate also but the balance of our -- (technical difficulty) -- lab products are not performing well. We believe much of this is impacted by lab work moving offshore to lower-lab-cost areas in the world.

We have analyzed this and we've come up with a two-part strategy, if you will, to address this issue. First of all, we are promoting Cercon as an all-ceramic more aesthetic low-labor solution. This is really being driven by the new software we introduced last quarter for Cercon that provides a better, more efficient utilization of the Cercon block and really makes it an economically competitive alternative to both precious metals and non-precious metal procedures.

Secondly, as many of you do know, we have considerable lab technology and resources all over the world, and we're currently finalizing a strategy for our U.S. lab operations to work in conjunction with our other global lab subsidiaries to provide a competitive alternative to the offshore options that many U.S. labs are choosing today. The strategy at this point is work in-process, so expect to have it finalized and implemented by year-end.

Looking at the rest of the world, the balance of the world grew internally by approximately 6%. This was led by a continuing strong growth in Asia of 20% for the quarter, bringing their year-to-date growth to 18%. The Middle East and Africa also grew in double digits and Japan grew at 8% internally. We find this very encouraging in Japan, given that their dental market is flat.

Just some comments on acquisitions -- during the second quarter, we announced two additional acquisitions, Glenroe Technologies and Raintree Essix, both orthodontics companies. Combined, they will add 14 to $16 million in annual revenue. We remain very active in the market pursuing other acquisition targets. While I can't be specific, we continue to be encouraged by what we see and, with a few exceptions, fair evaluations.

Some other items of interest -- with respect to our anesthetic pharmaceutical plant in Chicago, we had previously announced that we received approval from the MHRA, which is the regulatory authority for the UK, Australia and New Zealand, and have begun shipping to these countries. The FDA is currently in our facilities conducting their audit. We are pleased that we finally are getting this review underway so that we can get this facility up to a higher utilization by adding production for the U.S. market. But given the lateness of this review, however, we are in discussions with our current suppliers to extend the supply agreement with them to ensure that we have product available. We also anticipate that this delay will postpone any manufacturing of product for the U.S. in our Chicago facility until 2006. As a result, we will have additional unforecasted costs of approximately $4 million for the unabsorbed overhead in 2005.

Moving onto new products, Oraqix we continue to be very pleased with the market acceptance of this product. As you recall, it's our new non-injectable dental anesthetic for scaling and root planting. Sales in the United States are ahead of forecast and have a high reorder rate. We recently received approval for sale in Denmark, Spain and Finland and began selling activities this month. We expect approvals in Ireland and England this quarter with an expected launch in the fourth quarter.

I mentioned several products during the first-quarter conference call that continue to perform well; those are BioPure, which is our irrigant that is used to disinfect the towel in a root canal procedure, thus really dramatically reducing the probability of complications or failure resulting from bacterial contamination; also Calamus, which is a very unique, simple and user-friendly operation delivery system is also used in root canals. The filling material that is being put into the canal during the procedure is in cartridges that are designed for single-patient use, which really makes it more convenient, disposable and provides for quick, easy cleanup following the procedure. Those are two innovative products added to a very extensive and very successful portfolio that we have of endodontic products.

We are also very pleased with the sales performance of Xeno IV, which was our first single-component self-etching adhesive and SmartLife PS, which was an addition to our SmartLife LED curing light product line.

During the second quarter, we introduced interactive Mystique; this is the world's first low-friction translucent ceramic bracket. It has a clear interactive clip called neo-clip, which can be rapidly placed and removed from Mystique, which is our ceramic racket. It engages the wire very similarly to self-ligation, which is known for its benefits of reducing appointment time and improving oral hygiene. It was very well received at the recent orthodontic meeting in San Francisco, and we began shipping in June.

There were also numerous product line extensions that we introduced around the world during the second quarter, and we have a number of other new products scheduled for market introduction during the balance of 2005. We plan on introducing in excess of 20 new products in 2005, and that number excludes line extensions.

Just some closing comments -- before I turn the call over to Bill, I would like to make some closing remarks. We continue to be encouraged by the improvements in Germany and we're very pleased with our performance in other markets around the world. We expect the rate of growth to continue to improve throughout the year as the German market stabilizes.

With respect to profits, I have already mentioned that we will experience additional expenses associated with the Chicago anesthetic plant. We will also incur additional expenses associated with tax consultation that's related to our repatriation strategy and some other tax-related opportunities which Bill will discuss in more detail. These costs in total will be between 6 and $7 million. However, we expect to absorb these additional costs and are maintaining our guidance of $2.59 to $2.63 earnings per share for 2005.

That really concludes all of my remarks, so I will now turn the call over to Bill Jellison to take you through the P&L and balance sheet.

Thanks, Gary. Good morning, everyone. As Gary mentioned, net sales for the quarter of 2005 increased by 4.8% in total and increased by 7.4%, excluding precious metals. The sales increase, ex precious metals, for the quarter included a 2.2% increase from foreign exchange translation and 1.3% increase from acquisitions.

The geographic mix of sales, ex PM, in the second quarter of 2005 showed little change from last year's percents. The U.S. represented 42.9% of sales compared to 43.5% in the second quarter of last year; Europe was 36.9% this year compared to 37.2% in the same period last year; and the rest of the world was 20.2% of sales compared to 19.2% in the same period last year.

Germany continued to run lower than last year in the second quarter, however was improved in the second quarter compared to drastically lower levels in the first quarter. We expect continued improvements for Germany in the second half with the German market projected to be down for the year due to dental claim and reimbursement level changes implemented at the beginning of 2005.

Gross margins for the second quarter were 56.7%, ex precious metals, which were virtually flat compared to the second quarter of 2004. Margin rates were positively impacted by new products, manufacturing improvements and improved leverage in many of our businesses. However, these positives were offset in the quarter by lower precious metal sales and the unleveraged start-up costs of our new anesthetic facility. Rates are expected to only improve slightly the by the end of 2005 due to the negative impact of the precious metal product mix, primarily the result of the soft German dental market and the higher unleveraged start-up costs for the anesthetic facility.

SG&A expenses were $146.4 million or 36.5% of sales, ex precious metals this quarter, versus 35.8% in the prior year's second quarter. The higher expense level in the second quarter primarily resulted from noncapitalized costs relating to the new anesthetic plant in Chicago, costs related to the IDS, or the International Dental Show, which occurs every two years in the second quarter, and foreign exchange movements. Expenses are still projected to be lower as a percent of sales for the entire year.

Operational margins for the second quarter were 18.2% compared to 18.3% in the same period last year, while operating margins based on sales, excluding precious metals, were 20.2% compared to 20.8% in the second quarter of 2004. Operating margins are expected to run higher than last year by the time we get into the fourth quarter as a result of both the improved product mix and operational leverage.

Net interest and other expense in the quarter was $0.7 million, which is an improvement of $4.5 million compared to last year's second quarter. Net interest expense improved by 2.3 million in the quarter due to both lower borrowing levels and the net investment hedges utilizing the Japanese yen and the Swiss franc that we put into place in the first quarter of this year. Other Income and expense improved by about 2.2 million, primarily resulting from a foreign exchange transaction gain in the period compared to a slight transaction loss last year.

The corporate tax rate in the second quarter was 28% compared to 32% in the second quarter of 2004. The current quarter's operational tax rate is 30.3% or 30.5% year-to-date. We also had a favorable tax rate impact for the period from the settlement of tax audits, which had a $0.02 per diluted share favorable impact in the period. In light of this $0.02 per share pick-up and to better evaluate our repatriation options and opportunities under the American Jobs Creation Act, the genesis of Internal Revenue Code Section 965, we have begun a global tax project using external consultants. While this project will be an increase to our SG&A costs over the next two quarters, we expect it will help minimize our overall tax exposure on any current-year and/or future-year repatriations.

Income from continuing operations in the second quarter of 2005 was $57.9 million or $0.71 per diluted share. That's an 18.3% increase in diluted earnings per share over the second quarter of 2004. Without the $0.02 favorable tax impact in the period, diluted earnings per share would have still increased 15% in the period.

Operating cash flow was $40 million and the second quarter of 2005 compared to 62 million in the same period last year. Both receivables and inventories ended higher than anticipated in the period. However, tighter controls and divisional commitments should improve both of those categories by year-end. An increase in inventory days is required to support the anesthetic products during the new plant transition. However, many other inventory areas should improve, resulting in inventory days closer to 90 to 92 by year-end.

Receivable days stood at 55 days at the end of the second quarter compared to 56 days at the end of the first quarter and the record low level of 47 days achieved at year-end. Improvements are also expected in this area during the second half, resulting in AR days closer to 50 by year-end.

Capital expenditures were $12 million in the second quarter, yielding free cash flow or operating cash flow less CapEx of about $28 million. Depreciation and amortization for the quarter were $14 million. Dividends were $5 million again this quarter.

At the end of the second quarter of 2005, we had $366 million in cash and short-term investments, compared to 506 million at the end of 2004. Long-term debt was 658 million at the end of the quarter compared to $780 million at the end of 2004. In addition, we had 69 million of short-term debt and a derivative asset value of $27 million at the end of the quarter.

DENTSPLY repurchased $73 million of stock, or approximately 1.3 million shares, at an average price of $55.51 in the second quarter of 2005. Our total repurchases in 2005 now stand at $103 million, or 1.8 million shares, at an average price of 55.80. Based on the Company's current authorization to (indiscernible) up to 3 million shares of treasury stock, we still have approximately 1 million shares available for repurchase.

Finally, as Gary noted, we remain comfortable with a diluted EPS range of $2.59 to $2.63 for 2005, including the expenses associated with our global tax project and the additional expenses position with the Chicago anesthetic plant as well as the second quarter's $0.02 per share tax benefit. This guidance does not include the effect of any potential future decision to repatriate foreign earnings for purposes consistent with the American Jobs Creation Act of 2004.

That concludes our prepared remarks. We would be glad to answer any questions that any of you may have at this time.

(OPERATOR INSTRUCTIONS). Michael Goggler (ph), Boning and Scattergood (ph).

Good morning, everyone. Just two quick questions, one with regard to the repatriation of cash. I was wondering about how much you guys have sitting overseas and what the range is that you're looking at.

We currently have approximately $350 million that are sitting overseas, but we're actually looking in a range of up to $500 million on the repatriation.

Just a second question -- I mean, what are you seeing on the acquisition front?

Well, we're still very active; obviously I can't be specific. As I have said on previous calls, a lot of what we're looking at are both private and public. When you get into the private ones, decisions come into play that go beyond valuation. When does the family want to exit the business, and who in the family stays with the business? So there are issues that are affecting the timing -- not more the timing than the actual decision to divest the business. That's about all I can offer you without getting a little more specific.

I guess the other thing I can offer is we're looking at acquisitions primarily in the United States and Europe.

Gentlemen, thank you.

Derek Leckow, Barrington Research.

Thank you. Good morning, everybody. Just a question on the guidance for the next couple of quarters here -- it looks like we are going to have to adjust our models for these expenses, the tax expense and the Chicago plant delay. Could you help me with that a little bit? Where would we allocate those expenses, into which quarters?

I thing, really for both of those categories, that you could probably equally split them up between both the third quarter and the fourth quarter.

Okay. Then this primarily looks like on gross margin for the Chicago plant and then tax expense would just be out of SG&A?

Correct, plus some will be expensed onto Chicago; most of it will be gross profit.

Gross profit? Okay. Then I wondered if you could talk about your long-term debt plans. You have 658 million out there. Bill, could you just take us through that, the components of that and then talk about the maturities and what options you might have? Are you planning to perhaps reduce your debt levels going forward, or do you think you are at a comfortable level today?

Well, from an overall funding perspective, I would say, one, we're very comfortable with are overall debt-to-cap level. Our mandate is 35 to 40%, so we would expect to actually be more leveraged in total than we currently are today, which is what we got into before. When you talk about the amount of cash flow that we generate, the level of acquisitions and based on our overall debt-to-cap basis, that should imply that we should be doing either additional acquisitions or additional stock buyback and utilizing some of those funds that we ultimately have available.

As it relates to the specific debt that we've got out there, as I mentioned, we're looking to bring back up to $500 million of cash from the repatriation side. 350 of that is true cash that's sitting overseas. We would probably leverage up our overseas entities just a little bit, associate with that as well too, which would allow us then to pay down some additional debt here. Once we finalize on that specific amount and the strategy of that, I would expect that we will lay out a more formal refinancing plan associated with our overall Eurobond offering, which makes buyers at the end of next year and really our overall tax position. But right now, it's a revolving credit agreement that we've got in place, even for the repatriation. We should be in good shape.

Can you give us some idea for the average interest rate you're expecting for 2006?

Do you want to tell me where the interest rates are going on both sides? What I guess I can tell you is that, if you look at kind of how our interest rate dollars are in our second quarter here, you should expect us to kind of run at that same type of level or slightly below in the next couple of quarters. That will obviously continue to be a substantial improvement -- (technical difficulty) -- interest expense levels that we had last year. That is despite the level of increased stock repurchase that we've done. As I mentioned early on, we've done a couple of different net investment hedge positions, in essence allowing us to place the debt that we do have in some of the lower interest rate environments like Japan, like the Swiss franc, with obviously some still sitting on the euro as well. That positioning was meant to make sure that it took us out of the higher volatility and increasing volatility within the U.S. rates, because obviously most of our debt now is denominated in the foreign currency, which allows us a natural hedge on our investments in those locations as well, too. So you should expect it to continue to stay quiet a bit below our overall U.S. borrowing rates.

That's great. It looks like you guys have been really keeping up the pace on the share repurchase that's offsetting the impact of options and so forth. Do you anticipate making any changes to any of your compensation plans regarding the effect of options?

Not at this point, Derek. We have a very low percent of our population that actually is eligible for options. I think it's under 2%.

Just Gary, could you talk a little bit about the research that you're doing on the pharmaceutical and biotechnology side? Any new potential technologies that you've seen that might have applications for new products near-term?

Actually, they are. For competitive reasons, I can't get into the specifics, but we do have two projects that are going on within the pharmaceutical group. Of course, we have the other projects, which we've talked about before, that are within Georgia Tech. All of those projects at Georgia Tech are on targets and all of them have moved to the next stage, so those that were in proof of principle (ph) have in fact been successful. Of course, the other two technologies that we acquired were Faetif (ph) and Doxa. Both of those were in product development. You won't see a product from them this year. One of the two -- (technical difficulty).

I missed the last part there; I was getting some static. You said the Doxa product --

One of the two being Doxa (indiscernible) may very well be a product -- a launched product in 2006.

What is the current budget for this -- the pharmaceutical research in total?

I don't have it broken out by division -- (multiple speakers).

Can you give us an overall number, or just a general idea, a range of what --?

It's approximately 50 million in expense. Of course, we have a lot of other research that falls into cost of goods, which is under licensing agreements and technologies that we've acquired.

So 50 million in total, not just for the pharmaceutical piece?

Correct.

Thanks a lot, guys. I appreciate it.

Thank you. At this time, there are no further questions.

Okay. Well, thank you all for joining the conference call this morning and thank you for your continued interest in our company.

Thank you. This concludes today's second-quarter earnings release conference call. You may now disconnect.