Oct 28, 2010
Executives
Bret Wise - Chairman & CEO Chris Clark - President & COO Bill Jellison - SVP & CFO
Analysts
Brandon Couillard - Jefferies Jeff Johnson - Robert W. Baird Scott Green - Banc of America/Merrill Lynch
Operator
Good morning and thank you for joining with us for our third quarter conference call. This is Bret Wise, Chairman and CEO of DENTSPLY International and also with us on the call today are Chris Clark, our President and Chief Operating Officer; and Bill Jellison, our Senior Vice President and Chief Financial Officer.
Each of us will have some prepared statements to make this morning and then of course after our remarks we will be glad to answer any questions you may have. Before we get started, it's important to note that this conference call may include forward-looking statements involving risks and uncertainties.
These should be considered in conjunction with our disclosures of the risk factors and uncertainties in our 10-K and our quarterly and periodic reports with the SEC. The company undertakes no obligation to update or revise any forward-looking statements to reflect events or circumstances that may arise after the date of this call.
And as usual, a recording of this conference call and its entirety will be available on our website. This morning we are pleased to announce our results for the third quarter of 2010 with revenues up 2% on a reported basis and positive 0.1% on a non-GAAP basis and that's excluding precious metal content.
We continue to see the dental consumable market is stable overall with improvements occurring in international markets and the U.S. market needed by weak or non-existed job growth at this point.
As mentioned our sales ex-precious metals were essentially flat up 0.1%. This was driven by 2.0% internal growth, 0.4% acquisition growth to yield constant currency growth of 2.4 and this was essentially offset by negative currency translation of 2.3% to arrive at that overall growth number of 0.1% ex-precious metal.
On a regional basis internal growth was down 0.8% in the U.S., was positive 4.5% in Europe and was positive 2.7% for the rest of world. Our U.S.
growth was aided by continued positive growth in our specialty categories dental implants in particular and through chairside consumables, but was hurt by lower small equipment sales, also a very tough comp from last year when we are running heavy end-user promotions on certain of our small equipment products. In the U.S.
we are essentially flat on internal growth for the first nine months of the year and our overall assessment in the U.S. market has not shown any meaningful improvement over what we saw in first half of the year.
However, I think that should not be a surprise to anyone at this point as we look at the economic data and the job list recovery resulting in slow growth or no growth, perhaps of offices at this point. European growth running strong at 4.5%, that's helped in part by an easier comparison from the prior year particularly in the CIS region, but also from stronger and all of our specialty categories and in chairside consumables while lab products continue to represent a headwind on our European growth in the quarter.
Year-to-date internal growth in Europe is 3.7%; the reminder of the world had internal growth of 2.7 for the quarter and is 4.0% year-to-date. And we see generally positive development in most of the regions that we have in that category.
As usual we did amount for implemented price increases on October 1 in most of our consumable products, given very low interest rates on cash holdings, we believe there are may have been a bit more purchasing ahead of the price increases this year which we would expect to wash up the fourth quarter. From our perspective this makes sense as liquidity is certainly better than it was a year ago at this time and the dealers can easily make an extra one to two percentage points in 30 to 60 days by increasing their inventory ahead of the price increases.
And that can be significant to the yield for their business models. Our earnings non-GAAP came in at $0.45, it was $0.44 on a GAAP basis, $0.45 on a non-GAAP basis and that was a 2.3% improvement over the prior year quarter again on a non-GAAP basis.
This is basically consistent with the trend we've experienced in the first half of the year, although, we are now coming up against slightly tougher comps both in the third quarter and again in the fourth quarter. Earnings continue to be hurt by currency translation and transaction effects.
Despite that we saw higher gross margins in the quarter that were essentially offset by higher SG&A spending as the investments we've gained to implement beginning this year are now fully in place. And the prior year base spending was very low in both the third and fourth quarters of last year.
We would expect this trend to continue for the fourth quarter with improving gross margins and with higher spending in event of product releases in 2011; and also as compared to what was a very low base for SG&A expense in the fourth quarter of last year. Our cash flows continue to be strong and our priorities for cash deployment remain the same with acquisitions being our top priority.
Activity in this area has picked up with execution and timing risk of course remaining very high. Year-to-date we've closed four transactions and signed a fifth which is contributing a bit to constant currency growth at this point.
Our second priority is share repurchases where we acquired 6.2 million shares for $209 million year-to-date, completing roughly 80% of the share repurchase authorization we announced earlier in the year. Our product pipeline looks good for 2011 including what could be major initiatives in several product categories, hopefully, early in the year.
And that obviously is what's driving the higher spending a bit in the third quarter and in fourth quarters we prepare for those. For the full year outlook, our exposure in euro will likely continue to have a negative effect on our results in the fourth quarter, although the impact maybe less than what we saw in Q2 and Q3.
At current rate the euro was down about 6% from the average rate that we saw in Q4 last year. The strength of the Swiss franc and the Japanese yen will continue to have a negative impact on our cost to goods sold as these are major production or product sourcing regions for us.
Given the current currency rates and the continued lag in the U.S. economy and the dental market we are nearing our earnings guidance and now expect full year results to be in the $1.86 to $1.91 range and again as measured on a non-GAAP basis.
I'd like to now turn the call over to Chris Clark, who's going to speak more about our new product pipeline and the performance of our specialty businesses. Chris?
Chris Clark
Thank you, Bret and good morning everyone. I'd like to take the next few minutes and supply some additional perspective about couple of the new products we've introduced recently.
As well as more details of our performance in the specialty areas in general and in the implants in particular. On the new product front, innovation continues to be a corner stone strategy for us.
We are pleased with the performance of some of the key new products that we've introduced a few quarters ago that continue to gain significant market traction. These include the SureFil SDR, Bulk Fill Flowable composite which is gained over 35,000 new users at this point since introduction just over a year ago in the U.S.
and earlier this year in Europe. We're particularly pleased with the repurchase rate on this product as I'd indicated strong customer acceptance in addition to the strong trial levels.
We are also very pleased and continue to be pleased with the ProFile Vortex nickel titanium rotary files. These continue to gain competitive endodontic users in U.S.
for us and we continue to be pleased with the performance of that product. We are also pleased with the Ceramco iC porcelain systems.
These continue to be well received by laboratory technicians really for the versatility as well as for the beautiful aesthetics they create. In the last few months we've also introduced several new innovations in the market including the SmartLite Max LED curing light.
This offers dual wavelength technology and provides a wide range of versatility and confidence maturing all different types of restorative materials. Also on the restorative side, we introduced Xeno V plus.
This is our latest one component self etch adhesive and offers long working time, very short curing time, excellent bonding performance and clinical reliability. In the prosthetic area, we continue to expand our Compartis centralized manufacturing platform and we are now offering fabrication of precious metal substructures in the Europe and the U.S.
and also in Japan. We've also added new scanning option that provides broader appeal to our Compartis platform.
And as Bret mentioned, looking ahead, we are pleased with our innovation pipeline and we are looking forward to new product launches across several of our businesses early next year. And at this point we are spending again some of those opportunities now.
Now I'd like to provide some additional insights into our performance in the specialties area in general and specifically into implant performance. Specialties continue to be a strong growth platform in aggregate for us with third quarter and year-to-date internal growth both in the mid single-digit range.
All three of our specialty areas implants, endodontics and orthodontics have had positive internal growth for each of the three quarters in 2010 and we believe we continue to gain market share in this area as a whole. Now looking specifically at implants, our third quarter performance was encouraging.
Internal growth for the quarter was solidly in the mid single-digit range and continued a sequential strengthening of our growth rate throughout the year. Now this is an area where we continue to invest on several fronts including internally and also the acquisition and we have completed one small implant related acquisition earlier this year, and recently signed another.
Importantly we believe that, this global performance continues to indicate that we are gaining market share in implants. We believe our strong implant performance is really due to a number of factors, these include our two well excepted global implant systems, XiVE with its wide range of restorative options and also enclosed with its bone level design and tissue care positioning.
Also, the strong key opinion leader support we have in all the 20 years of clinical evidence. The additional restorative versatility of the Ankylos C/X Abutment connection that we introduced last year.
Our expanded implant prosthetics positioning which includes the ISUS custom milled implant bars and bridges in healthcare. And finally, a fact that we've invested in the periods over the last several quarters with were some of our key competitors have cut back.
We continue to believe that our implant business with Ankylos and XiVE is going faster than market as we continue to gain customers in many of the key markets around the world. Geographically on implants our term growth in the U.S.
implant market is double-digits through September on a well above market growth. We are pleased with our progress in generating new implant specialist customers in the U.S.
in particular as they were responding favorably to our increased focus in the enclosed tissue care message. Our growth in Europe is in the mid single-digit range for the quarter and we believe our performance in many geographies including the core German market continues to outpace market growth.
You might recall that we spoke of our global implant symposium on our first quarter call that event which was held in March in Barcelona has helped to continue our considerable momentum on this business and many countries in Europe including Germany. Looking forward we are continuing to make investments to continue the momentum on this business.
I look forward to sharing the results, some of the initiatives with you on future call. I'd now like to turn the call over to Bill Jellison, who will cover the financial results of quarter in greater detail.
Bill Jellison
Good morning, everyone. Net sales for the third quarter of 2010 increased by 2% in total and increased by 0.1% excluding precious metals.
The sales increased ex-precious metals for the quarter included a constant currency increase of 2.4% which includes a 2% increase from internal growth and a 0.4% increase from acquisitions. The quarter was also negatively impacted by 2.3% from foreign exchange translations.
The geographic mix of sales of ex-precious metals in the third quarter of 2010 included the U.S. at 40%, Europe represented 37% and the rest of the world was 23% of our sales.
Our internal growth in the quarter also benefited by a slightly higher buy and ahead of our price increases, strong performance from our specialty businesses and improvement in our non-dental business. But sales were negatively impacted by soft equipment sales which had a tougher comparison against some equipment promos which benefited the third quarter of last year and a decline in our lab business.
Currency rates not only had a negative impact on sales in the quarter but also negatively impacted earnings by just over a penny per share as the dollar was generally stronger compared to last year. The yen continued to be strong and the Swiss franc strengthened against the euro.
Based on current currency rates foreign exchange is expected to still have a slight negative impact in the fourth quarter as the Swiss and the yen continue to be strong and the euro is weaker than last year in the fourth quarter despite its recent strengthening compared to earlier this year. Gross profit margins as a percentage of sales ex-precious metals content in the third quarter of 2010, were 55.2% compared to 55% for the third quarter of 2009.
The rate was slightly higher than last year as the benefits from price increases and improved operational leverage were offsetting the negative impacts of both foreign exchange, product mix and the effect of acquisitions in the quarter. We expect the gross margins will again expand in the fourth quarter due to continued operating improvements particularly compared to the prior year when we were liquidating substantial inventories.
SG&A expenses were $182.1 million or 36.8% of sales of ex-precious metals in the third quarter of 2010 versus 36% in the third quarter of 2009. These expenses increased as a percentage of sales as we are running against lower levels that occurred in the back half of 2009 when our cost reductions were fully implemented and more importantly the investments we discussed at the beginning of the year, are now fully in place and should benefit us as we enter 2011.
We believe the fourth quarter will be our toughest comp in this category as we benefited from our lowest expense level as a percent of sales in the fourth quarter of last year. And the investments we see coming through in the third quarter will also be present in the fourth quarter.
Operational margins for the quarter were 16.7% compared to 17.5% in the third quarter of last year. Operating margins based on sales excluding precious metals were 18.3% compared to 18.8% last year in the same period.
Operating margins based on sales excluding precious metals for comparative purposes excluding recent acquisition, related activities and restructuring and other costs in both periods would have been 18.7% in the third quarter of 2010 and 19.1% in 2009. Net interest and other expenses in the third quarter was $5.3 million compared to 5.1 million last year in the third quarter.
But net interest was aided by higher cash balances although return rates remain very low on those balances. Offsetting this was higher interest expense on over $200 million of share repurchases thus far this year.
The corporate tax rate in the quarter was approximately 25% and we expect a tax rate of 25 to 26% to be a reasonable assumption for an operational tax rate for all of 2010. Net income attributable to DENTSPLY in the third quarter of 2010 with $63.1 million or $0.44 per diluted share compared to $67.5 million or $0.45 per diluted share in the third quarter of 2009.
Net income attributable to DENTSPLY on an adjusted non-GAAP basis excluding acquisition related costs, restructuring in other costs and income tax related adjustments was $64.9 million or $0.45 per diluted share in 2010, compared to $65.9 million or $0.44 per diluted share in the third quarter of 2009, a 2.3% improvement. Cash flow from operating activities for the first nine months of 2010 was up slightly at $249 million.
Capital expenditures were $30 million in the first nine months of the year with depreciation and amortization at $50 million in the first nine month. Inventory days were 103 at the end of the third quarter of 2010, a slight increase since year end but a slight reduction from 106 days in the third quarter of last year.
Accounts receivable days were 59 days at the end of the third quarter of 2010 compared to 61 days at the end of the third quarter in 2009 and 55 days at the end of the year. At the end of the third quarter of 2010 we had $534 million in cash and short term investments, total debt was 600 million at the end of the third quarter's fall.
Year-to-date we have repurchased approximately $209 million of our stock or approximately 6.2 million shares at an average price of roughly $33. Based on the company's authorization to maintain up to 22 million shares of treasury stock, we now have approximately 1.3 million shares available for repurchase.
Finally, as Bret noted our 2010 full year earnings per diluted share guidance is now 186 to 191 on a non-GAAP basis excluding restructuring and other costs, recent acquisition related activities and income tax related adjustments. That concludes our prepared remarks.
Thanks for your support and we'll be glad to answer any questions that you may have at this time.
Operator
The question-and-answer session will be conducted electronically (Operators Instructions) we will take our first question from Brandon Couillard with Jefferies.
Brandon Couillard - Jefferies
Hi. Thanks for taking the question.
Bill, on the gross margin line I thought you would have expected mix to be slightly favorable in the third quarter, but I think you called out that this was a negative impact in the period and how should we think about going into the fourth quarter?
Bill Jellison
The mix side of equation is probably still little bit of a drag. Keep in mind last year when we talked about mix.
It was a relatively big number and we expect that the mix impacts were going to take a while before that actually improved because of a number of purchasing related assumptions in each of our different franchise areas. However, as you look at the 4Q, as I mentioned before, we should still expect to see some operating margin improvements.
Last year, the fourth quarter was our lowest gross profit margin rate period and as I also mentioned, we ended up capitalizing some positive variances that occurred in the third quarter of this year which will also roll off in the fourth quarter.
Brandon Couillard - Jefferies
Based on current rates, do you expect FX to be a headwind to both revenue and operating margins in the fourth?
Bill Jellison
Actually, I'd say that we are still expecting it to be a little bit of a headwind at this point where rates are currently at, but probably not quite as much as it was in the third quarter.
Operator
(Operator Instructions) We will take our next question from Jeff Johnson with Robert W. Baird.
Jeff Johnson - Robert W. Baird
Just on the new products, Chris, you've provided a lot of detail on a lot of the products that have been launched, but costs has been a little elevated here ahead of some new product launches for 2011. I know you don't like to talk about new products before they launch, but obviously I'd assume the office-based MTM product that I am hearing now may be early in 2011 is one of those, but anything else you can give us regarding new products in 2011?
Bret Wise
The message we are trying to send here is that the pipeline is in really good shape and we've got numerous meaningful product launches that cross numerous businesses and I think those are probably more like Chicago mid-winter launches or perhaps ideas launches in the international market. As per our policy we are not going to describe those to the market in advance.
We'd rather bring those to market through the show which will boost our ability to have an impact on the dental market, we hope.
Chris Clark
The spending on that is clinical work; it is work with opinion leaders and basically marketing prep work in advance to those launches, again across several of our business.
Jeff Johnson - Robert W. Baird
Obviously U.S. organic growth here has been kind of bouncing around at the flattish range plus or minus a point.
If we kind of stay in that range over the next few quarters from a market perspective, you feel like as we get into Chicago mid-winter in February and beyond that those new products would have enough of an ability to drive a bit of a improvement even if market stays deadly flat here?
Bret Wise
We have characterized it; we believe that these new product introductions have the potential to have a positive effect on our performance versus market. Where market will end up, of course is anyone's guess at this point.
Until we see a couple of months or a quarter or two of job growth in the U.S., I don't expect the U.S. dental market to get robust.
But irrespective of that I think these new product launches can help us in our own results remain ahead of the market in the U.S.
Jeff Johnson - Robert W. Baird
And two last questions if I could. U.S.
organic growth again, we kind of swing from a minus 2.5% comp in Q3 last year to a plus 3% in Q4 and you are making some comments about the buy-ins maybe being a little bit bigger this year. So I think it wouldn't be surprising to see the organic growth number soften in the U.S.
next quarter a little bit sequentially. But the offset to that is that 3% comp in Q4 '09 is really a vestige of the prior year's issues and the sequential trend in Q4, '10 doesn't make me feel like U.S.
organic growth is going to fall off significantly in Q4. Am I off on that, just when I look at kind of absolute revenue numbers and sequential trends?
Bret Wise
The comment we made about small equipment to pressing the US growth rate in the third quarter, is a meaningful comment because during heavy end user promotions with small equipment particularly one or two lines last year, late in the second quarter and throughout the third quarter and that what caused the U.S. rates to be what it was.
Absent to that which is not a huge part of our business we would have low single-digit growth in the U.S. in our consumable category.
I wouldn't read too much into what's going to happen in the fourth quarter from the third quarter's U.S. growth number because it's artificially depressed because of the prior year based in the small equipment.
Jeff Johnson - Robert W. Baird
Last question for you, if I could, just on foreign currency. As we get into 2011, currency could have a little bit of a benefit maybe to you, but I am thinking more on product demand.
I know a lot of your European countries that you sell into some distributors maybe have been out of the market for DENTSPLY product over the last six to 12 months or maybe even a little longer given some dollar strength. With the dollar weakness here do you feel like there is any opportunity at all for those distributors to come back and start purchasing some more products just given a more favorable purchase price on their end?
Bill Jellison
We think that those dealers have been buying and obviously we've had some solid growth throughout the European area, this entire year as well as some of the rest of the world areas. From that perspective, maybe you are getting around a question that we produce in different parts of Europe including in Switzerland.
And Swiss is one of our key currencies for us as we ship products outside of Switzerland and sell into euros, that obviously has had some margin pressure for us but as far as product demand side goes, it's been actually very strong for those products that are coming out of that region.
Jeff Johnson - Robert W. Baird
But FX as a whole, and again not trying to get into 2011 too much, but FX as a whole, at least at this point, should be a bit of a tailwind for you if it holds at current levels for next year?
Bill Jellison
It's actually relatively flat. There's different currencies that are in different directions on that.
It really depends on where the Swiss goes and where the Japanese yen goes. The euro has been strengthening up a little bit recently although I think the last couple of days; it drifted back down some what.
But I'd say that we aren't expecting too much of an incremental impact on that with the exception of some of the margin rate impacts on Swiss related currencies if that stays strong.
Bret Wise
Just on a pure translation basis, we would think at least in the early party of next year, it won't have a drag that it had on this year and maybe neutral which would be better than a drag.
Operator
We will take our next question from Scott Green with Banc of America/Merrill Lynch.
Scott Green - Banc of America/Merrill Lynch
I was hoping you could help us put this higher level of SG&A spending in the back half of the year into perspective. I would think that marketing new products is kind of a recurring expense and so with SG&A ticking a little bit higher, is that going to continue to be the case until we see sort of a sales acceleration that allows you to leverage fixed costs better or is there opportunities into next year that will allow SG&A to tick lower as a percentage of sales?
Bret Wise
The circumstances we're going to face in the fourth quarter on SG&A is that we are accelerating spending ahead of these product launches. We got clinical trials; we have to do marketing as many of the things that Chris described earlier which is going to cause.
Fourth quarter is spending to be a little bit higher then it would have otherwise been. At the same time if you go back and look at the SG&A trends in last year, you will see that SG&A was extraordinary well in the fourth quarter.
Particularly as a percent of sales, so we are in that position just for this one quarter where we're going to have higher spending this year going up against the very low base last year and we've been kind of telegraphing that all year without these most recent additions to expense that we're going to put force so we can launch these products. I don't think you should assume that this is the norm.
When we get into next year's guidance which we'll do on our early February call. We'll give you more insights and to where we think spending will be in 2011.
But I don't think you should translate this into a new trend.
Bill Jellison
You should look at your trends kind of how SG&A is currently running. I think what you will see, the blip from the fourth quarter is that the fourth quarter of last year was absolutely lowest SG&A related rate as a percent of sales.
So as you move forward as well into 2011, you shouldn't see that same level of drag.
Scott Green - Banc of America/Merrill Lynch
When I look back historically in terms of contribution from acquisitions to the top-line, it is generally been maybe a couple of 100 basis points if I look back on average over the past decade or so. Did I interpret your commentary, that it seems like you're getting a little more active on M&A or the pipeline is picking up here and do you think we are kind of trending back towards that level versus it's been less than 100 basis points top-line contribution for a while now?
Bret Wise
In 2009 it was 450 basis points growth from acquisition and then in the depth of the recession we didn't transact many, in fact I don't think we transacted any deals in 2009. What you are seeing now is the consequence that we had for that one year.
Your other comments about us hoping that we can transact more is true, we are very active in looking at transactions and we hate to predict where it will be in the short-term because transaction risk is always very high but when you look at our balance sheet with over $500 million in cash, very strong balance sheet, good cash flow our target is to redeploy that in growing the company through acquisitions and our target is around 4% growth per year on average from acquisition. So this year is a little bit lower than normal and last year at 4.5% was normal or maybe just a little bit above normal.
Scott Green - Banc of America/Merrill Lynch
On previous calls you've indicated that the tax rate might move higher in/out years, so after this year now and I was hoping you could update us on your outlook for the tax rate as you see it today.
Bill Jellison
Obviously there's been a lot in discussion, not just in the U.S. but around the world as far as looking for ways to bring in revenue to different government.
At this point in time, we obviously don't know what's going to be changing on the U.S. front.
That's going to be a major driver. We hope that some of those things don't go into place but at this point in time, it's still little bit too early to tell what kind of changes are going to take place there.
As we know more facts associated with what different government bodies are doing from a tax positioning perspective that will get us into more reviews associated with how to make sure that we are doing kind of the best tax planning that we can around those areas.
Bret Wise
When we look around the world of how economies are performing, Germany cut their rate a year or maybe just two years ago and now, coming out of recession, they have a very low unemployment rate and the economy is very strong and in the U.S. of course, our government is talking about raising rates particularly on foreign earnings.
And thus, we don't see that much growth here. So, that's not a political statement or prediction to what's going to happen to tax rate but I think there's a lot of uncertainty as what's going to happen particularly with the U.S.
rates going into next year or next two years.
Operator
It appears there are no further questions in queue. At this time, I'd like to turn the conference back over to our presenters for any additional or closing remarks.
Bret Wise
Thank you for joining us this morning. We're pleased with how we've been performing year-to-date.
We think we've got some good prospects going into next year particularly on these new product launches and again we remain active and trying to find transactions to grow the company through acquisitions and we look forward to updating you on our progress as we move through the fourth quarter here and into early 2011. Thank you.
Operator
That does conclude today's conference. Thank you for your participation.