News Column

DENTSPLY INTERNATIONAL INC /DE/ - 10-Q - Management's Discussion and Analysis of Financial Condition and Results of Operations

July 31, 2014

This report contains information that may constitute "forward-looking statements" within the meaning of the Private Securities Litigation Reform Act of 1995. Generally, the use of terms such as "may," "could," "expect," "intend," "believe," "plan," "estimate," "forecast," "project," "anticipate," and similar expressions identify forward-looking statements. All statements that address operating performance, events or developments that DENTSPLY International Inc. ("DENTSPLY" or the "Company") expects or anticipates will occur in the future are forward-looking statements. Forward-looking statements are based on management's current expectations and beliefs, and are inherently susceptible to uncertainty, risks, and changes in circumstances that could cause actual results to differ materially from the Company's historical experience and our present expectations or projections. These risks and uncertainties include, but are not limited to, those described in Part I, Item 1A ("Risk Factors") of the Company's Form 10-K for the year ended December 31, 2013 and those described from time to time in our future reports filed with the Securities and Exchange Commission. The Company undertakes no duty and has no obligation to update forward-looking statements as a result of future events or developments.



OVERVIEW

Highlights

For the quarter ended June 30, 2014, worldwide internal sales growth

contracted slightly by 0.6%, as modest U.S. internal sales growth of 0.2% was more than offset by declines in internal sales growth for Europe and the Rest of World region of 1.3% and 0.6%, respectively. Second quarter 2014 earnings per diluted share of $0.62 grew 3.3% from $0.60 in the prior year period. On an adjusted basis (a non-GAAP measure), second quarter 2014 earnings per diluted share of $0.69 grew 4.5% from $0.66 in the same period in the prior year.



Operating margin for the first six months of 2014 was 15.6% an increase of

110 basis points as compared to 14.5% for the first six months of 2013. Operating cash flow for the six months ended June 30, 2014 was $220.2



million compared to $131.9 million for the six months ended June 30, 2013.

Company Profile DENTSPLY International Inc. is a leading manufacturer and distributor of dental and other consumable medical device products. The Company believes it is the world's largest manufacturer of consumable dental products for the professional dental market. For over 110 years, DENTSPLY's commitment to innovation and professional collaboration has enhanced its portfolio of branded consumables and small equipment. Headquartered in the United States, the Company has global operations with sales in more than 120 countries. The Company also has strategically located distribution centers to enable it to better serve its customers and increase its operating efficiency. While the United States and Europe are the Company's largest markets, the Company serves all major markets worldwide. Principal Products



The Company has four principal product categories: 1) Dental Consumable Products; 2) Dental Laboratory Products; 3) Dental Specialty Products; and 4) Consumable Medical Device Products.

Dental consumable products consist of dental supplies and devices and small equipment used in dental offices for the treatment of patients. The Company manufactures thousands of different dental consumable products marketed under more than one hundred brand names. DENTSPLY's dental consumable products within this category include dental anesthetics, prophylaxis paste, dental sealants, impression materials, restorative materials, tooth whiteners and topical fluoride. Small equipment products in the dental consumable category consist of various durable goods used in dental offices for treatment of patients. DENTSPLY's small equipment products include dental handpieces, intraoral curing light systems, dental diagnostic systems, and ultrasonic scalers and polishers. 35 -------------------------------------------------------------------------------- DENTSPLY's products in the dental laboratory products category include dental prosthetics, including artificial teeth, precious metal dental alloys, dental ceramics and crown and bridge materials. Equipment in this category includes computer aided design and machining (CAD/CAM) ceramic systems and porcelain furnaces. Dental specialty products are specialized treatment products used within the dental office and laboratory settings. DENTSPLY's products in this category include endodontic (root canal) instruments and materials, implants and related products, bone grafting materials, 3D digital scanning and treatment planning software, orthodontic appliances and accessories.



Consumable medical device products consist mainly of urology catheters, certain surgical products, medical drills and other non-medical products.

Principal Measurements

The principal measurements used by the Company in evaluating its business are: (1) internal sales growth by geographic region; (2) constant currency sales growth by geographic region; (3) operating margins of each reportable segment including product pricing and cost controls; (4) the development, introduction and contribution of innovative new products; and (5) sales growth through acquisition. The Company defines "internal sales growth" as the increase or decrease in net sales from period to period, excluding (1) precious metal content; (2) the impact of changes in currency exchange rates; and (3) net acquisition sales growth. The Company defines "net acquisition sales growth" as the net sales, excluding precious metal content, for a period of twelve months following the transaction date of businesses that have been acquired, less the net sales, excluding precious metal content, for a period of twelve months prior to the transaction date of businesses that have been divested. The Company defines "constant currency sales growth" as internal sales growth plus net acquisition sales growth. The primary drivers of internal growth includes global dental market growth, innovation and new products launched by the Company, and continued investments in sales and marketing resources, including clinical education. Management believes that over time, the Company's ability to execute its strategies allows it to grow at a modest premium to the growth rate of the underlying dental market. Management further believes that the global dental market has generally in the past and should over time in the future grow at a premium to underlying economic growth rates. Considering all of these factors, the Company assumes that the long-term growth rate for the dental market will range from 3% to 6% on average and that the Company targets a slight premium to market growth. Over the past several years, growth in the global dental and other healthcare markets have been restrained by lower economic growth in Western Europe and certain other markets compared to historical averages and, accordingly, market growth rates, and the Company's internal growth rate remains uncertain in the near term. The Company's business is subject to quarterly fluctuations of consolidated net sales and net income. The Company typically implements most of its price changes at the beginning of the first or fourth quarters. Price changes, other marketing and promotional programs as well as the management of inventory levels by distributors and the implementation of strategic initiatives, may impact sales levels in a given period. The Company also has a focus on maximizing operational efficiencies. Management continues to evaluate the consolidation of operations or functions to reduce costs. In addition, the Company remains focused on enhancing efficiency through expanded use of technology and process improvement initiatives. The Company believes that the benefits from these initiatives will improve the cost structure and help offset areas of rising costs such as energy, employee benefits and regulatory oversight and compliance. In connection with these efforts, the Company targets adjusted operating income margins to expand to 20% as the benefits of these initiatives are realized over time. In addition, the Company expects that it will record restructuring charges, from time to time associated with such initiatives. These restructuring charges could be material to the Company's consolidated financial statements and there can be no assurance that the target adjusted operating income margins will be achieved. Product innovation is a key component of the Company's overall growth strategy. New advances in technology are anticipated to have a significant influence on future products in dentistry and consumable medical device markets in which the Company operates. As a result, the Company continues to pursue research and development initiatives to support technological development, including collaborations with various research institutions and dental schools. In addition, the Company licenses and purchases technologies developed by third parties. Although the Company believes these activities will lead to new innovative dental and consumable medical device products, they involve new technologies and there can be no assurance that commercialized products will be developed. The Company will continue to pursue opportunities to expand the Company's product offerings through acquisitions. Although the professional dental and the consumable medical device markets in which the Company operates have experienced consolidation, 36 --------------------------------------------------------------------------------



they remain fragmented. Management believes that there will continue to be adequate opportunities to participate as a consolidator in the industry for the foreseeable future.

Reclassification of Prior Year Amounts

Certain reclassifications have been made to prior year's data in order to conform to current year presentation. Specifically, during the first quarter of 2014, the Company realigned reporting responsibilities for multiple locations as a result of changes to the management reporting structure. The segment information reflects the revised structure for all periods shown.



RESULTS OF OPERATIONS, QUARTER ENDED JUNE 30, 2014 COMPARED TO QUARTER ENDED JUNE 30, 2013

Net Sales Management believes that the presentation of net sales, excluding precious metal content, provides useful information to investors because a significant portion of DENTSPLY's net sales is comprised of sales of precious metals generated through sales of the Company's precious metal dental alloy products, which are used by third parties to construct crown and bridge materials. Due to the fluctuations of precious metal prices and because the precious metal content of the Company's sales is largely a pass-through to customers and has minimal effect on earnings, DENTSPLY reports net sales both with and without precious metal content to show the Company's performance independent of precious metal price volatility and to enhance comparability of performance between periods. The Company uses its cost of precious metal purchased as a proxy for the precious metal content of sales, as the precious metal content of sales is not separately tracked and invoiced to customers. The Company believes that it is reasonable to use the cost of precious metal content purchased in this manner since precious metal dental alloy sale prices are typically adjusted when the prices of underlying precious metals change. The presentation of net sales, excluding precious metal content, is considered a measure not calculated in accordance with the generally accepted accounting principles in the United States ("US GAAP"), and is therefore considered a non-US GAAP measure. The Company provides the following reconciliation of net sales to net sales, excluding precious metal content. The Company's definitions and calculations of net sales, excluding precious metal content, and other operating measures derived using net sales, excluding precious metal content, may not necessarily be the same as those used by other companies. Three Months Ended June 30, (in millions) 2014 2013 $ Change % Change Net sales $ 765.2$ 761.0$ 4.2 0.6 % Less: precious metal content of sales 34.3 45.1 (10.8 ) (23.9 %) Net sales, excluding precious metal content $ 730.9$ 715.9



$ 15.0 2.1 %

Net sales, excluding precious metal content, for the three months ended June 30, 2014 was $730.9 million, an increase of $15.0 million or 2.1% over the second quarter of 2013. The change in net sales, excluding precious metal content, was primarily a result of 1.8% increase in foreign currency translation. Precious metal content of sales declined mostly as a result of lower refinery volume compared to the same period a year ago.



Constant Currency and Internal Sales Growth

The following table includes growth rates for net sales, excluding precious metal content, for the three months ended June 30, 2014 compared with the three months ended June 30, 2013.

Three Months Ended June 30, 2014 United States Europe Rest of World Worldwide Internal sales growth 0.2 % (1.3 %) (0.6 %) (0.6 %) Acquisition sales growth 0.5 % 0.2 % 3.1 % 0.9 % Constant currency sales growth 0.7 % (1.1 %) 2.5 % 0.3 % 37

--------------------------------------------------------------------------------



United States

Net sales, excluding precious metal content, increased by 0.7% on a constant currency sales growth basis in the second quarter of 2014 as compared to the second quarter of 2013. Internal sales growth was led by increased sales in dental consumable products partially offset by sales declines in other product categories. Europe Net sales, excluding precious metal content, decreased by 1.1% on a constant currency sales growth basis in the second quarter of 2014 as compared to the second quarter of 2013. Negative internal sales growth was the result of sales declines in the dental consumable and dental laboratory products partially offset by increased sales in the consumable medical device products and dental specialty product categories.



Rest of World

Net sales, excluding precious metal content, increased by 2.5% on a constant currency sales growth basis in the second quarter of 2014 as compared to the second quarter of 2013, which was primarily the result of acquisition sales growth offset by negative internal sales growth in dental consumable products. Internal sales growth in the region was also highly influenced by the impact of an excise tax increase in Japan effective April 1, 2014. Gross Profit Three Months Ended June 30, (in millions) 2014 2013 $ Change % Change Gross profit $ 424.5$ 415.0$ 9.5 2.3 % Gross profit as a percentage of net sales, including precious metal content 55.5 % 54.5 % Gross profit as a percentage of net sales, excluding precious metal content 58.1 % 58.0 % Gross profit as a percentage of net sales, excluding precious metal content, increased by 10 basis points for the quarter ended June 30, 2014 compared to the quarter ended June 30, 2013. The increase in the gross profit rate was primarily the result of favorable net pricing slightly offset by the unfavorable impact of foreign currency movements as compared to the same three month period in 2013. Operating Expenses Three Months Ended June 30, (in millions) 2014 2013 $ Change % Change Selling, general and administrative expenses ("SG&A") $ 296.1$ 289.9$ 6.2 2.1 % Restructuring and other costs 1.2 2.2 (1.0 ) (45.5 %) SG&A as a percentage of net sales, including precious metal content 38.7 % 38.1 % SG&A as a percentage of net sales, excluding precious metal content 40.5 % 40.5 %



SG&A Expenses

SG&A expenses as a percentage of net sales, excluding precious metal content, for the quarter ended June 30, 2014 was unchanged compared to the quarter end June 30, 2013. The $6.2 million increase was primarily the impact of changes in foreign currency rates. 38

--------------------------------------------------------------------------------

Other Income and Expense Three Months Ended June 30, (in millions) 2014 2013 Change Net interest expense $ 10.1 $ 9.3$ 0.8 Other expense (income), net 0.6 4.2 (3.6 ) Net interest and other expense $ 10.7 $ 13.5$ (2.8 ) Net Interest Expense Net interest expense for the three months ended June 30, 2014 was $0.8 million higher compared to the three months ended June 30, 2013. The net increase is the result of a decline in non-cash fair value gains in the three months ended June 30, 2014 as compared to the same period in 2013, partially offset by a decline in interest expense as a result of lower average debt levels in 2014 compared to the prior year period. Other Expense (Income), Net Other expense (income), net for the three months ended June 30, 2014 was $3.6 million lower compared to the three months ended June 30, 2013. Other expense (income), net in the three months ended June 30, 2014 of $0.6 million is comprised primarily of $0.1 million of interest and non-cash charges relating to fair value adjustments and $0.4 million of other expense. Other expense (income), net in the second quarter of 2013 of $4.2 million was comprised primarily of $2.8 million of non-cash charges relating to cross currency basis swaps not designated as hedges that offset currency risk on intercompany loans and $1.1 million of currency transaction losses.



Income Taxes and Net Income

Three Months Ended June 30, (in millions, except per share data) 2014 2013 $ Change Effective income tax rate 22.4 % 20.9 % Equity in net (loss) income of unconsolidated affiliated company $ (0.4 )



$ 2.2 $ (2.6 )

Net income attributable to noncontrolling interests $ -



$ 1.5 $ (1.5 )

Net income attributable to DENTSPLY International$ 90.0

$ 87.2$ 2.8

Earnings per common share - diluted $ 0.62$ 0.60 Provision for Income Taxes The Company's effective tax rate for the second quarter of 2014 and 2013 was 22.4% and 20.9%, respectively. For the three months ended June 30, 2014, the effective tax rate was unfavorably impacted by the Company's change in the mix of consolidated earnings. The Company's effective income tax rate for 2014 includes the net favorable impact of amortization on purchased intangibles assets, restructuring and other costs, income related to credit risk adjustments on outstanding derivatives and various income tax adjustments, which impacted income before income taxes and the provision for income taxes by $13.5 million and $3.0 million, respectively. In 2013, the Company's effective income tax rate included the net favorable impact of amortization on purchased intangibles assets, restructuring and other costs, income related to credit risk adjustments on outstanding derivatives, and various income tax adjustments, which impacted income before income taxes and the provision for income taxes by $15.6 million and $4.6 million, respectively. 39 --------------------------------------------------------------------------------



Equity in net (loss) income of unconsolidated affiliated company

The Company's 17% ownership investment of DIO Corporation ("DIO") resulted in a net loss of $0.4 million on an after-tax basis for the second quarter of 2014 and net income of $2.2 million on an after-tax basis for the second quarter of 2013. The equity earnings of DIO include the result of mark-to-market changes related to the derivative accounting for the convertible bonds issued by DIO to DENTSPLY. The Company's portion of the mark-to-market changes recorded through DIO's net income for the second quarter of 2014 and 2013 was approximately $0.8 million and $2.4 million, respectively.



Net income attributable to noncontrolling interests

The portion of consolidated net income attributable to noncontrolling interests decreased $1.5 million for the three months ended June 30, 2014 as compared to the same three month in 2013 as a result of the contractual purchase of the remaining shares of a variable interest entity effective January 1, 2014. The Company anticipates the cash outflow for this purchase to be later in 2014.



Net Income attributable to DENTSPLY International

In addition to the results reported in accordance with US GAAP, the Company provides adjusted net income attributable to DENTSPLY International and adjusted earnings per diluted common share. The Company discloses adjusted net income attributable to DENTSPLY International to allow investors to evaluate the performance of the Company's operations exclusive of certain items that impact the comparability of results from period to period and certain large non-cash charges related to purchased intangible assets. The Company believes that this information is helpful in understanding underlying operating trends and cash flow generation. The adjusted net income attributable to DENTSPLY International consists of net income attributable to DENTSPLY International adjusted to exclude the impact of the following: (1) Acquisition related costs. These adjustments include costs related to integrating recently acquired businesses and specific costs related to the consummation of the acquisition process. These costs are irregular in timing and as such may not be indicative of past and future performance of the Company and are therefore excluded to allow investors to better understand underlying operating trends. (2) Restructuring and other costs. These adjustments include both costs and income that are irregular in timing, amount and impact to the Company's financial performance. As such, these items may not be indicative of past and future performance of the Company and are therefore excluded for the purpose of understanding underlying operating trends. (3) Amortization of purchased intangible assets. This adjustment excludes the periodic amortization expense related to purchased intangible assets. Beginning in 2011, the Company began recording large non-cash charges related to the values attributed to purchased intangible assets. These charges have been excluded from adjusted net income attributed to DENTSPLY International to allow investors to evaluate and understand operating trends excluding these large non-cash charges. (4) Income related to credit risk and fair value adjustments. These adjustments include both the cost and income impacts of adjustments in certain assets and liabilities that are recorded through net income which are due solely to the changes in fair value and credit risk. These items can be variable and driven more by market conditions than the Company's operating performance. As such, these items may not be indicative of past and future performance of the Company and therefore are excluded for comparability purposes. (5) Certain fair value adjustments related to an unconsolidated affiliated company. This adjustment represents the fair value adjustment of the unconsolidated affiliated company's convertible debt instrument held by the Company. The affiliate is accounted for under the equity method of accounting. The fair value adjustment is driven by open market pricing of the affiliate's equity instruments, which has a high degree of variability and may not be indicative of the operating performance of the affiliate or the Company. (6) Income tax related adjustments. These adjustments include both income tax expenses and income tax benefits that are representative of income tax adjustments mostly related to prior periods, as well as the final settlement of income tax audits. These adjustments are irregular in timing and amount and may significantly impact the Company's operating performance. As such, these items may not be indicative of past and future performance of the Company and therefore are excluded for comparability purposes. Adjusted earnings per diluted common share is calculated by dividing adjusted net income attributable to DENTSPLY International by diluted weighted-average common shares outstanding. Adjusted net income attributable to DENTSPLY International and adjusted earnings per diluted common share are considered measures not calculated in accordance with US 40 -------------------------------------------------------------------------------- GAAP, and therefore are non-US GAAP measures. These non-US GAAP measures may differ from other companies. Income tax related adjustments may include the impact to adjust the interim effective income tax rate to the expected annual effective tax rate. The non-US GAAP financial information should not be considered in isolation from, or as a substitute for, measures of financial performance prepared in accordance with US GAAP. Three



Months Ended June 30, 2014

Per Diluted (in thousands, except per share amounts) Net



Income Common Share

Net income attributable to DENTSPLY International $ 89,993$ 0.62 Amortization of purchased intangible assets, net of tax 8,319 0.06 Income tax-related adjustments 1,045 0.01 Restructuring and other costs, net of tax 943 0.01 Acquisition related activities, net of tax 380 -



Credit risk and fair value adjustments to outstanding derivatives, net of tax

(177 ) -



Gain on fair value adjustments related to an unconsolidated affiliated company, net of tax

(832 ) (0.01 ) Adjusted non-US GAAP earnings $ 99,671$ 0.69 Three Months Ended June 30, 2013 Per Diluted (in thousands, except per share amounts) Net



Income Common Share

Net income attributable to DENTSPLY International $ 87,228$ 0.60 Amortization of purchased intangible assets, net of tax 8,002 0.06 Restructuring and other costs, net of tax 1,962 0.01 Acquisition related activities, net of tax 746 0.01



Credit risk and fair value adjustments to outstanding derivatives, net of tax

457 - Income tax related adjustments (118 ) -



Gain on fair value adjustments at an unconsolidated affiliated company, net of tax

(2,446 ) (0.02 ) Adjusted non-US GAAP earnings $ 95,831$ 0.66 Operating Segment Results



Third Party Net Sales, Excluding Precious Metal Content

Three Months Ended June 30, (in millions) 2014 2013 $ Change % Change Dental Consumable and Certain International Businesses $ 183.6$ 170.6$ 13.0 7.6 %



Dental Specialty and Laboratory and Certain Global Distribution Businesses $ 408.6$ 413.4$ (4.8 ) (1.2 %)

Healthcare and Emerging Markets Businesses $ 139.6$ 132.8$ 6.8 5.1 % 41

--------------------------------------------------------------------------------

Segment Operating Income Three Months Ended June 30, (in millions) 2014 2013 $ Change % Change Dental Consumable and Certain International Businesses $ 66.1$ 59.9$ 6.2 10.4 % Dental Specialty and Laboratory and Certain Global Distribution Businesses $ 79.6$ 79.8 $



(0.2 ) (0.3 %)

Healthcare and Emerging Markets Businesses $ 10.0$ 8.6$ 1.4 16.3 %



Dental Consumable and Certain International Businesses

Net sales, excluding precious metal content, increased $13.0 million, or 7.6% for the three months ended June 30, 2014 as compared to 2013. On a constant currency basis, net sales, excluding precious metal content, increased 6.1% as compared to 2013 due to sales growth across all regions. Operating income increased $6.2 million for the three months ended June 30, 2014 as compared to 2013. The increase in operating income was primarily the result of sales growth and improved gross margins within these businesses.



Dental Specialty and Laboratory and Certain Global Distribution Businesses

Net sales, excluding precious metal content, decreased $4.8 million, or 1.2% for the three months ended June 30, 2014 compared to 2013. On a constant currency basis, net sales, excluding precious metal content, decreased 3.1% as compared to 2013 due to sales declines in several regions with the largest contraction being in Europe.



Operating income decreased $0.2 million compared to 2013, due to lower sales partially offset by improvement in gross margins rates across a number of businesses.

Healthcare and Emerging Markets Businesses

Net sales, excluding precious metal content, increased $6.8 million, or 5.1% for the three months ended June 30, 2014 as compared to 2013. On a constant currency basis, net sales, excluding precious metal content, increased 3.4% as compared to 2013. The growth was primarily related to increased sales of consumable medical device products.



Operating income improved $1.4 million during the three months ended June 30, 2014 as compared to 2013 primarily due to stronger sales, as well as lower operating expense levels within these businesses.

RESULTS OF OPERATIONS, SIX MONTHS ENDED JUNE 30, 2014 COMPARED TO SIX MONTHS ENDED JUNE 30, 2013 Net Sales Six Months Ended June 30, (in millions) 2014 2013 $ Change % Change Net sales $ 1,495.3$ 1,493.1$ 2.2 0.1 % Less: precious metal content of sales 75.3 104.5



(29.2 ) (27.9 %) Net sales, excluding precious metal content $ 1,420.0$ 1,388.6$ 31.4 2.3 %

Net sales, excluding precious metal content, for the six months ended June 30, 2014 was $1,420.0 million, an increase of $31.4 million or 2.3% compared to the six months ended June 30, 2013. The change in net sales, excluding precious metal content, was a result of 1.3% increase from foreign currency translation as well as 1.0% constant currency sales growth. Precious metal content of sales declined mostly as a result of lower refinery volume compared to the same period a year ago. 42

--------------------------------------------------------------------------------



Constant Currency and Internal Sales Growth

The following table includes growth rates for net sales, excluding precious metal content, for the six months ended June 30, 2014 compared with the six months ended June 30, 2013. Six Months Ended June 30, 2014 United States Europe Rest of World Worldwide Internal sales growth 0.1 % (1.3 %) 3.8 % 0.2 % Acquisition sales growth 0.4 % 0.1 % 3.2 % 0.8 % Constant currency sales growth 0.5 % (1.2 %) 7.0 % 1.0 % United States Net sales, excluding precious metal content, increased by 0.5% on a constant currency sales growth basis for the six months ended June 30, 2014 as compared to the same six month period of 2013. Internal sales growth was led by increased sales in the dental consumable product category offset by sales declines in other product categories.



Europe

Net sales, excluding precious metal content, decreased by 1.2% on a constant currency sales growth basis for the six months ended June 30, 2014 as compared to the six months ended June 30, 2013, primarily as a result of the geopolitical impact in the CIS countries. Excluding sales in the CIS, internal sales growth would have been a positive 0.4% for the six months ended led by increased sales in consumable medical device products and dental specialty products.



Rest of World

Net sales, excluding precious metal content, increased by 7.0% on a constant currency sales growth basis for the six months ended June 30, 2014 as compared to the six months ended June 30, 2013. Internal sales and acquisition growth was led by the dental specialty products category. Gross Profit Six Months Ended June 30, (in millions) 2014 2013 $ Change % Change Gross profit $ 818.7$ 803.2$ 15.5 1.9 % Gross profit as a percentage of net sales, including precious metal content 54.7 % 53.8 % Gross profit as a percentage of net sales, excluding precious metal content 57.6 % 57.8 % Gross profit as a percentage of net sales, excluding precious metal content, decrease 20 basis points for the six month period ended June 30, 2014 compared to the six months end June 30, 2013. The decline in the gross profit rate was primarily the result of the unfavorable impact of foreign currency movements slightly offset by favorable net pricing as compared to the same six month period in 2013. 43

--------------------------------------------------------------------------------

Operating Expenses Six Months Ended June 30, (in millions) 2014 2013 $ Change % Change Selling, general and administrative expenses ("SG&A") $ 584.0$ 583.6$ 0.4 0.1 % Restructuring and other costs 2.0 2.8 (0.8 ) (28.6 %) SG&A as a percentage of net sales, including precious metal content 39.1 % 39.1 % SG&A as a percentage of net sales, excluding precious metal content 41.1 % 42.0 %



SG&A Expenses

SG&A expenses as a percentage of net sales, excluding precious metal content, decreased 90 basis points in the six months ended June 30, 2014 when compared to the same period ended June 30, 2013. The rate reduction is primarily due to cost reduction initiatives and expense controls across a number of businesses, as well as higher expenses recorded in the first six months of 2013 relating to biannual international trade shows. Other Income and Expense Six Months Ended June 30, (in millions) 2014 2013 Change Net interest expense $ 19.6 $ 22.3$ (2.7 ) Other expense (income), net 1.0 7.1 (6.1 ) Net interest and other expense $ 20.6 $ 29.4$ (8.8 ) Net Interest Expense Net interest expense for the six month period ended June 30, 2014 was $2.7 million lower compared to the six months ended June 30, 2013. The net decrease is a result of a decrease in interest expense due to lower average debt levels in 2014 compared to the prior year period, partially offset by $1.3 million decrease in interest income due to lower balances of cross currency basis swaps designated as net investment hedges compared to the same six month period in 2013. Other Expense (Income), Net Other expense (income), net for the six months ended June 30, 2014 was $6.1 million lower compared to the six months ended June 30, 2013. Other expense (income), net for the six months ended June 30, 2014 was $1.0 million primarily consisting of $0.7 million of currency transaction losses. Other expense (income), net for the six months ended June 30, 2013 was $7.1 million, comprised primarily of $5.6 million of fair value adjustments on cross currency basis swaps not designated as hedges that offset currency risk on intercompany loans and $1.3 million of currency transaction losses. 44

--------------------------------------------------------------------------------



Income Taxes and Net Income

Six Months Ended June 30, (in millions, except per share data) 2014 2013 $ Change Effective income tax rate 22.9 % 14.1 % Equity in net (loss) income of unconsolidated affiliated company $ (0.7 )



$ 0.4$ (1.1 )

Net income attributable to noncontrolling interests $ 0.1$ 2.4$ (2.3 )

Net income attributable to DENTSPLY International$ 162.9$ 158.9$ 4.0

Earnings per common share - diluted $ 1.13$ 1.10 Provision for Income Taxes The Company's effective tax rate for the six month period of 2014 and 2013 was 22.9% and 14.1%, respectively. In the 2013 period, the Company recorded a tax benefit of $9.4 million related to U.S. federal legislative changes enacted in January 2013, relating to 2012, and a benefit of $3.1 million related to prior year tax matters. In the six months ended June 30, 2014, the effective tax rate was unfavorably impacted by the Company's change in the mix of consolidated earnings. The Company's effective income tax rate for 2014 includes the net favorable impact of amortization on purchased intangibles assets, restructuring and other costs, acquisition related activities, various income tax adjustments, and income related to credit risk adjustments on outstanding derivatives which impacted income before income taxes and the provision for income taxes by $29.1 million and $5.7 million, respectively. In the 2013 period, the Company's effective income tax rate included the net favorable impact of amortization on purchased intangibles assets, income related to credit risk adjustments on outstanding derivatives, restructuring and other costs, acquisition related activities and various income tax adjustments which impacted income before income taxes and the provision for income taxes by $34.9 million and $22.3 million, respectively.



Equity in net (loss) income of unconsolidated affiliated company

The Company's 17% ownership investment of DIO Corporation ("DIO") resulted in a net loss of $0.7 million on an after-tax basis for the six months end June 30, 2014 and net income of $0.4 million on an after-tax basis for the six months ended June 30, 2013. The equity earnings of DIO include the result of mark-to-market changes related to the derivative accounting for the convertible bonds issued by DIO to DENTSPLY. The Company's portion of the mark-to-market changes recorded through DIO's net income for the six month period in 2014 and 2013 was approximately $1.1 million and $0.5 million, respectively.



Net income attributable to noncontrolling interests

The portion of consolidated net income attributable to noncontrolling interests decreased $2.3 million for the six months ended June 30, 2014 as compared to the same period in 2013 as a result of the contractual purchase of the remaining shares of a variable interest entity effective January 1, 2014. The Company anticipates the cash outflow for this purchase to be later in 2014.



Net Income attributable to DENTSPLY International

In addition to the results reported in accordance with US GAAP, the Company provides adjusted net income attributable to DENTSPLY International and adjusted earnings per diluted common share. The Company discloses adjusted net income attributable to DENTSPLY International to allow investors to evaluate the performance of the Company's operations exclusive of certain items that impact the comparability of results from period to period and certain large non-cash charges related to purchased intangible assets. The Company believes that this information is helpful in understanding underlying operating trends and cash flow generation. The adjusted net income attributable to DENTSPLY International consists of net income attributable to DENTSPLY International adjusted to exclude the impact of the following:



(1) Acquisition related costs. These adjustments include costs related to integrating recently acquired businesses and specific costs related to the consummation of the acquisition process. These costs are irregular in timing and as such may not be indicative

45 -------------------------------------------------------------------------------- of past and future performance of the Company and are therefore excluded to allow investors to better understand underlying operating trends. (2) Restructuring and other costs. These adjustments include both costs and income that are irregular in timing, amount and impact to the Company's financial performance. As such, these items may not be indicative of past and future performance of the Company and are therefore excluded for the purpose of understanding underlying operating trends. (3) Amortization of purchased intangible assets. This adjustment excludes the periodic amortization expense related to purchased intangible assets. Beginning in 2011, the Company began recording large non-cash charges related to the values attributed to purchased intangible assets. These charges have been excluded from adjusted net income attributed to DENTSPLY International to allow investors to evaluate and understand operating trends excluding these large non-cash charges. (4) Income related to credit risk and fair value adjustments. These adjustments include both the cost and income impacts of adjustments in certain assets and liabilities that are recorded through net income which are due solely to the changes in fair value and credit risk. These items can be variable and driven more by market conditions than the Company's operating performance. As such, these items may not be indicative of past and future performance of the Company and therefore are excluded for comparability purposes. (5) Certain fair value adjustments related to an unconsolidated affiliated company. This adjustment represents the fair value adjustment of the unconsolidated affiliated company's convertible debt instrument held by the Company. The affiliate is accounted for under the equity method of accounting. The fair value adjustment is driven by open market pricing of the affiliate's equity instruments, which has a high degree of variability and may not be indicative of the operating performance of the affiliate or the Company. (6) Income tax related adjustments. These adjustments include both income tax expenses and income tax benefits that are representative of income tax adjustments mostly related to prior periods, as well as the final settlement of income tax audits. These adjustments are irregular in timing and amount and may significantly impact the Company's operating performance. As such, these items may not be indicative of past and future performance of the Company and therefore are excluded for comparability purposes. Adjusted earnings per diluted common share is calculated by dividing adjusted net income attributable to DENTSPLY International by diluted weighted-average common shares outstanding. Adjusted net income attributable to DENTSPLY International and adjusted earnings per diluted common share are considered measures not calculated in accordance with US GAAP, and therefore are non-US GAAP measures. These non-US GAAP measures may differ from other companies. Income tax related adjustments may include the impact to adjust the interim effective income tax rate to the expected annual effective tax rate. The non-US GAAP financial information should not be considered in isolation from, or as a substitute for, measures of financial performance prepared in accordance with US GAAP. Six Months Ended June 30, 2014 Per Diluted (in thousands, except per share amounts) Net



Income Common Share

Net income attributable to DENTSPLY International $ 162,871$ 1.13 Amortization of purchased intangible assets, net of tax 17,231 0.12 Income tax-related adjustments 2,942 0.02 Acquisition related activities, net of tax 2,346 0.02 Restructuring and other costs, net of tax 1,588 0.01



Credit risk and fair value adjustments to outstanding derivatives, net of tax

(801 ) (0.01 )



Gain on fair value adjustments related to an unconsolidated affiliated company, net of tax

(1,035 ) (0.01 ) Adjusted non-US GAAP earnings $ 185,142$ 1.28 46

--------------------------------------------------------------------------------

Six Months Ended June 30, 2013 Per Diluted (in thousands, except per share amounts) Net



Income Common Share

Net income attributable to DENTSPLY International $ 158,913$ 1.10 Amortization of purchased intangible assets, net of tax 16,378 0.11



Credit risk and fair value adjustments to outstanding derivatives, net of tax

3,190 0.02 Restructuring and other costs, net of tax 2,501 0.02 Acquisition related activities, net of tax 2,099 0.01



Gain on fair value adjustments at an unconsolidated affiliated company, net of tax

(519 ) - Income tax related adjustments (11,505 ) (0.08 ) Adjusted non-US GAAP earnings $ 171,057$ 1.18 Operating Segment Results



Third Party Net Sales, Excluding Precious Metal Content

Six Months Ended June 30, (in millions) 2014 2013 $ Change % Change Dental Consumable and Certain International Businesses $ 357.6$ 334.2$ 23.4 7.0 % Dental Specialty and Laboratory and Certain Global Distribution Businesses $ 800.3$ 802.3 $



(2.0 ) (0.2 %)

Healthcare and Emerging Markets Businesses $ 264.5$ 254.3$ 10.2 4.0 % Segment Operating Income Six Months Ended June 30, (in millions) 2014 2013 $ Change % Change Dental Consumable and Certain International Businesses $ 124.7$ 114.2$ 10.5 9.2 % Dental Specialty and Laboratory and Certain Global Distribution Businesses $ 153.5$ 149.4 $



4.1 2.7 %

Healthcare and Emerging Markets Businesses $ 14.7$ 10.1$ 4.6 45.5 %



Dental Consumable and Certain International Businesses

Net sales, excluding precious metal content, increased $23.4 million, or 7.0% for the six months ended June 30, 2014 compared to the same period in 2013. On a constant currency basis, net sales, excluding precious metal content, increased 5.8% as compared to the same period in 2013 due to sales growth in all regions. Operating income increased $10.5 million for the six months ended June 30, 2014 compared to 2013. The improvement in operating income was primarily the result of sales growth as well as improved gross margin rates within these businesses.



Dental Specialty and Laboratory and Certain Global Distribution Businesses

Net sales, excluding precious metal content, decreased $2.0 million, or 0.2% for the six months ended June 30, 2014 compared to 2013. On a constant currency basis, net sales, excluding precious metal content, decreased 1.6% as compared to the same period in 2013 due to sales declines in the United States and European regions, partially offset by stronger sales in the Rest of the World region. 47 --------------------------------------------------------------------------------



Operating income increased $4.1 million compared to the same period in 2013, primarily due to impact of foreign currency translation.

Healthcare and Emerging Markets Businesses

Net sales, excluding precious metal content, increased $10.2 million, or 4.0% for the six months ended June 30, 2014 compared to 2013. On a constant currency basis, net sales, excluding precious metal content, increased 3.2% when compared to the same period of 2013. The growth was primarily related to increased sales of specialty dental and consumable medical device products. Operating income improved $4.6 million during the six months ended June 30, 2014 compared to 2013 primarily due to increased sales and lower expense levels in these business.



CRITICAL ACCOUNTING POLICIES

Except as noted below, there have been no other significant material changes to the critical accounting policies as disclosed in the Company's Form 10-K for the year ended December 31, 2013.



Annual Goodwill and Indefinite-Lived Assets Impairment Testing

Goodwill

Goodwill is not amortized; instead, it is tested for impairment annually or more frequently if indicators of impairment exist or if a decision is made to sell a business. The valuation date for annual impairment testing is April 30. The performance of the Company's 2014 annual impairment test did not result in any impairment of the Company's goodwill. The weighted average cost of capital (" WACC") rates utilized in the 2014 analysis ranged from 8.6% to 14.0%. Had the WACC rate of each of the Company's reporting units been hypothetically increased by 100 basis points at April 30, 2014, the fair value of those reporting units would still exceed net book value. If the fair value of each of the Company's reporting units had been hypothetically reduced by 5% at April 30, 2014, the fair value of those reporting units would still exceed net book value. If the fair value of each of the Company's reporting units had been hypothetically reduced by 10% at April 30, 2014, due to competitive conditions, one reporting unit within the Dental Specialty and Laboratory and Certain Global Distribution Businesses segment would have a net book value exceeding its fair value by approximately $5.9 million. Goodwill for this reporting unit totals $122.7 million at June 30, 2014. To the extent that future operating results of this reporting unit do not meet the forecasted cash flows the Company can provide no assurance that a future goodwill impairment charge would not be incurred.



Indefinite-Lived Assets

Indefinite-lived intangible assets consist of tradenames and are not subject to amortization; instead, they are tested for impairment annually or more frequently if indicators of impairment exist or if a decision is made to sell a business. The valuation date for annual impairment testing is April 30. The performance of the Company's 2014 annual impairment test did not result in any impairment of the Company's indefinite-lived assets. If the fair value of each of the Company's indefinite-lived intangibles assets had been hypothetically reduced by 10% or the discount rate had been hypothetically increased by 50 basis points at April 30, 2014, the fair value of these assets would still exceed their book value.



LIQUIDITY AND CAPITAL RESOURCES

Six months ended June 30, 2014

Cash flow from operating activities during the six months ended June 30, 2014 was $220.2 million compared to $131.9 million during the six months ended June 30, 2013. The improvement in the first six months' cash from operations of $88.4 million was primarily the result of substantially lower cash taxes paid and lower working capital increases in accounts receivable and inventory as compared to the year ago period. The Company's cash and cash equivalents decreased by $8.0 million to $66.9 million during the six months ended June 30, 2014. For the six months ended June 30, 2014, the number of days for sales outstanding in accounts receivable increased by three days to 59 days as compared to 56 days at December 31, 2013 and are equal compared to the same period in 2013. On a constant 48 -------------------------------------------------------------------------------- currency basis, the number of days of sales in inventory increased to 123 days at June 30, 2014 as compared to 114 days at December 31, 2013 and 116 days at June 30, 2013. The Company has strategically increased inventory in a few businesses as part of transition plans associated with anticipated operational changes. The Company anticipates that inventory levels will gradually return to more normal levels by the end of 2015. The cash outflows for investing activities during the first six months of 2014 were $55.3 million, including capital expenditures of $48.8 million. The Company expects capital expenditures to be approximately $120.0 million for the full year 2014. At June 30, 2014, the Company had authorization to maintain up to 34.0 million shares of treasury stock under the stock repurchase program as approved by the Board of Directors. Under this program, the Company repurchased 1.2 million shares during the first six months of 2014 for $54.6 million. As of June 30, 2014, the Company held 21.0 million shares of treasury stock. The Company received proceeds of $12.2 million as a result of the exercise of 0.4 million of stock options during the six months ended June 30, 2014. The Company's total borrowings decreased by a net $108.9 million during the six months ended June 30, 2014, which includes an increase of $5.1 million due to exchange rate fluctuations on debt denominated in foreign currencies. The Company refinanced a portion of the first required payment of $75.0 million under the Private Placement Notes due February 2016 by issuing commercial paper. The second required payment of $100.0 million under the Private Placement Notes is due in February 2015 and has been classified as current on the balance sheet. At June 30, 2014, the Company's ratio of total net debt to total capitalization was 33.5% compared to 35.2% at December 31, 2013. The Company defines net debt as total debt, including current and long-term portions, less cash and cash equivalents and total capitalization as the sum of net debt plus equity. Under its five-year multi-currency revolving credit agreement, the Company is able to borrow up to $500.0 million through July 27, 2016. The facility is unsecured and contains certain affirmative and negative covenants relating to the operations and financial condition of the Company. The most restrictive of these covenants pertain to asset dispositions and prescribed ratios of indebtedness to total capital and operating income plus depreciation and amortization to interest expense. At June 30, 2014, the Company was in compliance with these covenants. The Company also has available an aggregate $500.0 million under a U.S. dollar commercial paper facility. The five-year revolver serves as a back-up to the commercial paper facility, thus the total available credit under the commercial paper facility and the multi-currency revolving credit facilities in the aggregate is $500.0 million. At June 30, 2014, outstanding borrowings were $62.0 million under the multi-currency revolving facility. The Company also has access to $78.4 million in uncommitted short-term financing under lines of credit from various financial institutions. The lines of credit have no major restrictions and are provided under demand notes between the Company and the lending institutions. At June 30, 2014, the Company had $5.2 million outstanding under these short-term lines of credit. At June 30, 2014, the Company had total unused lines of credit related to the revolving credit agreement and the uncommitted short-term lines of credit of $511.1 million. At June 30, 2014, the Company held $73.0 million of precious metals on consignment from several financial institutions. The consignment agreements allow the Company to acquire the precious metal at market rates at a point in time which is approximately the same time and for the same price as alloys are sold to the Company's customers. In the event that the financial institutions would discontinue offering these consignment arrangements, and if the Company could not obtain other comparable arrangements, the Company may be required to obtain third party financing to fund an ownership position in the required precious metal inventory levels. At June 30, 2014, the majority of the Company's cash and cash equivalents were held outside of the United States. Most of these balances could be repatriated to the United States, however, under current law, would potentially be subject to U.S. federal income tax, less applicable foreign tax credits. Historically, the Company has generated more than sufficient operating cash flows in the United States to fund domestic operations. Further, the Company expects on an ongoing basis, to be able to finance domestic and international cash requirements, including capital expenditures, stock repurchases, debt service, operating leases and potential future acquisitions, from the funds generated from operations and amounts available under its existing credit facilities. The Company intends retire or refinance the current portion of long-term debt due in 2014 utilizing available cash flow, available commercial paper and the revolving credit facilities as well as other sources of credit.



There have been no material changes to the Company's scheduled contractual cash obligations disclosed in its Form 10-K for the year ended December 31, 2013.

49

--------------------------------------------------------------------------------



NEW ACCOUNTING PRONOUNCEMENTS

Refer to Part 1, Item 1, Note 1, Significant Accounting Policies, to the Unaudited Interim Consolidated Financial Statements for a discussion of recent accounting standards and pronouncements.


For more stories on investments and markets, please see HispanicBusiness' Finance Channel



Source: Edgar Glimpses


Story Tools






HispanicBusiness.com Facebook Linkedin Twitter RSS Feed Email Alerts & Newsletters