Business context and reporting period
Henry Schein, Inc. filed this unaudited Form 10-Q for the quarter ended September 27, 2014. The company distributes health care products and services, primarily to dental, animal health and medical practitioners, and provides practice-management technology and related services. It reported two segments: health care distribution and technology and value-added services. Unless otherwise stated, amounts below are in millions of dollars.
Financial performance
| Metric | Q3 2014 | Q3 2013 | Nine months 2014 | Nine months 2013 |
|---|---|---|---|---|
| Net sales | $2,623.7 | $2,349.0 | $7,669.3 | $7,034.3 |
| Gross profit | $721.7 | $639.6 | $2,146.9 | $1,956.5 |
| Gross margin | 27.5% | 27.2% | 28.0% | 27.8% |
| Operating income | $174.1 | $160.5 | $512.2 | $490.2 |
| Net income attributable to Henry Schein | $114.8 | $107.4 | $333.1 | $307.3 |
| Diluted earnings per share | $1.34 | $1.23 | $3.88 | $3.49 |
- Q3 sales grew 11.7%; management attributed 10.9% to local-currency growth, comprising 6.4% internally generated growth and 4.5% acquisitions, with 0.8% from foreign exchange. Animal health sales increased 18.0%, dental 9.7%, medical 8.0%, and technology and value-added services 10.4%.
- For the first nine months, sales rose 9.0%: 4.6% internally generated local-currency growth, 3.6% acquisition growth and 0.8% foreign-exchange impact. Animal health grew 11.3%, dental 9.1%, technology and value-added services 11.2%, and medical 4.9%.
- Q3 gross margin improved 0.3 percentage points, but SG&A rose to 20.9% of sales from 20.4%. Operating margin was approximately 6.6%, versus 6.8% a year earlier. Nine-month SG&A was 21.3% of sales versus 20.8%.
- Operating cash flow for the first nine months was $318.5 million, down from $389.5 million. Capital expenditures were $60.8 million; operating cash flow less capital expenditures was approximately $257.7 million, compared with $350.8 million in 2013. The company attributed the operating cash-flow decline primarily to working-capital changes.
- Investing activities used $433.6 million, including $364.1 million for acquisitions and equity investments. Financing activities provided $11.5 million, compared with $349.2 million used in the prior-year period.
Liquidity, debt and balance sheet
| Metric | September 27, 2014 | December 28, 2013 |
|---|---|---|
| Cash and equivalents | $76.5 | $188.6 |
| Working capital | $1,222.4 | $1,284.0 |
| Total debt | $825.4 | $485.2 |
| Redeemable noncontrolling interests | $549.4 | $497.5 |
Debt includes $188.8 million of short-term bank borrowings, $5.8 million of current maturities and $630.8 million of long-term debt. Net debt was approximately $748.9 million, up from $296.6 million at year-end 2013. The company reported no outstanding balance on its $500 million revolving credit facility (which has a $200 million expansion feature) and said available cash, credit facilities and access to debt and equity markets were sufficient for foreseeable needs.
During September, the company extended its revolving credit agreement to 2019, increased and extended its uncommitted private-placement facilities to $975 million through 2017, and extended its receivables-securitization facility to April 2017. The securitization facility had $240 million outstanding at a 0.94% rate. The revolving facility had $10.1 million of letters of credit outstanding.
Material changes, outlook and risks
- Q3 net income attributable to Henry Schein rose 6.9%; nine-month net income attributable to the company rose 8.4%. The 2014 effective tax rate was 30.0% for Q3 and 30.7% year to date. The corresponding 2013 comparisons benefited from a $13.4 million release of a tax valuation allowance; the 2013 quarter also included a $12.5 million loss on the sale of an equity investment. These items affect period-to-period comparability.
- On June 30, 2014, the company acquired a 60% interest in SmartPak Equine, a U.S. provider of equine supplements and horse supplies that had approximately $105 million in 2013 sales. Other 2014 acquisitions were described as immaterial individually and in aggregate.
- On October 31, 2014, after quarter-end, the company announced a restructuring planned for fiscal 2015: approximately 2%–3% workforce reductions and facility closures, with estimated pretax costs of $35–$40 million, or approximately $0.29–$0.33 per diluted share. Management said the initiative is intended to create efficiencies and fund growth initiatives; the filing did not yet specify cost components or associated cash expenditures.
- Management noted that working-capital needs tend to increase from the end of the third quarter into the following first quarter and anticipated future increases in working capital requirements. It provided no specific revenue or earnings guidance in the supplied filing text.
- Key risks include competition and online commerce, supplier dependence, global and foreign-exchange exposure, acquisition integration, health-care regulation and reimbursement changes, drug-distribution and controlled-substance requirements, data privacy and security, and litigation. The company said pending legal matters were not expected to materially affect financial condition or results; accrued probable and estimable losses were not material.
- Some subsidiary minority holders can require the company to purchase their interests at fair value. These put rights and the $549.4 million recorded redeemable noncontrolling interest create potential future cash needs; valuation depends in part on expected earnings.
Most important facts for investors to verify
- How much of reported sales growth reflects ongoing internal growth versus acquisitions and foreign exchange, especially in animal health.
- Whether higher SG&A as a share of sales and lower operating cash flow persist, and how working capital develops seasonally.
- Debt growth, refinancing terms, covenant headroom and potential cash requirements from redeemable noncontrolling interests.
- The final restructuring cost, cash outlay, timing and realized savings compared with the announced $35–$40 million pretax estimate.
- Effects of tax-rate normalization and evolving health-care, drug-traceability, privacy and other regulatory requirements.