Henry Schein, Inc. — Q3 2019 Form 10-Q
Reporting period: Three and nine months ended September 28, 2019, compared with the periods ended September 29, 2018. The company distributes dental and medical products and provides practice-management technology and related services. Its Animal Health business was spun off and merged with Vets First Choice on February 7, 2019; it is reported as discontinued operations, so continuing-operations comparisons exclude that business.
Financial performance and position
| Metric | Q3 2019 | Q3 2018 | Nine months 2019 | Nine months 2018 |
|---|---|---|---|---|
| Net sales | $2,508.8m | $2,355.6m | $7,316.9m | $6,945.0m |
| Gross profit | $761.2m | $722.4m | $2,280.3m | $2,159.8m |
| Gross margin | 30.3% | 30.7% | 31.2% | 31.1% |
| Operating income | $187.2m | $123.3m | $521.9m | $442.6m |
| Net income from continuing operations | $143.2m | $96.2m | $388.3m | $325.6m |
| Diluted EPS from continuing operations attributable to Henry Schein | $0.91 | $0.59 | $2.47 | $2.03 |
- Q3 sales increased 6.5%; excluding $21.7m of transition-services revenue from Covetrus, sales rose 5.6%. Nine-month sales increased 5.4%, or 4.5% excluding $60.2m of Covetrus transition-services revenue. Management attributed growth to internal sales and acquisitions, partly offset by foreign exchange.
- Q3 segment trends: health care distribution sales rose 5.1%, including medical growth of 11.3% and dental growth of 2.1%; technology and value-added services rose 15.1%. For the first nine months, those segments increased 3.4% and 28.5%, respectively.
- Reported net income attributable to Henry Schein, including discontinued operations, was $140.6m in Q3 versus $121.5m; for nine months it was $364.9m versus $402.9m. The nine-month comparison includes Animal Health discontinued-operation losses in 2019 and income in 2018, as well as spin-off transaction costs.
- Continuing-operations cash from operations was $525.2m for nine months, up from $269.4m. Total operating cash flow, including discontinued operations, was $361.5m versus $390.8m. Continuing-operations investing cash use was $691.3m, primarily reflecting acquisitions and equity investments; continuing-operations financing cash provided was $176.1m.
- At September 28, 2019, cash was $75.3m, working capital was $1,207.1m, and total debt was $1,089.3m, down from $1,940.1m at December 29, 2018. Debt includes $107.8m of bank credit lines, $109.2m of current maturities and $872.2m of long-term debt. Operating lease liabilities were an additional $249.9m.
- Nine-month share repurchases were $325.0m. The company reported $75.0m remaining under its existing authorization at quarter-end; on October 30, 2019, the board authorized an additional $400m of repurchases.
Changes, outlook and key risks
- Operating income improved year over year, while Q3 gross margin declined 0.4 percentage points. Health care distribution gross margin fell to 28.1% from 28.5%; technology and value-added services margin increased to 73.2% from 71.9%.
- Comparisons are affected by a $38.5m dental antitrust settlement charge recorded in Q3 2018. The company recorded $15.8m of restructuring costs in the first nine months of 2019, compared with $19.7m in the comparable period; restructuring actions were complete by June 29, 2019, and no further charges were expected in 2019.
- The Animal Health separation generated $1.12bn distributed to Henry Schein and $361.1m of Share Sale proceeds. A transition-services agreement with Covetrus is expected to continue through August 2020.
- After quarter-end, the company sold its noncontrolling investment in Hu-Friedy. It estimated a fourth-quarter 2019 pretax gain of $225m–$275m, subject to contingent-consideration and tax accounting. The filing provides no broader quantitative earnings or revenue guidance.
- Management said existing cash, access to debt and equity markets, and available credit facilities should meet foreseeable capital needs. It also noted expected increases in working-capital requirements and seasonal inventory demands.
- Material legal matters include the Archer antitrust case, set for trial in February 2020; the IQ Dental case, which continued after an appellate ruling; and securities litigation in which some claims against the company and an executive survived a motion to dismiss. The FTC administrative law judge recommended dismissal of the FTC complaint against Henry Schein, subject to possible Commission review. The company was dismissed from the Summit County opioid case after agreeing to fund $1m for a pain-management education foundation and pay $250,000 of county expenses; other opioid-related cases remained pending. The company said accrued probable legal losses were not material.
- Other disclosed risks include competition and consolidation, supplier dependence, foreign-exchange exposure, regulatory and reimbursement changes, cybersecurity and privacy, acquisition integration, and litigation. Management reported disclosure controls were effective, but said continuing acquisition integrations and systems implementations constituted a material change in internal control over financial reporting.
Investor verification priorities
- Review continuing-operations sales growth separately from Covetrus transition-services revenue, acquisitions and foreign-exchange effects.
- Reconcile continuing-operations earnings and cash flow with reported totals that include discontinued operations and spin-off-related items.
- Assess the durability of segment margins, particularly the decline in health care distribution gross margin and the role of acquisitions in technology growth.
- Track acquisition spending, working-capital needs, debt maturities and the effect of share repurchases on liquidity and per-share results.
- Follow the Hu-Friedy gain’s final amount and tax treatment, and developments in the outstanding antitrust, securities and opioid-related proceedings.