Henry Schein, Inc. — FY2018 Form 10-K
Reporting period: Fiscal year ended December 29, 2018 (52 weeks); fourth quarter ended December 29, 2018. The reported 2018 results include the animal health business, which was spun off in February 2019. From Q1 2019, that business is to be reported as discontinued operations.
Business context
Henry Schein distributes dental and medical products and provides practice-management software and related services to more than one million customers. Its two reportable segments are health care distribution and technology and value-added services. The company completed its animal health separation and merger with Vets First Choice on February 7, 2019, creating Covetrus; Henry Schein no longer owns Covetrus or consolidates its results.
Financial performance
| Metric | FY2018 | FY2017 |
|---|---|---|
| Net sales | $13.202 billion | $12.462 billion |
| Gross profit / margin | $3.595 billion / 27.2% | $3.399 billion / 27.3% |
| Operating income / margin | $753.1 million / 5.7% | $859.4 million / 6.9% |
| Net income attributable to Henry Schein | $535.9 million | $406.3 million |
| Diluted EPS | $3.49 | $2.57 |
| Cash from operating activities | $684.7 million | $545.5 million |
- Sales rose 5.9%; management attributed growth to 5.2% local-currency growth and 0.7% foreign-exchange benefit. Technology and value-added services sales increased 16.2%, including 12.3% growth from acquisitions; health care distribution sales rose 5.6%.
- Operating income fell 12.4%, despite higher revenue. SG&A and related reported costs increased, and the distribution gross margin declined to 25.6% from 25.9%. Technology gross margin improved to 67.1% from 65.4%.
- Net income attributable to Henry Schein increased 31.9%, and diluted EPS rose from $2.57 to $3.49. The lower effective tax rate—22.4% versus 44.1%—was a major factor; 2017 included approximately $143 million of one-time Tax Act expense. FY2018 also included a $10 million reduction in the estimated transition tax.
- FY2018 Q4 sales were $3.375 billion versus $3.318 billion in Q4 2017. Q4 operating income was $179.6 million versus $241.2 million; net income attributable to Henry Schein was $133.0 million versus a loss of $8.5 million, and diluted EPS was $0.87 versus a loss of $0.06. The prior-year quarter included the Tax Act-related tax charge.
Liquidity, debt and capital allocation
- At year-end, cash and cash equivalents were $80.2 million, working capital was $956.4 million, and total debt was $1.964 billion, up from $1.666 billion a year earlier. Cash declined from $174.7 million.
- Operating cash flow increased by $139.2 million. Investing cash use was $193.0 million, while financing cash use was $603.8 million, driven chiefly by $668.5 million spent acquiring noncontrolling interests; share repurchases were $200 million.
- Credit-line borrowings had a 3.30% weighted-average rate at year-end, up from 2.27%. Management said cash, access to debt and equity markets, and available credit facilities were sufficient for foreseeable needs. The filing reports no off-balance-sheet arrangements.
- The company repurchased approximately $2.9 billion of shares cumulatively under its program, with $400 million authorized but unused at year-end. It did not pay dividends and did not anticipate doing so in the foreseeable future.
Material changes, outlook and risks
- Animal health separation: Covetrus distributed $1.12 billion of debt-financing proceeds and $361.1 million of share-sale proceeds to Henry Schein in connection with the transaction. Henry Schein repaid a separate $400 million loan when the spin-off closed. Management estimates continuing-operations FY2018 revenue of $9.4 billion and net income of $430.7 million; these are estimates, not the reported consolidated FY2018 figures above.
- Restructuring and unusual costs: FY2018 included $62.9 million of restructuring charges, $38.8 million of animal-health spin-off transaction costs, and a $38.5 million charge related to a proposed settlement of a dental-supplies antitrust class action. The restructuring is expected to continue in the first half of 2019; the company could not reasonably estimate additional 2019 charges.
- Management plans: The 2018–2020 strategic plan includes reducing costs to fund growth initiatives. The filing provides no specific revenue, earnings or margin guidance for 2019.
- Legal and regulatory exposure: Significant matters include dental distribution antitrust litigation and an FTC proceeding, securities litigation, and opioid-related lawsuits. The company recorded the $38.5 million proposed class-action settlement charge; it says its accrued estimate for other probable and estimable legal losses was not material. Outcomes and potential exposure remain uncertain.
- Other risks: The filing highlights price and competitive pressure, reliance on third-party suppliers and shippers, acquisition integration, foreign exchange and interest-rate exposure, healthcare regulation, privacy and cybersecurity, and the risk that the animal-health separation may not qualify as tax-free. A 5% change in the average U.S. dollar value against foreign currencies would have changed 2018 reported attributable net income by approximately $8 million, according to the company.
- The independent auditor gave an unqualified opinion on the financial statements and internal controls; management also concluded disclosure controls and internal control over financial reporting were effective at December 29, 2018.
Most important facts for investors to verify
- Reconcile reported FY2018 consolidated results with management’s estimated continuing-operations figures, and assess the post-spin-off earnings and revenue base.
- Assess the durability of sales growth and the decline in operating income and distribution margins, separating organic growth from acquisitions and other presentation effects.
- Review the effect of tax items on reported earnings and the remaining transition-tax obligation.
- Track post-spin-off debt, liquidity, and the use of proceeds, including repayment of the $400 million loan and the impact of the separation on future cash flows.
- Monitor outcomes and potential financial exposure from antitrust, securities and opioid litigation, as well as the completion and cost of restructuring.