Henry Schein, Inc. — Q1 2018 Form 10-Q
Business context and reporting period
The filing reports unaudited results for the three months ended March 31, 2018, compared with the three months ended April 1, 2017. Henry Schein distributes dental, animal health and medical products and provides healthcare technology and value-added services, operating through healthcare distribution and technology and value-added services segments.
Key financial metrics
| Metric | Q1 2018 | Prior-year quarter | Change or context |
|---|---|---|---|
| Net sales | $3.220 billion | $2.923 billion | Up 10.2% |
| Gross profit | $895.6 million | $822.9 million | Up 8.8% |
| Gross margin | 27.8% | 28.2% | Down 0.4 percentage points |
| Operating income | $206.1 million | $194.0 million | Up 6.3% |
| Net income | $148.6 million | $150.3 million | Down 1.1% |
| Net income attributable to Henry Schein | $140.2 million | $140.7 million | Down 0.4% |
| Diluted EPS | $0.91 | $0.88 | Up from prior year |
| Net cash used in operating activities | $70.9 million | $52.6 million | Cash use increased |
Sales growth included 5.9% local-currency growth—3.8% internally generated and 2.1% from acquisitions—and a 4.3% foreign-exchange benefit. Dental sales rose 10.2%, animal health 13.1%, medical 6.9%, and technology and value-added services 6.1%. Animal health and technology comparisons were affected by a change to agency-basis revenue recognition for certain products.
Healthcare distribution gross margin fell to 26.4% from 26.8%; technology and value-added services gross margin was 65.4% versus 65.3%. Selling, general and administrative expense increased 9.0% to $685.7 million, while declining slightly as a share of sales, to 21.3% from 21.5%. Interest expense increased $6.1 million, primarily due to higher borrowings and rates. The effective tax rate was 24.7%, compared with 20.7%.
At March 31, 2018, cash was $99.2 million, working capital was $1.265 billion, and total debt was $1.969 billion, versus $174.7 million, $1.257 billion, and $1.666 billion, respectively, at December 30, 2017. Operating cash use reflected working-capital needs, including inventory and receivables. Investing activities used $35.2 million; financing activities provided $27.8 million, including borrowings and payments for acquisitions of noncontrolling interests.
Material changes versus the prior comparable period
- Revenue increased, supported by organic growth, acquisitions and foreign-exchange movements. Reported animal health growth also reflected the change to agency accounting for certain products; excluding that effect, internally generated animal health revenue grew 7.7%, according to management.
- Gross margin declined despite higher gross profit. Net income attributable to Henry Schein was nearly flat, while diluted EPS increased; weighted-average diluted shares declined to 154.1 million from 159.8 million.
- Total debt rose about $302.8 million from year-end, while cash declined about $75.4 million. The weighted-average interest rate on credit-line borrowings increased to 2.59% from 2.27%.
- Cash used in operations increased by $18.4 million year over year, primarily due to working-capital requirements. Inventory turns declined to 4.7 from 5.1 year over year, and days sales outstanding increased to 43.9 from 42.4.
- The company recorded $3.8 million of restructuring costs for redundancies. It also completed no material acquisitions during the quarter, though it acquired a Brazilian animal health business with approximately $25 million in annual revenue.
Outlook, commentary, risks and unusual items
The supplied filing text does not provide a clear numerical earnings or revenue forecast. Management said it expects future working-capital requirements to increase and believes cash, debt-market access and available credit facilities are sufficient for foreseeable short- and long-term needs. The company noted that quarterly results are not necessarily indicative of full-year results and that sales and working capital are seasonal.
- Planned transactions after quarter-end: Henry Schein announced a dental technology joint venture with Internet Brands, Henry Schein One, with an initial 74% ownership stake for Henry Schein. The venture had approximately $400 million of pro forma 2017 sales and was expected to close in Q2 2018, subject to conditions.
- Animal health separation and merger: The company agreed to contribute its animal health business to Spinco, distribute Spinco shares to Henry Schein shareholders, and merge Spinco with Vets First Choice. Henry Schein expected $1.0–$1.25 billion in cash proceeds, planned for general corporate purposes, including share repurchases and debt repayment. Closing was expected by year-end 2018, subject to regulatory, tax and other conditions.
- Litigation: The company faces private antitrust actions and an FTC proceeding relating to alleged conduct in dental distribution, as well as a securities class action alleging misleading statements. The FTC complaint seeks equitable relief, not monetary damages; the company denies the allegations and intends to defend itself. The company stated that accrued probable and estimable legal losses were not material, but litigation outcomes remain uncertain.
- Tax and accounting: The company adopted ASC 606 using the modified retrospective method; it reported an immaterial opening retained-earnings adjustment and an immaterial ongoing income-statement effect. The Tax Cuts and Jobs Act estimates remained subject to evaluation; the company had recorded a $140 million transition-tax estimate in Q4 2017 and reported no material Q1 2018 adjustment.
- Controls: Management concluded disclosure controls were effective at March 31, 2018. The company reported material changes in internal control over financial reporting, considered in aggregate, related to acquisition integrations, systems implementations and revenue-recognition control enhancements.
- Principal stated risks: Competition and industry consolidation, supplier dependence, foreign-exchange and economic conditions, regulatory and privacy requirements, cybersecurity, litigation, acquisition integration, and the ability to complete and realize benefits from the announced transactions.
Important facts for investors to verify
- Whether Henry Schein One and the animal health separation/merger close on the expected timelines and on the stated terms, including final cash proceeds and ownership allocations.
- How much reported growth reflects underlying volume and pricing versus acquisitions, foreign exchange, and agency-basis presentation changes.
- Whether gross-margin pressure, higher interest costs and working-capital use persist, and how they affect earnings and cash generation.
- Debt levels, available borrowing capacity, interest rates and compliance with leverage covenants as the company funds transactions and other capital needs.
- Developments in the antitrust, FTC and securities litigation, including any changes to the company’s assessment of potential losses.
- Final effects of the Tax Act estimates and implementation of ASC 606 and related financial-reporting controls.