Business context and reporting period
Henry Schein, Inc. filed this Form 10-K for the 52-week fiscal year ended December 28, 2019. The company distributes dental and medical products and provides practice-management software and related services. Its reportable segments are health care distribution and technology and value-added services.
On February 7, 2019, Henry Schein completed the spin-off of its animal health business into Covetrus. That business is reported as discontinued operations; continuing-operations comparisons exclude it. The company received $1.12 billion from Covetrus financing and $361.1 million from a Covetrus share sale in connection with the transaction.
Financial results and liquidity
| Metric | FY 2019 | FY 2018 | Change / context |
|---|---|---|---|
| Net sales | $9.986 billion | $9.418 billion | Up 6.0%; excluding Covetrus transition-services sales, up 5.2% |
| Gross profit / margin | $3.091 billion / 31.0% | $2.911 billion / 30.9% | Margin up 0.1 percentage point |
| Operating income | $718.3 million | $600.6 million | Up 19.6% |
| Net income from continuing operations | $725.5 million | $450.4 million | Includes $186.8 million after-tax gain from equity investment sales in 2019 |
| Net income attributable to Henry Schein | $694.7 million | $535.9 million | 2019 includes a $6.0 million attributable loss from discontinued operations |
| Diluted EPS, continuing operations | $4.69 | $2.80 | Significantly affected by 2019 investment-sale gain |
| Operating cash flow, continuing operations | $820.5 million | $451.0 million | Higher net income, lower working-capital needs and increased affiliate distributions |
| Investing cash flow, continuing operations | $(422.3) million | $(164.3) million | Higher acquisition and equity-investment payments, partly offset by investment-sale proceeds |
| Financing cash flow, continuing operations | $(363.4) million | $(402.2) million | Included debt repayments and $525 million of share repurchases |
Fourth-quarter 2019 sales were $2.669 billion, versus $2.473 billion a year earlier. Quarterly operating income was $196.3 million versus $158.0 million; continuing-operations diluted EPS was $2.25 versus $0.77. The quarter included the $186.8 million after-tax gain on investment sales.
Health care distribution sales rose 4.2% for the year; dental sales increased 1.1% and medical sales 11.7%. Technology and value-added services sales increased 26.1%, with acquisitions contributing substantially. Segment gross margin was 28.9% for distribution, down from 29.2%, and 72.0% for technology and value-added services, up from 69.0%.
At year-end, cash and cash equivalents were $106.1 million and working capital was $1.188 billion. Total debt was $756.7 million, down from $1.940 billion; long-term debt was $622.9 million and current maturities were $109.8 million. The $750 million revolving credit facility had no borrowings outstanding. Operating lease liabilities totaled $241.6 million. The company reported no off-balance-sheet arrangements.
Material changes versus the prior period
- Continuing-operations sales grew 5.2% excluding transition-services sales, but reported growth included $81.3 million of Covetrus product sales under the transition-services agreement.
- Operating income increased despite lower distribution gross margin; reported SG&A and restructuring costs were lower than in 2018, which included $38.5 million of litigation settlements and $54.4 million of restructuring costs. 2019 restructuring costs were $14.7 million.
- Interest expense fell to $50.8 million from $76.0 million, primarily because of lower borrowings under bank credit lines.
- The effective tax rate increased to 23.4% from 20.0%. The 2018 rate included tax benefits and charges related to tax reform and legal-entity reorganizations.
- Sales of Hu-Friedy and other equity investments generated a $250.2 million pretax gain ($186.8 million after tax). This gain is unusual and materially boosted reported earnings.
- Year-end shares outstanding were lower, and the company repurchased $525 million of stock during 2019. No dividends were declared in 2018 or 2019.
Outlook, risks and unusual items
The filing provides no specific numerical earnings or revenue guidance. Management described its objective as expanding its global value-added offering, growing existing and new customer relationships, developing technology and services, and pursuing acquisitions and joint ventures. A restructuring initiative begun in November 2019 to address stranded spin-off costs and improve efficiency was expected to be completed by the end of 2020; the company said it could not yet estimate its cost.
The Covetrus transition-services agreement was expected to continue through August 2020. The filing discusses COVID-19-related closures at certain China businesses and possible infection-control supply constraints, but states that the broader economic and supply-chain impact was uncertain and could materially adversely affect results. Other key risks include intense competition and pricing pressure, reliance on third-party suppliers, foreign-exchange movements, cyber and privacy incidents, healthcare regulation, and acquisition integration.
Legal matters include the Archer antitrust case, for which trial proceedings were stayed pending a further Supreme Court review; opioid-related claims against the company or affiliates (fewer than 125 cases were disclosed); and a Covetrus securities action relating to the spin-off. The FTC complaint against Henry Schein was dismissed with the administrative decision becoming final in November 2019. The company said accrued probable and estimable litigation losses were not material. A proposed settlement of the Henry Schein securities class action was subject to definitive documentation and court approval; the company expected insurance to cover payments. The opioid matter involving Summit County was dismissed with prejudice, alongside a $1 million donation and $250,000 payment of county expenses.
The auditor issued unqualified opinions on the financial statements and internal control over financial reporting. The filing identifies acquired-intangible valuation and uncertain transfer-pricing tax positions as critical audit matters. Management reported effective disclosure controls and internal control, while noting continuing acquisition integrations and system implementations.
Important facts for investors to verify
- How much future earnings growth is supported by underlying operations after excluding the $186.8 million after-tax investment-sale gain?
- Whether organic growth, especially in dental distribution, can improve while distribution gross margins remain under pressure.
- Whether acquisition-led technology growth converts into sustainable operating profit, given rising segment expenses and goodwill.
- Progress and costs of the restructuring due by the end of 2020, and the expected wind-down of Covetrus transition services.
- Updates on COVID-19 effects, supplier availability, and any resulting changes in demand or operating costs.
- Developments in antitrust, opioid and securities litigation, and the outcome of tax audits and transfer-pricing discussions.
- Debt maturities, liquidity needs, acquisition spending and the pace of share repurchases.