Henry Schein, Inc. — Q1 2019 Form 10-Q
Reporting period: Three months ended March 30, 2019; comparisons are with the three months ended March 31, 2018. Amounts below are in U.S. dollars. The Animal Health business was separated on February 7, 2019 and is presented as discontinued operations, affecting comparisons.
Financial performance
| Metric | Q1 2019 | Q1 2018 | Change |
|---|---|---|---|
| Net sales from continuing operations | $2,360.3 million | $2,273.5 million | +3.8% |
| Gross profit | $751.7 million | $719.1 million | +4.5% |
| Gross margin | 31.8% | 31.6% | +0.2 percentage points |
| Operating income | $172.4 million | $162.2 million | +6.3% |
| Net income from continuing operations | $123.6 million | $114.7 million | +7.8% |
| Continuing-operations diluted EPS attributable to Henry Schein | $0.78 | $0.72 | +$0.06 |
| Net income attributable to Henry Schein, including discontinued operations | $109.8 million | $140.2 million | Down 21.7% |
| Diluted EPS, including discontinued operations | $0.73 | $0.91 | Down $0.18 |
- Sales excluding transition-services agreement (TSA) revenue were $2,345.6 million, up 3.2%. Management reported 6.0% local-currency growth, comprising 3.7% internally generated growth and 2.3% from acquisitions, partly offset by a 2.8% foreign-exchange impact.
- Health care distribution sales rose 1.9%; dental sales were essentially flat, while medical sales grew 6.8%. Technology and value-added services sales increased 35.1%, largely from acquisitions; management said underlying internally generated growth was 2.5% after adjusting for a change in revenue recognition.
- Health care distribution gross margin declined to 30.0% from 30.3%. Technology and value-added services gross margin increased to 72.1% from 66.3%, primarily reflecting higher-margin offerings at Henry Schein One.
- SG&A was $574.6 million and restructuring costs were $4.6 million. Interest expense was $16.3 million; the effective tax rate was 24.6%, compared with 24.4%.
Cash flow, debt and liquidity
- Cash from operating activities of continuing operations was $133.3 million, versus cash used of $64.6 million a year earlier. Total operating cash flow, including discontinued operations, was negative $33.7 million, including $167.1 million of discontinued-operations outflows.
- Continuing-operations investing cash flow was negative $596.5 million, primarily reflecting $604.0 million of payments for equity investments and acquisitions. Continuing-operations financing cash flow was positive $484.1 million.
- Cash and cash equivalents were $88.1 million at March 30, 2019. Working capital was $1,230.3 million.
- Total debt was $1,282.5 million, down from $1,940.1 million at December 29, 2018. This includes $299.9 million of bank credit lines and $982.6 million of long-term debt, before current-maturity classification. Operating lease liabilities of $255.8 million are additional.
- Management said cash, access to private debt and equity markets, and available credit facilities were sufficient for foreseeable short- and long-term capital needs. The $750 million revolving facility matures in April 2022; the $350 million receivables securitization facility expires April 2020.
Material changes, outlook and risks
- Animal Health separation: The spin-off transferred the business to Covetrus, which Henry Schein no longer consolidates. The company received a $1.12 billion distribution and $361.1 million from a Covetrus share sale; it repaid a $400 million committed loan. TSA product sales to Covetrus contributed $14.6 million of Q1 revenue and are expected to continue through 2020.
- Discontinued operations recorded a $9.0 million net loss in Q1 2019 versus $33.9 million of income in Q1 2018. The 2019 loss primarily included $20.9 million of spin-off transaction costs. The filing does not provide a numerical full-year earnings or revenue forecast.
- The company acquired North American Rescue, with stated annual sales of approximately $184 million, and Lighthouse 360, with stated annual sales of approximately $50 million. Goodwill recorded for these acquisitions was $160.1 million and $143.9 million, respectively.
- A restructuring program intended to reduce costs and fund growth initiatives may eliminate approximately 2%–3% of the workforce and close facilities. Q1 restructuring expense was $4.6 million; further 2019 costs were expected, but management said it could not yet estimate their amount.
- Material exposures include continuing dental-distribution antitrust litigation, an FTC proceeding, securities litigation, and opioid-related lawsuits. The company reported that the $38.5 million charge for a proposed dental antitrust class settlement was paid into a settlement fund in January 2019, with court approval still pending at the filing date. It said other accrued probable and estimable legal losses were not material; outcomes remain uncertain.
- Other stated risks include competition and industry consolidation, supplier dependence, foreign-exchange and macroeconomic conditions, acquisition integration, regulation and reimbursement changes, cybersecurity and data privacy, and litigation. Management reported effective disclosure controls; it also identified material changes in internal control over financial reporting associated with acquisitions, systems implementations and lease-accounting enhancements.
Important facts for investors to verify
- How much sales and earnings growth is organic, after separating acquisition, currency and TSA effects?
- Whether the Animal Health separation and TSA transition affect future comparability, cash flows and operating costs as expected.
- Acquisition purchase accounting, integration progress and returns on the substantial Q1 investment outlay.
- Debt capacity, refinancing of the receivables securitization facility, and the effect of lease obligations and redeemable noncontrolling interests on liquidity.
- Developments and potential financial exposure in antitrust, securities and opioid-related proceedings, including approval and implementation of the proposed class settlement.
- Additional restructuring charges and the timing and realization of expected cost savings.