Henry Schein, Inc. — Q3 2015 Form 10-Q
Business context and period. Henry Schein distributes health care products and provides technology and value-added services, primarily to dental, animal health and medical practitioners. This unaudited filing covers the three and nine months ended September 26, 2015; comparisons are with the periods ended September 27, 2014. Balance-sheet comparisons are with December 27, 2014. Amounts below are in U.S. dollars.
Financial performance
- Third-quarter sales: $2.686 billion, up 2.4% reported. Local-currency growth was 8.3%, including 4.8% internally generated growth and 3.5% from acquisitions; foreign exchange reduced reported growth by 5.9%.
- Third-quarter earnings: Gross profit was $748.9 million, with a 27.9% gross margin versus 27.5%. Operating income was $188.9 million versus $174.1 million. Net income attributable to Henry Schein was $127.7 million versus $114.8 million; diluted EPS was $1.52 versus $1.34.
- Nine-month results: Sales were $7.779 billion, up 1.4% reported; local-currency growth of 7.8% was partly offset by a 6.4% foreign-exchange impact. Gross profit was $2.213 billion and gross margin was 28.4%, versus $2.147 billion and 28.0%. Operating income was $533.3 million versus $512.2 million. Net income attributable to Henry Schein was $349.1 million versus $333.1 million; diluted EPS was $4.14 versus $3.88.
- Segments: Q3 health care distribution sales rose 2.3% reported, while technology and value-added services rose 3.0%. Within distribution, medical sales increased 24.3%, while dental and animal health sales fell 2.5% and 3.4%, respectively, primarily reflecting currency effects. For the nine months, medical sales rose 18.0%; dental fell 3.2%, and animal health was down 0.1%.
- Cash flow: Nine-month operating cash flow was $288.5 million, down from $318.5 million, which management attributed primarily to working-capital changes. Investing cash outflow was $203.5 million versus $433.6 million, mainly due to lower acquisition and equity-investment payments. Financing cash outflow was $98.0 million versus $11.5 million of inflow.
- Liquidity and debt: Cash was $60.5 million, down from $89.5 million at year-end 2014; working capital was $1.323 billion versus $1.133 billion. Total debt was $798.4 million versus $731.5 million. The company reported no borrowings under its $500 million revolving facility, which has a $200 million expansion feature; other short-term bank lines had $186.9 million outstanding. Management said available cash, access to debt and equity markets, and existing credit facilities were sufficient for foreseeable needs.
Material changes and notable items
- Sales growth was substantially stronger in local currency than reported, as foreign exchange reduced sales growth by 5.9% in Q3 and 6.4% year to date. Nine-month accumulated other comprehensive loss attributable to the company increased to $199.7 million from $95.1 million at year-end, primarily reflecting currency translation.
- Q3 included a one-time $6.3 million income-tax benefit following a favorable response to a tax petition. The Q3 effective tax rate was 26.5%, compared with 30.0%; excluding the benefit, it would have been 30.0%. The nine-month effective rate was 29.0%, or 30.2% excluding the benefit.
- Restructuring costs were $8.4 million in Q3 and $22.5 million year to date. The company now expected the initiative, including elimination of approximately 2% to 3% of its workforce and facility closures, to finish in the first half of fiscal 2016. Expected total pretax costs were $35 million to $40 million; estimated remaining costs were $12 million to $15 million.
- The company completed the acquisition of an 85% interest in veterinary-supplies distributor KRUUSE on September 1, 2015; KRUUSE reported approximately $90 million of 2014 sales. Other acquisitions were described as immaterial individually and in aggregate.
- Inventory turns declined to 5.5 from 5.8 year over year; days sales outstanding increased slightly to 40.6 from 40.5 days.
Outlook, risks and contingencies
The filing provides no specific sales, earnings or EPS guidance. Management said restructuring is intended to reduce costs and fund initiatives in its 2015–2017 strategic plan, and anticipated higher future working-capital needs, which can vary with sales, inventory purchases and seasonality. Management cautioned that interim results are not necessarily indicative of full-year results.
- Risks highlighted include competition, supplier and customer dependence, economic conditions, acquisitions and integration, foreign-exchange exposure, health-care regulation and reimbursement changes, online competition, information-system disruption, cyber and privacy incidents, and tax-law changes. The company uses foreign-currency forwards for selected exposures but does not hedge translation of foreign profits.
- A September 2015 antitrust and related lawsuit by SourceOne Dental alleges exclusionary conduct and seeks equitable, compensatory, treble and punitive damages; no amount was specified. Henry Schein said it would defend the case and did not expect a material adverse effect. The company reported that accrued probable and estimable legal losses were not material.
- The company had approximately $90.9 million of unrecognized tax benefits, of which $74.0 million would affect the effective tax rate if recognized. It did not expect changes over the next 12 months to materially affect its financial statements. The company was disputing IRS proposed adjustments for tax years 2009–2011 and said it did not expect a significant effect on financial position, liquidity or results.
- Management concluded disclosure controls were effective as of September 26, 2015. It also reported that acquisition activity, integration and systems implementations represented a material change in internal control over financial reporting, with change-management controls incorporated into its annual assessment.
Important facts for investors to verify
- Whether local-currency organic growth, especially in dental and animal health, offsets continued foreign-exchange pressure.
- Whether operating cash generation improves as inventory turns and working-capital requirements evolve.
- Actual restructuring charges, completion timing and realized savings relative to the $35 million–$40 million expected total cost.
- Debt growth, funding needs for acquisitions and redeemable noncontrolling interests, and compliance with credit-facility covenants.
- Developments in the SourceOne litigation and the IRS tax dispute, including any changes to the company’s assessments.