Henry Schein, Inc. — FY 2013 Form 10-K
Reporting period: Fiscal year ended December 28, 2013 (52 weeks). The filing also reports fourth-quarter results; this is an annual report, not a standalone quarterly filing.
Business context
Henry Schein distributes dental, animal health and medical products and provides practice-management software and related services. It serves more than 800,000 customers, operates in 25 countries and reports two segments: health care distribution and technology and value-added services.
Financial performance
| Metric | FY 2013 | FY 2012 | Change |
|---|---|---|---|
| Net sales | $9.561 billion | $8.940 billion | +6.9% |
| Gross profit | $2.656 billion | $2.508 billion | +5.9% |
| Operating income | $677.1 million | $619.0 million | +9.4% |
| Net income attributable to Henry Schein | $431.6 million | $388.1 million | +11.2% |
| Diluted EPS | $4.93 | $4.32 | +14.1% |
| Cash from operating activities | $664.2 million | $408.1 million | +$256.1 million |
Consolidated gross margin was approximately 27.8% versus 28.0%; operating margin was approximately 7.1% versus 6.9%. The reported effective tax rate fell to 28.7% from 31.1%; excluding a $13.4 million valuation-allowance reduction, management said the 2013 rate would have been 30.7%.
Health care distribution sales grew 6.7% to $9.241 billion; technology and value-added services grew 12.9% to $320.0 million. Animal health was the fastest-growing distribution business, up 12.0% reported, including acquisition growth. Segment operating income was $590.7 million for distribution and $86.4 million for technology and value-added services.
Fourth-quarter 2013 sales were $2.526 billion, operating income $186.9 million, net income attributable to Henry Schein $124.3 million and diluted EPS $1.43. Fourth-quarter 2012 figures were $2.408 billion, $181.3 million, $112.5 million and $1.26, respectively.
Liquidity, debt and capital allocation
- Cash and cash equivalents were $188.6 million at year-end, up from $122.1 million; working capital was $1.284 billion, compared with $1.232 billion.
- Total debt was $485.2 million, down from $533.3 million. This included $29.5 million drawn on short-term bank lines, $5.4 million of current maturities and $450.2 million of long-term debt.
- The company had no borrowings under its $500 million revolving credit facility (with a $200 million expansion feature); $10.1 million of letters of credit were outstanding. A separate receivables securitization facility had $160 million outstanding at a 0.96% stated rate.
- Investing cash outflow was $266.6 million and financing cash outflow was $336.0 million. The company repurchased $300.3 million of stock in 2013; $300 million remained authorized. It reported no expected cash or stock dividends in the foreseeable future.
- Inventory turns declined to 5.9 from 6.2; receivable days outstanding increased slightly to 40.0 from 39.8.
Material changes and unusual items
- Total sales growth included 3.6% internally generated growth, 3.2% acquisition growth and 0.1% foreign-exchange benefit. Animal health growth included 6.8% acquisition growth.
- Distribution gross margin fell to 26.5% from 26.8%, which management primarily attributed to animal health’s greater mix of lower-margin pharmaceuticals. Technology and value-added services margin declined to 64.0% from 64.8%, primarily due to product mix.
- Operating cash flow rose substantially, with management citing improved earnings and favorable working-capital changes, including comparison against 2012 inventory purchases made ahead of possible medical-device tax-related price increases.
- In the third quarter, a Middle East dental-distributor divestiture generated a $12.5 million loss ($0.14 per diluted share); the company also paid $13.4 million in connection with the divestiture. The investment had been fully impaired at 2012 year-end.
- The company recorded a $13.4 million tax valuation-allowance reduction in the third quarter. In the first quarter, it recorded $6.2 million of one-time noncash interest expense from accelerated amortization of financing costs after repaying animal-health transaction debt.
- After year-end, Henry Schein completed an approximately 60% investment in dental implant manufacturer BioHorizons on December 30, 2013; the filing recorded a $145 million loan to BioHorizons at year-end. It also completed an announced acquisition of five European businesses during the first quarter of 2014.
Outlook, risks and contingencies
Management said demand growth could be slower under prevailing economic and industry conditions and expects historical quarterly seasonality to continue, with sales and operating profits generally higher in the third and fourth quarters. It forecast a 2014 effective tax rate of approximately 30%, but provided no specific sales or earnings guidance in the filing. Management said cash, debt-market access and available credit facilities were sufficient for foreseeable short- and long-term needs.
Key risks include intense price competition, dependence on third-party suppliers, shipping cost and service exposure, customer consolidation and purchasing groups, macroeconomic and foreign-currency effects, acquisition integration, and evolving pharmaceutical, medical-device, fraud-and-abuse, privacy and software regulations. The Drug Quality and Security Act creates phased prescription-drug tracing and licensing requirements; the company was still assessing its impact. The filing describes ordinary-course litigation and says pending matters and accrued estimated losses were not material. Redeemable noncontrolling interests, subject to holders’ put rights, rose to $497.5 million from $435.2 million.
The independent auditor issued an unqualified opinion on the financial statements and internal controls; management also concluded disclosure controls and internal control over financial reporting were effective as of year-end.
Investor verification priorities
- Separate underlying growth from acquisitions and assess whether animal-health acquisition-led growth and lower-margin product mix persist.
- Reconcile reported earnings and EPS with the tax valuation benefit, divestiture loss and debt-refinancing charge.
- Review the sources and sustainability of the operating-cash-flow increase, including working-capital timing and inventory trends.
- Monitor debt maturities, covenant headroom, receivables-facility usage and potential cash requirements from redeemable noncontrolling interests.
- Check the integration, financing and subsequent-period contribution of BioHorizons and the European acquisitions.
- Assess the cost and operational effects of new drug-traceability, Sunshine Act, privacy and electronic-health-record requirements.