Henry Schein, Inc. — Q2 2018 Form 10-Q
Reporting period: Three and six months ended June 30, 2018; comparisons are with the periods ended July 1, 2017. Unless noted, financial figures below are in U.S. dollars.
Business context
Henry Schein distributes dental, animal health and medical products and provides healthcare technology and value-added services. It reports two segments: health care distribution and technology and value-added services. The unaudited interim statements were prepared under U.S. GAAP.
Financial performance
| Metric | Q2 2018 | Six months 2018 |
|---|---|---|
| Net sales | $3.327 billion, up 8.7% | $6.547 billion, up 9.4% |
| Gross profit | $901.1 million, up 7.4%; margin 27.1% vs. 27.4% | $1.797 billion, up 8.1%; margin 27.4% vs. 27.8% |
| Operating income | $201.3 million, down from $210.7 million | $407.5 million, up from $404.6 million |
| Net income attributable to Henry Schein | $141.2 million vs. $136.1 million; diluted EPS $0.92 vs. $0.86 | $281.4 million vs. $276.8 million; diluted EPS $1.83 vs. $1.74 |
| Operating cash flow | Not provided separately | $216.9 million vs. $176.1 million |
Q2 consolidated net income was $147.5 million, down 1.4% from $149.6 million; the increase in income attributable to Henry Schein reflects lower income attributable to noncontrolling interests. Interest expense rose to $17.9 million in Q2 and $35.4 million for the first half, primarily due to higher borrowings and interest rates. The six-month effective tax rate was 24.8%, unchanged year over year.
Health care distribution generated 96.5% of first-half sales and grew 9.6%; technology and value-added services grew 5.5%. Reported sales growth included local-currency growth, acquisitions and favorable foreign-exchange translation. Management noted that certain animal-health and technology products shifted from gross to agency revenue recognition, affecting reported growth.
Financial position and liquidity
- At June 30, 2018, cash was $111.3 million, working capital was $909.0 million, and total debt was $2.177 billion, compared with $174.7 million, $1.257 billion and $1.666 billion, respectively, at December 30, 2017.
- Bank credit lines were $1.179 billion; long-term debt was $985.4 million, including current maturities. The company had a $400 million committed loan outstanding, obtained to help fund the $365 million purchase of additional interests in Butler Animal Health.
- First-half investing cash outflow was $74.6 million, versus $191.4 million a year earlier, mainly reflecting lower acquisition and equity-investment payments. Financing cash outflow was $222.3 million, primarily due to $652.7 million spent acquiring noncontrolling interests, partly offset by borrowings.
- Management said cash, market access and available credit facilities were sufficient for foreseeable short- and long-term needs. It also expects working-capital requirements to increase. Receivable days rose to 43.3 from 42.4 a year earlier; inventory turns fell to 4.9 from 5.3.
Material changes, outlook and unusual items
- Animal-health transaction: Henry Schein planned to contribute its animal-health business to Spinco and combine it with Vets First Choice. The company expected a tax-free cash dividend of $1.0 billion to $1.25 billion and intended to use proceeds for general corporate purposes, including debt repayment and share repurchases. Closing was targeted by year-end 2018, subject to approvals and other conditions.
- Restructuring: Announced July 9, 2018, after quarter-end. The plan was expected to eliminate approximately 2%–3% of the workforce and close certain facilities. Estimated 2018 pre-tax costs were $45 million–$55 million, or $0.22–$0.27 per diluted share. The company had recorded $18.7 million of restructuring costs in the first half.
- Technology joint venture: Henry Schein One with Internet Brands closed July 1, 2018, after quarter-end. Henry Schein owned 74% at formation; pro forma 2017 sales were approximately $400 million.
- Accounting: The company adopted ASC 606 in 2018. It reported an immaterial opening retained-earnings adjustment and expected an immaterial ongoing income-statement impact. Comparative periods were not restated.
- Foreign exchange: First-half foreign-currency translation loss was $95.6 million, compared with a $114.3 million gain in the prior-year period; this reduced comprehensive income but was not an operating cash-flow measure.
- Legal and regulatory matters: Disclosed cases include dental-supply antitrust class actions, an FTC proceeding, a securities class action, a medical-supply antitrust case and opioid-related litigation. The company said it intended to defend itself; it considered the FTC matter not expected to materially affect financial position, liquidity or results. Accrued probable, estimable legal losses were described as not material.
- Other risks: Management cited competition and industry consolidation, supplier dependence, economic and currency conditions, regulation, cybersecurity and data privacy, litigation, and the ability to complete and realize benefits from the animal-health transaction. No material changes to previously disclosed risk factors were reported.
Important facts for investors to verify
- Progress, final terms, timing and actual cash proceeds of the planned animal-health separation and Vets First Choice merger.
- Whether restructuring costs and workforce or facility reductions remain within the announced estimates, and the expected savings and timing.
- Debt levels, borrowing costs and liquidity following the Butler interest purchase and any use of separation proceeds.
- Underlying sales and margin trends excluding currency, acquisitions and agency-versus-gross revenue presentation changes.
- Developments in the antitrust, FTC, securities and opioid-related matters, including any change in potential exposure or accruals.
- Integration and financial-control implications of acquisitions, systems changes, ASC 606 implementation and the Henry Schein One joint venture.