DENTSPLY SIRONA Inc. quarterly report, Q2 FY2023

DENTSPLY SIRONA Inc. — Q2 2023 Form 10-Q Summary

Business context and reporting period

DENTSPLY SIRONA is a global dental products and technology manufacturer, with additional continence-care products through Wellspect Healthcare. This unaudited Form 10-Q covers the three and six months ended June 30, 2023, compared with the corresponding 2022 periods.

Effective April 1, 2023, the Company reorganized its reporting structure into Connected Technology Solutions, Essential Dental Solutions, Orthodontic and Implant Solutions, and Wellspect Healthcare. Prior-period segment information was recast.

Key financial metrics

Metric	Q2 2023	Q2 2022	Six months 2023	Six months 2022
Net sales	$1,028 million	$1,023 million	$2,006 million	$1,992 million
Gross profit	$550 million	$581 million	$1,069 million	$1,102 million
Gross margin	53.5%	56.7%	53.3%	55.3%
Operating income	$80 million	$119 million	$78 million	$216 million
Net income attributable to DENTSPLY SIRONA	$86 million	$73 million	$67 million	$142 million
Diluted EPS	$0.40	$0.34	$0.31	$0.66
Net cash provided by operating activities	Not separately provided	Not separately provided	$83 million	$266 million

Q2 reported sales increased 0.5%; organic sales increased 2.3% after a 1.8% foreign-exchange headwind. Six-month reported sales increased 0.7%, while organic sales increased 3.6% after a 2.9% foreign-exchange headwind.

Q2 segment sales were $309 million for Connected Technology Solutions, $377 million for Essential Dental Solutions, $270 million for Orthodontic and Implant Solutions, and $72 million for Wellspect Healthcare.
Q2 adjusted operating income was $221 million, down from $261 million. Connected Technology Solutions declined to $26 million from $50 million; Essential Dental Solutions declined to $125 million from $136 million; Orthodontic and Implant Solutions declined to $49 million from $57 million; and Wellspect increased to $21 million from $18 million.
Q2 SG&A was $416 million, R&D was $49 million, and restructuring and other costs were $5 million. Six-month restructuring and other costs were $64 million.
The Q2 income tax benefit was $39 million, producing an effective tax rate of negative 83.2%. The six-month tax benefit was $44 million and the effective tax rate was negative 239.3%, primarily due to a partial valuation allowance release on net operating loss carryforwards.

Cash flow, debt and liquidity

Six-month operating cash flow was $83 million, compared with $266 million in 2022. The decline primarily reflected working-capital changes, lower collections, higher operating expenses and vendor-payment timing.
Capital expenditures were $72 million in the first half. Full-year 2023 capital expenditures are estimated at approximately $150 million to $170 million.
Cash and cash equivalents were $295 million at June 30, 2023, down from $365 million at December 31, 2022. Net cash decreased by $70 million during the first half.
Total debt was $2.102 billion carrying value, including $261 million of current debt and $1.841 billion of long-term debt. Net debt was $1.807 billion, and net debt to total capitalization increased to 32.8% from 29.3% at year-end 2022.
The Company had $487 million of remaining borrowing capacity under credit lines. A new $700 million senior unsecured multicurrency revolving facility expires in May 2028. Commercial paper borrowings were $240 million, and short-term debt carried a weighted-average interest rate of 5.4%.
The Company was in compliance with its debt covenants and stated that it expects available cash, operating cash flow and borrowing capacity to fund operating needs, capital expenditures and debt service for the next twelve months.

Material changes versus the prior comparable period

Sales growth was modest, but gross profit fell 5.2% in Q2 and 3.0% for the first half. Gross margin declined 320 basis points in Q2 and 200 basis points for the first half.
Management attributed margin pressure to lower volumes, foreign-exchange headwinds, inflation in materials and distribution, product mix, and higher inventory-obsolescence expense. Pricing actions and improved orthodontics profitability partly offset these effects.
Operating income declined substantially because of lower gross profit, higher SG&A and R&D, restructuring charges, and increased interest expense.
Interest expense rose to $21 million in Q2 and $40 million for the first half, primarily because of higher interest rates on short-term and other borrowings.
The Company completed a $150 million accelerated share repurchase, receiving approximately 3.9 million shares in total. Share repurchase authorization remaining at June 30, 2023 was $590 million.
Inventory increased to $657 million from $627 million at year-end, while the inventory reserve increased to $96 million from $83 million. Trade receivables increased to $670 million from $632 million.

Guidance, outlook, commentary and risks

The February 2023 restructuring plan targets an 8% to 10% reduction in the global workforce and approximately $200 million to $225 million of annual cost savings. The plan is expected to be substantially completed by mid-2024.
Total one-time restructuring and other charges are estimated at $115 million to $135 million, with the majority expected to be cash expenditures in 2023. Actual costs and timing may differ.
Management expects to maintain annual R&D investment at no less than 4% of net sales.
Macroeconomic risks include recessionary pressure, higher interest rates affecting dental-equipment financing, weaker elective-procedure demand, inflation, supply-chain disruptions, labor costs and foreign-exchange volatility. Europe was particularly weak, while U.S. and Rest-of-World organic sales were stronger.
Sales in Russia and Ukraine represented approximately 2% of Q2 consolidated sales. Net assets in those countries were $67 million, including $44 million of cash in Russia that may be difficult or costly to repatriate because of currency controls.
The Company identified no impairment in its April 1, 2023 goodwill and indefinite-lived intangible-asset testing. However, a hypothetical 100-basis-point increase in discount rates would produce a material impairment in the Connected Technology Solutions reporting unit, which had $293 million of goodwill.
Material weaknesses in internal control over financial reporting remained unremediated at June 30, 2023. They relate to management tone and control environment, personnel expertise, customer incentive and variable-consideration accounting, and segregation of duties over manual journal entries. Disclosure controls were therefore deemed ineffective.
The SEC investigation related to revenue recognition and distributor incentive programs remains ongoing. The Company also faces securities litigation, derivative litigation and other legal matters; at this stage, management cannot estimate potential losses for the principal securities-related matters.
An IRS examination includes a proposed adjustment related to a 2016 internal reorganization and a $451 million distribution. Management believes its tax position is supportable, but an adverse outcome could materially affect results, financial position and liquidity.

Most important facts for investors to verify

Whether the restructuring delivers the targeted $200 million to $225 million of annual savings and whether total charges remain within the $115 million to $135 million estimate.
Progress in remediating the four material weaknesses and the timing of effective-control testing and auditor validation.
Underlying gross-margin recovery amid inflation, inventory-obsolescence costs, foreign-exchange pressure and product-mix changes.
Operating cash-flow conversion, working-capital requirements and the effect of increased short-term borrowings and interest rates on liquidity.
Potential outcomes and costs of the SEC matter, securities and derivative litigation, and the IRS tax dispute.
Whether adverse changes in discount rates, demand or operating forecasts trigger future goodwill or intangible-asset impairment charges.