DENTSPLY SIRONA Inc. quarterly report, Q3 FY2016

DENTSPLY SIRONA Inc. — Q3 2016 Form 10-Q Summary

Business context and reporting period

Unaudited results cover the three and nine months ended September 30, 2016. DENTSPLY International merged with Sirona Dental Systems on February 29, 2016; 2016 results include Sirona from the merger date, while prior-year reported results generally reflect legacy DENTSPLY only. The company operates in Dental and Healthcare Consumables and Technologies, serving professional dental and related medical markets.

Key financial metrics

Metric	Q3 2016	Q3 2015	9M 2016	9M 2015
Net sales	$954.2 million	$648.9 million	$2,748.8 million	$2,003.2 million
Gross profit	$513.6 million	$369.5 million	$1,459.4 million	$1,142.5 million
Operating income	$126.6 million	$98.6 million	$320.5 million	$282.1 million
Net income attributable to DENTSPLY SIRONA	$92.5 million	$84.5 million	$322.9 million	$192.6 million
Diluted EPS	$0.39	$0.59	$1.48	$1.35
Cash flow from operations	Not provided for quarter	Not provided for quarter	$341.0 million	$371.0 million

Reported sales increased 47.0% in Q3 and 37.2% for the first nine months, primarily because of the Sirona consolidation.
Gross margin excluding precious metal content declined to 54.7% in Q3 from 58.7% and to 54.1% for nine months from 59.0%. Management attributed the decline principally to Sirona’s lower margin, purchase-accounting effects, product mix and currency.
Q3 operating margin was 13.3% of reported sales; adjusted operating margin was 20.8% of sales excluding precious metal content, versus 21.0% in the prior-year quarter. Nine-month adjusted operating margin was 22.1%, versus 20.4%.
Adjusted diluted EPS was $0.66 in Q3, unchanged from the prior-year quarter. Nine-month adjusted diluted EPS was $2.11, versus $1.98.
Cash and cash equivalents were $330.7 million at September 30, 2016, compared with $284.6 million at December 31, 2015.
Total debt, including current maturities, was approximately $1.586 billion at September 30, 2016, compared with approximately $1.153 billion at year-end 2015. Net debt to total capitalization was 13.1%, versus 27.1% at year-end 2015.
The company had $174.5 million of unused borrowing capacity under its revolving credit agreement and short-term lines. It was in compliance with all debt covenants.

Material changes versus comparable periods

On a pro forma combined-business basis, sales excluding precious metal content increased 0.8% in Q3 and 2.4% for nine months. Nine-month internal sales growth was 2.6%.
Q3 combined-business constant-currency growth was 0.4%; the United States declined 3.1%, Europe grew 1.6% and Rest of World grew 3.8%.
Technologies sales excluding precious metal content were $442.0 million in Q3 and $1.204 billion for nine months, versus $164.6 million and $527.6 million, respectively, in the prior-year reported periods, largely reflecting Sirona.
Sirona contributed $735.2 million of sales and $162.4 million of operating income from February 29 through September 30, 2016.
The all-stock Sirona merger issued approximately 101.8 million shares and was recorded at preliminary consideration of $6.256 billion. It added $3.763 billion of goodwill and $2.435 billion of identifiable intangible assets.
The company completed acquisitions including MIS Implants Technologies and a healthcare consumables business for total consideration of approximately $341.4 million net of cash acquired; preliminary goodwill recorded was $234.1 million.
The company repurchased $699.6 million of common stock during the first nine months, including $99.6 million in Q3, and paid $46.7 million of cash dividends during the nine months.
Operating cash flow declined $30.0 million year over year, primarily due to higher receivables, income-tax payments, merger transaction fees and integration costs.

Guidance, outlook, risks and unusual items

Management expects 2016 capital expenditures of approximately $110 million to $125 million; $79.0 million had been spent through September 30.
In October 2016, the company announced proposed manufacturing, logistics and distribution reorganizations. Estimated costs could reach $85 million, primarily severance, over the following two years.
Nine-month income tax benefit included a $77.1 million valuation-allowance release related to foreign interest deduction carryforwards. Excluding specified tax matters, management reported a 17.0% effective tax rate for the nine months.
Q3 results included $44.3 million of purchased-intangible amortization, $14.6 million of business-combination costs and fair-value adjustments, and $8.9 million of restructuring and other costs.
Goodwill and indefinite-lived intangible impairment tests performed in April 2016 identified no impairment. Management noted that a material deterioration in reporting-unit performance could result in future impairment, particularly in one Technologies reporting unit with approximately $64.5 million of goodwill.
Pending matters include product-related class actions, an appeal involving a False Claims Act lawsuit, and ongoing U.S. government inquiries concerning export controls and economic sanctions. The company cannot predict the ultimate outcome of the government inquiries and states that unfavorable resolutions could materially affect results, liquidity or reputation.
The company has substantial international exposure: approximately two-thirds of sales are outside the United States. Foreign currency movements reduced nine-month sales excluding precious metals by approximately 1.3% and diluted EPS by approximately $0.06.
On October 27, 2016, after the reporting date, the company issued €350 million of senior notes at a weighted average interest rate of 1.40% and used the proceeds to repay the $375 million revolving-credit draw used to fund acquisitions.

Most important facts for investors to verify

Separate the effect of the Sirona acquisition from underlying performance; reported growth is not directly comparable with 2015.
Reconcile GAAP EPS of $0.39 in Q3 with adjusted EPS of $0.66 and assess the recurring nature of excluded amortization, merger and restructuring costs.
Monitor gross-margin recovery, integration benefits and the impact of Sirona’s lower margin profile.
Evaluate post-merger leverage, acquisition funding, refinancing activity and remaining liquidity after the October 2016 debt issuance.
Assess whether the proposed restructuring can deliver expected savings and whether costs could approach the disclosed $85 million estimate.
Review tax benefits, purchase-accounting allocations, goodwill sensitivity and the potential for future impairment charges.
Follow the export-control inquiries and pending litigation, for which the filing states that a reasonable loss range is not currently estimable.