Henry Schein, Inc. — Q3 2010 Form 10-Q
Reporting period: Three and nine months ended September 25, 2010; comparisons are with periods ended September 26, 2009. Henry Schein distributes healthcare products and services, including dental, medical, animal-health and international distribution, and provides healthcare-practice technology solutions.
Financial performance
| Metric | Q3 2010 | Q3 2009 | Nine months 2010 | Nine months 2009 |
|---|---|---|---|---|
| Net sales | $1,893.5m | $1,659.4m | $5,503.2m | $4,752.3m |
| Gross profit | $537.5m | $476.3m | $1,596.1m | $1,390.5m |
| Gross margin | 28.4% | 28.7% | 29.0% | 29.3% |
| Operating income | $137.4m | $113.9m | $379.1m | $326.4m |
| Net income attributable to Henry Schein | $87.9m | $96.4m | $232.8m | $224.7m |
| Diluted EPS | $0.94 | $1.05 | $2.50 | $2.48 |
| Operating cash flow | Not stated for quarter | Not stated for quarter | $176.8m | $218.4m |
Q3 sales rose 14.1%, while operating income increased about 20.6%. Attributable net income and diluted EPS declined, principally in a quarter with a substantially higher effective tax rate: 31.8% versus 14.0%. Management attributes the prior-year rate difference mainly to a 2009 reduction in the valuation allowance on foreign deferred tax assets. For the first nine months, sales rose 15.8%, attributable net income rose about 3.6%, and diluted EPS increased from $2.48 to $2.50.
For the first nine months, selling, general and administrative expense increased 13.6% to $1,204.7m but declined as a share of sales to 21.9% from 22.3%. The continuing-operations effective tax rate was 31.9%, compared with 26.3% in 2009; excluding the prior-year valuation-allowance benefit, the filing says the 2009 rate would have been 32.9%.
Segments and material changes
- Q3 healthcare-distribution sales increased 14.1% to $1,844.4m; technology sales increased 13.7% to $49.1m. Nine-month increases were 15.9% and 13.0%, respectively.
- Animal-health sales rose sharply following the December 2009 acquisition of a majority interest in Butler Animal Health Supply. Acquisitions contributed 12.7 percentage points of Q3 local-currency company sales growth and 12.6 points for the nine-month period; internally generated revenue contributed 3.7% and 3.0%, respectively.
- International Q3 sales declined 3.8% in reported dollars, despite 3.4% local-currency growth, largely because of currency effects. Medical internal sales excluding influenza vaccine sales declined 3.7% in Q3 and 2.0% year to date.
- Consolidated gross margin fell 0.3 percentage points in both comparison periods. Management cited product mix for lower healthcare-distribution and technology margins.
Cash, debt and liquidity
- At September 25, 2010, cash and cash equivalents were $203.7m, down from $471.2m at December 26, 2009. Working capital was $960.1m, versus $1,127.3m.
- Total debt was $609.8m, compared with $267.9m at year-end 2009. This includes $201.1m of bank credit lines, $25.1m of current maturities and $383.5m of long-term debt.
- Nine-month operating cash flow was $176.8m; investing cash outflow was $374.0m, principally reflecting $353.3m of equity investments and business acquisitions; financing cash outflow was $76.2m. Cash declined $273.4m before a $6.0m favorable exchange-rate effect.
- On September 3, the company redeemed $240m of 3% convertible notes for approximately $240m cash and issued 732,422 common shares. It also issued $100m of 3.79% private-placement notes due September 2020. The company reported approximately $195m outstanding under its revolving credit facility at quarter-end.
- Management said cash, access to private debt and equity markets, and available credit facilities were sufficient for currently foreseeable needs. It expects working-capital requirements to increase. Auction-rate securities of $13.9m net of temporary impairments were not readily liquid, although management said this would not affect funding of operations or growth.
Outlook, risks and unusual items
- No specific revenue or earnings-per-share guidance is provided in the filing. Management described demand growth as likely to remain slower under current economic and industry conditions.
- Management expected $15m–$20m of capital-project investment during the remainder of fiscal 2010 and said it expected to repurchase a total of $50m of common stock by year-end. At September 25, $52.9m remained authorized for repurchases.
- On October 14, 2010, the company announced an agreement to acquire Provet Holdings for approximately $91m in cash, subject to shareholder and court approval and customary conditions; closing was expected around year-end.
- Butler’s acquisition-related debt had a reported effective interest rate of 5.5%, with a large final installment of $301.6m due December 31, 2015. Put rights held by Butler minority owners may require future purchases at fair value; redeemable noncontrolling interests rose to $299.1m from $178.6m at year-end, including a $50.8m fair-value increase.
- The company recorded $12.3m of restructuring costs in the first nine months, including actions affecting 184 positions and smaller locations; $7.9m remained accrued at quarter-end. The filing also identifies economic and demand uncertainty, acquisition integration, competition, regulation, supplier dependence, currency and interest-rate exposure, and information-system disruption among relevant risks.
- Management reported disclosure controls were effective. It identified acquisition and systems integration activity as a material change in internal control over financial reporting; the filing describes related change-management controls.
Important facts for investors to verify
- How much of future sales and earnings growth is organic versus acquisition-driven, particularly in animal health, and whether the Butler integration produces expected benefits.
- Whether working-capital demands and acquisition spending continue to pressure operating cash flow, liquidity and debt levels.
- The effect of the elevated tax rate compared with the unusually low prior-year rate on future reported earnings and EPS.
- Potential cash obligations from Butler minority-holder put rights and the timing and funding of the Provet transaction.
- Whether margin pressure, weaker medical demand excluding influenza vaccines, and international currency movements persist.