DENTSPLY SIRONA Inc. — Q3 2022 Form 10-Q Summary
Business context and reporting period
DENTSPLY SIRONA is a global manufacturer of professional dental technologies, equipment, implants, clear aligners, instruments, and consumables, with two reportable segments: Technologies & Equipment and Consumables. This unaudited Form 10-Q covers the three and nine months ended September 30, 2022, compared with restated comparable periods in 2021.
The 2021 comparative financial statements were restated for errors involving customer incentive programs, sales returns, warranty reserves, variable consideration, and certain China product returns. The Audit and Finance Committee completed its related investigation on October 29, 2022.
Key financial metrics
| Metric | Q3 2022 | Q3 2021 | 9M 2022 | 9M 2021 |
|---|---|---|---|---|
| Net sales | $947 million | $1,040 million | $2,939 million | $3,128 million |
| Gross profit | $508 million | $569 million | $1,610 million | $1,743 million |
| Gross margin | 53.7% | 54.7% | 54.8% | 55.7% |
| Operating income (loss) | $(1,218) million | $132 million | $(1,002) million | $436 million |
| Net income (loss) | $(1,077) million | $84 million | $(935) million | $292 million |
| Diluted EPS | $(5.01) | $0.38 | $(4.34) | $1.32 |
| Operating cash flow | Not provided for quarter | Not provided for quarter | $375 million | $435 million |
Q3 reported sales declined 8.9%, including an 8.2% foreign-exchange headwind; organic sales declined 0.7%. Nine-month reported sales declined 6.0%, while organic sales increased 0.3% after a 6.3% foreign-exchange impact.
- Q3 Technologies & Equipment sales were $556 million, down 9.0% reported but up 0.6% organically. Segment adjusted operating income declined 45.5% to $73 million.
- Q3 Consumables sales were $391 million, down 8.7% reported and 2.5% organically. Segment adjusted operating income declined 1.6% to $121 million.
- Nine-month segment adjusted operating income was $676 million, down from $817 million.
- Q3 SG&A increased 1.9% to $401 million, and R&D increased 5.2% to $41 million. R&D represented 4.3% of sales for the quarter and 4.5% for the nine-month period.
Liquidity, cash flow, debt, and balance sheet
- Cash and cash equivalents were $418 million at September 30, 2022, compared with $339 million at December 31, 2021.
- Nine-month operating cash flow was $375 million, down $60 million year over year. Capital expenditures were $117 million; full-year 2022 capital expenditures were estimated at approximately $150 million to $160 million.
- Cash used in investing activities was $109 million, compared with $319 million in 2021, primarily because the prior year included $248 million of acquisition payments.
- Cash used in financing activities was $168 million, including a $150 million accelerated share repurchase and $78 million of dividends.
- Total debt, including current maturities, was $1,983 million; net debt was $1,565 million. Net debt to total capitalization increased to 30.2% from 26.0% at year-end 2021.
- The company reported $503 million of remaining borrowing capacity under available credit lines. It was in compliance with debt covenants at September 30, 2022.
- Inventory increased to $592 million from $515 million at year-end, and days of inventory increased to 137 from 110. Management expects existing cash, operating cash flow, and borrowing capacity to fund operating requirements, capital expenditures, and debt service for the next twelve months.
Material changes versus the prior comparable period
- The company recorded a $1.187 billion goodwill impairment charge in Q3, consisting of $1.100 billion for Digital Dental Group and $87 million for Equipment & Instruments within Technologies & Equipment.
- The company recorded $94 million of indefinite-lived tradename and trademark impairments and reported total intangible asset impairment and other costs of $97 million in Q3 and $107 million for nine months.
- Impairments were driven by weakened demand, higher discount rates and cost of capital, foreign-currency effects, inflation, supply-chain costs, and lower forecasted cash flows.
- Net identifiable intangible assets declined to $1.875 billion from $2.319 billion at year-end, while goodwill declined to $2.584 billion from $3.976 billion.
- Foreign-currency translation losses reduced other comprehensive income by $310 million for the nine-month period and contributed to accumulated other comprehensive loss of $844 million.
- The company repurchased 3.1 million shares for $150 million under an accelerated share repurchase agreement; $740 million remained available under the $1.0 billion authorization at September 30, 2022.
- Investigation, remediation, legal, accounting, professional-service, severance, and retention costs totaled approximately $45 million for the first nine months and are expected to continue into Q4 2022 and 2023.
Outlook, management commentary, risks, and unusual items
- Management cited continuing supply-chain constraints, component shortages, higher raw-material and freight costs, labor shortages, inflation, rising interest rates, weaker discretionary spending, and competitive pressures.
- China sales declined by $55 million during the first nine months versus 2021 due to COVID-19 restrictions and lower patient traffic. China’s implant business may face price reductions when a local volume-based procurement program begins in late Q4 2022 or Q1 2023.
- Sales in Russia and Ukraine represented approximately 3% of consolidated sales, and net assets in those countries totaled approximately $90 million, including $73 million of cash held in Russia. Management reported no material impact from the conflict through September 30, 2022, but identified escalation and supply-chain disruption as risks.
- Remaining goodwill at the impaired Digital Dental Group and Equipment & Instruments reporting units was $234 million and $192 million, respectively, with fair values approximately equal to carrying values. Further deterioration in assumptions could produce additional impairment charges.
- Management expects annual R&D investment to remain at least 4% of net sales. No formal revenue or earnings guidance was provided in the filing.
- Disclosure controls and internal control over financial reporting were ineffective as of September 30, 2022. Three material weaknesses remained unremediated, involving tone at the top, staffing and expertise for variable consideration, and controls over customer incentive arrangements and revenue recognition.
- The company faces securities litigation related to revenue recognition and customer incentive disclosures, an IRS dispute involving a $546 million worthless-stock deduction, and Swedish tax matters with potential additional tax exposure. The company could not estimate potential losses for the securities litigation.
- The company obtained lender and noteholder consents after delayed quarterly filings. The delayed financial statements were delivered on November 9, 2022, before the November 14 deadline, and management stated that no debt default occurred.
Most important facts for investors to verify
- Whether the remediation plan eliminates the three unremediated material weaknesses and restores effective disclosure controls.
- Whether further goodwill or indefinite-lived intangible impairments occur, particularly given the sensitivity of several reporting units to discount rates and forecast changes.
- Whether organic demand, dealer inventory normalization, China restrictions, and the Chinese implant procurement program affect future sales and margins.
- Whether supply-chain, inflation, labor, freight, and foreign-exchange pressures continue to reduce gross and adjusted operating margins.
- Whether operating cash flow remains sufficient to support debt service, capital expenditures, dividends, share repurchases, and investigation-related costs.
- The ultimate outcomes and potential financial exposure from securities litigation, the IRS dispute, and Swedish tax proceedings.