Welcome to the Dentsply Sirona First Quarter 2022 Results Conference Call. All participants will be in listen only mode. Should you need assistance, please signal conference specialist by pressing the star key followed by zero. After today's presentation, there will be an opportunity to ask questions. To ask a question, you may press Star then one on your telephone keypad. To withdraw your question, please press Star then two. Please note this event is being recorded. I would now like to turn the conference over to Andrea Daley, Vice President of Investor Relations. Please go ahead.
Thank you, Anthony, and good morning, everyone. Welcome to our first quarter earnings call. Joining me for today's call is John Groetelaars, our Chief Executive Officer, and Barbara Bodem, our CFO. I'd like to remind you that an earnings call, press release and slide presentation related to the call are available in the investors section of our website at www.dentsplysirona.com. Before we begin, please take a moment to read the forward-looking statements in our earnings press release. During today's call, we may make certain predictive statements that reflect our current views about future performance and financial results. We base these statements on certain assumptions and expectations on future events that are subject to risks and uncertainties. Our most recently filed Form 10-K and any updating information in subsequent SEC filings lists some of the most important risk factors that could cause actual results to differ from our predictions.
In today's conference call, our remarks will be based on non-GAAP financial results. We believe that non-GAAP financial measures provide investors with useful supplemental information about financial performance of our business, enable the comparison of financial results between periods where certain items may vary independently of business performance, and allow for greater transparency with respect to key metrics used by management in operating our business. Please refer to our press release for the reconciliation between GAAP and non-GAAP results. With that, I will now turn the call over to John.
Thank you, Andrea, and thank you all for joining us this morning for the Q1 earnings call. Today, we will cover four items. I'll start with an overview of the first quarter. Barb will cover the quarter's preliminary financial results and our updated 2022 outlook, and then I will finish by providing a strategic operating update. Before we begin, let me start with why I'm excited to be here and why I took the role as interim CEO. I joined Dentsply Sirona's board because of the value I believe the company can create for its shareholders over the near, medium, and long term. First, the company plays in an attractive category with real growth opportunities. Macro trends are supportive, and those who can innovate, leverage global scale and execute judiciously will emerge as long-term winners. Second, Dentsply Sirona has a strong foundation.
The company's plan has allowed it to focus its innovation efforts, strengthen its demand generation capabilities, and simplify the operating structure. Third, we are approaching the interim period with a sense of urgency and a focus on execution. We are not coming from a standing start. Barb and I have been working together for many years and we have vast public company experience where we have grown the business while focusing on costs and pursuing disciplined capital allocation strategies. With that opening, Q1 was a challenging quarter which led to disappointing results. Barb will share more with you about how the key drivers of underperformance impacted the quarter's financial results, including the weaker sales performance in the U.S., global supply chain challenges, and unfavorable foreign exchange rates. While we have challenges, we also have areas of the business performing quite well.
Our European region delivered organic growth of 7% and our strategic growth categories, including the implants and SureSmile business, grew high single digits and double digits, respectively. Additionally, this quarter we were pleased with the double-digit sequential growth of our total clear aligner business. We have updated the 2022 outlook, which further considers the significant macroeconomic headwinds that are unfolding, including impacts from prolonged supply chain challenges, COVID-related restrictions in China, Russia, Ukraine-related disruptions, and unfavorable foreign exchange rates. We are committed to returning cash to shareholders in Q1, and we announced a double-digit dividend increase and completed a $150 million ASR program. Lastly, an important point to highlight is that innovation is vital to our growth, and we continue to invest for future growth despite the challenging macroeconomic environment. Moving now to slide six.
As I mentioned, Q1 was a challenging quarter with revenue of $965 million, which represents a decline of 1.4% on an organic basis versus the prior year. Our operating margin was 15.9%. The rate was impacted by lower manufacturing volumes and inflationary pressures, while SG&A and R&D investments were maintained to support innovation and the expected volume recovery.
Before I turn the call over to Barb to provide more details on our financial performance, I would like to address the Form 12b-25 we filed with the SEC this morning. As a result of an ongoing investigation by the Audit and Finance Committee of the Board of Directors, Dentsply Sirona has not been able to finalize its financial statements or its assessment of the impact of the investigation on its financial statements for the three months ending March 31st, 2022, and we are therefore unable to file the Form 10-Q on a timely basis. For additional information, please refer to our SEC filings. Needless to say, we're eager for the audit committee to complete its work and for the company to be able to file the 10-Q as expeditiously as possible. We will provide updates as there is more information to share.
With that, I'll turn the call over to Barb.
Thank you, John. Good morning, everyone, and thank you for joining us. Today, I will cover first quarter preliminary results and then provide an update on our 2022 outlook. As a reminder, our remarks today will be based on non-GAAP financial results, unless otherwise noted. Please refer to the reconciliation tables at the back of the press release and slides, both of which are posted in the investor section of our website. Before I begin, I would like to note how excited I am to join the company in an interim capacity. I've worked with John over the past three years as a public company CFO, and I am now looking forward to working with the rest of the team at Dentsply Sirona as we execute against the many opportunities that are ahead of us.
In the first quarter, the business delivered revenue of $965 million, in line with the preliminary results we announced on April 19th. In comparison to prior year, organic sales declined by 1.4% and reported sales declined by 6.1%. The decline versus last year was driven by foreign exchange, U.S. regional performance, increasing challenges in our global supply chain, and emerging COVID-related softness in China. Regions outside of the U.S. posted healthy growth in the period, along with the global implants SureSmile businesses. While we continued to experience supply chain constraints, most notably in imaging, the demand for these products remains strong, as evidenced by our high order backlog.
Also, as a reminder, Q1 2021 was a period where the dental industry was continuing to replenish in certain categories from COVID, particularly in consumables, providing a difficult year-over-year comparison. Similarly, our Byte business was up against tough year-over-year comps. That said, we are pleased with the sequential growth that Byte posted in the quarter. To highlight underlying momentum, Byte unique visitor traffic hit a record high in March. Gross profit was $547 million or 56.7% of sales. Gross margin rate declined 280 basis points year-over-year due to foreign exchange, unfavorable mix and volumes, and inflationary pressure on materials and distribution costs. These headwinds were partially offset by benefits from recently launched products and price increases. SG&A expenses were $349 million or 36.2% of sales.
On an absolute basis, SG&A decreased by 1%. R&D spend was $45 million, an increase of 11.1% year-over-year, which reflects our continued commitment and focus on accelerating our innovation pipeline. As a reminder, last quarter, we reclassified certain expenses from SG&A and to R&D. This had no impact on operating margin, and the prior year period adjustment was $3 million. Operating income was $153 million, down 30% versus last year. This was due to unfavorable foreign exchange rates, U.S. performance, supply chain pressures, and increased investments in R&D. As a result, operating margin was 15.9%. We attribute approximately 60% of the year-over-year decline to the transitory macro challenges of foreign exchange, inflationary pressures, and the impact of COVID in China.
As a result, adjusted earnings per share was $0.52 versus $0.72 in the prior year quarter. Operating cash flow was $93 million, a 90% increase year over year, mostly to fluctuations in working capital. The company has a strong balance sheet and finished the quarter with $374 million in cash on hand. During the quarter, we returned $174 million to shareholders in the form of increased dividends and $150 million of share repurchases. Now turning to the segment performance in the quarter. Technologies and equipment organic sales declined 0.5%, and consumables decreased 2.7%. The T&E segment organic sales decline was driven by CAD/CAM, while implants posted strong growth in the quarter with contributions from all regions.
Our CAD/CAM business declined versus last year due to lower sales in the U.S., while it grew outside of the U.S. As shared last quarter, in Q1, we executed on our plan for Primemill to focus available supply on needed spare parts. Ortho slightly decreased year-over-year as the anticipated decline in Byte, given the tough comps year-over-year offset growth in SureSmile. As I mentioned previously, we are pleased with the momentum we are seeing in the clear aligners sequentially. The E&I business posted growth despite supply chain constraints, which primarily continued to impact sales of 3D imaging equipment. The consumables segment organic sales decline was driven by lower sales in the U.S., patient volume softness attributed to COVID in certain markets, most notably in China, and supply chain constraints.
Endo, a strategic growth area, posted growth in the quarter across all regions, and we are pleased with the progress from recent product launches. The sales decline was partly offset by benefit from price increases taken in the fourth quarter of 2021. Now, turning to financial performance by region during the first quarter. U.S. sales were $299 million. Organic sales declined by 13.5% due to the lower sales in CAD/CAM and certain consumables, supply chain constraints, and tough year-over-year comps, primarily in consumables and Byte. Dealer sales were lower due to higher CAD/CAM inventory levels at the start of the quarter. Implants and Endo both posted growth in the region.
European sales were $416 million, with organic growth of 7% attributed to robust performance in the T&E segment, with strategic growth areas including CAD/CAM, ortho, and implants all posting double-digit growth. Rest of the world sales were $250 million, representing organic growth of 1.4%, with growth in both segments. Resto, CAD/CAM, and implants experienced healthy growth in the period. Rest of the world growth was unfavorably impacted by increased government restrictions associated with COVID variants, primarily in China, as well as market disruptions in Australia as a result of flooding. Now, let me provide you an update on the financial expectation we have for the 2022 full year.
Given the significance of the headwinds we experienced in Q1 and what we can reasonably estimate for the remainder of the year, we are updating our 2022 outlook. We now expect fiscal 2022 organic sales growth to be in the 2%-3% range. This equates to a net sales range of $4.1 billion-$4.2 billion. The dental market remains attractive and resilient despite pandemic variant outbreaks, which continue to challenge certain markets. Additionally, our robust R&D platform and pipeline are enhancing our commercial solutions to meet the most pressing needs of our end customers and channel partners. As we navigate a difficult external environment, we continue to focus on opportunities to sustain and drive expansion of margin.
While we expect to see some period-to-period fluctuations, we estimate that for the full year, operating margin rate will be greater than 17%. Over the last few years, this organization has delivered considerable margin expansion through simplification and portfolio optimization. We believe those initiatives will serve as a solid foundation, enabling us to better navigate the acute macro challenges. Our expected 2022 adjusted earnings per share is now in the range of $2.35-$2.55. I would like to now touch upon the five key drivers impacting our revised outlook. They are listed on slide 13 in the earnings presentation. First, we continue to see governmental restrictions in response to COVID variant outbreaks in China.
The impact from these restrictions started mid Q1 and has persisted through April, and we are now estimating a prolonged impact further into the year. For reference, in 2021, China represented approximately 5% of the company's total sales, and therefore the continuation of major disruption in the market is a notable headwind. Additionally, we are closely monitoring this disruption's potential impact on our global supply chain. Our commercial and supply chain teams are working diligently to effectively navigate and minimize the impact to our business and customers. Another regional challenge is the disruption from the conflict between Russia and Ukraine, which was not considered in our original outlook. Our revised outlook has been risk-adjusted, removing all sales to Ukraine for the remainder of the year and reducing sales to Russia in compliance with known sanctions.
The risk adjustment represents a modest headwind for the total company. On the supply chain, material shortages and inflationary pressures also represent significant headwinds, which we now expect to continue through the rest of the year. The component shortages impacting several parts of our business, most notably 3D imaging, have been significant. However, we are encouraged by the continuation of strong customer end customer demand globally. Lastly, we have revised our foreign exchange assumptions based on the weakening euro, which represents a larger headwind for us versus the original outlook. Our updated assumption for the euro to U.S. dollar exchange rate for the full year is 1.08, which is lower than our previous assumption of 1.14 and the fiscal year 2021 average of 1.19.
We view these five drivers as significant but transitory headwinds, and our team is working diligently to navigate and minimize the impact of these challenges. Now, let me provide some color on the quarterly cadence for the rest of the year. First, we are projecting sequential growth over the remaining periods of the year. In Q2, we anticipate sequential growth will come from normalizing dealer inventory levels as well as benefits from recent product launches and price increases. These improvements will be partially offset with softer commercial volumes in China and Ukraine. The back half of the year will further benefit from the momentum we are seeing in strategic parts of the business and the opportunities we can capitalize on through strong execution, including new product launches.
We continue to project that our clear aligners business will grow sequentially, and Byte will be a contributor to 2022 growth. As a reminder, in Q2, Byte will continue to face tough comps to the strong pandemic-driven performance in the first half of 2021. Nonetheless, it is highly additive to our overall clear aligner strategy, and we are seeing the merits of the transaction come through. In closing, we are optimistic that despite a challenging environment, the renewed focus we are now applying will benefit the trajectory of the company. Over the long term, we believe that improved execution, combined with the resilience of the dental market, will allow us to continue to expand revenue and earnings. The strength of our EBITDA generation enables a very competitive cash flow yield to our shareholders.
We remain committed to returning at least 50% of our free cash flow to our shareholders through a combination of dividends and share repurchases. With that, I will now turn the call back to John.
Thank you, Barb. Moving on, I wanted to provide some perspective on our strategy and priorities moving forward. First, we have a robust portfolio of leading products and solutions in a strong end market that gives us confidence in our future. The long-term strategy of the company is compelling with a healthy innovation pipeline that is positioned to deliver growth. I believe in it, and so does our board. This strategy is one of the key aspects that attracted me to this organization as I was considering joining the board. The Dentsply Sirona team has continued to sharpen the strategy over time while improving innovation capabilities, which, combined with a renewed focus on execution, will create powerful momentum going forward. I would like to highlight that the expectations we have for the business don't change.
We expect to build on our capabilities to deliver over the long term, specifically reliable 4%-5% top-line growth, continuous improvement in margins, and ultimately double-digit earnings growth once we cycle past the acute challenges we are currently facing. Our strategy of delivering superior integrated workflows in critical procedures will allow this company to become the vital digital partner to the dentist. I'm not new to digital transformation. We were on a similar journey at Hill-Rom, and I plan to draw upon those experiences as I work closely with the team here to accelerate the transformation with relentless focus on driving improved outcomes for our customers. Barb and I are a proven team with a demonstrated track record of driving long-term shareholder value while executing with rigor across a broad portfolio in a very challenging macro environment that we have all been witnessing in the past few years.
The challenges we see at Dentsply Sirona have a high degree of correlation to challenges that we have both successfully navigated in the past. Importantly, we are both committed to delivering sequential financial improvement on the preliminary Q1 results as we take the reins of leadership at the company. While we believe in the company strategy, we also believe there is value in conducting an evaluation of our operational performance to ensure that we are laser-focused on our key priorities moving forward. Turning now to slide 16. We have a robust 2022 launch schedule already underway, as evidenced by the launch event we held on May 4 to bring DS Core to market. DS Core will deliver end-to-end digital workflow from diagnosis to treatment, and it represents an important first step on a long journey of innovation in the dental market.
Reiterating my earlier comments, we are committed to innovation, and we will continue to deliver it. This company has a rich history of innovating, and we intend to be the leader on the forefront of the digital transformation in the dental industry. An important area to enable accelerating our digital portfolio is in software development. This organization has invested resources over the last 18 months to overhaul the entire approach in this area, shifting from developing individual software for a long list of different devices and treatment plans to building a single platform that will support all of our devices and an extensive treatment planning portfolio. Primeprint is now launching in our select markets on a limited basis.
We are excited about Primeprint as it offers complete integration with the CEREC system and will allow the dentist to produce things like night guards, surgical guides, and full-scale models quickly and inexpensively. This launch will also come with a complete service package through DS Core, including DS Core Create, which is a comprehensive design workflow to help save valuable dentist time. Our innovation is focused on bringing leading solutions to our four key procedural areas in dentistry, aligners, implants, resto, and endo. Over the last year, the Dentsply Sirona team has been able to bring innovation to each of these areas, and we will continue that momentum with focus on what these solutions mean to our strategy to deliver superior integrated workflows. Integrated workflows that start with diagnostic excellence, easy-to-use treatment planning, and essential consumables.
Through integrated workflows, we can widen our share of wallet, become the essential partner, and provide significant value to our customers. Let me highlight a few closing comments. We are encouraged by the good momentum we have in strategic growth areas of the business like implants and clear aligners. We are also very pleased with the performance in our international markets in such a challenging environment as further evidence that our strategy is working. Our focus going forward will be on driving disciplined and robust execution to capitalize on the momentum. As we exit this quarter, we remain confident that the portfolio is well positioned in an attractive market to drive sustainable growth over the long term, and that will continue to be our top priority.
In my first few weeks, I have seen a very engaged, mission-driven and passionate organization that is ready to embrace a clear set of priorities to address our supply chain challenges, U.S. performance, and deliver strong new product growth. This is a renewed sense of confidence that we will build upon as we move through the remainder of the year. The revised 2022 outlook now reflects known macro challenges. We are confident in the strength of the underlying business, and we will move expeditiously to complete our diagnostic analysis so that we can accelerate progress against a compelling strategy with a focus on execution. With this, we are optimistic about the sequential improvement we expect to see throughout 2022. The search process is underway for the permanent CEO and CFO.
The board is focused on finding candidates with a track record of world-class execution and operational expertise who can best position Dentsply Sirona as the innovation leader with the most extensive global footprint in the dental market. In the meantime, Barbara and I are here to serve the organization. We will provide leadership stability and bring our diverse experiences to the table in partnership with the high caliber Dentsply Sirona team. We will not be shy in taking swift action where we see improvement opportunities, and we intend to use the interim period to strengthen the base and do the hard work required to drive value creation for our shareholders. Finally, we look ahead with optimism. The Dentsply Sirona team is strong and resilient. I am confident that together we can overcome near term challenges to deliver improvements and drive sustainable results.
With that, let me now open up the call for questions.
We will now begin the question and answer session. To ask a question, you may press star then one on your telephone keypad. If you're using a speakerphone, please pick up your handset before pressing the keys. To withdraw your question, please press star then two. Please limit yourself to one question and one follow-up. At this time, we'll pause momentarily to assemble our roster. Our first question will come from Elizabeth Anderson with Evercore. You may now go ahead.
Hi, guys. Thanks so much for your question. My first question is regarding the audit investigation. Is that only related to 1Q results? I noticed a couple of comments on your slides about inventory management, and is that the primary focus of the investigation? Thanks.
Yeah. Hey, Elizabeth, it's John. Thanks for the question. I think the language in the disclosure with the SEC is probably the best reference point, but it is specifically related to activity that took place in Q3 and Q4 of last year, 2021. Since the investigation is still open, we are unable to file our Q1 results.
Got it.
To your point about the investigation's focus, it is around the use of incentives with dealers and the implication of those incentives, as it relates to, the accounting of that, as well as whether those incentives were directed by executives of the company, both former executives as well as potentially, executives that are still here, to hit compensation targets.
Got it. Okay, that's very helpful. My second question is regarding the guidance. I appreciate the guidance that you gave, and thank you for sort of taking us through the different headwinds and how you're incorporating them into the guidance. My question there, in terms of the share repurchases, the $150 million that was done in the second quarter, we should think of that as incremental to the outlook that you put into the share count. 'Cause at 218, I think, for the new share count, that seems potentially a little bit more conservative than the $150 million might imply. I just wanted to make sure I wasn't missing something on that front.
Hi, Elizabeth, it's Barb.
Hi.
As we talked about the year, you know, we did indicate that we are going to be returning about 50% of our free cash flow back in the form of the increased dividends as well as share repurchases. For the year, I think the $150 is somewhat in line with where we thought the full year was going to be. In fact, if you look at our free cash flow, there's probably room for additional share repurchases in the future quarters as well.
Okay. That's very helpful. Thanks so much.
Our next question will come from Kevin Caliendo with UBS. You may now go ahead.
Hi. Thanks for taking my question. It's sort of following up on Elizabeth's question, but and I do appreciate the guidance bridge. It's really, really helpful and very transparent. If there is any sort of inventory write-down or anything that needs to happen, has that been contemplated in any way, shape, or form in this guidance? Are you comfortable that there's nothing that would prompt another sort of re-rating down? Is there any comfort that you can work through whatever inventory might be in the channel in an efficient manner so that it wouldn't be another sort of write-off, write-down?
Hi, Kevin, it's Barb. Let me do my best to answer your question, and thank you for it. First of all, if you looked at our 10-K for 2021, we flagged in the 10-K at the time that we estimated we had about $50 million of excess CAD/CAM inventory at the end of the year. As we talked about in the prepared remarks and in the presentation, that burn of inventory has shown up in our Q1 U.S. results. U.S. was down 13.5% in the first quarter. The majority of that decline was related to burning of inventory, primarily CAD/CAM, but some consumable as well, at the dealers.
With regards to our own balance sheet and the inventory we have on our own balance sheet, there's no question about, you know, the accounting of the inventory we have on our own balance sheet. It's really about how much inventory did we put into our dealers' hands at the end of last year, and how long is that going to take for us to burn it off during the course of 2022. Does that help?
That's actually really, really helpful. Thank you. Can I ask a quick follow-up?
Sure.
Just in terms of cadence of how we should think about the rest of the year and progressing. I know originally there was a target of exiting the year with a higher margin than the average for the year. Do you still see? You know, while obviously the operating margin's lower now and understandably so, is there a particular cadence we should think about in terms of margin progression, or earnings progression for the year?
As we think about operating margin, you know, it does fluctuate a little bit from quarter to quarter. But generally, the trajectory of ending the year in a stronger place is what you should be thinking about. As we talked about in the prepared remarks, we are expecting sequential improvement over the next few quarters. But as you think about where we're gonna exit for the year, I know that we had talked about previously, you know, exiting 2022 at a 22% operating margin. We do not believe that is a realistic expectation given the macro headwinds that we're looking at. We do think that exiting the year probably closer to 20% is likely.
Hopefully, that helps you with the magnitude of the change as well as the progression throughout the course of the year.
That's really, really helpful. Thank you so much.
Our next question will come from Jason Bednar with Piper Sandler. You may now go ahead.
Hey, good morning. Thanks for taking the questions. Maybe if I could start on the revenue guide, forgive me if I missed all of the bridge here. You know, it's coming down by a couple points versus where we were previously and, you know, back on the 4Q call. You know, Russia and Ukraine completely coming out of the revenue guide, that's a couple points on its own. And you're updating for the 1Q shortfall and the lockdowns in China. I guess maybe just help us bridge from where we were before to where we are now. Is it stronger pricing or stronger pricing outlook, or something else that's helping limit from coming even lower than where we were before?
Jason, it's a great question. Let me try to frame, you know, what we're seeing from a revenue standpoint. There are three sort of elements that are bringing down our volume, our sales forecast for the full year, beyond FX, okay? FX is a major headwind, but if we talk about organic sales, the three key drivers are really China. You know, we've seen starting in the latter part of March, and we've seen it continue through April, that the shutdown in China related to COVID is impacting our sales. What we've included in our outlook for the full year is that that will continue on throughout the course of the year. That's the biggest volume change assumption that we've made in our forecast.
The second piece. I just wanna make sure that we're clear on the impact of Ukraine and on Russia. For Ukraine, we have pulled out sales for the remainder of the year, but our Ukraine sales are relatively small. For Russia, all we've pulled out are those sales that would not be in compliance with the sanctions as we understand them. We have pulled out those sales, but again, it's a small piece of the overall sales. Russia and Ukraine together last year, I think, was about 3%. We're talking about modifying those two, not taking out the full revenues for those two countries for the full year. Then the last piece.
Okay.
of the volume change really is related to U.S. performance and the piece of the Q1 underperformance that we'll likely hold on to for the full year. It's the smaller piece. The majority of all our volume changes are really related to China.
All right, that's really helpful, Barb. Just to clarify, then I got a follow-up. Just to clarify, is there a stronger pricing outlook now embedded in the revenue guide, the 2%-3% organic outlook that you're coming out with today? Then, John and Barb, you just wanna ask, I mean, you both have pretty deep experience here in med tech. You have the characteristics outlined that the board is looking for in a permanent leadership team. Can each of you comment on whether you're candidates to hold the permanent CEO or and CFO role, or if this is truly a role with an interim label and the board's exclusively taking an external approach to the search?
Jason, I'll take the first one on price, and I'll let John answer the second one around the search. With regards to price, when we started the year with our outlook, we had communicated that we were looking at price, given the current environment and the inflationary pressures we see on supply chain, that we were gonna be looking at price. Everything in our outlook is consistent with that original guide for the full year. We are looking at price. We've pulled forward price increases into Q2 that typically would've been in Q3. That was all included in the original guide for the year, and is not a sort of incremental. I think Andrea is correcting me that typically we would. We also did price increases last Q4 as well.
Correct. Correct.
Okay.
Typically would be in the fourth quarter.
Okay. From a price standpoint, it's not a lot of upside versus the original guide. It's very consistent with what we started the year with.
Then Jason, on your question about the CEO and CFO search, Barb and I are both approaching this with a great deal of zest and vigor and enthusiasm to be interims. We are not the type who are gonna be passive caretakers. However, we are interims, and we do not expect to be part of the search process or candidates for the permanent CEO and CFO search. Both those positions will be filled by new permanent leaders in those roles. Those searches are underway and we would expect to draw some excellent talent to those searches.
All right. Very helpful. Thanks so much.
Our next question will come from Erin Wright with Morgan Stanley. You may now go ahead.
Great. Thanks. Can you give us a sense of the dynamics in the North American market? I guess how much of the weakness was attributable to the underlying demand trends versus the supply chain constraints versus maybe some of the proactive normalization in dealer inventories? Was that already meaningful in the quarter, or is that just going forward at this point? Thanks.
Yeah, Erin, let me start, then I'll pass over to Barb. You know, I think the underlying fundamentals of the U.S. business, and for that matter, the global business in the end markets, the growth categories of implants, aligners, digital and endo, as well as our innovation pipeline, continue to be very strong. We do need to work through excess inventory that was in the channel in the U.S., and we would expect to work through that as the year progresses, and I'll pass over to Barb for more specifics there. The underlying fundamentals are very strong. I think you've seen that from our peers and their reporting over the last week, that, you know, that is a resilient, solid market, growth rate that we're participating with.
Erin, just to continue on with that, when we look at the decline in the U.S. market in Q1, the majority of that, the largest part, portion of that was related to inventory burn, CAD/CAM, and a little bit of consumables. About 20% of that decline, I would say, was associated with a combination of supply chain constraints and maybe a little bit lower demand than what we expected, but probably about 80% of that was really related to inventory. Now, with regards to consumables, we think that that was done in the quarter and we will have normalized in Q2.
With regards to CAD/CAM, we expect that there's gonna be some continuing burn in Q2, and that'll take us to the second half of the year before we start to normalize there.
Okay, great. That was really helpful. Just on the comment you were making around ortho and demand trends across clear aligners, what's now anticipated for SureSmile and separately Byte in 2022?
Yeah. We have a very positive outlook for our clear aligner business. We have to cycle past some tough comps on the Byte side from last year still in this remaining quarter. As we look at it, we see a large under-penetrated market that's growing at high double digits, and we would expect to start growing in line with that market growth rate as we get to the second half of the year. We're quite bullish on our combined offering of SureSmile and Byte.
Okay, great. Thank you.
Our next question will come from Jeff Johnson with Baird. You may now go ahead.
Jeff, are you there? You might be on mute.
Jeff, are you there?
I'm here. Can you hear me?
We can now.
Okay. Thank you. John, I don't like to look backwards, but you know, I think some clarification or some understanding of maybe the change that happened last month would be helpful just to understand kind of forward look on the company. Was the change made because of some of these channel issues that you're talking about, the financial investigation into the year-end, kind of stuff? Was that it? I mean, when I look back, you know, Don did take out about $250 million in costs. I think a lot of the pipeline you highlighted is because of some of the initiatives and focus he'd put on innovation. I think he did some good things as well.
Would you expect that the board really kind of continues to focus on those good things with the new leadership? Again, just any clarification on what ultimately drove the change would be helpful, I think.
Listen, yeah. I think it's two questions there. One is the strategy and the direction of the company and our progress towards that strategy, which is intact. That is not changing. We're committed to it. We think it's a very viable and very powerful vision as well as the strategy behind it and the innovation pipeline that is in place. With respect to Don and Don's termination, we have really no further comment beyond what was already said around the circumstances around that. As you can appreciate, we're informing you about everything we possibly can at this time, and there's an ongoing investigation that's being led by the audit committee. It would be, you know, inappropriate for me to comment or speculate or draw any conclusions about an ongoing investigation until it's completed.
Once we have information from that investigation, we'll share it with you and all investors, but we don't have any further comment about that at this time.
All right. Thank you. Barb, just as we think about the Byte business, especially, you know, I think some of us were braced for a potential write-down of that business today. You know, I know you did see some sequential improvement in that business. How are you thinking about, I guess, that deal and kind of the amount of goodwill that's on the balance sheet? Would you expect at this point, is that trending towards any kind of a write-down, and, you know, maybe confidence level on that business getting back to any kind of year-over-year growth in the next year or two? Thank you.
Jeff, it's a great question. With regards to Byte, you know, we remain, you know, very positive about the transaction as well as the performance. As you all know, in the first half of last year, we had some very strong sort of pandemic-related demand that came through, and that meant that we are going to have some headwinds in the first half of this year from a volume growth. For the year, we are expecting Byte to be a grower. We highlighted that we were expecting to see sequential growth. So far, the business is performing very much in line with what we said. For the year, it's gonna be, you know, additive to the overall aligner business.
When you think about, you know, what does it do for us, as a company, you know, not only is it adding to that top line growth, but it is also accretive to our gross margin, which is a positive. You know, from an op margin standpoint, it may take us a little bit of time before we get accretive there, but that's not unexpected for an acquisition of this type. With regards specifically to goodwill and valuation, you know, we go through an annual process, where we will evaluate our goodwill pools and determine whether or not, you know, there's any impairment that we need to look at. We have that process in front of us. At this point in time, I have no reason to believe that we have an impairment coming on this.
You know, again, we have a normal process that we need to go through later in the year. You know, clearly, if there's anything that changes in that outlook, you know, it'll be reflected in our published filings.
Thank you.
Next question, please.
Our next question will come from Jon Block with Stifel. You may now go ahead.
Great. Thanks, guys. Good morning, and thanks for all the color. Maybe I'll go back to, you know, the 2022 revenue outlook. In my opinion, is only sort of modestly stepping down, especially with 8% of the sales in China and Russia. The OI is much more impacted in the big decline year-over-year. Maybe, Barbara, if you can comment on the decrementals, and I get it, you know, the bridge on slide, I think it's 14, but maybe a little bit more color on the decrementals. More importantly, how do we think about that greater than 17% going forward? You know, under the prior leadership, there was sort of that cadence of in and around 100 basis points plus in OI expansion per annum.
Do we think about this as sort of a one-time step down and a snapback to where we were prior? Or, maybe as best you can extrapolate that number going forward, and then I've got a follow-up.
Absolutely. So it's a great question. The key driver, you know, and we tried to highlight it in our bridge in the presentation material. As you think about the decrement between the top line step down and the bottom line step down is really around our gross margin. You know, in the gross margin area, you know, it is driven by the volumes coming down and having a less favorable mix than where we would have been previously. It's also being brought down by FX, which is a significant headwind. I think we've quantified that as about a $0.15 headwind relative to the prior guidance for the year. Then supply chain.
Supply chain is a combination of inflationary pressures as well as sort of constraints on components. That's another $0.15 as you look at it. When you look across that entire bridge to get to your question of, you know, what do we see as transitory versus what is sort of a underlying performance, probably about 70% of that step down in EPS for the year is related to the big trends around FX, around China, around the pressures that everybody is experiencing on supply chain. When you think about where do we wanna go forward, I mean, the company has two great levers about how do we get past these macro headwinds in 2022 and get back on the path of performance for 2023.
I mean, first of all, from a sales standpoint, we have a really well-positioned portfolio in a very attractive market. You know, continued excellence in execution there gives us opportunities to continue to improve our sales growth and improve our profitable sales growth. The second piece is, as was highlighted earlier, I think by Jeff, the company has done a remarkable job of addressing operating margin through cost savings through portfolio optimization. That gives us a really strong sort of foundation to continue to get on that path for margin expansion once we get some of these headwinds behind us. We really do see this year as a bit of a one-time where we've got a lot of things working against us, but we think those things are largely transitory.
As we get to 2023, you know, we'll be exiting the year strongly as we sequentially improve, and we'll be, you know, setting 2023 up for a strong year.
Yeah. I think we'll. That's a good way to summarize it. We expect to end the year at around 20% op margin as we mentioned earlier. When we get to 2023 guidance, we'll articulate it then. There's obviously a lot of moving pieces in the macro right now that everyone's dealing with, and we're no different. We'll certainly provide updated guidance for 2023 when we get to the end of the year.
Understood. Maybe just a quicker follow-up. John, your thought on implants. It was another strong quarter. I think you called that high single digit growth. The company recently restaged the portfolio call. You know, some of these growth rates are off of easier comps. Your thoughts on, you know, the overall market with a consumer that might be weakening for implants, and then Dentsply Sirona's ability to continue to put up these solid numbers maybe as we cycle through and start to get to some more difficult comps. Thanks for your time, guys.
Yeah. We're very pleased on the implant side with our PrimeTaper launch. That's going very well and in helping to drive robust growth across all the regions. In Q1, it was high single digits, and we would expect to see continued performance with the market throughout the year. We're very pleased about the performance there. You know, as it relates to the economic question, whether it's implants or aligners, you know, we think that the digital dentistry vision and strategy that we're pursuing actually makes a dentist office more efficient and more productive, and that trend towards digital dentistry and the workflows that go with it, including aligners and implants and other restorations, I think will help offset some of that inflationary pressure.
Of course, we're going to adapt and adjust where needed to refine our segmentation in any direct-to-consumer businesses that can help offset any headwinds that we might see from inflation. We haven't seen it trending in our business to date, but we're certainly being proactive to prepare for that.
Thank you, guys.
Our next question will come from Matt Miksic with Credit Suisse. You may now go ahead.
Thanks so much. Maybe just some follow-ups on some of the topics here you've been talking about. You know, the first on the inventory that you went through, Barb, and I think then went through some color on the fact that on the capital side, the CAD/CAM side, that it'll take another couple of quarters or a few quarters to work through that. If it was $150 million, you know, is that, you know, are we $20-$30 million of the way through that? Is that. You know, can you give us some color as to how far along that CAD/CAM inventory we are with Q1? And then I have one follow-up.
Matt, thanks for the question. In the 10-K, we highlighted that there was approximately $50 million of excess inventory at the end of 2021. We've seen a portion of that burn off in Q1 of this year. We expect the balance to largely work its way through next quarter. By the time we get to Q3, we should be getting normalized. That's sort of the trajectory of what we expect around the U.S. inventory burn.
Thanks for that clarification. On the margin, the delta to EPS and the delta to margins, I guess if we look at the $0.70 reduction roughly from your prior range to your current range, you know, that would imply a slightly heavier impact on margins than, say, the 300-400 basis point delta that you gave in your full year guide. Can you talk about what some of the offsets to that are that give you the or what the additional delta is there that maybe, you know
I guess if I do the math on EPS, it looks like it would be more like, you know, another 100 basis points lower. I'm just trying to get some color as to what you're doing to offset that if anything.
Matt, I may not be following, you know, your math as we go through. In the presentation, we tried to highlight it pretty clearly as to where the pieces would be. As we walk through, you know, there is about $0.25 that is really driven by the change in sales and the change in volumes that we would see because of the headwinds. Again, that's primarily around China, but also it has Ukraine and Russia in there, and then a little bit with regards to U.S. performance. As we think about the balance of the changes, you know, FX is a big piece. We also have an equal amount, another $0.15 that we think would be related to supply chain constraints.
The balance of that, you know, that we highlighted, I think it's the last bar on that chart. We talked about investments that we're gonna continue to make in our, you know, primarily our R&D and our commercial organizations. If you walk through those pieces, that pretty much gets you to where our guide is for the full year from an EPS perspective. In terms of, you know.
Yeah
Other levers that we're looking at, we've talked a little bit about price. We really haven't changed our outlook on price. That's pretty consistent with where we started. We will, you know, continue to be working hard on supply chain and making sure that we can contain that. I'm just trying to think through the rest of the P&L. I think the other place where you may see some favorability that may help you from an overall equation is, you know, we are seeing a slightly better tax rate for the full year. So maybe that's a little bit of that offset that you're looking for. You know, but again, we have a little bit of a headwind when it comes to interest, just like many other people as well.
You know, as you get later in the day and you're going through further questions, if we can, you know, provide any more color through Andrea, we'll certainly do so.
That's helpful. Yeah, I guess I get about 500 basis points if I tax effect those EPS numbers, and your guide came down by about 400. You know, some of the other things you mentioned should help explain that delta. Thanks so much, Barb.
No worries.
Oh, we'll take one more question. Please, Anthony.
Okay. Our next question will be from Rachel Vatnsdal with JP Morgan. You may now go ahead.
Great. Thanks for taking the questions. Appreciate the color that you've given on China and that the region's going to be pressured for the year due to the lockdowns. Can you just dig into that a bit more? How significant do you expect those headwinds to be in 2Q? What's assumed for the cadence in the back half of the year for China? Do you think that you'll be able to recoup any of those volumes once the region reopens?
Yeah, let me start on that one, Rachel. China represents more than half of the regional headwinds that we're now putting in the outlook, somewhere around 60% actually. It's by far the biggest. We do expect that they're gonna go on throughout the year. Once you know, once we get past the end of the year, there's no reason to think once the COVID situation in China resumes and lockdowns are a lot less frequent or non-existent. There's no reason to believe that the business wouldn't come back to the prior levels in 2021.
Got it. That's helpful. On the EPS bridge, you guys have flagged the 15% or $0.15 decline stemming from investments. Could you just walk us through what those are gonna go towards for the year? Thanks.
I'll start and then John, if you wanna add in, please do. I think the most significant is if you look at R&D, and you can see that a little bit in Q1. You know, last year we talked about how as the world reopened and we got back to more normal performance, that we were going to accelerate our investment in our pipeline. R&D investment is a big piece of that as we go forward. Beyond that, you know, it really gets to more support and an ongoing focus in our commercial organizations, and making sure that, you know, we have teams in place that are well-positioned to be working with our customers and helping them going forward.
No, I wouldn't add to that.
Okay. Okay.
Let's close with a comment and thank you all for joining the call this morning. As you can appreciate, I think you can see that we're trying to do our best to inform you about everything we possibly can this morning at this time. Barb and I are confident that with the help of the management team here, we're going to successfully address any findings while leading us forward to make a stronger team at Dentsply Sirona. You know, we really believe in the vision and the strategy that we're pursuing, and we will pursue it with all of our might and effort. Thank you very much for your time.