DENTSPLY SIRONA Inc. — FY2017 Form 10-K Summary
Business context and reporting period
DENTSPLY SIRONA Inc. is a global manufacturer of professional dental products, technologies, equipment and selected healthcare consumables, operating in more than 120 countries. The filing covers the fiscal year ended December 31, 2017; fourth-quarter information is included in the annual filing. The Company reports two segments: Technologies & Equipment and Consumables. Approximately 65% of consolidated sales were generated outside the United States, and dental products and technologies represented approximately 92% of sales.
The 2017 results include twelve months of Sirona operations, compared with ten months in 2016 following the February 29, 2016 merger. Prior-period segment information was reclassified to conform to the revised two-segment structure.
Key financial metrics
| Metric | FY2017 | FY2016 | Change |
|---|---|---|---|
| Net sales | $3,993.4 million | $3,745.3 million | +6.6% |
| Net sales excluding precious metal content | $3,952.9 million | $3,681.0 million | +7.4% |
| Gross profit | $2,188.5 million | $2,000.9 million | +9.4% |
| Gross margin excluding precious metal content | 55.4% | 54.4% | +100 basis points |
| Operating income | $(1,562.3) million | $454.7 million | Decline |
| Net income attributable to Dentsply Sirona | $(1,550.0) million | $429.9 million | Decline |
| Diluted EPS | $(6.76) | $1.94 | Decline |
| Adjusted diluted EPS | $2.66 | $2.78 | -4.3% |
| Cash flow from operating activities | $601.9 million | $563.4 million | +$38.5 million |
| Capital expenditures | $144.3 million | $125.0 million | +$19.3 million |
| Cash and cash equivalents | $320.6 million | $383.9 million | -$63.3 million |
| Total debt | $1,641.7 million | $1,532.2 million | +$109.5 million |
| Net debt to total capitalization | 16.6% | 12.4% | +4.2 percentage points |
Reported operating results were substantially affected by non-cash impairment charges. The Company recorded $1,650.9 million of goodwill impairment and $346.7 million of indefinite-lived intangible asset impairment, primarily related to CAD/CAM, Imaging and Treatment Center reporting units within Technologies & Equipment. Restructuring and other costs totaled $425.2 million, including $55.4 million of restructuring expense and $369.8 million of impairment charges and legal settlements.
Adjusted operating income was $791.4 million, or 20.0% of sales excluding precious metal content, compared with $804.2 million, or 21.8%, in 2016. Adjusted net income was $618.2 million compared with $617.1 million in 2016.
Segment and operating performance
- Technologies & Equipment: Sales excluding precious metal content were $2,160.3 million, up 8.8%; segment operating income was $411.0 million, up 15.5%. Combined-business constant-currency sales declined 0.1%, with negative internal growth of 2.8%, reflecting weakness in equipment demand and competition.
- Consumables: Sales excluding precious metal content were $1,792.6 million, up 5.8%; segment operating income was $487.1 million, up 9.4%. Combined-business constant-currency sales grew 3.7%, including 3.1% internal growth.
- Geography: Sales excluding precious metal content increased 4.6% in the United States, 10.8% in Europe and 6.1% in the Rest of World.
- Research and development: R&D investment increased to $151.7 million from $128.5 million.
Material changes versus the prior comparable period
- Reported sales growth benefited from the inclusion of two additional months of Sirona sales, estimated at $112.7 million excluding precious metal content.
- Distributor inventory changes associated with new equipment distribution agreements increased reported 2017 sales by approximately $23 million. Distributor inventories increased approximately $26 million in 2017 versus $3 million in 2016.
- The Company expects distributor inventory reductions to negatively affect 2018 sales by approximately $40 million.
- Gross margin improved by 100 basis points, primarily because merger-related fair-value adjustments rolled off, partly offset by lower equipment sales related to distribution-channel changes.
- Cash conversion remained positive despite the GAAP net loss because the impairment charges were non-cash. Working capital consumed $149.3 million of operating cash flow, compared with $54.8 million in 2016; inventory days increased to 131 from 113.
- The Company repurchased approximately 6.2 million shares for $400.3 million and paid $78.3 million of dividends. The Board subsequently authorized a total remaining repurchase capacity of $500 million.
- Senior management experienced significant turnover in late 2017. Donald M. Casey Jr. became Chief Executive Officer effective February 12, 2018, and Nicholas W. Alexos became Chief Financial Officer effective November 10, 2017.
Liquidity, debt and commitments
The Company reported $320.6 million of cash and cash equivalents and approximately $531.2 million of unused borrowing capacity under its revolving credit facility and other short-term lines. Long-term debt, including the current portion, was $1,620.8 million, and the Company reported $1,641.7 million of total debt including short-term borrowings. Management stated that ongoing cash requirements are expected to be funded through cash, operating cash flow and available credit facilities.
The Company was in compliance with debt covenants at December 31, 2017. Key covenant thresholds included debt-to-total-capitalization of no more than 0.6 to 1.0 and operating income excluding depreciation and amortization to interest expense of at least 3.0 times. Contractual obligations totaled $2,237.3 million, including long-term borrowings, operating leases, interest, postemployment obligations and precious metal consignment arrangements.
Outlook, commentary, risks and unusual items
- Management expects 2018 capital expenditures of approximately $130 million to $140 million.
- The Company targets approximately $100 million of cost reductions over several years. German restructuring initiatives are expected to cost approximately $65 million, with estimated annual savings of approximately $11 million to $14 million over the next one to three years.
- The principal operating concern is continued weakness in Technologies & Equipment end-user demand, increased competition and uncertainty associated with the transition to a multi-distributor model.
- Goodwill and intangible asset valuations remain sensitive to revenue growth, operating margins, discount rates, foreign exchange rates, tax assumptions and market conditions. Additional impairment charges could be material.
- The Tax Cuts and Jobs Act produced a provisional net tax charge of $20.1 million, including a $62.2 million deemed-repatriation tax expense and a $42.1 million deferred-tax remeasurement benefit. The accounting was incomplete at filing and could be revised.
- The Company recorded $23.1 million of legal settlements and reached a $1.2 million settlement with OFAC and BIS concerning possible export-control and sanctions violations. An SEC Division of Enforcement investigation concerning accounting and disclosures remained ongoing, and the ultimate outcome was not predictable.
- Additional risks include foreign exchange exposure, distributor and customer concentration, product liability and regulatory compliance, supply disruptions, cyberattacks, debt covenant compliance, litigation, reimbursement changes and execution of integration and restructuring programs.
- PricewaterhouseCoopers LLP issued an unqualified audit opinion and concluded that internal control over financial reporting was effective as of December 31, 2017.
Most important facts for investors to verify
- Whether Technologies & Equipment end-user demand and operating margins stabilize after the 2017 impairments.
- The actual 2018 effect of the estimated $40 million distributor inventory reduction.
- Progress toward the $100 million cost-reduction target and the timing and cash cost of German restructuring.
- Whether additional goodwill or intangible impairments are required under updated forecasts.
- Final accounting consequences of the Tax Cuts and Jobs Act, including repatriation and GILTI-related amounts.
- Developments and potential financial exposure from the SEC investigation, Roth Licensing arbitration and other litigation.
- Debt maturities, covenant headroom, liquidity after repurchases and acquisitions, and the Company’s ability to sustain dividends.
- Underlying performance excluding non-GAAP adjustments, particularly the reconciliation from GAAP operating loss to adjusted operating income and from GAAP net loss to adjusted EPS.