Henry Schein, Inc. — Q3 2018 Form 10-Q
Reporting period: Three and nine months ended September 29, 2018, compared with the periods ended September 30, 2017. Amounts below are in U.S. dollars; financial amounts are rounded to millions unless otherwise noted.
Business context
Henry Schein distributes dental, animal health and medical products and provides healthcare technology and value-added services. It reported two segments: healthcare distribution and technology and value-added services. The company was preparing to separate its Animal Health business and combine it with Vets First Choice; that transaction had not closed by quarter-end.
Financial performance
| Metric | Q3 2018 | Q3 2017 | Nine months 2018 | Nine months 2017 |
|---|---|---|---|---|
| Net sales | $3,279.7 million | $3,161.1 million | $9,826.8 million | $9,143.5 million |
| Gross profit | $888.6 million | $836.1 million | $2,685.2 million | $2,498.1 million |
| Gross margin | 27.1% | 26.4% | 27.3% | 27.3% |
| Operating income | $165.9 million | $213.5 million | $573.4 million | $618.2 million |
| Net income attributable to Henry Schein | $121.5 million | $138.0 million | $402.9 million | $414.8 million |
| Diluted earnings per share | $0.79 | $0.87 | $2.62 | $2.61 |
Q3 sales increased 3.8%; management attributed the change to 5.1% local-currency growth, partly offset by a 1.3% foreign-exchange headwind. Nine-month sales rose 7.5%, reflecting 5.9% local-currency growth and a 1.6% currency benefit. Segment sales growth was strongest in technology and value-added services, although acquisitions contributed substantially to that segment’s growth.
Q3 operating income fell 22.3% and attributable net income fell 12.0%, despite higher sales and gross margin. SG&A, litigation settlement, spin-off transaction and restructuring costs increased; interest expense also rose. For the first nine months, operating income declined 7.2% and attributable net income declined 2.9%. Approximate operating margin was 5.1% in Q3 versus 6.8% a year earlier, and 5.8% year to date versus 6.8%.
Cash flow and liquidity: Nine-month operating cash flow was $390.8 million, compared with $307.5 million. Investing activities used $146.4 million, versus $320.8 million, mainly reflecting lower acquisition and equity-investment spending. Financing activities used $318.5 million, compared with $16.1 million provided in the prior-year period, principally due to $664.9 million of acquisitions of noncontrolling interests. Cash ended at $119.7 million, down from $174.7 million at year-end 2017. Working capital was $964.2 million, down from $1,257.0 million.
Total debt was $2,157.7 million at September 29, 2018, up from $1,666.1 million at December 30, 2017. This included $1,144.9 million of bank credit lines and $1,000.3 million of long-term debt. The company reported a 3.06% weighted-average rate on credit-line borrowings, versus 2.27% at year-end 2017. Management stated that cash, access to debt and equity markets, and available credit facilities were sufficient for foreseeable capital needs.
Material changes, outlook and notable items
- Litigation charge: A proposed classwide settlement in the dental supplies antitrust case, subject to court approval, resulted in a $38.5 million Q3 charge.
- Restructuring: The company expected total 2018 pre-tax restructuring costs of $45 million to $55 million, or $0.22 to $0.27 per diluted share. The plan included eliminating approximately 2% to 3% of the workforce and closing certain facilities. It recorded $27.5 million through nine months.
- Animal Health transaction: Henry Schein expected to distribute shares of a newly formed company combining its Animal Health business with Vets First Choice. It expected a tax-free cash dividend of $1.0 billion to $1.25 billion and planned to use proceeds for general corporate purposes, including share repurchases and debt repayment. The company was working toward a closing by year-end 2018 or early 2019, subject to approvals and other conditions.
- Henry Schein One: A joint venture with Internet Brands launched July 1, 2018. Henry Schein owned 74% initially; the transaction generated $412.8 million of initial goodwill, allocated to technology and value-added services.
- Taxes: The nine-month effective tax rate was 23.3%, versus 26.3%. Q3 included a provisional $10 million transition-tax benefit. The company said it did not expect material remaining Tax Act adjustments, while noting that its estimates could be refined.
- Legal and regulatory exposure: In addition to the settled-for-proposed-approval antitrust class action, the filing describes pending antitrust, securities class action, FTC and opioid-related litigation. The company said it intended to defend itself; outcomes and potential exposure in these cases remain uncertain. It stated that other accrued probable and estimable legal losses were not material.
- Other operating considerations: Receivable days outstanding increased to 43.8 from 43.2 a year earlier, and inventory turns declined to 4.9 from 5.3. Foreign-currency translation reduced nine-month comprehensive income by $106.2 million.
- Guidance: The filing provides restructuring-cost expectations and transaction timing, but no general revenue, earnings or EPS guidance.
Most important facts for investors to verify
- Progress, closing conditions, timing and final economics of the Animal Health/Vets First Choice transaction, including the expected cash dividend and debt-repayment plans.
- Whether the $38.5 million dental antitrust settlement receives court approval and the status and potential exposure of the other disclosed litigation.
- Restructuring costs incurred versus the $45 million to $55 million estimate, and whether the initiative delivers expected savings.
- Debt levels, interest costs, liquidity and working-capital trends following the large noncontrolling-interest purchases and planned divestiture.
- Underlying segment growth and margins, distinguishing organic performance from acquisitions, currency effects and the animal-health revenue-recognition change.