Henry Schein, Inc. — Q2 2017 Form 10-Q
Reporting period: Quarter and six months ended July 1, 2017; comparisons are to the periods ended June 25, 2016. Amounts below are in U.S. dollars unless noted.
Business context
Henry Schein distributes health care products and provides technology and value-added services, primarily to dental, animal health and medical practitioners. It reports two segments: health care distribution and technology and value-added services.
Financial performance and liquidity
| Metric | Q2 2017 | Q2 2016 | Six months 2017 | Six months 2016 |
|---|---|---|---|---|
| Net sales | $3,059.5 million | $2,872.6 million | $5,982.4 million | $5,585.6 million |
| Gross profit / margin | $839.2 million / 27.4% | $801.5 million / 27.9% | $1,662.1 million / 27.8% | $1,579.3 million / 28.3% |
| Operating income | $210.7 million | $180.7 million | $404.6 million | $356.9 million |
| Net income attributable to Henry Schein | $136.1 million | $120.1 million | $276.8 million | $233.8 million |
| Diluted EPS | $1.71 | $1.46 | $3.48 | $2.83 |
- Q2 sales increased 6.5%; management attributed growth to 4.4% internally generated revenue and 3.3% acquisitions, partly offset by a 1.2% foreign-exchange impact. Six-month sales increased 7.1%.
- Q2 health care distribution sales rose 6.7%; technology and value-added services sales rose 1.4%. Health care distribution gross margin declined to 26.0% from 26.5%, while technology gross margin rose to 65.9% from 64.4%.
- Q2 operating income rose 16.6% and attributable net income rose 13.3%. Six-month attributable net income increased 18.4%. The six-month effective tax rate was 24.8%, versus 29.1%.
- Six-month operating cash flow was $176.1 million, down from $199.4 million; investing cash outflow was $191.4 million, versus $120.4 million. Financing provided $15.5 million, compared with $91.9 million used in the prior-year period.
- At July 1, cash was $74.7 million, working capital was $1.234 billion, and total debt was $1.402 billion, up from $1.219 billion at year-end 2016. Current liabilities were $2.230 billion and current assets were $3.464 billion.
Material changes versus the prior comparable period
- Revenue and earnings increased, but consolidated gross margin fell by 0.5 percentage point in both the quarter and six-month period, largely reflecting distribution segment margin pressure.
- Interest expense increased to $12.2 million in Q2 from $7.4 million and to $23.6 million for six months from $14.5 million, primarily due to higher borrowings, higher bank-line rates and a Brazil financing arrangement.
- Q2 restructuring costs were zero, compared with $20.4 million in Q2 2016. Management said the restructuring program was complete and it did not expect restructuring charges in 2017.
- Operating cash flow declined despite higher earnings, primarily due to working-capital movements. Accounts receivable days sales outstanding improved to 40.9 days from 41.4; inventory turns remained 5.4.
- The company entered a new $750 million revolving credit agreement maturing in April 2022, replacing a $500 million facility previously scheduled to mature in 2019. It also issued $100 million of private-placement notes at 3.42% in June.
Outlook, commentary, risks and unusual items
- The filing provides no quantified forward earnings or revenue guidance. Management stated that cash, access to debt and equity markets, and available credit facilities were sufficient for foreseeable short- and long-term capital needs; it also anticipates higher future working-capital requirements.
- Adoption of stock-compensation accounting guidance reduced six-month income tax expense by approximately $19.3 million. This benefited reported-period earnings; the filing notes that stock-award tax benefits and deficiencies are now included in income tax expense.
- A $5.325 million pre-tax Q2 charge ($0.04 per share) settled SourceOne Dental litigation; Henry Schein denied wrongdoing and was dismissed from that case with prejudice. Separate dental-industry antitrust class actions remained pending, and the company said it intended to defend itself vigorously.
- Redeemable noncontrolling interests increased to $747.0 million from $607.6 million at year-end, including a $129.0 million fair-value adjustment. These adjustments do not affect EPS, but depend in part on estimated subsidiary earnings.
- Key disclosed risks include competition and industry consolidation; supplier dependence; acquisition integration; foreign-exchange and economic uncertainty; healthcare regulation and reimbursement changes; litigation; and information-security, privacy and cyber risks. The company also highlighted uncertainty around U.S. health reform and future regulatory requirements.
Important facts for investors to verify
- Whether organic growth persists after separating acquisition contribution, foreign exchange and the animal-health change from agency to gross revenue recognition.
- Whether distribution gross-margin pressure continues and how much operating cash flow is affected by receivables, inventory and payables.
- Debt levels, interest costs, credit-facility availability and compliance with leverage covenants; the filing reports $577.5 million of bank credit-line borrowings.
- Developments, potential exposure and any future accruals related to the pending antitrust class actions.
- The repeatability of earnings growth excluding the $19.3 million tax benefit from the new stock-compensation accounting guidance and the SourceOne settlement charge.