Envista Holdings Corporation

My name is Stephanie and I will be your conference facilitator today. At this time, I would like to welcome everyone to the InVista Holdings Corporation's second quarter 2020 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 this time, simply press star then the number one on your telephone keypad. If you would like to withdraw your question, press the pound key. I will now turn the conference over to Mr. John Bedford, Vice President of Investor Relations. Mr. Bedford, you may begin your conference.

Thanks, Stephanie. Hello, everyone, and thanks for joining us on the call. With us today are Amir Agday, our President and Chief Executive Officer, and Howard Yu, our Chief Financial Officer. I'd like to point out that our earnings release, the slide presentation supplementing today's call, and the reconciliation and other information required by SEC Regulation G relating to any non-GAAP financial measures provided during the call are all available on the Investors section of our website, www.investico.com. The audio portion of this call will be archived on the Investors section of our website later today under the heading Events and Presentations and will remain archived until our next quarterly call. A replay of this call will also be available. 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 year-over-year performance. Unless otherwise noted, all references in these remarks and supplemental materials to company specific financial metrics relate to the second quarter of 2020 and all references to period-to-period increases or decreases in financial metrics are year-over-year. We may also describe certain products and devices which have applications submitted and pending for certain regulatory approvals or are available only in certain markets. During the call, we will make forward-looking statements within the meaning of the federal securities laws, including statements regarding events or developments that we believe or anticipate will or may occur in the future. These forward-looking statements are subject to a number of risks and uncertainties, including those set forth in our SEC filings, and actual results might differ materially from any forward-looking statements that we make today. These forward-looking statements speak only as of the date that they are made, and we do not assume any obligation to update any forward-looking statements except as required by law. With that, I'd like to turn the call over to Amir.

Thanks, John, and welcome everyone to INVISTA's second quarter 2020 earnings call. Before we begin the call, I would like to express my gratitude for our employees' tremendous work in the first half of the year. While it has been a challenging operating environment, I'm grateful for their efforts put forth and humbled leading such a customer-centric, hardworking, and committed team. Thank you for all that you do for InVista, our customers, and our key stakeholders. Additionally, in support of the social reform movements that are occurring globally, we affirm our commitment to create an environment for our employees to work as their authentic selves and continue making diversity and inclusion a priority for our business. We are encouraged by the pace of recovery in the global dental markets, which has steadily progressed during the quarter. As a result of dental offices and businesses beginning to reopen, our core growth, which declined over 60% in April, We have experienced the most visible improvement in our orthodontic and implant businesses and continue to have record demand for our infection prevention products. When we began the second quarter, we redefined our near-term priorities to focus on the safety of our employees, providing exceptional service to our customers and preserving InVista's financial strength. Safety is at the top of the mind every day and we are taking a thoughtful approach focused on our employees' health. Our workforce has been incredibly agile and those who are able to work remotely will continue to do so in areas of the world where returning to an office is unsafe. Our manufacturing and distribution centers continue to undergo daily sanitation procedures and employees are following appropriate protocols which has allowed us to minimize disruption within our business. We treat our customers at the forefront of everything we do. We are embracing adopting and many more. During the first half of the year, we completed several hundred educational courses and trained more than 250,000 professionals. These trainings generated thousands of new leads For our sales force, we are now converting into new customers. We are beginning to see the results, particularly in our mobile business, where we experienced double-digit growth for our DSO customers in June. This acceleration was due in part to our successful efforts to help customers accelerate education during the COVID-19 shutdown. With the infection prevention procedures different across the world, our metrics team provided customers with guidance and recommendations on sanitation procedures to help ensure they have the resources needed to restart their businesses. We also developed, in collaboration with our partners, a practice recovery program offering packages to support dental practice recovery. The feedback from our customers and our partners has been extremely positive with hundreds of new customer leads generated for our partners and the ability to cross-promote other Kerr consumable products. It took significant actions to preserve our financial strength, which has enabled us to maintain our strategic investments. We exceeded our temporary cost reduction target and reduced operating expenses excluding restructuring and other exceptional charges by approximately $110 million or 35% year-over-year. This was driven by a combination of temporary and permanent initiatives including furloughs, compensation reduction, and a strong discretionary These efforts, in combination with aggressive working capital management, helped improve our liquidity position while generating positive operating cash flow in the quarter. Our near-term priorities were important to ensure that we were able to advance our strategic growth priorities, reduce structural costs, and reshape The portfolio. During the quarter, we advance these long-term objectives which will lead to a stronger investor over time. Starting with our growth investments in China, we maintain our investment. Through the outbreak, align our team to implement a targeted program to train and onboard new orthodontic and implant customers The private sector is approximately half of our overall China business. As a result, our orthodontic business grew a double-digit rate in the second quarter, including more than 25% growth in the private sector, which we believe outpaced the market. Our implant business is beginning to build positive momentum. and grew at a mid-single-digit rate in the month of June. In our infection prevention business, we completed the installation of two new production lines for our Kaviside branded disinfectant in late June, which will increase production capacity by 25%. Our infection business grew at double-digit rate in the first half of the year. We anticipate the other lines will help drive more than 30% growth in the second half of the year, which is approximately 200 basis points of revenue growth for Envista. We will continue to add additional production capacity and expect demand to continue as customers adapt to more stringent procedures designed to mitigate wireless spread globally. Our cabi wipes and Kaviside Solution received registration by the EPA confirming their use against disinfection of COVID-19. In June, we delivered our innovative N1 implant system to 10 of our key experts in Europe. This is a major milestone for the Nobel Biocare team after more than four, five years of product development. Customer can look forward to an integrated implant workflow from planning to prosthetic delivery, including new techniques like Osseoshaper, a treatment protocol that allows clinicians to treat patients with two easier-to-use lower-speed instruments, which ultimately results in less discomfort and faster healing time for patients. We will continue to roll out N1 to select customers as we move into the second half of the year. Similarly, our Spark Clear aligners continue to be well received by customers, including one key expert who has now treated over 600 cases with more than 25 other customers who have completed more than 100 cases each. Customers valued the excellent clinical outcomes, clarity, stain resistance, and software workflow that the product offers. During the COVID-19 shutdown, we made a substantial effort to train new providers and installed several new manufacturing lines, which will increase our case capacity moving into the second half of the year. We are pleased by the rebound in case submission rates, which are now exceeding pre-COVID levels. Plans are in place to double the current customer base by the end of the year. Collectively, we anticipate that Spark and Enron will contribute more than 1% of growth to InVista in the second half of 2020 Moving in 2021, we expect both products will make meaningful contributions to investors' growth. We also made substantial progress on the structural cost actions we outlined in Q1, which are targeted to generate permanent savings of more than $100 million on an annualized basis and substantially improve our operating margins. Today we have completed planned headcount reduction action which will secure more than $70 million of the targeted savings. We will continue consolidation and simplification of our footprint and anticipate the remainder of the permanent cost reduction program will be completed by the end of the fourth quarter. We are actively managing the portfolio and in the second quarter we announced our intention to exit the treatment unit business in Brazil and Pelton and Crane in North America. Together we presented approximately 4% of our total 2019 revenue. Last orders were taken in the second quarter and we anticipate being exited from these businesses by the end of the third quarter. These businesses had near break-even EBITDA margins and were declining prior to the COVID-19 outbreak. Finally, Gail Shepherd, a seasoned executive with extensive experience, joined our board of directors, adding a broad set of capabilities and expertise to the board. While the last three months have been challenging, our continuous improvement mindset and process discipline, both hallmarks of the INVISTA business system, have helped us successfully navigate and exceed our commitments while furthering our strategic priorities. I will now turn it to Howard, who will provide further details on the quarter.

Thanks, Amir. Second quarter sales declined 49.2% to $362 million. Sales were adversely impacted 1.6% from discontinued products and 1.7% from foreign currency and were positively impacted 0.3% from acquisitions and 50 basis points from pricing. Core sales decreased approximately 46.2% primarily due to lower demand in most major geographies due to the COVID-19 pandemic. Geographically, sales in developed markets were down approximately 50% with both Western Europe and the US declining at a similar rate. The US improved through the quarter as we saw more favorable conditions within our specialty businesses. Within Western Europe, demand also improved within the quarter but at a slower rate than the U.S. as Southern Europe and the U.K. remained under lockdown for a longer period. Turning to emerging markets, China sales declined at a mid-single-digit rate which is an improvement from the first quarter performance which was down more than 35%. This improvement was led by our orthodontic business which grew at a double-digit rate and our consumables business which grew at a mid-single-digit rate. Emerging markets outside of China were most impacted from the COVID-19 related office shutdowns, with India and the Middle East sales down more than 70%. We finished breakeven on adjusted EBITDA as the cost actions we implemented in the quarter helped to partially mitigate the impact of the decline in volume. Our adjusted gross margin and adjusted operating profit margin also declined during the quarter due to these factors and our second quarter adjusted diluted EPS was negative 10 cents. Given the substantial progress on our permanent cost savings initiatives and the improving environment, we anticipate being able to reduce some of our temporary cost measures yet still achieve a meaningful reduction in operating expenses in Q3 inclusive of incremental public company spending. We spent $60 million on restructuring during the quarter, which was focused on reducing our structural cost and reshaping the portfolio. Approximately $20 million of these charges are related to non-cash items, including asset impairment and inventory adjustments related to the exit of our Pelton and Crane and Bazillion treatment unit businesses. Cash management was our principal focus coming into the quarter, and the team did an excellent job minimizing our cash burn rate and preserving liquidity. Working capital was a positive benefit of $14 million, and in combination with the strong spending controls, we were able to generate positive operating cash flow of $5 million. Our strong cash management in combination with $503 million of net proceeds from the convertible debt issuance helped to improve our cash position to $822 million by the end of Q2. As we move through the second half of the year and into 2021, we believe we are in a good position to consider deleveraging while maintaining flexibility to continue to fund our strategic growth and cost initiatives. Turning now to our two business segments. Our specialty products and technology segment sales were down 46.8%. while core revenue declined 45.6% due to the impact of COVID-19. Of our major businesses, orthodontics and implants have seen the most significant improvement in demand from April to June due in part to treatments that were delayed during the initial phases of the pandemic. During the quarter, our Ormco business introduced our highly successful DQ2 bracket system into the China market. While the pandemic forced the cancellation of a planned live launch, the China team hosted a virtual product introduction attended by more than 2,000 doctors. This is a great example of how our teams have successfully adapted to the new operating environment and furthers Ormco's cadence of new product introductions, which helped improve our new products as a share of revenue to nearly 20% up meaningfully since 2018. Our implant product portfolio is well positioned to help clinicians in the current operating environment where efficiency and same-day restoration is increasingly important due to the more time-consuming infection prevention protocols. The Novel Active Implant System is a leading solution and a pioneer in immediate loading implants that allow patients to have both an implant and a temporary prosthetic placed in the same visit. Clinicians can be even more efficient when using our implant planning software, DTX Implant, and the X-Guide Navigated Surgery Solution, which saves time by providing more consistent implant placement. With these solutions, our customers can offer their patients same-day implant placements, which improves efficiency by reducing the number of office visits. Specialty products and technologies adjusted operating profit margin declined to 6.2%. due to lower revenue, which was only partially offset by our cost reduction efforts. In our equipment and consumables segment, sales decreased 51.4%, while our core sales decreased 46.9%. Core sales in both our equipment and consumables had similar performance in the quarter. Discontinued products adversely impacted sales by 2.6%, and we anticipate discontinued products will have an adverse impact of approximately 8% of segment sales in the second half of 2020. Within consumables, our infection prevention business grew at a double-digit rate in the first half of the year, and we anticipate our investment and capacity will help deliver more than 30% of growth in the second half of the year. We exited the quarter with a record backlog of more than 25 million as the demand for our wipes and disinfecting solutions from medical and dental professionals far exceeded supply. We were also encouraged by the sequential improvement in end user demand from April to June for restorative products in North America and Western Europe. In our equipment business, imaging has been more resilient than expected due in part to maintenance revenue as well as increased demand for our solutions designed to improve connectivity and workflow. This is particularly true in our DTX workflow software, which streamlines image acquisition, diagnostics, treatment planning, and treatment execution in one easy-to-use system, replacing the need to have several imaging and clinical operating systems. Since our commercial launch in the U.S. in March, we have seen early success in bundling imaging products and workflow software together as streamlined solutions. Equipment and consumables adjusted operating profit margin decreased to negative 2.6% due to lower revenue, which were only partially offset by our cost reduction efforts. I'll now turn it back to Amir, who will walk you through some details of the current operating environment.

Thanks, Howard. Similar to last quarter, we're not issuing formal guidance given the uncertainty created by the pandemic. I wanted to provide some additional commentary on current business trends and our expectations for the business as we move into the third quarter. Let me begin with what we see as the most important factors impacting the rate of market growth. And I will then move to our sales trends and outlook. The first factor we are watching closely is the increasing infection rate, especially in the US, and the response of various federal, state, and local governments. Encouragingly, in areas that have seen COVID-19 infections rise in the US, dental practices have not been forced to close for elective procedures, nor have we yet to see significant changes in demand. But this remains an area of concern We are monitoring the velocity of patients returning to the offices as well as the maximum number of patients each office can see given the additional time needed for infection prevention protocols. While it's clear these conditions have caused a reduction in the amount of patient appointments available per day, we have started to see doctors take actions to counteract this impact, including extending their hours and using teledentistry to supplement office visits. Clinicians, especially DSO customers, have also been more focused on maximizing patient procedures per visit, which is a trend that may help counteract revenue recovery versus maximum number of patient visits per day in the near term. Finally, while our results have been steadily improving through Q2 and into Q3, we are monitoring the sustainability of this recovery. We are analyzing our partners' inventory position, pent-up demand as offices reopen, the long-term effect of the economic shock that occurred in the first half, and patients' willingness to return to dental offices. Let me now comment on the current market trends focusing on our largest three regions, North America, Europe, and China. As you mentioned earlier, sales have trended positively through the quarter, which has continued in the month of July. China, approximately 9% of our business, was the best performing region in the second quarter with patient volumes improving to approximately 80% of pre-COVID levels. We are cautiously optimistic about the outlook for China in the third quarter as patient volumes continue to rebound. The demand for implants improves and we benefit from shared gains in our orthodontic business. In North America, our largest region, at 48% of our business, we are experiencing better demand for our product as we move into July. Customers' demand of implants, orthodontics, and traditional consumables have been stronger than anticipated as patients are returning for previously delayed procedures and as we enter a thin orthodontic season. In Western Europe, representing 22% of our business, we continue to experience a wide divergence in performance. We anticipate the best performing areas will continue to be Germany, Austria, France, and Scandinavia as a combination of pent-up demand and easing restrictions should lead to a meaningful improvement from the second quarter. Finally, we believe demand in the rest of the world We remain challenged as nations including India and Brazil have high COVID-19 infection rates or remain under government-ordered lockdowns. In conclusion, we are encouraged by the progression of the global dental market demand during the quarter. Our strategic growth investments, including N1 and SPARC, remain on track, and we have made significant progress to reduce our structural cost position. After the exit of Pelton and Crane and our Brazilian treatment unit businesses, we believe our portfolio is well positioned for the new normal, with more than 85% of revenue from consumables and lower-cost equipment. The progress on our priorities during the quarter was made possible by our employees' teamwork, solidarity, and tireless work ethic. We're committed to our customers' success as we navigate through these uncertain times. These efforts and our improved execution positions us well for better financial performance going forward.

Thanks, Amir. That concludes our formal comments. Stephanie, we're now ready to take questions.

At this time, if you would like to ask a question, please press star, then the number one on your telephone keypad. That's star, then the number one on your telephone keypad to ask a question. Your first question comes from the line of Elizabeth Anderson with Evercore.

Hi, guys. Congrats on a great performance in a tough environment. I just had a couple of questions in terms of the demand trend that you're seeing. If we think about the core consumable business and equipment and consumables How would you say that sort of like you ended the quarter? I'm just trying to sort of get a little bit more detail on that part of the business. And then on the equipment part, how are you seeing practices think about equipment purchases? Are they still sort of interested? Is it something that they're pushing off to 21? Any details you could provide there would be helpful. Thanks.

Yeah. Thank you, Elizabeth. So let's start with the consumable. As you can imagine, at the end of March, we saw The trough, it just, as you can imagine, as offices started closing, the demand for the day-to-day consumables dropped significantly. And our partners also, like us, they start managing their cash flow and working capital, and they start setting whatever need that they have to inventories that they have. So As we mentioned, our overall business in April was as low as over 60%. And I think that was a throw-off of our business as inventories came in line. And as we saw a slow and a steady gradual improvement, starting with China and in other geographies, demand for traditional consumables continued to increase going forward. In the traditional consumables, we normally look at it from three different perspectives. The infection prevention aspect of that business, as we mentioned, grew double-digit and continued to grow both on the dental as well as the medical. More on medical to begin with, but as we progressed through the quarter, we saw more and more increase on the dental side. Endo, driven primarily by Pain that customers were experiencing and dentists needed to provide that support really was not that impacted. Even though a smaller part of our business, it maintained throughout the quarter. But restorative, which is a big part of our traditional consumable, we saw a rebound starting in May and throughout June, which has continued through July. While inventories declined, We saw the demand continue to increase and it was driven by a whole lot of work that did it internally. We put a series of programs with our partners to get dentists back to work and we have seen the outcome of that by demand for a specific set of products increasing throughout the quarter. This recovery varies significantly from geography by geography. But I can tell you that we are optimistic, cautiously optimistic, and really encouraged with what we have seen in the past three to four months.

Thank you. That's helpful. Can I also, you mentioned that you were, you know, obviously your cash balance has, you know, is in a pretty good state and the operating cash flow in the quarter was obviously pretty impressive given the macro environment. As you go through the back half of the year, how do you think about delevering versus potentially some M&A or other capital allocation decisions you could make on that perspective?

Elizabeth, I want to make sure I answer your question on equipment as well because you asked about equipment. So let me answer that and then Howard should answer the question about the capital allocation and M&A. Thank you. We had anticipated that equipment is going to be slower ramp and it's going to take some time for this to take place as we go forward. And what we saw was some of the equipment that was already, the orders were in our hand, Surprisingly, and I can say that we were encouraged that we saw minimum cancellation. We continued to provide those services going forward. Our equipment, specifically on our imaging, we have a large portion of our imaging that is contractual-based services in an ongoing basis, and we saw that to continue. It really did not get impacted as much. Imaging has been resilient. and has continued that trend. As we move through the quarter, we saw it coming back. On the other hand, the larger capital equipment pieces, these are $50,000 and above, we're seeing a slower ramp. And as you mentioned, if people do not have to make those investments, expected to be seeing that ramp throughout the second half and through 2021. One of the things that we did during the quarter was we really reshaped our portfolio. 85% of our portfolio today are consumables that people need every day or equipment that are less than $5,000 that people use it, the limited need for installation and maintenance. The remaining 15% are larger equipment, and we expect that to see a slower recovery as we go forward.

Sure, sure. So let me go ahead and answer. You're right, Elizabeth. We did have a strong free cash flow, really better than anticipated at a decline less than $5 million. And largely this is a function of strong working capital management and cost actions that we took really to preserve liquidity. As I mentioned earlier, cash management was one of the focal points for us coming into the quarter. and then those cost actions, you know, more than $100 million that Amir had talked about in the quarter also exceeded the plan and helped mitigate some of the impact on the revenue decline. As it relates to leveraging, I think near term our priorities continue to be centered around executing on these cost actions. We're about 70% of the way there and we'll finish the remaining portion here in the second half of the year and so we'll see that read out for the full year next year. and then initially we're focused on reducing leverage driven by those cost actions and we'll look as the recovery continues on our underlying business and then more intermediate and long-term, M&A is still a major part of our strategy and we'll certainly look to go ahead and take advantage of any dislocations coming out of this current environment as well.

Okay, great. Thank you, Howard.

Yep.

Your next question comes from the line of Jeff Johnson with Baird.

Hey, Jeff. Hey, good afternoon, guys. How are you? I wanted to ask a question, I guess, first starting on just gating throughout the quarter, and you both gave a lot of detail. I appreciate that. But for a simple guy like me, is it as simple to think about kind of the numbers in April, May, June, kind of down 65, 45, 25? Is that... and Amir, I know we heard, you know, say July momentum is continuing. Do you think we continue to improve off that June exit rate? You know, a lot of us kind of a little concerned that we might hit a structural headwind, and you talked about it for some of the operatory turnover reasons and what have you. But should we continue to see improvement at this point, you think, in kind of July, August, September time period? Just any high-level thoughts would be helpful.

Yeah, thanks, Jeff. You're right, we were minus 60%, a little bit more than minus 60% down in April, and we saw gradual improvement, geography by geography, product category by product category through the month of May, and then it got better and better in June, and we were watching very carefully to see if this is purely driven by pent-up demand, and we continue to watch that very carefully, but We have seen gradual improvement, May better than April, June better than May, and so far what we have seen in July, we have seen better performance in July than June. Our visibility is fairly limited, and that's the reason we have been cautious not to provide expectations, not to set expectations, provide a forecast until we have better visibility going forward. What we have seen today are traditional consumer beginning to recover in June and continue to move up. As we mentioned, orthodontic as well as the implant piece has improved a lot better than we expected. And we are cautiously optimistic on what we're seeing both in July and as far as we can see in Q3. We're watching a few things very carefully. We're watching the pent-up demand versus recurring. One-time buy versus a continuation. We're watching the inventory disallocation. And we have seen inventories have gone down. We want to make sure that this is not a one-time buy to rebuild inventories. Our inventories have been down, I would say, since 2017 by over 50%. So I've never seen inventories to be at that level down. And last but not least, we are watching very carefully the number of patients The number of appointments and since over 50% of our business is direct, we have a really good feel for what is taking place in that area. Sum it all up. We are cautiously optimistic and I have to say that we have been surprised and we are hoping that this trend to continue, we're watching every aspect of this and not backing off neither in our short term nor on our long term priorities.

Understood. Thank you. And maybe just on Spark, it seems like to me now you're expecting somewhere in the neighborhood of $20 to $25 million for the year. You know, I'd love to hear kind of how that compares to maybe your pre-COVID expectations. I think that's about in line. So I'm a little surprised by that in a good way. But maybe kind of how you're thinking about building off that $20 to $25 million base in 2020 and maybe implications going into 2021.

Yeah, thank you, Jeff. You're absolutely correct. We started the year, January, February, it was really strong and we had set expectation that this should be about 50 basis point of growth for us compared to the 2019. That $15 to $20 million was what we had communicated. Obviously, we have an internal plan that we should do better than that internal plan. We are really pleased with what we are seeing, both from doctors and patients, this clarity, stain resistance. Thank you very much. We're confident that we can deliver at 100 basis point of a growth both from a SPARC and N1. And the reason for it is demand is there. Number of cases are coming. Right now we're getting more cases than we did back in January. And more customers have been trained and they are in the queue. We think we can double the size of our customer base by end of the year. So the numbers that you coded, it's in the ballpark. And our goal is to get to over $100 million product line Over the next few years, we're building the capacity, we're building the infrastructure to accomplish that objective. Thank you.

Your next question is from the line of Tycho Peterson with J.P. Morgan.

Hi. This is Eleni. I'm for Tycho. Thanks for taking your question. I wanted to start with the infection prevention business. You noted that it grew double digits in the first half of the year. And I recall in the first quarter, you said more than 35%. So just wondering if it decelerated in Turkey or how it's been trending, and then whether you could see upside to the 200 basis points tailwind in the back half of the year, given the added capacity.

Yes, absolutely. So last year, Infection prevention business was over $150 million. And we make products like disinfectant liquids and wipes. And they generally kill most viruses. We saw a substantial growth in the first half, a double-digit growth. And right now, as we started Q3, we have over $25 million backlog. We're adding capacity. We think another 25% capacity would be online in Q3. One other important factor in here is the mix of this business. About 40% is medical, 60% is dental. So we saw a ramp at the beginning of a quarter, a lot of medical, and as we got to the halfway through the quarter, end of the quarter, and now dental is ramping up. So to answer your question, the 200 basis points, is something that we feel very comfortable for second half. We think that this business could be up to about $275 million in the next year or so because the demand is there, capacity is there, and product, as we mentioned, has got really good traction and the new EPA approval gives us additional confidence that we can continue to expand it. And it's making a difference. It's making a difference in office openings, making customers, patients, dentists safer, safer environment to operate.

Great, that's very helpful. And then one question on the velocity of patients returning to offices. You mentioned gradual improvement through the quarter, but thinking in light of the increasing infection rate in the U.S., whether there has been a change in pace in July.

Yeah, really good question. On one hand, we've watched every patient The statistics, you watch what ADA shares and various services, various surveys that they're taking place. We are doing that in an ongoing basis. The internal data that we have are not showing any significant negative impact today. But we are watching that very closely on the regional level to make sure that we really understand what is taking place at the regional level. Outside China, you know, we experienced a similar dynamic as U.S. As you recall, there were some geographies that they put it back, new controls in place. And these are the areas that we are watching carefully. These are areas of uncertainty that we are watching and managing moving forward. But thankfully, we haven't seen anything that indicates the rise in the number of COVID cases correlated with what we are seeing from a demand perspective.

Great. Thank you. Our next question comes from the line of John Block with Siepel.

Thanks, guys. Good afternoon. Amir, you mentioned pent-up demand. You know, what are your thoughts on the industry's backlog? And, you know, I would think that backlog aided results in the second quarter. I'm guessing it's likely going to aid results in the third quarter. But what do you think about the rate of improvement for the market? Is that sustainable? into the fourth quarter if the backlog, tailwind call it, is depleted at that point. We sort of love your thoughts there, and then I've just got to follow up.

Yeah, yeah, of course. Thank you. You know, it's really difficult to put a number on it. We think pent-up demand definitely has played a role. On doctor's side, many offices close abruptly without restocking. We know that, as I mentioned earlier, Over 50% of our business is direct. We have a really good feel for what is taking place. We have a good feel for what's going on on the inventory side of our partners. And so that was the first thing we saw on the doctor's side. On the customer side, what we have seen, a lot of these proved in March, April, and May, and they all need implants. Orthos, to see patient, they needed to see patient in person. They're using teledentistry to compensate for it, but we have been really positively encouraged and surprised by the traditional bracket-on-wire, the ramp that we are seeing. We have talked to our own customers, and they're telling us that the rate that they're seeing is what they expect moving forward. Restoration and other procedures were put off temporarily, It seems like it's ramping back up. We're monitoring our expectation for the third quarter for a measured improvement from our exit rate in June. And so far, what we have seen in July has been really encouraging, cautiously optimistic. I think pent-up demand plays a role here in June and July, but hard to put a number on it. Repeat buys. as well as continuation of number of patients is something that would give us a feel in order to be able to answer that question, is it sustainable through Q3 and Q4?

I think, John, this is Howard, just to maybe jump in here as well. I think that a lot of the actions around cost that we've taken really make us feel comfortable regardless of the environment going forward that will be positioned well. And so that's something else that we feel good about.

Got it. Thanks, Howard. Helpful color as well, Amir. I'll shift gears. I think maybe with the second question, you guys have a sizable position within DSOs. You know, any high-level color on how those entities are growing versus the more fragmented mom-and-pops? And could your positioning within the DSOs be a long-term benefit if we see accelerated consolidation coming out of COVID-19? Thanks for your time, guys.

Yeah. So as you mentioned before, it's a really important part of our move-forward plan Thank you very much. with the DSOs during the quarter, and in June, Nobel Revenue with the DSOs were double-digit. It puts us in a really position of a strand for DSOs to look to keep more procedures in-house. One of the things that we have seen, we watched very carefully the top 10 DSOs in the United States, the recovery ramp by geography, and as you mentioned, that encouraging sign that we are seeing is something that is repeated by them as well. As far as further consolidation, I really cannot comment on it. That's something that DSOs are watching very carefully. But what we have seen at some point beginning of March, they really put all of their addition, either the NOVA or acquisition, they put it on hold. But what we are hearing in June, in July, they are ramping that back up again. They are asking us, they're working with us and our partner to start considering some of the de novas that were put on hold at the beginning of the quarter, try to wrap that back up. Thanks, guys.

Your next question comes from the line of John Crager with William Blair.

Thanks very much. Amir, I wanted to come back to the topic of inventories. It sounds like you're watching this very closely in the channel. What is your sense about where you stand? Have they stabilized, likely to go back up, or could we see some more downward pressure as some of your partners also try to manage their cash flow?

Yes, yes, very good. Thanks, John. Inventory position have been in the best place since we have been tracking it. But inventory is one aspect of it. The other part of that is share and sell-out data. We have a really good field for a key large partners. We're looking at the share. We're looking at the inventory. We look at our position and sell through. As I mentioned, inventories has declined over 50% from three years ago. Year to date, that inventory correction impact on our equipment and consumable sales is over 7%. So 7% additional growth because of that inventory correction. If I look at what impacted us most is capacity in infection prevention, which we are working through. We have a $25 million backlog that we can really work through that and help partners, help customers get back to work. But getting to that question of inventories, I think From our point of view, we expect that to have leveled off. We are seeing this match of a selling and sell-out. And what we saw in July, orders that are coming through in July, is a good indication that in some product categories, in some specific partners, that inventory has reached a level, a point that now the orders are coming through in order to respond to the demand out there. I want to put some numbers around that 50% down. That's over $95 million since 2017. That's very helpful.

That's great. Thanks. And one follow-up, and this relates to Spark and N1. As you get more experience with these new products, how comfortable are you that the sales generation will be incremental? As opposed to, you know, migration with some of your existing customers from older brands, be it Ormco or Nobel.

Yeah, so let me answer this Spark first and I'll come back to N1. You know, we are keeping a very close eye on our current customer. As we have mentioned before, our target, initial target for Spark is current Ormco customers. The ramp that we have seen, you know, bracket and wire. as well as our clear aligner match. So we are seeing the same sort of ramp in our bracket and wire coming out of trough and it tells us and through the survey with our current customer we're confident that there is no switching taking place. Both are improving. Aligner is obviously improving a lot faster as we go forward. Our N1 The assessment is that it's going to be some level of capitalization when we get to that ramp. But our goal is to get incremental business that far exceed that capitalization in 2021 and 2022. We think it's going to be a meaningful impact in our growth and our in-plant growth, specifically at Nobel in 2021 and 2022.

Very helpful. Thank you.

Again, if you would like to ask a question, please press star, the number one on your telephone keypad. Your next question is from Nathan Rich with Goldman Sachs.

Hi, Nate. Hi. Good afternoon. Hi, John. Good afternoon, Amir and Howard. If I could start with looking out to kind of 2021, Amir, with the comments you made around, you know, new products kind of making a meaningful contribution. It seems obviously like the uptake of Spark is going pretty well. For M1, what type of contribution should we expect next year and what would that assume with respect to the U.S. approval and launch? Do you feel like just kind of based on the traction that you're seeing kind of early, in Europe, that that could be a kind of meaningful contributor to the top line next year, regardless of kind of what the ramp up in the U.S. looks like.

Yeah, very good. Thanks, Nate. So N1 is approved in Europe. We have the C market, and we have started registering that in different geographies in Europe. We think that that would be, as we mentioned, N1 and Spark combination, about 100 base suspended growth for the second half of this year. We are in the process of going through regulatory procedures both from our skin, the surface, as well as N1 in the U.S. I really cannot comment when that would be completed. We were pleasantly surprised how quickly it got approved in Europe and we are hoping that that would get approved and the impact of that in U.S. would be really meaningful later part of 2021 and 2022. But N1 in the rest of the world, I think it would be a significant growth factor for us for the coming years. We expect that to be an important part of Nobel growth trajectory combination of what we have done with the sales force, past new product. I think Nobel, we're really encouraged with what we are seeing with Nobel, North America, Europe, as well as China. And I think N1 would be another element in here to get this business back on the growth trajectory.

Great. And then, Howard, if I could ask a follow-up on margins. You mentioned, you know, the company being in a good position kind of regardless of how fast kind of revenue comes back. Could you maybe, you know, as you start to see revenues improve, how we should think about margin progression at the end of the year? And then kind of bigger picture as we look out, you know, it seems like you're on track to achieve the $100 million of permanent cost savings. You know, what would you kind of see as sort of the level of margins that you would be targeting on a more normalized type of revenue run rate?

So, Nate, I'm not 100% I heard the entire question just because the quality of the sound, but I think the first question you asked was with regards to just overall margins and the cost actions that we've taken. We do feel really good about the cost actions, both the temporary that exceeded $100 million, and we plan on easing off of that as we go forward here, some of these furloughs and the like, given that the underlying business is improving. But with regards to the structural cost changes, again, in excess of $100 million, we feel like we're well on our way through that, about 70%. And we'll finish that here in the second half. The portion that we've completed to date is largely around headcount. As we move forward, it will be around footprint, back office as well. and so we will be able to show and demonstrate $100 million of savings starting in the first quarter of 2021. And then as it relates to near term, maybe the decrementals here, we did have better than 30% decrementals here in Q2. As we do ease off of some of these temporary actions, as well as we continue to invest in some of these key initiatives that Amir has outlined, largely around the SPARC as well as N1, infection prevention and the like, DTX. You know, we think that the decrementals going into Q3 and Q4 will likely be a little bit less than the 30%. It will be probably closer in the 35% to 40% range.

Great. Thank you.

Yep.

I'd now like to turn the conference back over to management.

Thanks, Stephanie. Thanks, everybody. I appreciate the time today, and we'll be around for the rest of the week to answer questions. Thank you. Thank you very much.

Thank you. This concludes today's conference call. You may now disconnect.