Henry Schein, Inc. — Q2 2010 Form 10-Q
Reporting period: Three and six months ended June 26, 2010; comparisons are with periods ended June 27, 2009. Financial statement amounts below are in millions of dollars unless stated otherwise.
Business context
Henry Schein distributes healthcare products and services, principally to office-based dental, medical and animal-health practitioners, and provides practice-management technology and related services. Its reportable segments are healthcare distribution and technology. Results include the majority-owned Butler Animal Health business acquired at the end of 2009.
Financial performance
| Metric | Q2 2010 | Q2 2009 | Six months 2010 | Six months 2009 |
|---|---|---|---|---|
| Net sales | $1,849.4 | $1,607.4 | $3,609.7 | $3,092.8 |
| Gross profit | $545.6 | $475.9 | $1,058.7 | $914.3 |
| Operating income | $138.0 | $122.0 | $241.8 | $212.6 |
| Net income attributable to Henry Schein | $84.0 | $73.5 | $144.9 | $128.3 |
| Diluted EPS | $0.90 | $0.81 | $1.56 | $1.43 |
- Sales increased 15.1% in Q2 and 16.7% year to date. Management attributed most growth to acquisitions: Q2 local-currency growth included 13.5% from acquisitions and 2.1% internally generated growth; six-month growth included 12.5% from acquisitions and 2.6% internally generated growth.
- Gross margin was 29.5% in Q2 versus 29.6%; six-month gross margin was 29.3% versus 29.6%. Six-month healthcare distribution margin edged down to 28.3% from 28.4%, while technology margin declined to 69.1% from 72.3%, primarily due to product mix.
- Q2 operating margin was approximately 7.5% versus 7.6%; six-month operating margin was approximately 6.7% versus 6.9%. Six-month results included $12.3 million of restructuring costs, compared with $4.0 million a year earlier.
- Interest expense rose to $9.2 million in Q2 from $6.4 million and to $18.3 million for six months from $13.2 million, primarily reflecting debt associated with the Butler acquisition, partly offset by repayment of senior notes in 2009. The six-month effective tax rate was 31.9%, down from 33.1%.
Cash flow, debt and liquidity
- For the first six months, operating cash flow was $129.0 million, up from $79.6 million. Investing cash use was $282.4 million, principally reflecting $251.6 million of acquisition and equity-investment payments; financing provided $5.6 million. Cash declined to $321.1 million from $471.2 million at year-end 2009.
- Total debt was $548.9 million at June 26, 2010, versus $267.9 million at December 26, 2009. Long-term debt was $523.4 million; the company reported no borrowings under its $400 million revolving facility and $9.1 million of letters of credit. Working capital was $1,186.3 million.
- The Butler Animal Health acquisition-related debt had a current effective interest rate of 5.5%, with a large final installment of $301.6 million due December 31, 2015. Debt covenants include potential excess-cash-flow prepayments and interest-rate hedging requirements.
- Henry Schein’s $240 million convertible notes mature in 2034, but holders could require purchase on August 15, 2010. Management stated it planned to call the notes for redemption before the end of Q3 2010 and expected to use available credit and cash if required to purchase notes. Remaining $20 million senior notes mature September 27, 2010.
- Management expected to spend approximately $25–$35 million on capital projects during the remainder of 2010 and stated that available cash, capital-market access and credit facilities were sufficient for foreseeable needs. No earnings or revenue guidance was provided in the supplied filing text.
Material changes, outlook and risks
- Butler Animal Health materially expanded animal-health sales and drove much of the year-over-year revenue and debt increase. Animal-health sales rose 269.7% in Q2 and 270.6% year to date, primarily from the acquisition; internal growth was modest.
- Medical sales were flat in Q2, partly because prior-year sales of products related to H1N1 were unusually high. International growth was partly offset in Q2 by currency movements. Technology revenue grew, but segment gross margin declined on product mix.
- The first-quarter 2010 restructuring eliminated 184 positions and closed smaller locations; $9.997 million remained accrued at quarter-end, with most expected to be paid during 2010.
- Approximately $19.7 million of auction-rate securities remained difficult to liquidate because auctions had failed since 2008. The company reported no known issuer payment problems and said the illiquidity would not affect ongoing funding. About $0.3 million remained in the Reserve Primary Fund liquidation.
- Put rights held by minority investors in Butler and other subsidiaries create potential future cash-purchase obligations. The Oak Hill put could become exercisable from December 31, 2010, subject to contractual annual caps; Burns’ put rights begin in 2014.
- Risks cited include economic and customer-demand uncertainty, competition, supplier dependence, acquisition integration and financing, international and foreign-exchange exposure, healthcare regulation, product liability, information-system disruption, and changes in tax law. The filing also notes new healthcare-reform provisions that may affect pricing, reporting and distribution.
- Management said disclosure controls were effective. Ongoing acquisition and systems integration was identified as a material change in internal control over financial reporting. Management stated pending legal matters were insured or not expected to have a material adverse effect.
Most important facts for investors to verify
- How much reported growth and future earnings depend on Butler and other acquisitions versus internally generated sales, and whether integration delivers expected synergies.
- Liquidity and repayment capacity around the August 2010 convertible-note holder put/redemption dates, the September 2010 senior-note maturity, and Butler’s substantial 2015 balloon payment.
- Potential cash requirements from Butler minority-holder put rights and other redeemable noncontrolling interests.
- Whether gross-margin pressure, especially in technology and healthcare distribution, persists as product mix changes.
- Progress in integrating acquired businesses and systems, and any resulting control or reporting issues; also monitor restructuring payments and capital spending.
- Recoverability and timing of liquidity for auction-rate securities, and developments in healthcare regulation, litigation and other disclosed risks.