Henry Schein, Inc. — Q3 2017 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2017; comparative periods ended September 24, 2016. Amounts below are U.S. dollars. The filing is unaudited.
Business context
Henry Schein distributes health care products and services to dental, animal health and medical practitioners, and provides practice software and other value-added services. It operates in 33 countries through two reportable segments: health care distribution and technology and value-added services. A two-for-one stock split took effect in September 2017; share and per-share comparisons reflect the split.
Financial performance
| Metric | Q3 2017 | Q3 2016 | Nine months 2017 | Nine months 2016 |
|---|---|---|---|---|
| Net sales | $3,161.1 million | $2,865.1 million | $9,143.5 million | $8,450.7 million |
| Gross profit | $836.1 million | $787.7 million | $2,498.1 million | $2,367.0 million |
| Gross margin | 26.4% | 27.5% | 27.3% | 28.0% |
| Operating income | $213.5 million | $200.7 million | $618.2 million | $557.6 million |
| Net income attributable to Henry Schein | $138.0 million | $133.7 million | $414.8 million | $367.6 million |
| Diluted EPS | $0.87 | $0.82 | $2.61 | $2.23 |
- Sales increased 10.3% in the quarter and 8.2% year to date. Q3 growth included 4.8% internally generated revenue, 4.0% acquisition growth and 1.5% foreign-exchange benefit. Year-to-date growth included 5.0% internally generated revenue, 3.4% acquisition growth and a 0.2% foreign-exchange headwind.
- Q3 health care distribution sales rose 10.6%; dental, animal health and medical sales grew 11.1%, 11.7% and 8.0%, respectively. Technology and value-added services sales increased 4.1%. In animal health, reported organic growth benefited from a change to gross revenue recognition for certain products; excluding that effect, Q3 internally generated growth was 7.8%.
- Gross margin fell year over year in both periods. Management attributed distribution margin pressure to faster growth in lower-margin medical and animal health businesses, extended contracts with large dental support organizations, and European dental performance, particularly Germany. Q3 SG&A was $622.5 million, up 7.0%, but declined to 19.7% of sales from 20.3%.
- Q3 net income attributable to the company increased 3.2%; nine-month net income increased 12.9%. Nine-month effective tax rate was 26.3%, versus 29.0%; adoption of stock-compensation accounting guidance reduced nine-month tax expense by approximately $19.5 million.
Cash flow, debt and liquidity
- Nine-month operating cash flow was $307.5 million, down from $378.1 million, primarily due to working-capital changes, including a larger cash outflow from receivables. Investing cash use was $320.8 million, versus $179.8 million, mainly reflecting increased acquisition and equity-investment payments. Financing provided $16.1 million, compared with $198.3 million used in the prior period.
- At September 30, 2017, cash was $79.9 million and working capital was $1.345 billion. Total debt, including bank credit lines, was $1.557 billion, up from $1.219 billion at December 31, 2016. Cash less total debt implies approximately $1.477 billion of net debt.
- The company reported access to cash, credit facilities and debt and equity markets sufficient for currently foreseeable needs. It replaced its $500 million revolving facility with a $750 million facility maturing in April 2022; $175.0 million was drawn on that facility and $456.9 million on other short-term bank lines. Weighted-average rates on all credit-line borrowings rose to 2.09% from 1.61% at year-end 2016.
- Private placement capacity was increased to $1 billion, available on an uncommitted basis through September 2020. The company also extended its $350 million receivables securitization facility to April 2020. These facilities carry covenants and other restrictions.
Outlook, risks and unusual items
- The filing provides no specific earnings or revenue guidance. Management anticipates working-capital needs may increase and notes that requirements have historically risen from the end of Q3 into the following first quarter. It says liquidity is sufficient for currently foreseeable short- and long-term needs.
- Management estimated North American hurricanes reduced Q3 internally generated revenue growth by approximately 0.3% overall. Restructuring activities are complete; no 2017 restructuring charges are expected.
- In October 2017, the company sold its 21.4% interest in D4D Technologies and expects a Q4 2017 loss of approximately $17–18 million, or $0.10–$0.11 per diluted share.
- Material litigation includes dental-distribution antitrust class actions, Archer & White’s antitrust case (trial scheduled for February 2018), and a new IQ Dental antitrust complaint. The company intends to defend these matters; accrued estimated losses were not material at September 30, 2017.
- Other disclosed risks include competition and industry consolidation, supplier dependence, acquisition integration, currency movements, health care regulation and reimbursement changes, privacy and cybersecurity, and evolving U.S. and European data-protection requirements. Management reported effective disclosure controls; acquisition integrations and system implementations collectively represented a material change in internal control over financial reporting.
Most important facts for investors to verify
- Whether sales growth can continue without further erosion in health care distribution gross margins, especially given large-customer contracts and product mix.
- Whether operating cash conversion improves after the year-to-date working-capital outflow and higher acquisition-related investment.
- Debt levels, borrowing costs, covenant headroom and the terms and availability of uncommitted private placement capacity.
- The Q4 D4D sale loss and its final accounting, alongside progress and costs from acquisitions and integration.
- Developments, potential exposure and any material changes in the dental antitrust litigation; the filing does not quantify a clear potential loss.
- The durability of earnings growth after the one-time benefit from adoption of stock-compensation tax guidance.