ENVISTA HOLDINGS CORPORATION INTRODUCTION
Management's Discussion and Analysis of Financial Condition and Results of Operations of our business is designed to provide a reader of our financial statements with a narrative from the perspective of management. You should read the following discussion in conjunction with the sections entitled "Envista Holdings Corporation Audited Consolidated and Combined Financial Statements" included in this Annual Report on Form 10-K. Management's Discussion and Analysis of Financial Condition and Results of Operations is divided into seven sections: • Basis of Presentation • Overview • Results of Operations
• Liquidity and Capital Resources
• Qualitative and Quantitative Disclosures About Market Risk
• Critical Accounting Estimates
• New Accounting Standards
BASIS OF PRESENTATION The accompanying consolidated and combined financial statements present our historical financial position, results of operations, changes in equity and cash flows in accordance with accounting principles generally accepted inthe United States ("GAAP"). The consolidated and combined financial statements for periods prior to the Separation were derived from Danaher's consolidated financial statements and accounting records and prepared in accordance with GAAP for the preparation of carved-out combined financial statements. Through the date of the Separation, all revenues and costs as well as assets and liabilities directly associated with our business have been included in the consolidated and combined financial statements. Prior to the Separation, our consolidated and combined financial statements also included allocations of certain general, administrative, sales and marketing expenses and cost of sales from Danaher's corporate office and from other Danaher businesses to us and allocations of related assets, liabilities, and Danaher's investment, as applicable. The allocations were determined on a reasonable basis; however, the amounts are not necessarily representative of the amounts that would have been reflected in the financial statements had we been an entity that operated independently of Danaher during the applicable periods. Related party allocations prior to the Separation, including the method for such allocation, are discussed further in Note 21 to our audited consolidated and combined financial statements. Following the Separation, our consolidated financial statements include our accounts and our wholly owned subsidiaries and no longer include any allocations of expenses from Danaher to us. Our consolidated and combined financial statements may not be indicative of our results had we been a separate stand-alone entity throughout the periods presented, nor are the results stated herein indicative of what our financial position, results of operations and cash flows may be in the future. We have incurred and will incur additional costs as a separate public company. As a separate public company, our total costs related to such support functions may differ from the costs that were historically allocated to us from Danaher. These additional costs are primarily for the following: • additional personnel costs, including salaries, benefits and potential
bonuses and/or stock-based compensation awards for staff additions to
replace support provided by Danaher that is not covered by the Transition
Services Agreement; and
• corporate governance costs, including board of director compensation and
expenses, audit and other professional services fees, annual report and
proxy statement costs,
and legal fees and stock exchange listing fees.
Certain factors could impact the nature and amount of these separate public
company costs, including the finalization of our staffing and infrastructure
needs. Moreover, we are incurring and expect to incur certain nonrecurring
internal costs to implement certain new systems, although we believe such costs
going forward will not have a material impact on our financial statements.
46
--------------------------------------------------------------------------------Our business consists of two segments: Specialty Products & Technologies and Equipment & Consumables. For additional details regarding these businesses, refer to "Item 1. Business" included in this Annual Report on Form 10-K.
OVERVIEW
General
We provide products that are used to diagnose, treat and prevent disease and ailments of the teeth, gums and supporting bone, as well as to improve the aesthetics of the human smile. With leading brand names, innovative technology and significant market positions, we are a leading worldwide provider of a broad range of dental implants, orthodontic appliances, general dental consumables, equipment and services, and are dedicated to driving technological innovations that help dental professionals improve clinical outcomes and enhance productivity. Our research and development, manufacturing, sales, distribution, service and administrative facilities are located in more than 30 countries acrossNorth America ,Asia ,Europe , theMiddle East andLatin America . During 2019, 56% of our sales were derived from customers outsidethe United States . As a global provider of dental consumables, equipment and services, our operations are affected by worldwide, regional and industry-specific economic and political factors. Given the broad range of dental products, software and services provided and geographies served, we do not use any indices other than general economic trends to predict our overall outlook. Our individual businesses monitor key competitors and customers, including to the extent possible their sales, to gauge relative performance and the outlook for the future. As a result of our geographic and product line diversity, we face a variety of opportunities and challenges, including rapid technological development in most of our served markets, the expansion and evolution of opportunities in emerging markets, trends and costs associated with a global labor force, consolidation of our competitors and increasing regulation. We operate in a highly competitive business environment in most markets, and our long-term growth and profitability will depend in particular on our ability to expand our business in emerging geographies and emerging market segments, identify, consummate and integrate appropriate acquisitions, develop innovative and differentiated new products and services, expand and improve the effectiveness of our sales force, continue to reduce costs and improve operating efficiency and quality and effectively address the demands of an increasingly regulated global environment. We are making significant investments to address the rapid pace of technological change in our served markets and to globalize our manufacturing, research and development and customer-facing resources (particularly in emerging markets and our dental implant business) in order to be responsive to our customers throughout the world and improve the efficiency of our operations. Key Trends and Conditions Affecting Our Results of Operations Industry Trends We operate in the large and growing global dental products industry. We believe growth in the global dental industry will be driven by: • an aging population;
• the current underpenetration of dental procedures, especially in emerging
markets;
• improving access to complex procedures due to increasing technological
innovation;
• an increasing demand for cosmetic dentistry; and
• growth of DSOs, which are expected to drive increasing penetration of, and
access to, dental care globally.
Product Development, New Product Launches andCommercial Investment A key element of our targeted value creation strategy is to drive growth through portfolio development and product innovation. Our future growth and success depend on both our pipeline of new products and technologies, including new products and technologies that we may obtain through license or acquisition, and the expansion of the use of our existing products and technologies. We believe we are a leader in dental research and development ("R&D"), with$155 million of R&D expenditures in 2019 and a track record of product innovation, business development and commercialization. Additionally, investment in our commercial sales organization, particularly within our implant business and in emerging markets, is critical to our growth strategy. Our sales in emerging markets grew at a low-single digit compounded annual growth rate from 2017 through 2019 with sales inChina growing at a compounded annual growth rate above 10% during this time period. 47 -------------------------------------------------------------------------------- Foreign Exchange Rates Significant portions of our sales and costs are exposed to changes in foreign exchange rates. During the year endedDecember 31, 2019 , our products were sold in more than 100 countries and 56% of our sales were denominated in foreign currencies. We seek to manage our foreign exchange risk, in part, through our operations, including managing same-currency sales in relation to same-currency costs and same-currency assets in relation to same-currency liabilities. As our operations use multiple foreign currencies, including the euro, British pound, Brazilian real, Australian dollar, Japanese yen, Canadian dollar and Chinese yuan, changes in those currencies relative to theU.S. dollar will impact our sales, cost of sales and expenses, and consequently, net income. Exchange rate fluctuations in emerging markets may also directly affect our customers' ability to buy our products in these geographic markets. In the year endedDecember 31, 2019 , our period-over-period sales growth was unfavorably impacted by 2.5% from changes in foreign currency exchange rates relative to theU.S. dollar. General Economic Conditions In addition to industry-specific factors, we, like other businesses, face challenges related to global economic conditions. Dental costs are largely out-of-pocket for the consumer and thus utilization rates can vary significantly depending on economic growth. While many of our products are considered necessary by patients regardless of the economic environment, certain products and services that support discretionary dental procedures may be more susceptible to changes in economic conditions. Manufacturing and Supply In order to sell our products, we must be able to reliably produce and ship our products in sufficient quantities. Many of our products involve complex manufacturing processes and are produced at one or a limited number of manufacturing sites. Minor deviations in our manufacturing or logistical processes, unpredictability of a product's regulatory or commercial success or failure, the lead time necessary to construct highly technical and complex manufacturing sites and shifting customer demand increase the potential for capacity imbalances. For a discussion of risks relating to our manufacturing process, refer to "Item 1A. Risk Factors-Risks Related to Our Business." Components of Sales and Costs and Expenses Sales Our sales are primarily derived from the sale of dental consumables, equipment and services to third-party distributors and end-users. For additional information regarding our products, including descriptions of our products, refer to "Item 1. Business-Business Segments." Costs and Expenses and Other Cost of sales consists primarily of cost of materials, facilities and other infrastructure used to manufacture our products and shipping and handling costs attributable to delivering our products to our customers. Also included in cost of sales are productivity improvement and restructuring expenses related to our manufacturing operations. Selling, general and administrative ("SG&A") expenses consist of, among other things, the costs of selling, marketing, promotion, advertising and administration (including business technology, facilities, legal, finance, human resources, business development and procurement) and amortization expense for intangible assets that have been acquired through business combinations. Also included in SG&A are productivity improvement and restructuring expenses related to our administrative operations. R&D expenses consist of project costs specific to new product R&D and product lifecycle management, overhead costs associated with R&D operations, regulatory costs, product registrations and investments that support local market clinical trials for approved indications. We manage overall R&D based on our strategic opportunities and do not disaggregate our R&D expenses by the nature of the expense or by product as we do not use or maintain such information in managing our business. Nonoperating income (expense) consists of the non-service cost components of net periodic benefit costs (which include interest costs, expected return on plan assets, amortization of prior service cost or credits and actuarial gains and losses). 48 -------------------------------------------------------------------------------- Business Performance During the year endedDecember 31, 2019 , our sales decreased 3.5%, while core sales were flat as compared to the comparable period of 2018. In order to establish period-to-period comparability, beginning with the third quarter of 2019 (the first quarter during which we reported our results as a separate, public company), we modified the definition of core sales to exclude the impact from sales of discontinued products (for the definition of "core sales" or "core revenue" refer to "Results of Operations" below). The impact of foreign currency exchange rates reduced sales in the year endedDecember 31, 2019 by 2.5% compared to the comparable period of 2018. The impact of discontinued products decreased revenues in the year endedDecember 31, 2019 by 1.0%. Geographically, core sales growth in emerging markets was partially offset by decreasing core sales in developed markets during the year endedDecember 31, 2019 . Core sales in emerging markets increased at a mid-single digit rate during the year endedDecember 31, 2019 as compared to 2018, led primarily by continued strength inChina . Emerging markets represented approximately 24% of our sales for the year endedDecember 31, 2019 . Core sales in developed markets decreased at a low-single digit rate during the year endedDecember 31, 2019 as compared to 2018, primarily due to declines inWestern Europe andNorth America . For additional information regarding our sales by geographical region during the years endedDecember 31, 2019 and 2018, refer to Note 16 to our audited consolidated and combined financial statements in this Annual Report on Form 10-K. Acquisitions Our growth strategy contemplates future acquisitions. Our operations and results can be affected by the rate and extent to which appropriate acquisition opportunities are available, acquired businesses are effectively integrated and anticipated synergies or cost savings are achieved. There were no material business acquisitions during the years endedDecember 31, 2019 and 2018. In 2017, we acquired the remaining noncontrolling interest and settled other related liabilities associated with one of our prior business combinations in our Specialty Products & Technologies segment for consideration of$89 million . Currency Exchange Rates On a year-over-year basis, currency exchange rates negatively impacted reported sales by approximately 2.5% for the year endedDecember 31, 2019 compared to the comparable period of 2018, primarily due to the strength of theU.S. dollar against most major currencies. Any future strengthening of theU.S. dollar against major currencies would adversely impact our sales and results of operations for the remainder of the year, and any weakening of theU.S. dollar against major currencies would positively impact our sales and results of operations for the remainder of the year.U.S. Tax Cuts and Jobs Act OnDecember 22, 2017 , theU.S. Tax Cuts and Jobs Act ("TCJA") was enacted, which substantially changed theU.S. tax system, including lowering the corporate tax rate from 35% to 21% (beginning in 2018). As a result of the TCJA, we recognized a provisional tax liability of approximately$36 million in 2017 for the transition tax on deemed repatriation of foreign earnings. We also remeasuredU.S. deferred tax assets and liabilities based on the income tax rates at which the deferred tax assets and liabilities are expected to reverse in the future (generally 21%), resulting in an income tax benefit of approximately$73 million . In 2018, we finalized the provisional amounts recorded in 2017. The net tax effect to adjust the provisional amounts was not material to our consolidated and combined financial statements. For further discussion of the TCJA, refer to "-Income Taxes." 49 --------------------------------------------------------------------------------UK's Referendum Decision to Exit the EU In a referendum onJune 23, 2016 , voters approved for theUK to exit the EU. A withdrawal agreement negotiated by and between theUK prime minister and the EU was ratified by theUK parliament inDecember 2019 . TheUK exited the EU onJanuary 31, 2020 . A transition period began and business will remain as usual while theUK remains in the EU customs union untilDecember 31, 2020 . There is uncertainty as to what will occur after theDecember 31st deadline and the nature of theUK's future relationship with the EU is still unclear. We continue to monitor the status of Brexit and plan for potential impacts. To mitigate the potential impact of Brexit on the import of goods to theUK , we have increased our level of inventory within theUK . The ultimate impact of Brexit on our financial results is uncertain. For additional information, refer to "Item 1A. Risk Factors-General Risks" section of this Annual Report. Public Company Expenses As a result of the Separation, we are subject to the Sarbanes-Oxley Act and reporting requirements of the Exchange Act. We are now required to have additional procedures and practices as a separate public company. As a result, we have incurred and will continue to incur additional personnel and corporate governance costs, including internal audit, investor relations, stock administration and regulatory compliance costs. RESULTS OF OPERATIONS The following discussion and analysis of our consolidated and combined statements of earnings should be read along with our audited consolidated and combined financial statements included elsewhere in this Annual Report on Form 10-K. For more information on the consolidated and combined basis of preparation, see Note 1 to our audited consolidated and combined financial statements elsewhere in this Annual Report on Form 10-K. Year Ended December 31, % Change % Change ($ in millions) 2019 2018 2017 2019/2018 2018/2017 Sales$ 2,751.6 $ 2,844.5 $ 2,810.9 (3.3 )% 1.2 % Cost of sales 1,238.5 1,242.7 1,189.7 (0.3 )% 4.5 % % of sales 45.0 % 43.7 % 42.3 % Gross profit 1,513.1 1,601.8 1,621.2 (5.5 )% (1.2 )% % of sales 55.0 % 56.3 % 57.7 % Operating costs: SG&A expenses 1,080.9 1,131.4 1,062.2 (4.5 )% 6.5 % % of sales 39.3 % 39.8 % 37.8 % R&D expenses 154.7 172.0 172.4 (10.1 )% (0.2 )% % of sales 5.6 % 6.0 % 6.1 % Operating profit 277.5 298.4 386.6 (7.0 )% (22.8 )% % of sales 10.1 % 10.5 % 13.8 % Nonoperating income (expense), net 1.5 2.7 0.1 NM NM Interest expense, net (3.5 ) - - NM - % Earnings before income taxes 275.5 301.1 386.7 (8.5 )% (22.1 )% % of sales 10.6 % 10.6 % 13.8 % Income taxes 57.9 70.4 85.6 (17.8 )% (17.8 )% Net income 217.6 230.7 301.1 (5.7 )% (23.4 )% 50
-------------------------------------------------------------------------------- Non-GAAP Measures In order to establish period-to-period comparability, beginning with the third quarter of 2019 (the first quarter during which we reported our results as a separate, public company), we modified the definition of core sales to exclude the impact from sales of discontinued products. We exclude sales from discontinued products because discontinued products do not have a continuing contribution to operations and management believes that excluding such items provides investors with a means of evaluating our on-going operations and facilitates comparisons to our peers. Core growth for the year endedDecember 31, 2019 , set forth in this Management's Discussion and Analysis of Financial Condition and Results of Operations excludes the impact from sales of discontinued products. For all other periods set forth in this Management's Discussion and Analysis of Financial Condition and Results of Operations or elsewhere in this Annual Report on Form 10-K, the impact from sales of discontinued products is included in core sales growth. References to the non-GAAP measure of core sales (also referred to as core revenues or sales/revenues from existing businesses) refer to sales calculated according to GAAP, but excluding: • sales from acquired businesses;
• sales from discontinued products; and
• the impact of currency translation.
Sales from discontinued products includes major brands or major products that we have made the decision to discontinue as part of a portfolio restructuring. Discontinued brands or products consist of those which we (1) are no longer manufacturing, (2) are no longer investing in the research or development of, and (3) expect to discontinue all significant sales of within one year from the decision date to discontinue. The portion of sales attributable to discontinued brands or products is calculated as the net decline of the applicable discontinued brand or product from period-to-period. The portion of sales attributable to currency translation is calculated as the difference between: • the period-to-period change in sales; and
• the period-to-period change in sales after applying current period foreign
exchange rates to the prior year period.
Core sales growth should be considered in addition to, and not as a replacement
for or superior to, sales, and may not be comparable to similarly titled
measures reported by other companies. We believe that reporting the non-GAAP
financial measure of core sales growth provides useful information to investors
by helping identify underlying growth trends in our on-going business and
facilitating comparisons of our sales performance with our performance in prior
and future periods and to our peers. We also use core sales growth to measure
our operating and financial performance. We exclude the effect of currency
translation from core sales because currency translation is not under our
control, is subject to volatility and can obscure underlying business trends.
Throughout this discussion, references to sales volume refer to the impact of
both price and unit sales and references to productivity improvements generally
refer to improved cost-efficiencies resulting from the ongoing application of
EBS. We believe our deep-rooted commitment to EBS helps drive our market
leadership and differentiates us in the dental products industry. EBS
encompasses not only lean tools and processes, but also methods for driving
growth, innovation and leadership. Within the EBS framework, we pursue a number
of ongoing strategic initiatives relating to customer insight generation,
product development and commercialization, efficient sourcing, and improvement
in manufacturing and back-office support, all with a focus on continually
improving quality, delivery, cost, growth and innovation.
Core Sales Growth
2019 vs. 2018 2018 vs. 2017
Total sales growth (GAAP) (3.5 )% 1.0 %
Less the impact of:
Discontinued products 1.0 % - %
Currency exchange rates 2.5 % (0.5 )%
Core sales growth (non-GAAP) - % 0.5 %
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2019 Compared to 2018
Operating profit margins were 10.1% for the year ended
spending on productivity initiatives and discretionary expenses, lower R&D
spend and cost savings associated with productivity initiatives - 40 basis
points
2018 Compared to 2017
Operating profit margins were 10.5% for the year ended December 31, 2018 as
compared to 13.8% in 2017. The following factors impacted year-over-year
operating profit margin comparisons:
2018 vs 2017 operating profit margin comparisons were favorably impacted by:
• Trade name impairments and the cost of related productivity improvement
initiatives in 2017 - 45 basis points
2018 vs 2017 operating profit margin comparisons were unfavorably impacted by: • Lower 2018 sales of equipment and traditional consumables, incremental
year-over-year costs associated with sales and marketing growth
investments, lower overall pricing and the effect of year-over-year
changes in currency exchange rates, net of incremental year-over-year cost
savings associated with the continuing productivity improvement
initiatives taken in 2018 and 2017 and higher core sales in specialty
consumables - 200 basis points
• The 2018 costs and estimated liability related to a legal contingency -
130 basis points
• The 2017 gain related to the settlement of liabilities associated with an
interest in a prior business combination and the incremental net dilutive
effect in 2018 of acquired businesses - 45 basis points
Business Segments
Sales by business segment were as follows ($ in millions):
For the Year Ended December 31,
2019 2018 2017
Specialty Products & Technologies $ 1,342.7 $ 1,369.8 $ 1,310.6
Equipment & Consumables 1,408.9 1,474.7 1,500.3
Total $ 2,751.6 $ 2,844.5 $ 2,810.9
SPECIALTY PRODUCTS & TECHNOLOGIES
Our Specialty Products & Technologies segment develops, manufactures and markets
dental implant systems, dental prosthetics and associated treatment software and
technologies, as well as orthodontic bracket systems, aligners and lab products.
Specialty Products & Technologies Selected Financial Data
For the Year Ended December 31,
($ in millions) 2019 2018 2017
Sales $ 1,342.7 $ 1,369.8 $ 1,310.6
Operating profit 227.7 241.3 246.0
Depreciation 17.7 17.9 19.4
Amortization 57.7 59.0 52.4
Operating profit as a % of sales 17.0 % 17.6 % 18.8 %
Depreciation as a % of sales 1.3 % 1.3 % 1.5 %
Amortization as a % of sales 4.3 % 4.3 % 4.0 %
52--------------------------------------------------------------------------------
Core Sales Growth
2019 vs. 2018 2018 vs. 2017
Total sales growth (GAAP) (2.0 )% 4.5 %
Less the impact of:
Discontinued products 1.5 % - %
Currency exchange rates 2.0 % (1.0 )%
Core sales growth (non-GAAP) 1.5 % 3.5 %
2019 Compared to 2018
Price in the segment negatively impacted sales growth by 1.0% on a
year-over-year basis in the year ended December 31, 2019 , and is reflected as a
component of core sales growth.
Core sales growth for the segment was led by emerging markets, primarily China ,
partially offset by declines in Western Europe and North America , for the year
ended December 31, 2019 . Core sales for premium implant systems increased,
partially offset by a decrease in core sales for value implant systems due to
lower demand. Increased demand for orthodontic products was partially due to
recent product launches.
Operating profit margins decreased 60 basis points during the year ended
December 31, 2019 as compared to 2018. The following factors unfavorably
impacted year-over-year operating profit margin comparisons:
• Lower overall sales price and incremental year-over-year costs associated
with various new product development and growth investments, partially
offset by higher core sales volumes, and incremental year-over-year cost
savings associated with continuing productivity improvement initiatives
taken in 2018 - 60 basis points
2018 Compared to 2017 Price in the segment negatively impacted sales growth by 0.5% on a year-over-year basis during 2018 as compared to 2017, and is reflected as a component of core sales growth. Geographically, year-over-year core sales growth in 2018 was led by the emerging markets, primarilyChina andNorth America . Core sales for implant systems increased, driven by demand inNorth America and the emerging markets. Core sales growth for orthodontic products was led byChina andRussia partially offset by weaker demand inNorth America . Operating profit margins declined 120 basis points during 2018 as compared to 2017. The following factors impacted year-over-year operating profit margin comparisons: 2018 vs 2017 operating profit margin comparisons were favorably impacted by: • Incremental year-over-year costs related to productivity improvement
initiatives taken in 2017 - 20 basis points
2018 vs 2017 operating profit margin comparisons were unfavorably impacted by: • Incremental year-over-year costs associated with sales and marketing
growth investments, unfavorable product mix and lower overall pricing,
partially offset by higher 2018 sales from existing businesses, cost
savings associated with productivity improvement initiatives taken in 2018
and 2017 and year-over-year changes in currency exchange rates - 140 basis
points
In 2018, we determined that certain trade names in the segment were finite-lived
and we began amortizing these trade names as of January 1, 2018 . This
determination resulted in an increase in amortization expense as a percentage of
sales during 2018 as compared to 2017.
EQUIPMENT & CONSUMABLES
Our Equipment & Consumables segment develops, manufactures and markets dental
equipment and supplies used in dental offices, including digital imaging
systems, software and other visualization/magnification systems; handpieces and
associated consumables; treatment units and other dental practice equipment;
endodontic systems and related consumables; restorative materials and
instruments, rotary burs, impression materials, bonding agents and cements and
infection prevention products.
53
--------------------------------------------------------------------------------Equipment & Consumables Selected Financial Data
For the Year Ended December 31,
($ in millions) 2019 2018 2017
Sales $ 1,408.9 $ 1,474.7 $ 1,500.3
Operating profit 105.8 120.5 152.9
Depreciation 19.6 20.3 19.3
Amortization 31.8 31.6 29.3
Operating profit as a % of sales 7.5 % 8.2 % 10.2 %
Depreciation as a % of sales 1.4 % 1.4 % 1.3 %
Amortization as a % of sales 2.3 % 2.1 % 2.0 %
Core Sales Growth
2019 vs. 2018 2018 vs. 2017
Total sales growth (GAAP) (4.5 )% (1.5 )%
Less the impact of:
Discontinued products 1.0 % - %
Acquisitions and other - % (0.5 )%
Currency exchange rates 2.5 % (0.5 )%
Core sales growth (non-GAAP) (1.0 )% (2.5 )%
2019 Compared to 2018
Price in the segment negatively impacted sales growth by 0.5% on a
year-over-year basis in the year ended December 31, 2019 , and is reflected as a
component of core sales growth.
Core sales for the segment decreased in the year ended December 31, 2019 as
demand in China was offset by lower sales in North America and Western Europe .
Equipment core sales decreased in North America due to lower demand. Core sales
of traditional consumables decreased due to lower demand in North America and
Western Europe , partially offset by growth in China .
Operating profit margins decreased 70 basis points during the year ended
December 31, 2019 as compared to 2018. The following factors impacted
year-over-year operating profit margin comparisons:
• Lower core sales volumes and overall sales price, incremental
year-over-year costs associated with sales and marketing growth
investments and new product development initiatives in 2019, partially
offset by decreases in productivity improvement and restructuring related
charges in 2019 compared to 2018 and cost savings associated with
productivity initiatives taken in 2018 - 70 basis points
2018 Compared to 2017 Price in the segment negatively impacted sales growth by 0.5% on a year-over-year basis during 2018 as compared with 2017 and is reflected as a component of core sales growth. Year-over-year core sales declined as lower demand inNorth America andWestern Europe more than offset increased demand in emerging markets. Core sales of equipment declined in 2018 primarily due to declines inNorth America due to the realignment of distributors and manufacturers in the dental industry. Demand for traditional consumable product lines inNorth America andWestern Europe declined year-over-year reflecting inventory destocking by several distribution partners. Operating profit margins declined 200 basis points during 2018 as compared to 2017. The following factors impacted year-over-year operating profit margin comparisons: 2018 vs 2017 operating profit margin comparisons were favorably impacted by: • Trade name impairments and the cost of related productivity improvement initiatives in 2017 - 65 basis points 54
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2018 vs 2017 operating profit margin comparisons were unfavorably impacted by: • Lower 2018 sales of equipment and traditional consumables, lower overall
pricing, incremental year-over-year costs associated with sales and
marketing growth investments and the impact of year-over-year changes in
foreign currency exchange rates, net of cost savings associated with
productivity initiatives taken in 2018 and 2017 - 255 basis points
• The incremental net dilutive effect in 2018 of acquired businesses
- 10 basis points
COST OF SALES AND GROSS PROFIT
For the Year Ended December 31,
($ in millions) 2019 2018 2017
Sales $ 2,751.6 $ 2,844.5 $ 2,810.9
Cost of sales 1,238.5 1,242.7 1,189.7
Gross profit $ 1,513.1 $ 1,601.8 $ 1,621.2
Gross profit margin 55.0 % 56.3 % 57.7 %
2019 Compared to 2018
The decrease in cost of sales during the year ended December 31, 2019 as
compared to 2018 was primarily due to lower sales with an unfavorable sales mix
and the impact of foreign currency exchange rates.
The year-over-year decrease in gross profit margin during the year ended
December 31, 2019 as compared to 2018 was due primarily to lower overall pricing
and unfavorable sales mix, partially offset by incremental year-over-year cost
savings associated with restructuring activities and continued productivity
improvement actions taken in 2018 and the impact of foreign currency exchange
rates in 2019.
2018 Compared to 2017
Cost of sales increased $53 million , or 4.5%, during 2018 as compared with 2017
due primarily to the impact of higher sales volumes of specialty products,
product mix and the impact of foreign currency exchange rates partially offset
by lower sales of equipment and traditional consumables and incremental
year-over-year cost savings associated with the restructuring and continued
productivity improvement actions taken in 2018 and 2017.
Gross profit margins decreased 140 basis points on a year-over-year basis during
2018 as compared to 2017, due primarily to unfavorable product mix, lower
overall pricing and the impact of foreign currency exchanges rates, partially
offset by incremental year-over-year cost savings associated with restructuring
activities and continued productivity improvement actions taken in 2018 and
2017.
OPERATING EXPENSES
For the Year Ended December 31,
($ in millions) 2019 2018 2017
Sales $ 2,751.6 $ 2,844.5 $ 2,810.9
Selling, general and administrative expenses 1,080.9 1,131.4 1,062.2
Research and development expenses 154.7 172.0 172.4 SG&A as a % of sales 39.3 % 39.8 % 37.8 % R&D as a % of sales 5.6 % 6.0 % 6.1 % 2019 Compared to 2018 The year-over-year decrease in SG&A expenses as a percentage of sales for the year endedDecember 31, 2019 as compared to 2018 was primarily due to lower discretionary spend, incremental year-over-year savings associated with the restructuring and continued productivity improvement actions taken in 2018, partially offset by continued investments in sales and marketing growth initiatives, lower expenses for legal matters and incremental corporate costs. 55 -------------------------------------------------------------------------------- Year-over-year, R&D expenses (consisting principally of internal and contract engineering personnel costs) as a percentage of sales decreased during the year endedDecember 31, 2019 as compared to 2018 primarily due to a decrease in spending on product development initiatives, partially offset by lower sales in 2019. 2018 Compared to 2017 SG&A expenses as a percentage of sales increased 200 basis points on a year-over-year basis for 2018 compared to 2017. The increase was primarily due to continued investments in sales and marketing growth initiatives and a provision for legal matters of$36 million , partially offset by incremental year-over-year savings associated with the restructuring and continued productivity improvement actions taken in 2018 and 2017 and lower costs associated with 2018 restructuring actions compared to 2017 restructuring actions. R&D expenses as a percentage of sales decreased 10 basis points on a year-over-year basis in 2018 as compared to 2017 primarily as a result of increased sales in 2018. Total R&D spending was essentially flat on a year-over-year basis in 2018 as compared to 2017. NONOPERATING INCOME (EXPENSE), NET As described in Note 10 to our audited consolidated and combined financial statements, we adopted ASU No. 2017-07, Compensation-Retirement Benefits (Topic 715): Improving the Presentation of Net Periodic Pension Cost and Net Periodic Postretirement Benefit Cost onJanuary 1, 2017 . The ASU requires companies to disaggregate the service cost component from the other components of net periodic benefit costs and requires companies to present the other components of net periodic benefit cost in nonoperating income (expense), net. The ASU requires application on a retrospective basis. The other components of net periodic benefit costs included in nonoperating income (expense), net for the years endedDecember 31, 2019 , 2018 and 2017 were$1.5 million ,$2.7 million , and$0.1 million , respectively. INTEREST COSTS AND FINANCING For a discussion of our outstanding indebtedness, refer to Note 13 to our audited consolidated and combined financial statements elsewhere in this Annual Report on Form 10-K. INCOME TAXES General Income tax expense and deferred tax assets and liabilities reflect management's assessment of future taxes expected to be paid on items reflected in our consolidated and combined financial statements. We record the tax effect of discrete items and items that are reported net of their tax effects in the period in which they occur. Our effective tax rate can be affected by changes in the mix of earnings in countries with different statutory tax rates (including as a result of business acquisitions and dispositions), changes in the valuation of deferred tax assets and liabilities, accruals related to contingent tax liabilities and period-to-period changes in such accruals, the results of audits and examinations of previously filed tax returns, the expiration of statutes of limitations, the implementation of tax planning strategies, tax rulings, court decisions, settlements with tax authorities and changes in tax laws and regulations, including the TCJA and legislative policy changes that may result from theOECD's initiative on Base Erosion and Profit Shifting. For a description of the tax treatment of earnings that are planned to be reinvested indefinitely outsidethe United States , refer to "-Liquidity and Capital Resources" below. As GAAP accounting for income taxes requires the effect of a change in tax laws or rates to be recognized in income from continuing operations for the period that includes the enactment date, we recognized an estimate of the impact of the TCJA in the year endedDecember 31, 2017 under the separate return method. As a result of the TCJA, we recognized a provisional tax liability of$36 million in 2017 for the Transition Tax. We also remeasuredU.S. deferred tax assets and liabilities based on the income tax rates at which the deferred tax assets and liabilities are expected to reverse in the future (generally 21%), resulting in an income tax benefit of$73 million in 2017. The TCJA imposes tax onU.S. stockholders for global intangible low-taxed income (GILTI) earned by certain foreign subsidiaries. We are required to make an accounting policy election of either: (1) treating taxes due on future amounts included inU.S. taxable income related to GILTI as a current period tax expense when incurred (the "period cost method"); or (2) factoring such amounts into our measurement of our deferred tax expense (the "deferred method"). In 2018, we elected the period cost method for our accounting for GILTI. 56 --------------------------------------------------------------------------------
Year-Over-Year Changes in the Effective Tax Rate
For the Year Ended December 31,
2019 2018 2017
Effective tax rate 21.0 % 23.4 % 22.1 %
Our effective tax rate for the years ended December 31, 2018 and 2017 differs
from the U.S. federal statutory rates of 21.0% for 2018 and 35.0% for 2017, due
principally to our earnings outside the United States that are indefinitely
reinvested and taxed at rates different than the U.S. federal statutory rate. In
addition:
• The effective tax rate of 21.0% in 2019 includes 240 basis points of net
tax benefits primarily related to the excess tax benefit associated with
the exercise of employee stock options and vesting of RSUs, as well as the
release of reserves upon the expiration of statutes of limitation,
partially offset by increases for changes in estimates associated with
prior period uncertain tax positions and a valuation allowance on losses
attributable to certain foreign jurisdictions.
• The effective tax rate of 23.4% in 2018 includes 60 basis points of net
tax benefits primarily related to the excess tax benefit associated with
the exercise of employee stock options and vesting of RSUs, as well as the
release of reserves upon the expiration of statutes of limitation,
partially offset by increases in net reserves from audit settlements.
• The effective tax rate of 22.1% in 2017 includes 900 basis points of net
tax benefits primarily related to the revaluation of net
liabilities from 35.0% to 21.0% due to the TCJA as well as the excess tax
benefit related to the exercise of employee stock options and vesting of
RSUs, partially offset by income tax expense related to the Transition Tax
on foreign earnings due to the TCJA as well as a valuation allowance on
losses attributable to certain foreign jurisdictions.
We conduct business globally and file numerous income tax returns in U.S.
federal, state and foreign jurisdictions. The non-U.S. countries in which we
have a material presence include Canada , China , Finland , Germany and
Switzerland . We believe that a change in the statutory tax rate of any
individual foreign country would not have a material effect on our consolidated
and combined financial statements given the geographic dispersion of our taxable
income.
We are routinely examined by various domestic and international taxing
authorities. In connection with the Separation, we entered into the agreements
with Danaher, including the Tax Matters Agreement. The Tax Matters Agreement
distinguishes between the treatment of tax matters for "Joint" filings compared
to "Separate" filings prior to the Separation. "Joint" filings involve legal
entities, such as those in the United States , that include both Danaher's and
our operations. By contrast, "Separate" filings involve certain entities
(primarily outside of the United States ), that exclusively include either
Danaher's or our operations, respectively. In accordance with the Tax Matters
Agreement, Danaher is liable for and has indemnified us against all income tax
liabilities involving "Joint" filings for periods prior to the Separation. We
remain liable for certain pre-Separation income tax liabilities including those
related to our "Separate" filings. Pursuant to U.S. tax law, we expect to file
an initial U.S. federal income tax return for the 2019 short tax year with the
IRS during 2020. Therefore, the IRS has not yet begun an examination of our
initial U.S. federal income tax return. Our operations in certain U.S. states
and foreign jurisdictions remain subject to routine examination for tax years
beginning with 2009.
We perform a comprehensive review of our global tax positions on a quarterly
basis. Based on these reviews, the results and resolutions of matters with tax
authorities, tax rulings and court decisions, expiration of statutes of
limitations, and reserves for uncertain tax positions are accrued and adjusted
as necessary. For a discussion of risks related to these and other tax matters,
refer to "Risk Factors-General Risks."
COMPREHENSIVE INCOME
2019 Compared to 2018
For the year ended December 31, 2019 , comprehensive income decreased $1 million
as compared to 2018. The decrease was primarily due to lower net income and
higher pension plan losses, partially offset by lower foreign currency
translation losses.
57
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2018 Compared to 2017
Comprehensive income decreased $397 million in 2018 as compared to 2017,
primarily due to a loss of $85 million from foreign currency translation
adjustments in 2018 as compared to a translation gain of $252 million in 2017 as
well as lower net income in 2018. We also recorded a gain on pension plan
adjustments of $7 million for 2018 compared to a loss of $3 million for 2017.
INFLATION
The effect of inflation on our sales and net income was not significant in any
of the years ended
LIQUIDITY AND CAPITAL RESOURCES
Before the Separation, we were dependent upon Danaher for all of our working
capital and financing requirements under Danaher's centralized approach to cash
management and financing of its operations. Our financial transactions were
accounted for through our former parent investment, net account. Accordingly,
none of Danaher's cash, cash equivalents or debt has been assigned to us for the
periods prior to the Separation.
As a result of the Separation, we no longer participate in Danaher's cash
management and financing operations. We assess our liquidity in terms of our
ability to generate cash to fund our operating and investing activities. We
continue to generate substantial cash from operating activities and believe that
our operating cash flow and other sources of liquidity are sufficient to allow
us to manage our capital structure on a short-term and long-term basis and
continue investing in existing businesses and consummating strategic
acquisitions.
Following is an overview of our cash flows and liquidity:
Overview of Cash Flows and Liquidity
Year Ended December 31,
($ in millions) 2019 2018 2017
Net cash provided by operating activities $ 397.5 $
400.1
Payments for additions to property, plant and equipment$ (77.8 ) $ (72.2 ) $ (48.9 ) Proceeds from sales of property, plant and equipment 1.6 - 0.1 All other investing activities (2.2 ) (3.3 ) (6.1 ) Net cash used in investing activities$ (78.4 ) $
(75.5 )
Proceeds from the public offering of common stock, net of issuance costs
$ 643.4 $
- $ - Consideration paid to Danaher in connection with the Separation
(1,950.0 ) - -
Net proceeds from borrowings, net of deferred costs 1,315.9 - -
Repayment of borrowings (0.3 ) - -
Net transfers to Former Parent (116.5 ) (324.6 ) (215.2 ) Payment for purchase of noncontrolling interest and related transactions
- - (89.0 )
All other financing activities (0.2 ) - -
Net cash used in financing activities $ (107.7 ) $
(324.6 )
Operating Activities Cash flows from operating activities can fluctuate significantly from period-to-period for working capital needs and the timing of payments for income taxes, restructuring activities, pension funding and other items impacting reported cash flows. Net cash provided by operating activities was$397.5 million during the year endedDecember 31, 2019 and$400.1 million in 2018. The decrease was primarily due to lower net income and higher levels of prepaid expenses and other assets, accrued liabilities and payments of operating lease liabilities, partially offset by higher levels of working capital and higher non-cash expenses on a year-over-year basis. 58 -------------------------------------------------------------------------------- Investing Activities Cash flows relating to investing activities consist primarily of cash used for capital expenditures. Capital expenditures are made primarily for increasing capacity, replacing equipment, supporting new product development and improving information technology systems. Net cash used in investing activities increased by$3 million during the year endedDecember 31, 2019 as compared to 2018. The increase was primarily driven by expenditures to increase production capacity in the Specialty Products & Technologies segment and expenditures related to becoming a separate company. Financing Activities and Indebtedness Cash flows relating to financing activities consist primarily of cash flows associated with the issuance of common stock, debt borrowings and transfers to Danaher prior to the Separation. Net cash used in financing activities was$108 million during the year endedDecember 31, 2019 compared to$325 million of cash used in 2018. The year-over-year decrease in cash used in financing activities was primarily due to lower transfers to Danaher prior to the Separation. We borrowed approximately$1.3 billion under senior credit facilities and received net proceeds of$643 million from the IPO. These proceeds were paid to Danaher as partial consideration for Danaher's transfer of the assets and liabilities of its Dental business to us. For a description of our outstanding debt as ofDecember 31, 2019 and the senior credit facilities, refer to Note 13 to our audited consolidated and combined financial statements in this Annual Report on Form 10-K. We intend to satisfy any short-term liquidity needs that are not met through operating cash flow and available cash primarily through our revolving credit facility. As ofDecember 31, 2019 , we had no borrowings outstanding under the revolving credit facility and we had the ability to incur an additional$250 million of indebtedness in direct borrowings under the revolving credit facility. As ofDecember 31, 2019 , we were in compliance with all of our debt covenants. 2018 Compared to 2017 Net cash provided by operating activities increased$41.0 million during 2018 as compared to 2017. A reduction in net income was more than offset by a reduction in cash used for trade accounts receivables, inventories and accounts payable compared with the prior year. The aggregate of prepaid expenses and other assets, deferred taxes and accrued expenses also provided a higher source of cash in 2018 compared to 2017. The timing of various employer related liabilities, customer funding and accrued expenses drove the majority of this change. Net cash used in investing activities increased$20.6 million during 2018 as compared to 2017, due primarily to an increase in capital expenditures during 2018 to increase production capacity in the Specialty Products & Technologies segment. Net cash used in financing activities increased$20.4 million during 2018 as compared to 2017 as we returned more cash to Danaher in 2018 as compared to 2017 partially offset by cash paid for the purchase of a noncontrolling interest in 2017. Cash and Cash Requirements Until the Separation, we were dependent upon Danaher for all of our working capital and financing requirements under Danaher's centralized approach to cash management and financing of operations of its subsidiaries. Because we were part of Danaher for the periods prior to Separation, no cash, cash equivalents and borrowings were included in our audited combined financial statements as ofDecember 31, 2018 . For all periods prior to the Separation, other financial transactions relating to our business operations were accounted for through our former parent investment, net account. 59 -------------------------------------------------------------------------------- As ofDecember 31, 2019 , we held$211 million of cash and equivalents that were held on deposit with financial institutions. Of this amount,$14 million was held withinthe United States and$197 million was held outside ofthe United States . We will continue to have cash requirements to support working capital needs, capital expenditures and acquisitions, pay interest and service debt, pay taxes and any related interest or penalties, fund our restructuring activities and pension plans as required, repurchase shares of our common stock and support other business needs. We generally intend to use available cash and internally generated funds to meet these cash requirements, but in the event that additional liquidity is required, particularly in connection with acquisitions, we may also borrow under our revolving credit facility, enter into new credit facilities or access the capital markets. We may also access the capital markets from time to time to take advantage of favorable interest rate environments or other market conditions. However, there is no guarantee that we will be able to obtain alternative sources of financing on commercially reasonable terms or at all. See "Item 1A. Risk Factors-Risks Related to Our Business." While repatriation of some cash held outsidethe United States may be restricted by local laws, most of our foreign cash could be repatriated tothe United States . Following enactment of the TCJA and the associated transition tax, in general, repatriation of cash tothe United States can be completed with no incrementalU.S. tax; however, repatriation of cash could subject us to non-U.S. jurisdictional taxes on distributions. The cash that our non-U.S. subsidiaries hold for indefinite reinvestment is generally used to finance foreign operations and investments, including acquisitions. The income taxes, if any, applicable to such earnings including basis differences in our foreign subsidiaries are not readily determinable. As ofDecember 31, 2019 , we believe that we have sufficient sources of liquidity to satisfy our cash needs, including our cash needs inthe United States . Contractual Obligations The following table sets forth, by period due or year of expected expiration, as applicable, a summary of our contractual obligations as ofDecember 31, 2019 under (1) operating lease obligations, (2) purchase obligations, (3) long-term debt and (4) other long-term liabilities reflected on our consolidated balance sheet under GAAP. Refer to "Off-Balance Sheet Arrangements" for a discussion of other contractual obligations that are not reflected in the table below. Less Than One More Than 5 ($ in millions) Total Year 1-3 Years 4-5 Years Years Operating lease obligations (a)$ 256.1 $ 32.7 $ 52.1 $ 42.2 $ 129.1 Purchase obligations (b) 90.5 89.9 0.6 - - Long-term debt 1,323.3 - 1,323.3 - - Other long-term liabilities (c) 399.3 - 51.7 21.1 326.5 Total$ 2,069.2 $ 122.6 $ 1,427.7 $ 63.3 $ 455.6
_________________________
(a) As described in Note 5 to our audited consolidated and combined financial
statements, certain leases require us to pay real estate taxes, insurance,
maintenance and other operating expenses associated with the leased
premises. These future costs are not included in the table above. As
discussed in Note 2 to our audited consolidated and combined financial
statements, we adopted Accounting Standards Codification ("ASC") 842 related
to lease accounting on
table above differ from the future lease liability recognized under ASC 842,
as the lease liability recognized under ASC 842 discounts the lease payments
while the minimum lease payments are not discounted. Additionally, ASC 842
allows a lessee to elect to combine or separate any non-lease components in
an arrangement with the lease components for the calculation of the lease
liability while the minimum lease payments exclude any non-lease components.
(b) Consist of agreements to purchase goods or services that are enforceable and
legally binding and that specify all significant terms, including fixed or
minimum quantities to be purchased, fixed, minimum or variable price
provisions and the approximate timing of the transaction.
(c) Primarily consist of obligations under product service and warranty policies
and allowances, performance and operating cost guarantees, estimated
environmental remediation costs, self-insurance and litigation claims,
pension obligations, deferred tax liabilities and deferred compensation
obligations. The timing of cash flows associated with these obligations is
based upon management's estimates over the terms of these arrangements and
is largely based upon historical experience.
60-------------------------------------------------------------------------------- Off-Balance Sheet Arrangements Guarantees and Related Instruments The following table sets forth, by period due or year of expected expiration, as applicable, a summary of our off-balance sheet commitments as ofDecember 31, 2019 . Amount of Commitment Expiration per Period Less Than One More Than 5 ($ in millions) Total Year 1-3
Years 4-5 Years Years
Guarantees and related instruments
Guarantees consist primarily of outstanding standby letters of credit and bank guarantees. These guarantees have been provided in connection with certain arrangements with vendors, customers, financing counterparties and governmental entities to secure our obligations and/or performance requirements related to specific transactions. Other Off-Balance Sheet Arrangements In the normal course of business, we periodically enter into agreements that require us to indemnify customers, suppliers or other business partners for specific risks, such as claims for injury or property damage arising out of our products or services or claims alleging that our products or services infringe third-party intellectual property. We have not included any such indemnification provisions in the contractual obligations table above. Historically, we have not experienced significant losses on these types of indemnification obligations. Debt Financing Transactions OnSeptember 20, 2019 , we entered into the Credit Agreement with a syndicate of banks, pursuant to which we borrowed approximately$1.3 billion as of the date hereof, consisting of a three-year,$650 million senior unsecured term loan facility and a three-year, €600 million senior unsecured term loan facility, which are referred to as the "Term Loans." The Credit Agreement also includes a five-year,$250 million senior unsecured multi-currency revolving credit facility, which is referred to as the "Revolving Credit Facility." Pursuant to the Separation Agreement, all of the net proceeds of the Term Loans were paid to Danaher as partial consideration for the dental business that Danaher transferred to us. The Credit Agreement requires us to maintain a Consolidated Leverage Ratio (as defined in the Credit Agreement) of 3.75 to 1.00 or less; provided that the maximum Consolidated Leverage Ratio will be increased to 4.25 to 1.00 for the four consecutive full fiscal quarters immediately following the consummation of any acquisition by us or any subsidiary of ours in which the purchase price exceeds$100 million . The Credit Agreement also requires us to maintain a Consolidated Interest Coverage Ratio (as defined in the Credit Agreement) of at least 3.00 to 1.00. Borrowings under the Credit Agreement are prepayable at our option at any time in whole or in part without premium or penalty. Term Loans may not be reborrowed once repaid. Amounts borrowed under the Revolving Credit Facility may be repaid and reborrowed from time to time prior to the maturity date. We have unconditionally and irrevocably guaranteed the obligations of each of our subsidiaries in the event a subsidiary is named a borrower under the Revolving Credit Facility. The Credit Agreement contains customary representations, warranties, conditions precedent, events of default, indemnities and affirmative and negative covenants, including covenants that, among other things, limit or restrict our and/or our subsidiaries ability, subject to certain exceptions and qualifications, to incur liens or indebtedness, merge, consolidate or sell or otherwise transfer assets, make dividends or distributions, enter into transactions with our affiliates, and use proceeds of the debt financing for other than permitted uses. The Credit Agreement also contains customary events of default. Upon the occurrence and during the continuance of an event of default, the lenders may declare the outstanding advances and all other obligations under the Credit Agreement immediately due and payable. Legal Proceedings Please refer to Note 12 to our audited consolidated and combined financial statements included in this Annual Report for information regarding legal proceedings and contingencies, and for a discussion of risks related to legal proceedings and contingencies, please refer to "Item 1A. Risk Factors-General Risks."
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