Business context and reporting period
Henry Schein, Inc. filed this unaudited Form 10-Q for the three months ended March 28, 2015, compared with the three months ended March 29, 2014. The company 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. The filing describes operations in 29 countries and service to more than 1 million customers.
Financial performance
Amounts below are in millions of dollars unless otherwise noted.
| Metric | Q1 2015 | Q1 2014 | Change |
|---|---|---|---|
| Net sales | $2,463.6 | $2,430.2 | +1.4% |
| Gross profit | $713.4 | $696.7 | +2.4% |
| Gross margin | 29.0% | 28.7% | +0.3 percentage points |
| Operating income | $161.4 | $157.3 | +2.6% |
| Net income attributable to Henry Schein | $103.4 | $102.1 | +1.3% |
| Diluted EPS | $1.22 | $1.18 | +3.4% |
| Net cash used in operating activities | $(26.7) | $(55.2) | $28.6 less cash used |
The effective tax rate was 31.0%, compared with 31.2%. Interest expense rose to $6.3 million from $5.3 million, primarily due to increased borrowings. Other, net fell to $0.1 million from $3.6 million, which included a prior-year contractual payment from a European animal health supplier.
Segments
- Health care distribution sales were $2,377.9 million, up 1.2%; operating income was $136.1 million, versus $133.8 million. Distribution gross margin increased to 27.6% from 27.3%.
- Technology and value-added services sales were $85.7 million, up 5.4%; operating income was $25.2 million, versus $23.4 million. Segment gross margin was 67.5% in both periods.
- Dental sales declined 3.6% as reported, while animal health sales grew 4.6%, medical sales grew 11.6%, and technology and value-added services sales grew 5.4%.
Cash flow, debt and liquidity
Operating cash use was $26.7 million, compared with $55.2 million a year earlier; management attributed the improvement primarily to changes in net working capital. Investing cash use was $30.3 million, down from $167.1 million, mainly because acquisition and equity-investment payments were lower. Financing provided $35.8 million, versus $161.7 million, reflecting lower net debt proceeds, partly offset by fewer acquisitions of noncontrolling interests.
Cash and equivalents were $59.2 million at March 28, 2015, down from $89.5 million at December 27, 2014. Working capital was $1,255.4 million. Total debt was $831.4 million, up from $731.5 million at year-end; long-term debt included $275.0 million under the receivables securitization facility, compared with $150.0 million at year-end. The company had $163.1 million outstanding on other short-term bank credit lines. No amount was drawn on its $500 million revolving facility, which includes a $200 million expansion feature. Management said available cash, debt and equity market access, and credit facilities were sufficient for foreseeable capital needs.
Accounts receivable days sales outstanding increased to 41.2 days from 40.8 days a year earlier; inventory turns declined to 5.3 from 5.6.
Material changes and unusual items
- Reported sales growth of 1.4% included 7.4% local-currency growth—4.8% internally generated and 2.6% from acquisitions—partly offset by a 6.0% foreign-exchange impact.
- The company recorded $6.9 million of restructuring costs in the quarter. The 2015 initiative is expected to eliminate approximately 2% to 3% of the workforce and close certain facilities. Total pre-tax costs were estimated at $35 million to $40 million, with $30 million to $35 million remaining as of April 30, 2015.
- Foreign-currency translation generated a $109.9 million other comprehensive loss, compared with a $7.8 million gain in the prior-year quarter. Comprehensive loss attributable to Henry Schein was $3.3 million, versus income of $107.1 million.
- The company repurchased 542,029 shares for $75.7 million during the quarter; $224.2 million remained available under its repurchase authorization at March 28.
- Two European dental acquisitions completed during the quarter had combined approximate annual revenues of $15 million. The acquisition of scil animal care company, with annual sales of approximately $83 million, closed March 31, after the reporting period.
Outlook, commentary and risks
The filing provides no specific full-year earnings or revenue guidance. Management said the restructuring is intended to reduce costs and fund growth initiatives for its 2015–2017 strategic planning cycle. It also expects working-capital requirements to increase and noted that sales seasonality and inventory purchasing can affect cash needs.
Key risks discussed include competition and online commerce, supplier and customer dependence, economic and health care industry changes, acquisitions and integration, foreign-currency movements, regulatory and reimbursement changes, fraud-and-abuse and product-distribution requirements, data privacy and information-system disruptions, and evolving regulation of health care software. The company uses foreign-currency forwards to hedge selected exposures but does not hedge translation of foreign profits.
Unrecognized tax benefits were approximately $82.9 million, of which $62.5 million would affect the effective tax rate if recognized. The company disputed IRS adjustments for tax years 2009–2011 in Tax Court and said it did not expect a significant effect on financial position, liquidity or results. Management reported no material change in risk factors from its prior Form 10-K and said pending legal matters were not expected to have a material adverse effect. Disclosure controls were considered effective; the quarter’s acquisitions, integrations and systems implementations were described as a material change in internal control over financial reporting.
Most important facts for investors to verify
- Whether local-currency sales growth continues and offsets the impact of foreign exchange, especially in dental and international operations.
- Whether restructuring delivers expected efficiencies and growth funding, and whether total costs remain within the $35 million–$40 million estimate.
- Working-capital conversion, operating cash flow and the trend in inventory turns and receivable days.
- The increase in total debt and receivables-securitization borrowings, along with compliance with credit-facility covenants and access to liquidity.
- Integration and performance of recent acquisitions, including scil, and the effects of ongoing regulatory, tax and currency exposures.