HENRY SCHEIN INC quarterly report, Q1 FY2014

Business context and reporting period

Henry Schein, Inc. filed this unaudited Form 10-Q for the three months ended March 29, 2014, compared with the three months ended March 30, 2013. The company distributes health care products and provides technology and value-added services, primarily to dental, animal health and medical practitioners.

Unless otherwise stated, amounts below are in U.S. dollars. The filing reports financial statements in thousands.

Financial performance and position

SG&A rose 9.3% to $539.4 million, increasing to 22.2% of sales from 21.5%. The effective tax rate was 31.2%, versus 31.9%. Net cash used in investing was $167.1 million, primarily reflecting greater acquisition and equity-investment payments; financing provided $161.7 million.

Material changes versus the prior comparable period

• Sales growth reflected 2.9% internally generated local-currency growth, 2.7% acquisition growth and 0.4% foreign-exchange benefit. Dental sales grew 8.9%; animal health and medical sales grew 2.4% and 2.2%, respectively; technology and value-added services grew 8.9%.
• Health care distribution gross margin increased to 27.3% from 27.0%, while technology and value-added services margin increased to 67.5% from 64.0%. Management attributed the distribution margin improvement mainly to relatively stronger dental sales and the technology margin improvement to product mix.
• Operating income growth lagged sales growth as SG&A rose faster than revenue. Health care distribution operating income was $133.8 million, down from $134.5 million; technology and value-added services operating income increased to $23.4 million from $19.2 million.
• Other income/expense improved to $1.8 million of income from $9.9 million of expense. The prior-year period included a $6.2 million accelerated amortization charge on deferred financing costs; Q1 2014 included a supplier contractual payment related to a change to a non-exclusive sales model.
• Q1 2014 acquisitions included approximately 60% of BioHorizons, completed just before the quarter, and five European businesses acquired on February 3. The company acquired an 80% interest in Poland’s Medivet on April 2, after quarter-end.

Liquidity, debt and capital allocation

Debt increased during the quarter alongside acquisition spending and other capital uses. The company reported $144.0 million of bank credit-line borrowings, $106.0 million of current maturities and $541.7 million of long-term debt. Debt included a $100 million term loan due July 9, 2014, $250 million under a receivables securitization facility, and $250 million of private-placement notes. The revolving credit facility had $115 million outstanding and expires in September 2017; total credit-line borrowings carried a 1.34% weighted-average rate.

Operating cash outflow reflected working-capital changes, including a $219.3 million decline in accounts payable and accrued expenses. The company repurchased $75.3 million of common stock and spent $83.8 million acquiring noncontrolling interests. It said cash, access to debt and equity markets, and existing credit facilities were sufficient for foreseeable short- and long-term needs, and anticipated future increases in working-capital requirements.

Outlook, commentary, risks and unusual items

• No specific earnings or revenue guidance was provided. Management said current operating, economic and industry conditions could result in slower demand growth and attributed some U.S. dental, animal health and medical sales weakness to severe winter weather.
• Management described the industry as highly competitive and subject to consolidation, cost-containment pressures and changing health care laws. The filing highlights acquisition integration and synergy risks, supplier and customer dependence, online competition, information-system disruption, foreign-exchange exposure and regulatory, privacy and compliance requirements.
• New or evolving requirements discussed include prescription-drug tracking and wholesaler licensing, health care payment disclosures, HIPAA, electronic health record standards and the delayed ICD-10 implementation date. Compliance may add cost or disrupt operations.
• Redeemable noncontrolling interests were $482.7 million, valued using Level 3 inputs; estimates depend in part on expected subsidiary earnings. Unrecognized tax benefits were approximately $55.0 million, including $41.1 million that would affect the effective tax rate if recognized; management did not expect the anticipated 12-month change to have a material impact.
• The company reported no material changes to previously disclosed risk factors or market-risk exposure. It said pending legal matters and accrued estimated losses were not material, and disclosure controls were effective as of March 29, 2014.

Important facts for investors to verify

• Whether the $100 million term loan due July 9, 2014 was refinanced or repaid, and how debt and interest costs evolved after quarter-end.
• Whether acquisition-related revenue and integration deliver expected returns, including the subsequent Medivet acquisition.
• Whether operating cash flow and working capital improve, given the larger quarterly operating cash outflow and management’s expectation of higher working-capital needs.
• Whether elevated SG&A and the different growth and margin trends across segments persist, and whether the supplier payment was nonrecurring.