Envista - Q2 2023

Transcript

Moderator (participant)

Hello, my name is Chelsea, and I will be your conference call facilitator this afternoon. At this time, I would like to welcome everyone to Envista Holdings Corporation's second quarter 2023 earnings results conference call. All lines have been placed on mute to prevent any background noise. After the speaker's remarks, there will be a question-and-answer session. If you would like to ask a question during that time, press star, then one on your telephone keypad. If you would like to withdraw your question, please press star and then two on your telephone keypad. I will now turn the call over to Mr. Stephen Keller, Vice President of Investor Relations of Envista Holdings. Mr. Keller, you may begin your conference call.

Stephen Keller (VP, Investor Relations)

Good afternoon. Thanks for joining the call. With us today are Amir Aghdaei, our President and Chief Executive Officer, and Howard Hu, our Chief Financial Officer. 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 investor section of our website, www.envistaco.com. The audio portion of this call will be archived on the investor section of our website later today under the heading Events & Presentations. It will remain archived until our next quarterly call. During the presentation, we will describe some 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 noticed, references in these remarks to company-specific financial metrics relate to the second quarter of 2023, 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 under regulatory approvals or available only in certain markets. 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. Actual results might differ materially from any forward-looking statements that we make today.

These forward-looking statements speak only as of the date that they are made. We do not assume any obligation to update any forward-looking statements except as required by law. With that, I'd like to turn over the call to Amir.

Amir Aghdaei (President and CEO)

Thank you, Stephen. Welcome to Envista's second quarter 2023 earnings call. We appreciate you taking the time to join us today. As anticipated, our performance in the second quarter accelerated as we continue to focus on partnering with dental professionals to digitize, personalize, and democratize oral care. This quarter, we delivered core revenue growth of 2.1% and achieved an adjusted EBITDA margin of 19.1%. Sequentially, our adjusted EBITDA margin increased 90 basis points versus Q1 2023. We expect our performance to continue to accelerate in the second half of 2023, and we are positioned to meet our full year guidance of low single-digit growth and adjusted EBITDA margin of 20% or greater.

Before I turn it over to Howard to discuss our second quarter results in more detail, I want to take this opportunity to provide further perspective on the current operating environment and then offer an update on our progress toward our strategic priorities. Globally, the dental market remains dynamic. While patient demand remains resilient, macro uncertainties, including geopolitical risks, continue to weigh heavily on the mind of both patients and clinicians, creating an uneven operating environment. In the second quarter, we saw some notable but not widespread weakness in higher-end dental procedures, including adult orthodontic cases and full-arch restorations. This weakness mostly came in the form of patients postponing treatments versus canceling the procedures. Offsetting this weakness, we saw a strength in the demand for restorative dental care and have further seen a continued commitment from clinicians to make selective investments in their practices.

Clinicians are working to digitize their practices, and as a result, we saw a strong growth in our DEXIS IOS business in the second quarter. As we look to second quarter or second half of the year, we expect dental demand to remain resilient and our performance to strengthen as we focus on execution. Long term, we continue to work to accelerate our core growth, expand our margins, and transform our portfolio. The Envista Business System, EBS, underpins our execution rigor, and we use it every day to continuously improve our operational capabilities in order to deliver better serve our customers and our shareholders. Two recent examples of EBS in action include the successful development and launch of a new product in our Orascoptic business and an annual President's Kaizen focused on improving customer satisfaction and streamlining our internal operations in our orthodontic business.

For those of you less familiar with our full portfolio, Orascoptic is a leading provider of loupes for all dental professionals, including oral surgeons, orthodontists, dentists and dental hygienists. The business operates within our Specialty Products & Technologies segment. Recognizing the need to drive innovation and growth, the Orascoptic leadership team used the EBS Voice of Customer tool to design the next generation of loupes, the RDH Elevate, targeted at dental hygienists market, a predominantly female market that has traditionally been underserved. The RDH Elevate is a titanium frame designed to eliminate discomfort, while still prioritizing style with custom designs that are lightweight and affordable. It's a high-quality, fashion-centric option. This is recent debut, we have seen rapid adoption, contributing to our high single-digit growth in this business. This is a great demonstration of how utilizing EBS can accelerate our product development plans, igniting growth and improving customer satisfaction.

Turning to our own core orthodontic business, in the second quarter, the leadership team ran a President's Kaizen aimed at advancing our EBS journey while driving continuous improvement throughout the organization. During the concentrated week-long, the orthodontics team ran 11 individual Kaizens involving over 100 employees. Each Kaizen was focused on a different process that was standardized, simplified, and improved. Our team successfully identified and implemented concrete improvements that will produce over $5 million in annual cost savings while enhancing our customers' experience. The event positively impact our full orthodontic business, including the Spark, and is another step in our journey of consistently improving margins. Focusing on our progress in Q2, our uniquely positioned orthodontic business continues to perform well, driven by sustained performance in a Spark Clear Aligners.

Once again, Spark was able to drive significant year-over-year growth, while also growing double digits sequentially. We continue to leverage EBS to drive the Spark growth formula, and we are consistently adding new doctors, increasing case volumes at existing doctors, and growing our revenue per case. The Spark is well positioned to contribute to Envista's long-term growth. While our traditional bracket and wire business was negatively impacted by U.S. sanctions on Russia, we continue to make progress with our Damon Ultima System worldwide. This innovative bracket and wire solution provides orthodontists more control for faster and more precise finishing. In the U.S., more than 30% of our sales of Damon products now consist of Damon Ultima. In Europe, penetration continues to accelerate.

Our solutions for implant-based tooth replacements declined low single digits in the quarter, with solid growth across most geographies, impacted by declines in Russia and pockets of weakness in North America. In China, we grew mid single digit, offsetting the impact of value-based pricing, VBP, through increased volumes, driven by an accelerated demand for implants, as well as meaningful gain in share. VBP has narrowed the pricing difference between Nobel Biocare and other competitors in the local market, and this has encouraged many clinicians to trade up to our leading implant solutions. As expected, an adjusted EBITDA margin improved sequentially over the first quarter of 2023, increasing 90 basis points to 19.1%. This expansion occurred despite a temporary reduction in high-margin sales to Russia, the impact of the China VBP price reductions, and our continued investments in our long-term growth initiatives.

We leverage EBS to manage margins through a systematic focus on price optimization, cost controls, structural cost reductions, and de-emphasizing of non-strategic and less profitable businesses and geographies. We expect margin to expand in the second half of 2023, and we remain on track to deliver full-year guidance while making meaningful investments in long-term growth. We remain focused on building a stronger, differentiated, and growth-oriented portfolio. Having owned it for more than one year, our DEXIS IOS business is now included in our core growth and is contributing to improvements in both growth and margin within our Equipment & Consumables business. The IOS market remains underpenetrated, and DEXIS IOS is well positioned to capitalize on growth in this area. In July, we reached the 1-year anniversary of the Osteogenics Biomedical acquisition. Moving forward, Osteogenics will be reported as core growth within the Specialty Products & Technologies segment.

This business continues to perform well and will be accretive to our growth in 2023 and beyond. Combined, both acquired businesses are expected to contribute 75 basis point or greater of core sales growth for Envista in 2023. While we are excited about the strategic moves that we have made today, we see additional opportunities to further improve our portfolio. We're committed to pursuing a disciplined and a strategic approach to capital deployment. We utilize our EBS-driven M&A approach to manage our robust pipeline of inorganic partnerships and investments, and continuously cultivating new opportunities. I will now turn the call over to Howard to go through our second quarter financials and provide more details on our segment performance.

Howard Yu (CFO)

Thanks, Amir. In the second quarter, we delivered sales of $662.4 million. This represents an increase of 2.6% over the second quarter of 2022 on a reported basis. Acquisitions contributed 1.7% of growth, while foreign currency exchange rates negatively impacted sales by 1.2%. Core sales for the quarter grew 2.1%. Our growth reflects continuing growth in our Specialty Products & Technologies segment, as well as a return to growth in our Equipment & Consumables segment. From a geographic perspective, Europe grew high single digits, while North America declined low single digits. Emerging markets grew mid single digits, with strong growth in most markets, but being weighed down by the decline in Russia. China grew in the quarter with a strong rebound in volume, offsetting the VBP-related price declines.

For 2023, we expect China to show modest growth net of the VBP pricing impact. Our second quarter adjusted gross margin was 57.9%, which is down 80 basis points from prior-year. The decline in gross margins was primarily attributable to an unfavorable product mix, VBP-driven price declines, and continued investment in our long-term growth. Our adjusted EBITDA margin was 19.1%, which represents a 60 basis point decline versus Q2 of 2022, and a 90 basis point sequential improvement from Q1 of 2023. Our adjusted diluted EPS in the quarter was $0.43, compared to $0.48 in the comparable period of the prior-year. The reduction in the EPS for the quarter was primarily driven by an increase in interest expense from higher interest rates. Core revenue in our Specialty Products & Technologies segment grew 1.7%.

In the second quarter, our combined orthodontic business grew high single digits, with Spark continuing to expand rapidly. Our traditional bracket and wires business declined high single digits, negatively impacted by the Russian sanctions. As we have discussed, we expected this impact in the quarter, and we anticipate being able to resume shipments of these products to Russia again in the third quarter. Our implant-based tooth replacement business declined low single digits in the quarter. We saw solid growth across most geographies, offset by pockets of weakness in North America. China grew mid single digits, with strong volumes offsetting the impact of VBP pricing. Adjusted operating profit in this segment was 18.7% in the second quarter. This is down both year-over-year and sequentially, as we continue to invest in our long-term growth and are managing the impact of VBP-driven price declines.

Turning to our Equipment & Consumables segment, core sales in the second quarter increased 2.9% compared to Q2 of 2022. The return to growth in E&C segment is driven by our continued strong partnership with our key distribution customers, as well as our EBS-focused execution, which helps drive strong sell-out and ensure we are driving performance all the way to the clinics. Our equipment business grew low single digits, driven by strong growth in IOS, which is now part of core growth, and by the improving performance of our traditional imaging business. It is important to note that we continue to de-emphasize non-strategic geographies and solutions in order to concentrate our efforts in markets where we can build a sustainable competitive advantage. This will allow us to accelerate both growth and margins over the long term.

On the consumable side, we delivered mid-single-digit growth, driven by strong performance in our restorative and endodontics businesses and modest growth in our infection prevention business. Globally, we believe that the distributor sell-out of our consumable solutions continues to outpace the market. Channel inventories remain healthy, and we expect this business to continue to perform well throughout 2023. In the second quarter, adjusted operating profit in the Equipment and Consumables segment was 25.7%. This represents 400 basis points of margin improvement versus prior year. Margin performance in the Equipment and Consumables segment is truly a demonstration of the power of EBS. We are relentlessly focused on driving productivity, optimizing our operating structure, and managing price to protect and deliver improving margins.

In the second quarter, we generated $61 million of free cash flow and ended the quarter with over $650 million in cash. We continue to make progress on our free cash flow management and remain committed to our midterm goal of delivering annual free cash flow in excess of net income. We have a strong balance sheet that provides us the flexibility to pursue additional inorganic growth opportunities when the right assets become available at attractive valuations. Now, I will turn the call over to Amir to discuss our outlook for the balance of the year and provide closing comments.

Amir Aghdaei (President and CEO)

Thanks, Howard. Looking forward, we remain confident in our long-term strategy, as well as our ability to deliver our outlook for the full year, 2023. We expect core sales to grow low single digits and to achieve adjusted EBITDA margin of 20% or greater for the full year. While we are confident in our outlook for 2023, it is important to note that we do anticipate some continued quarterly volatility. The second half of last year was volatile, with a relatively strong third quarter, followed by a much weaker fourth quarter. Given last year's performance, we expect results to accelerate throughout the remainder of 2023 and for the fourth quarter to be our strongest quarter for both growth and margins. Before we conclude the call, I would like to acknowledge the leadership change that we announced last week.

After more than 20 years with Danaher and Envista, my partner and friend, Howard, has decided to pursue a new opportunity outside Envista and the dental industry. As the original CFO of Envista, Howard has had a tremendous impact on our business and helped position us for long-term growth. He has been an important advisor to me and the whole Envista team, and we will miss him after he leaves in late September. Howard, thank you for your leadership, your partnership, and many contributions to Envista.

Howard Yu (CFO)

Thank you, Amir. I've truly appreciated the opportunity to work with you and the entire Envista team. I am proud of what we accomplished as a new public company, and I'm confident that Envista will continue to deliver on its vision of digitizing, personalizing, and democratizing dental care. Envista is well positioned to continue to accelerate growth, expand margins, and further transform the portfolio.

Amir Aghdaei (President and CEO)

I want to reiterate that our priorities remain the same. We intend to accelerate growth, expand our operating margins, and further improve and transform our portfolio through active and disciplined capital deployment. Our EBS focus and continuous improvement culture will help us manage through short-term volatility while progressing towards our long-term targets. We are institutionalizing EBS within our culture and our operations, ensuring that each leader across Envista is retrained and exceptionally knowledgeable in our tools and best practices. Here today, we have held 10 one-week EBS back to basics trainings, designed to reimmerse each leader in our business system. This initiative hasn't only been impactful to our business performance, but also engaging and enabling of our leaders to execute our continuous improvement approach. We intend to continue and further enhance our training as we move forward.

We're well positioned to be a leader in both orthodontics and in implant-based tooth replacements. Our comprehensive clinical offerings, including our imaging and diagnostic solutions, will improve the productivity of dental professionals while empowering them to plan and deliver personalized and predictable treatment for each patient. Our preference is to partner with dental professionals to improve patients' lives by digitizing, personalizing, and democratizing dental care. We're focused on delivering long-term value for patients, our customers, our employees, and our shareholders.

Howard Yu (CFO)

Thanks, Amir. That concludes our formal comments. We are now ready for questions.

Moderator (participant)

At this time, if you would like to ask a question, please press star one on your touch tone phone. You may remove yourself from the queue at any time by pressing star two. Once again, that is star one to ask a question. Our first question will come from Elizabeth Anderson with Evercore ISI. Your line is open.

Elizabeth Anderson (Analyst)

Hi, guys. Thanks so much for the question. Howard, sorry to see you go. Congratulations on, on your new opportunity. I think just maybe as sort of a, a last question as, as you sort of go through your last earnings call, how do we think about, like, the current demand environment? I know we've talked about some of the ups and downs over the first half of the year and into the second quarter, but as we kind of parse apart, you know, as we started to be in the third quarter with sort of maybe broadly speaking, by like China, Europe and North America, that would be helpful to hear more color there. Thank you.

Amir Aghdaei (President and CEO)

Yeah. Thank you, Elizabeth. Overall, patient demand remains resilient. What we hear from doctors, group practices, DSOs, they remain bullish on the long-term outlook for dental demand, but we're mindful of the macroeconomic risks. What we are seeing is a continued strength in general and restorative care. We see some isolated weakness in higher-end dental procedures, such as postponement of treatment versus canceling it, and a full-arch restoration and some adult type of support on the ortho side. We are seeing some caution from clinician, resulting in managing inventory, a lot more strict format than what we have seen before, specifically on implant, bracket and wire. On a segment-by-segment, implant-based tooth placement replacement is resilient demand, but we are seeing some notable but not widespread weakness in high-end. Ortho, resilient, except Russia, that is volatile, and we have some challenges there.

Our traditional imaging, we have improved it significantly, also demand remains weak due to macro concern and high interest rate. Our comps are becoming a lot easier to manage as we go through the second half. IOS, we see a continued strong demand, both from doctors as well as group practices and DSOs, because they intend to digitize and expand their capabilities. Our consumable, what we are seeing is demand is stable and resilient. When I look at the geography by geography, Europe demand is resilient, but as you can imagine, you know, this is summer vacation, and it's summer rolling vacation to north, to southern part of Europe. In North America, we haven't seen any significant change. We see demand continue to be resilient. As I mentioned, a fa- pockets of weakness in higher-end dental procedures.

China, I was in China for a week last week, as what we saw, demand as expected, has improved significantly compared to the COVID-impacted comparables. We expect to see further increase in second half. There are some key issues, customer sentiment, as well as some focus on spending, such as travel versus dental care. Russia continues to be volatile. Continuing the conflict in there doesn't really allow you to have a direct forecast on what you can expect quarter to quarter. Rest of the world, emerging market, our demand has been resilient, and we have performed extremely well.

Put it all back together, I think the forecast that we put together and communicated at low single digit considers all these variables in here, and given some of the acquisition as well as EBS, we feel positive about what we can deliver in second half and for the whole year.

Elizabeth Anderson (Analyst)

Got it. That's super helpful. Maybe just sort of similarly, for people who are looking at the, the full year margin guidance and saying, "Okay, hey, we're two quarters in, and yes, the margins are definitely improving sequentially and, and took a very nice step up, Q over Q," how do you think about that versus the ramp into the last two quarters of the year? Any particular, like, profitability drivers to step up in the third quarter versus fourth quarter, or any other sort of details you can provide for us for how to think about that?

Amir Aghdaei (President and CEO)

We expect we had said that before, Elizabeth, that second half is going to be stronger, as we go through the year, we're going to see better performance. If I break it down to say, where is the growth coming from? Growth is going to come to a large degree on a specialty products and technologies. Spark continues to add new doctors. Existing doctors, they're putting more new cases. We're going to different geographies. Prices are improving, growth margin is improving. Acquisition becoming part of our core growth, combination of IOS plus Osteogenics. We expect those to improve and impact our core growth by over 75 basis points. Then we would have a much easier comp, specifically on equipment, considering what we had to deal with last year in Russia and China.

Core growth are driven by these factors that we talked about on top of, you know, being very targeted on how our go-to market operates. On the EBITDA side, our volume and mix is improving, specifically on the specialty part. Profitability of Spark, the growth margin is improving every quarter, and the impact of the EBS-driven productivity is very visible and obvious. As you have seen in our Equipment & Consumables business in Q2, we expect to continue to drive that as we go forward in second half. As we mentioned before, we have been very targeted. Geographies, businesses, that they're not really competitively advantaged, they're not growing, they're not profitable, and we have moved away from them very systematically, quarter after quarter, and that really now is beginning to pay off.

We have more work to do in here, but we feel confident about what we have ahead of us in second half.

Elizabeth Anderson (Analyst)

Got it. Thanks so much.

Moderator (participant)

Thank you. Our next question will come from Michael Cherny with Bank of America. Your line is open.

Michael Cherny (Analyst)

Good afternoon. Thank you for taking the question. I want to dive in a little bit more to the commentary you made around the back half of the year, if I could, Howard, in terms of the cadence and the year-over-year comps. You tend to have some level of 3Q-4Q ramp, but it sounds like we should be expecting something fairly steeper than normal. I know you're not commenting specifically on giving quarterly guidance, but in terms of those moving pieces, how should we think about, aside from comps, some of the biggest differences between the expected 3Q and 4Q growth?

Howard Yu (CFO)

Yeah. So, so Michael, I think that we do see and have anticipated this throughout, and I think even when we provided guidance, we, we talked in context of first half being a bit slower, sluggish, both on, in terms of growth as well as around the margin profile. Certainly, as Amir described, as we see that improved growth and the volume come through, that's clearly going to have some pull effect in a positive manner on the margins. So that's one thing. You know, we've emphasized as part of EBS, productivity improvement. Look no further than Spark. I think that every quarter, sequentially, we continue to see improvements in that margin profile, and we'll see a significant step up here in the second half as well. You know, China's recovering. That's gonna certainly improve those margins.

We talked about China. If that business grows, even with the VBP impact, we feel confident that we're going to see that profitability show up. We talked about the IOS ramp. As that business, which is, you know, as we acquired, faster growing, but also improved margins, we'll see that fall through as that growth continues to happen. Then, you know, just basic around EBS and the productivity improvements that we looked at to do. We've taken some actions even in the second quarter, which will yield some results here in the second half. We feel confident that that's going to help drive some of that. Clearly, Q4 is going to be the most significant, largely because it's the largest revenue quarter for us.

So you're going to see margins step up significantly between Q3 and Q4.

Michael Cherny (Analyst)

Just one other maybe housekeeping question more than anything else, but you had a pretty nice sequential step down versus the last few quarters in corporate expenses. Is that part of those targeted restructurings that you've done? Is that something we should consider to be sustainable relative to the overall profit metrics?

Howard Yu (CFO)

Yeah. I think when we look at things around, productivity gains, restructuring, I mean, we, we want to be mindful about, you know, customer-facing, folks that are in the manufacturing plants and, and to impact those things the least. Clearly, we're going to go ahead and take actions where we can, not impacting our customer centricity and focus there. We will see continued impact on the corporate as, as, as you've seen already.

Michael Cherny (Analyst)

Got it. Thanks so much.

Howard Yu (CFO)

Sure.

Moderator (participant)

Thank you. Our next question comes from Jeff Johnson with Baird. Your line is open.

Jeff Johnson (Analyst)

Hey, guys. Good evening. Thanks for taking the questions, and, Howard, best of luck in the new role. I'll miss the, the good dinners and the, detailed conversations we've had in the past, so good luck on that.

Howard Yu (CFO)

Thank you.

Jeff Johnson (Analyst)

Maybe, Amir. Yeah, maybe, Amir, I could ask you a question on Europe and a question on implants. Europe, you know, as you were ticking through your answer to Elizabeth, you said maybe some vacations and all that. I mean, I know we hear that frequently in Europe, but, you know, leading economic indicators, not the best right now. One of your competitors came out with a report tonight and reported, you know, softer than expected European performance. They cited Germany specifically from a macro standpoint. Obviously, they have a big legacy business in Germany, so maybe it's nothing more than that.

Just, you know, how comfortable are you with what we're seeing macro-wise in Europe, that the European business can stay, you know, healthy and, and continue to contribute to that improving growth profile here in the second half?

Amir Aghdaei (President and CEO)

Yeah. Thank you, Jeff. Over 25% of our business comes from Europe, and, you know, for the past, I would say 8 quarters, we have performed extremely well in Europe. What is driving it? I, I'll talk about macro in a second. I'll answer your question, but I want to tell you what we have been doing that results in, in this outperformance. Our clear aligner business in Europe is the fastest growing part of our business, and it's purely because of segmentation, the network effect, the training, education, and very systematic rollout that we have started in Spain, and we extended it to France and going geography by geography. We are expanding that business very rapidly throughout Europe.

Our implant business, and I think, you know, we talked about this a few years ago, is that we have to improve our execution in Europe. We have delayered the organization. We have improved customer experience. Every geography has very targeted focus to the customers, that building relationship and growing that. Our implant business performs extremely well compared to the other geographies worldwide. Look at our consumable business has been growing high single digit every quarter for the past 8 quarters. I want to talk about macro, but let's figure out what the macro look like versus our performance. Macro in Europe, exactly the same thing. You said, Jeff, we are hearing the same thing. On the ground, what we execute, segments we are going after, we're being very targeted, very deliberate, and we have improved the customer experience throughout Europe....

by consolidating and building a new customer center in Prague, we are building a new factory for the Spark delivery so we can reduce the turnaround time significantly in Europe. All of that has allowed us to be doing extremely well, we are replicating a lot of those success stories in U.S. as well. Macro, important. Execution always trumps macro, that's what we have done in Europe, we've done it in China, we have done it in emerging markets. We are replicating it in North America as we go forward.

Jeff Johnson (Analyst)

All right, that's helpful. Thank you. The, the implant question, you know, I think you gave enough detail on, on Europe and China, this quarter. We can kind of back into that North American number, probably was down about mid-single digits, year-over-year. Is, is that close? And if it is, how does that compare to maybe the Q1, Q2 performance? I know you've talked about some company-specific efforts to kind of restimulate growth in that business. You know, when do you expect that to get back to a positive growth?

You know, the thing we're hearing on the North American dental implant market, you know, especially with regards to your business, is, M1 maybe just not scaling at this point, still waiting for some evidence there, but also some trade down to value happening that's maybe not going to the Implant Direct business, but to some of the other value players in the US. You know, as I, as I kind of throw those things out there, just how much-

Amir Aghdaei (President and CEO)

Yeah

Jeff Johnson (Analyst)

... of that seems to fit with kind of what you're seeing, and, and, and how do you think about this business over the next maybe six-12 months? Thanks.

Amir Aghdaei (President and CEO)

Yeah, yeah, those are all really good questions, Jeff. As usual, you have tremendous amount of insight and point exactly what the challenges are, and we're not shying away from discussing what the macro issues are versus what the challenges on executions are. The macro in North America continues to be resilient. We are not seeing anything that says radically, the implant business has changed. On the other hand, some of the high-end selective procedures, like, you know, full-arch restoration, is $25,000-$30,000 investment. If people can wait a little bit longer, they will wait for it. They postpone it. They're not canceling it. They postpone it. When we talk to the oral surgeons and the people that we work with, they're not seeing a radical shift in the number of patients that they're coming to.

They see a little bit of a postponement. What we see on the ground is tighter inventory control, and to be very specific, you know, if you used to buy one month's worth of inventory at the oral surgeon, now they're buying two weeks at a time. So why is that important? We manage things at the local level, at the regional level, then we go to the geography, even at the zip code level. When we point at pockets of challenge, there are pockets of North America implant business that does extremely well because they do the fundamental, they do the basics very well. We've got a great brand, we've got a great product portfolio, we've got dedicated community of surgeons. We have pockets of localized execution challenge.

For example, when there is an open territory, those regions that they have somebody standing by, jump in there, co-cover the territory, they don't see a drop. Those that they don't, it takes three-six months to fill that territory. As an outcome, we see a drop in that segment. Those that they have a really good on-the-ground inventory management, daily work, funnel management, they see performance managed through all of those. Those that they don't, we see a significant discrepancy between performance. In Europe, we have been able to solve a lot of this problem. We have consistency from one region to the next. In US, we're going through a same process. Each region is standardizing the daily work, funnel management, you know, replacement of those open territories.

We are confident that this is going to improve every quarter, and as we go forward, our intention is to get the growth at or above market. At this one, we know for a fact that we're not performing in our full potential.

Moderator (participant)

All right, thank you. Our next question will come from Brandon Couillard with Jefferies. Your line is open.

Brandon Couillard (Analyst)

Hey, thanks. Good afternoon. I mean, it would be helpful if you could just unpack exactly what you saw in imaging in the second quarter, whether it was up or down on a year-over-year basis, and that improvement, just a function of easier comps and how you thinking about that segment in the second half of the year.

Amir Aghdaei (President and CEO)

Yeah. Thanks, Brandon. To make sure that it was a little bit soft, you asked about imaging, correct? Imaging business in performance?

Brandon Couillard (Analyst)

Yes, sir.

Amir Aghdaei (President and CEO)

Okay, absolutely. If you recall, we talked about a little bit of a macro issue. Well, let's, let's figure out who actually buys imaging product. There are three group of people. one, you open a new operatory, you add to existing setup, or you, you know, if you're a DSO, you open a new location. That has slowed down to some degree because of interest rate, because of resources. two, you do replacement. Replacement of existing product that they are five, six, seven, seven years old, and that also has been impacted to a degree. Last but not least, you haven't had it. You want to put a CBCT in, you want to put the iOS in, in order to be able to expand the capabilities that you have in the office.

That segment, as we talked about, the IOS growth has been in place. You put the macro aside, what we have done, we have started looking at segment, geographies, product categories that have competitive advantage. They're linked to our overall strategy, and we have really growth potential in the long run. Starting Q2, Q3 of last year, we started exiting specific geographies and segments, and that really had an impact. We deployed a whole set of standards around roadmap management, value proposition, go-to-market, customer experience. These have been at work. We're beginning to see the outcome of all of that in Q2. If you look at our imaging business, to be transparent, declined double-digit in Q1. It improved significantly in Q2.

Additional IOS put it in a positive, low single-digit positive, even without IOS, our traditional imaging business improved significantly in Q2 versus Q1. We expect that improvement continues throughout the year. To sum it up, macro is what it is. EBS at work, try to do things right, manage the portfolio, focus resources and investment to our high-growth, differentiated product categories, continue to improve our go-to-market. That's what we're doing. That's the outcome that we expect. More profitable and get back to growth second half and continue that through 2024.

Speaker 11

Thank you. Howard, wish you all the best as well. Just two for you. What was the benefit of the 1 extra selling day in the quarter? What should we pencil in for free cash flow conversion for the year? Thanks.

Howard Yu (CFO)

I think Thanks, Brandon. I think, with regards to one extra selling day in the quarter, you know, it wasn't as meaningful because, you know, we did have more growth on the ENC side, which is mostly a distributor type of business. I would say that that's not going to be, or didn't have as much of an impact. As it relates to free cash flow, look, we continue to improve. We talked about the midterm goal of getting free cash flow in excess of net income. We feel that, you know, second quarter is a good illustration of how we introduce some more discipline as it relates to working capital, as well as profitability improving.

We'll see that here, certainly in the second half, with Q4 being the largest contributor.

Moderator (participant)

Okay, thank you. Our next question will come from Jon Block with Stifel. Your line is open.

Jon Block (Analyst)

Thanks, guys. Good afternoon. For the 2023 guidance, you know, you guys seem to have confidence, but it still is a steep slope for 2H. Amir, you talked about a dental market that showed some slowdown. I think you said in the higher-end part of the market, you've got a $1 billion is implant business. You're not far off from almost a $250 million run rate in clear aligners. I guess where I'm going with this is, what does the guidance assume or embed, you know, for the balance of the year? Are you extrapolating out, call it the current trends, and you guys can get there? Or is it an underlying assumption for a market pickup with some of those, what you're describing as higher-end types of cases?

Amir Aghdaei (President and CEO)

Thank you, John. you know, we have a process in place that we continue to work through. We have done that from, in Danaher and since separation, and that's a scenario planning. We continue scenario plan, what the expectation look like, and we consider all the different variables into that model. In that model, we anticipated that VBP is going to be an important factor, but we didn't really assume significant uptick on the volume. We knew Russia is going to be volatile. We have a growth model on a Spark. We know exactly, because from the time that we put a training program, we get people in, we know what happens 30 days, 60 days, 90 days after. We know the active doctors, how many cases do they put in place, implant placement. We have funnel.

At least about 90 days, we can look at our funnel and take a look at the conversion ratios, what would that look like, NPIs, new product introduction, as well as the marketing program. When we put all of that together, our core growth assumption in second half is based on growth on the Specialty Products & Technologies. To a large degree, the Spark is driving it. Acquisition is in moving to the core growth. We got over 75 basis point of an impact for the full year, but IOS came to play only starting end of April. We have a full second half in here. We have Osteogenics in second half. We have easier comps, specifically for equipment. We have China out of the COVID. The ramp is taking place. As I mentioned, I was there last week. We're seeing a good uptick in here.

A combination of all of that, plus what we are seeing on improving mix, margin, profitability, gross margin improvement as far, productivity that we are getting. What Howard talked about, some of the changes we have done on G&A in Q2, that gives us the confidence to see what the second half is going to look like. That's how we have built this plan. Far, it's playing exactly what we expected. We said every quarter is going to be better than the previous quarter. We have proven that in Q2 result, and we expect that will take off, assuming some of the seasonalities between Q3 and Q4. We think second half is going to look a lot better than the first half, and confident that we can deliver what the guidance that we have provided.

Jon Block (Analyst)

Okay. That was very helpful. I, I guess it just sounds like you're not embedding in a pickup in the market, Amir. You're, you're pointing to sort of company-specific variables and momentum in some of those businesses that give you the confidence on, on the 2H step up, if that's correct?

Howard Yu (CFO)

Yeah.

Jon Block (Analyst)

Okay, great. Thank you. Maybe just to pivot, a little bit more specific to Russia. The Russia revenue headwinds, maybe, Howard, if you can quantify that, you know, the swing in the wires and brackets growth rate of nearly 1,000 basis points sort of implies it could be $10 million or $10 million and change, and, maybe if you can give a more specific number, and then how that returns. In other words, is that all a 3Q in 2023 event in your opinion, or is that somewhat staggered between 3Q-4Q in 2023? Thanks, guys.

Howard Yu (CFO)

Yeah, sure. Sure, John. The majority of the impact as it pertains to Russia, because it didn't impact all products, these sanctions, right? It's mostly U.S.-born products. That had a disproportionate impact on our bracket and wire. Had a little bit of impact on our implant as well. I think we had said that sales would be impacted in that, you know, particular segment by up to $10 million. I think in the end, we probably was, was a little shy of that as it relates to the impact, but clearly very profitable business for us. What we've said is that, you know, the licenses should get cleared and that we should be able to resume shipping all these products here in the third quarter.

We would anticipate that we're not losing those orders, whether they get made up here in the third quarter or fourth quarter, or whether there's some broader impact associated with all the things that are going on in Russia. Certainly, you know, it's pretty volatile as Amir's pointed out, but we feel confident in our position there. We think that we'll be able to continue to get our business, you know, as a key component of our growth in the emerging markets, particularly as it pertains to our specialty products. So, we feel confident about what we're going to be able to do there in the second half.

Jon Block (Analyst)

Okay, perfect. thanks for the color, guys.

Howard Yu (CFO)

Sure.

Moderator (participant)

Thank you. Our next question will come from Jason Bednar with Piper Sandler. Your line is open.

Jason Bednar (Analyst)

Hey, thanks for taking the questions, and a lot of the same sentiments here, Howard. You know, congrats on the new role, and we'll miss working with you. I wanted to start just with the, with the questions here, maybe another question on the EBITDA margin guidance and the implied improvement here in the second half. Apologies upfront if I missed any of this. I've been hopping between a couple of calls, but I'm trying to reconcile maybe the EBITDA margin you posted here in the second quarter for your two reporting segments in the context of that second half margin ramp that you have out there. I guess the question is, does the margin improvement more come from SP&T, given the low level we're at here in the first half in that segment?

I hear what you're saying on the improvements you expect to see from Spark, or does the margin momentum build even further in E&C after what was a really nice quarter, I thought, here in, in the second quarter? Really just trying to get a sense of the source of the margin improvement as we think about that, that steeper ramp in 2H.

Howard Yu (CFO)

Yeah. Thanks, Jason. I, I think that we will see significant improvement in the second half as it relates to margin profile coming from the SP&T segment. We talked about the impact associated with the Russia sanctions, and so as we get through some of those, that's going to bring back much of the bracket and wire business and the implant business associated with Russia. Clearly, those are at higher than fleet average margins, right? Then, as it, as it relates to sequential or first half, second half comparisons, we've talked about the Spark profitability profile continuing to improve every quarter sequentially, and so we'll clearly see that happen here in the second half as well.

You know, even with some of the acquisitions, the Osteogenics business, that goes into core, brings through volume, along with this, some improved margins as well, we anticipate. Just overall volumes improving on the specialty side. While we did have some growth in the second quarter, we anticipate growth in the specialty being a little bit accelerated here in the second half, and so that will be the case. We're clearly pleased with the performance on E&C margin expansion of over 400 basis points. You know, we don't want to commit to saying that that's going to improve further yet. We also know that, you know, with the EBS culture, that we're going to continue to look to get additional productivity there.

Then you'll see some margin improvement, as we talked about earlier in the call around the corporate functions, too.

Jason Bednar (Analyst)

All right. All right, that's really helpful. It definitely sounds like, you know, probably more, more coming from SP&T, but so maybe for a follow-up, the E&C price declines here on a year-over-year basis in the second quarter, I think it was, you know, something down 80 basis points. It was about a three-point sequential step down. Can you talk about what the source of that step down was, what the delta was in Equipment & Consumables pricing from 1 Q and 2 Q? It was just a bigger quarter-to-quarter change than we're accustomed to seeing, but also trying to understand maybe how much of this pricing move was strategic to drive the better volume growth that we saw here in the second quarter.

Howard Yu (CFO)

Yeah, I mean, you know, as, as we talked about, we allow each of the opcos to, you know, look at how they go ahead and maximize growth, profitability, and part pricing is part of that equation. So I will say that on the E&C side, there was some, you know, pricing concessions given on the imaging hardware side. You know, with, with concerns around the interest rates and the like, we want to meet customers where they need it. So quite honestly, we'll go ahead and be willing to move a little bit on that pricing, to go ahead and secure that business. I think that we've done a nice job of doing that. Certainly being mindful of the overall margin profile.

So we'll continue to focus in on making and executing on that front as well. You know, maybe as a related matter here, we talked about inflation and things like that. I know that the topic hasn't come up, but we have seen some moderation here in the second quarter, and particularly around direct materials. So that affords us a little bit of opportunity to work with around pricing to secure those deals on the imaging side. So we feel good about that. You know, pricing, each of the opcos are a little bit different with regards to that. The big pricing impact as it relates to the Specialty is clearly coming from VBP in China.

Other than that, we've seen some nice pricing upticks in businesses like Spark, as well as bracket and wire, and as well as our consumables areas within E&C. Again, this is exactly the plan, is to let the opcos manage to, to improve growth as well as profitability.

Jason Bednar (Analyst)

Yeah, very helpful. Makes for the extra color there as well, and the inflationary pressures there.

Moderator (participant)

Thank you. Our last question will come from Nathan Rich with Goldman Sachs. Your line is open.

Nathan Rich (Analyst)

Great. Thanks for taking the question, and Howard, let me add my congratulations and best wishes as well. I guess, could, could you maybe talk about how China played out over the last few months, especially from a consumer demand standpoint? I'd be curious to, to get a sense of how your expectations for China over the back half of the year, maybe change relative to what they were three months ago or coming into the year.

Amir Aghdaei (President and CEO)

Yeah. Thanks, Nate. You know, as I mentioned, I had a really great week in China. I met with some of the largest hospitals in Shanghai, largest DSOs and many customers, as well as our own team. You know, China, VBP, it's played out exactly as expected. really brought the prices down, and the public sector, somewhere close to almost 50%, but the volume has increased. You can definitely see the volume has increased. As an outcome of that, this ramp that they expected, and we were watching this very carefully, is beginning to take place. 15 provinces on the ortho side, they have increased price, they have gone through VBP, but they're pausing to see what's the impact on the implant look like before they take the next step.

Now unpacking that, we are seeing a strong patient traffic, and the two other phenomenons are happening in here. One, the gap between the premium and value has closed significantly. If the gap is closed, a lot of clinicians, they're making a decision, "Hey, go for a premium brand. Go buy Nobel, because the gap is not that much." The second part that we witnessed, and it is very much at play, is the three-unit bridge versus the implant. The price gap between the two procedure has closed significantly, and a lot of clinicians are beginning to think, "Hey, better place implants than doing that three-unit bridge, given that the price difference is not that much." The DSOs and some others, they're beginning to become really comfortable on placing implant. As an outcome, we are seeing a significant volume growth.

Watch it very carefully to see what's going on in implant, what's going on with the pricing. The volume growth has been better than what we expected, and prices are pretty much playing exactly as we had anticipated. Now, putting that aside, there are still some challenges on the ground. The housing crisis, the slower growth, consumer spending, all of that is realities that the China economy as a whole is dealing with it. We're talking specifically on a specialty part, such a small segment of the market, which we think is going to continue to be resilient going forward. We expect China to be flat for 2020, impacting with the huge impact on the VBP and given that Q1 was a really difficult quarter, but it has improved, and we expect to see more improvement in second half.

Nathan Rich (Analyst)

Great. And maybe, Howard, a quick follow-up for you. You know, I appreciate the color on EBS. I think, you're also kind of looking at certain restructuring actions in China to kind of right-size that business. You know, I think also, you know, you've taken some actions in equipment. I'm just curious if, you know, you could maybe help us think about the magnitude of those, and are those savings that we should expect to help the back half of the year when it comes to a margin standpoint?

Howard Yu (CFO)

Yeah, Nate, I, I, I do think that we have, we continuously look at all of our operations and make sure that the size of the operations as it relates to the cost structure and the like, are commensurate. Certainly in China, we've taken some actions and, you know, to date, even as Amir's come back last week, you know, none of those restructurings have impacted the customer-facing components, and if anything, I think the team is even more focused. I would say that that's also true on the imaging side. As we alluded to, that business had not been growing for several quarters now. Taking the appropriate actions to rightsize that business was also the right thing to do.

We'll clearly see that impact, you know, throughout the rest of this year as well. Some of those actions were taken earlier in this year.

Nathan Rich (Analyst)

Great. Thank you.

Howard Yu (CFO)

Sure.

Speaker 12

Tha.ks, everyone. Appreciate, appreciate the time. We look forward to talking to you guys next quarter. Thank you very much.

Moderator (participant)

Thank you, ladies and gentlemen. This does conclude today's conference call, and we appreciate your participation. You may disconnect at any time.