Henry Schein, Inc. — FY2017 Form 10-K
Business context and reporting period. Henry Schein distributes dental, animal-health and medical products and provides practice-management software and related services. The annual report covers the 52 weeks ended December 30, 2017; the prior fiscal year had 53 weeks. The company reported two segments: health care distribution and technology and value-added services.
Financial performance and liquidity
| Metric | FY2017 | FY2016 |
|---|---|---|
| Net sales | $12.462 billion | $11.572 billion |
| Gross profit / margin | $3.399 billion / 27.3% | $3.226 billion / 27.9% |
| Operating income | $859.4 million | $771.6 million |
| Net income attributable to Henry Schein | $406.3 million | $506.8 million |
| Diluted earnings per share | $2.57 | $3.10 |
| Cash from operating activities | $545.5 million | $642.6 million |
- Revenue rose 7.7%. Management attributed growth to 5.1% internally generated revenue, 3.6% from acquisitions and 0.5% foreign-exchange benefit, with the comparison affected by the extra week in FY2016.
- Dental sales increased 8.9%, animal-health sales 6.9%, medical sales 6.9%, and technology and value-added services sales 2.9%.
- Gross margin fell 0.6 percentage point, primarily reflecting lower health-care distribution margins; that segment’s margin declined from 26.5% to 25.9%. Technology and value-added services margin increased from 64.2% to 65.4%.
- Operating income increased 11.4%, while selling, general and administrative expenses rose 5.4% and declined as a share of sales, from 20.8% to 20.4%.
- Operating cash flow decreased $97.1 million, primarily due to working-capital needs, including higher receivables and inventory. Investing cash outflow was $342.3 million; financing cash outflow was $112.6 million.
- Cash and cash equivalents were $174.7 million and working capital was $1.257 billion at year-end. Total debt, including bank credit lines and current and long-term debt, was $1.666 billion, up from $1.219 billion. The current ratio was approximately 1.45, based on reported current assets and liabilities.
Material changes and unusual items
- Net income attributable to Henry Schein fell 19.8%. The principal unusual item was approximately $143 million of tax expense from the 2017 Tax Cuts and Jobs Act: a provisional $140 million transition tax on previously untaxed foreign earnings and a $3 million deferred-tax revaluation charge. Excluding those items, management reported an effective tax rate of 26.7%, versus the actual 44.1% rate.
- The company reported a $17.6 million loss on the sale of an equity investment. Interest expense increased $21.8 million, primarily due to higher borrowings and rates and a Brazilian financing arrangement.
- Fourth-quarter consolidated net income was $8.5 million; net income attributable to Henry Schein was a loss of $8.5 million, or diluted loss per share of $0.06, reflecting the tax charge. Quarterly sales were $3.318 billion and operating income was $241.2 million.
- Share repurchases totaled $450 million in FY2017. The company had $200 million remaining under its authorization at year-end and did not anticipate paying dividends in the foreseeable future.
- The two-for-one stock split approved in 2017 is reflected retroactively in reported share and per-share data.
Outlook, risks and contingencies
- Management expected an FY2018 effective tax rate of approximately 24%. The filing does not provide a specific revenue, earnings or cash-flow forecast.
- The company cited acquisition opportunities, customer-base expansion and cross-selling as strategic priorities. It also noted seasonality, with revenues and profitability generally higher in the third and fourth quarters.
- Key risks include intense price competition and industry consolidation; reliance on third-party suppliers; shipping costs; integration of acquisitions; foreign-exchange and macroeconomic exposure; changing health-care regulation; and cybersecurity, privacy and software-certification requirements.
- Tax Act estimates were provisional and could change as further guidance and information became available. The company was assessing the effects of new GILTI and BEAT provisions effective in 2018.
- Several dental-industry antitrust matters were pending. A class-action case and claims by Archer sought damages and other relief; IQ Dental’s case had been dismissed but was appealed. In February 2018, the FTC filed a separate complaint seeking equitable relief, not monetary damages; Henry Schein denied the allegations and said it would defend the matter. The company stated that the FTC matter was not expected to materially affect its financial condition or results. Accrued probable and estimable legal losses at year-end were not material.
- Management and BDO reported effective disclosure controls and internal control over financial reporting; BDO issued unqualified opinions on the financial statements and internal controls.
Important facts for investors to verify
- How much of sales and operating-income growth was organic versus acquisition-related, and how comparable the results are given FY2016’s extra week.
- Whether distribution gross-margin pressure persists and whether acquisition-related growth translates into earnings and cash flow.
- The final Tax Act accounting, cash-payment schedule for the $140 million transition tax, and the effect of GILTI and BEAT on the FY2018 tax rate.
- Debt growth, borrowing costs, working-capital requirements, and compliance with credit-facility leverage covenants.
- Developments and potential financial exposure in the antitrust matters, including the FTC complaint and appealed IQ Dental case.
- Execution and control risks from acquisitions and systems implementations; the filing identified these as material changes to internal-control processes while concluding controls remained effective.