UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
-----------
FORM 10-Q
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(Mark One)
X Quarterly report pursuant to Section 13 or 15(d) of the Securities Exchange
- --- Act of 1934
FOR THE PERIOD ENDED March 29, 2003
OR
Transition report pursuant to Section 13 or 15(d) of the Securities
- --- Exchange Act of 1934
COMMISSION FILE NUMBER: 0-27078
HENRY SCHEIN, INC.
(Exact Name of Registrant as Specified in Its Charter)
DELAWARE 11-3136595
(State or Other Jurisdiction of (I.R.S. Employer Identification No.)
Incorporation or Organization)
135 DURYEA ROAD
MELVILLE, NEW YORK
(Address of Principal Executive Offices)
11747
(Zip Code)
Registrant's Telephone Number, Including Area Code: (631) 843-5500
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days:
Yes X No
--
Indicate by check mark whether the registrant is an accelerated filer
(as defined in Exchange Act Rule 12b-2).
Yes X No
--
As of May 06, 2003 there were 44,192,146 shares of the Registrant's Common Stock
outstanding.
HENRY SCHEIN, INC. AND SUBSIDIARIES
INDEX
Page
----
PART I. FINANCIAL INFORMATION
ITEM 1. Consolidated Financial Statements:
Balance Sheets as of March 29, 2003 and December 28, 2002 ...... 3
Statements of Income and Comprehensive Income for the three
months ended March 29, 2003 and March 30, 2002 .............. 4
Statements of Cash Flows for the three months ended
March 29, 2003 and March 30, 2002 ........................... 5
Notes to Consolidated Financial Statements ..................... 6
ITEM 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations .................. 11
ITEM 3. Quantitative and Qualitative Disclosures about Market Risk ........ 20
ITEM 4. Controls and Procedures ........................................... 20
PART II. OTHER INFORMATION
ITEM 1. Legal Proceedings ................................................. 21
ITEM 6. Exhibits and Reports on Form 8-K .................................. 23
Signature ......................................................... 23
2
PART 1. FINANCIAL INFORMATION
ITEM 1. CONSOLIDATED FINANCIAL STATEMENTS
HENRY SCHEIN, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(In thousands, except share data)
March 29, December 28,
2003 2002
----------- -----------
(unaudited) (audited)
ASSETS
Current assets:
Cash and cash equivalents ................................................ $ 186,995 $ 200,651
Marketable securities .................................................... 14,442 31,209
Accounts receivable, less reserves of $37,762 and $36,200, respectively... 381,128 368,263
Inventories .............................................................. 334,910 323,080
Deferred income taxes .................................................... 28,725 29,919
Prepaid expenses and other ............................................... 67,846 74,407
----------- -----------
Total current assets ................................................... 1,014,046 1,027,529
Property and equipment, net of accumulated depreciation and amortization
of $108,397 and $101,519, respectively ................................... 148,728 142,532
Goodwill ................................................................... 305,638 302,687
Other intangibles, net of accumulated amortization
of $4,505 and $4,151, respectively ....................................... 8,787 7,661
Investments and other ...................................................... 74,083 77,643
----------- -----------
$ 1,551,282 $ 1,558,052
=========== ===========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable ......................................................... $ 213,868 $ 243,166
Bank credit lines ........................................................ 3,213 4,790
Accruals:
Salaries and related expenses .......................................... 44,708 53,954
Merger, integration, and restructuring costs ........................... 2,779 3,044
Acquisition earnout payments ........................................... -- 1,460
Taxes and other expenses ............................................... 115,753 114,254
Current maturities of long-term debt ..................................... 2,600 2,662
----------- -----------
Total current liabilities .............................................. 382,921 423,330
Long-term debt ............................................................. 242,868 242,561
Other liabilities .......................................................... 25,109 24,196
----------- -----------
Total liabilities ...................................................... 650,898 690,087
----------- -----------
Minority interest .......................................................... 9,070 6,748
----------- -----------
Stockholders' equity:
Preferred stock, $.01 par value, authorized 1,000,000,
issued and outstanding: 0 and 0, respectively .......................... -- --
Common stock, $.01 par value, authorized 120,000,000,
issued: 44,144,423 and 44,041,591, respectively ........................ 441 440
Additional paid-in capital ............................................... 440,369 436,554
Retained earnings ........................................................ 451,286 430,389
Treasury stock, at cost, 0, and 62,479 shares, respectively............... -- (1,156)
Accumulated comprehensive loss ........................................... (597) (4,794)
Deferred compensation .................................................... (185) (216)
----------- -----------
Total stockholders' equity ............................................. 891,314 861,217
----------- -----------
$ 1,551,282 $ 1,558,052
=========== ===========
See accompanying notes to consolidated financial statements.
3
HENRY SCHEIN, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
AND COMPREHENSIVE INCOME
(In thousands, except per share data)
(unaudited)
Three Months Ended
------------------------
March 29, March 30,
2003 2002
--------- ---------
Net sales ........................................................... $ 737,997 $ 647,093
Cost of sales ....................................................... 536,580 468,703
--------- ---------
Gross profit ...................................................... 201,417 178,390
Operating expenses:
Selling, general and administrative ............................... 159,212 143,192
--------- ---------
Operating income ................................................ 42,205 35,198
Other income (expense):
Interest income ................................................... 2,392 2,439
Interest expense .................................................. (4,733) (4,828)
Other - net ....................................................... 685 (566)
--------- ---------
Income before taxes on income, minority interest and equity
in earnings of affiliates ..................................... 40,549 32,243
Taxes on income ..................................................... 15,206 12,064
Minority interest in net income of subsidiaries ..................... 737 569
Equity in earnings of affiliates .................................... 160 120
--------- ---------
Net income .......................................................... $ 24,766 $ 19,730
========= =========
Comprehensive income:
Net income ........................................................ $ 24,766 $ 19,730
Foreign currency translation adjustment ......................... 4,339 (1,317)
Other ........................................................... (142) (61)
--------- ---------
Comprehensive income ................................................ $ 28,963 $ 18,352
========= =========
Net income per common share:
Basic ........................................................... $ 0.56 $ 0.46
========= =========
Diluted ......................................................... $ 0.55 $ 0.45
========= =========
Weighted average common shares outstanding:
Basic ........................................................... 44,008 42,791
========= =========
Diluted ......................................................... 45,069 44,069
========= =========
See accompanying notes to consolidated financial statements.
4
HENRY SCHEIN, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
(unaudited)
Three Months Ended
------------------------
March 29, March 30,
2003 2002
--------- ---------
Cash flows from operating activities:
Net income ................................................................ $ 24,766 $ 19,730
Adjustments to reconcile net income to net cash used in
operating activities:
Depreciation and amortization ......................................... 8,544 5,798
Provision for losses and allowances on trade receivables .............. 1,535 1,234
Provision (benefit) for deferred income taxes ......................... 2,068 (1,716)
Undistributed earnings of affiliates .................................. (160) (120)
Minority interest in net income of subsidiaries ....................... 737 569
Other ................................................................. (85) 30
Changes in operating assets and liabilities (net of purchase acquisitions):
(Increase) decrease in accounts receivable .............................. (12,537) 4,613
Increase in inventories ................................................. (8,824) (3,796)
Decrease (increase) in other current assets ............................. 10,837 (195)
Decrease in accounts payable and accruals ............................... (40,966) (64,933)
--------- ---------
Net cash used in operating activities ....................................... (14,085) (38,786)
--------- ---------
Cash flows from investing activities:
Capital expenditures ...................................................... (13,508) (17,590)
Business acquisitions, net of cash acquired ............................... (2,281) (28,150)
Purchase of marketable securities with maturities of more than
three months ............................................................ (4,101) (10,455)
Maturities of marketable securities with maturities of more than
three months ............................................................ 26,430 --
Other ..................................................................... (1,487) (302)
--------- ---------
Net cash provided by (used in) investing activities ......................... 5,053 (56,497)
--------- ---------
Cash flows from financing activities:
Principal payments on long-term debt ...................................... (254) (12,013)
Proceeds from issuance of stock upon exercise of stock
options by employees .................................................... 4,600 7,183
Payments for repurchases of common stock .................................. (6,483) --
Proceeds from borrowings from banks ....................................... 935 481
Payments on borrowings from banks ......................................... (2,610) (394)
Other ..................................................................... 65 (423)
--------- ---------
Net cash used in financing activities ....................................... (3,747) (5,166)
--------- ---------
Net decrease in cash and cash equivalents ................................... (12,779) (100,449)
Effect of exchange rate changes on cash and cash equivalents ................ (877) 503
--------- ---------
Cash and cash equivalents, beginning of period .............................. 200,651 193,367
--------- ---------
Cash and cash equivalents, end of period .................................... $ 186,995 $ 93,421
========= =========
See accompanying notes to consolidated financial statements.
5
HENRY SCHEIN, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(In thousands, except employee and share data)
(unaudited)
NOTE 1. BASIS OF PRESENTATION
The consolidated financial statements include the accounts of Henry Schein,
Inc. and its wholly-owned and majority-owned subsidiaries (collectively, the
"Company").
In the opinion of the Company's management, the accompanying unaudited
consolidated financial statements contain all adjustments (consisting of only
normal recurring adjustments) necessary to present fairly the information set
forth therein. These consolidated financial statements are condensed and
therefore do not include all of the information and footnotes required by
accounting principles generally accepted in the United States for complete
financial statements. The consolidated financial statements should be read in
conjunction with the Company's consolidated financial statements and
supplementary data included in the Company's Annual Report on Form 10-K for the
year ended December 28, 2002. The Company follows the same accounting policies
in preparation of interim financial statements.
The results of operations and cash flows for the three months ended March
29, 2003 are not necessarily indicative of the results to be expected for the
fiscal year ending December 27, 2003 or any other period.
NOTE 2. SEGMENT DATA
The Company has two reportable segments: healthcare distribution and
technology.
The healthcare distribution segment, which is comprised of the Company's
dental, medical, and international business groups, distributes healthcare
products (primarily consumable) and services to office-based healthcare
practitioners and professionals in the combined United States, Canada, and
international markets. Products, which are similar for each business group, are
maintained and distributed from strategically located distribution centers.
The technology segment consists primarily of the Company's practice
management software business and certain other value-added products and services
that are distributed primarily to healthcare professionals in the United States
and Canada.
The Company's reportable segments are strategic business units that offer
different products and services to the same customer base. Most of the
technology business was acquired as a unit, and the management at the time of
acquisition was retained. The following tables present information about the
Company's business segments:
6
HENRY SCHEIN, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(In thousands, except employee and share data)
(unaudited)
Three Months Ended
--------------------
March 29, March 30,
2003 2002
--------- ---------
Net Sales:
Healthcare distribution (1):
Dental (2) ............................... $ 313,956 $ 295,281
Medical (3) .............................. 277,140 231,422
International (4) ........................ 129,600 105,838
--------- ---------
Total healthcare distribution ........ 720,696 632,541
Technology (5) ............................... 17,301 14,552
--------- ---------
$ 737,997 $ 647,093
========= =========
- ----------
(1) Consists of consumable products, small equipment, laboratory products,
large dental equipment, branded and generic pharmaceuticals, surgical
products, diagnostic tests, infection control and vitamins.
(2) Consists of products sold in the United States and Canada.
(3) Consists of products sold in the United States Medical and Veterinary
markets.
(4) Consists of products sold in the Dental, Medical and Veterinary markets,
primarily in Europe.
(5) Consists of practice management software and other value-added products and
services, which are distributed primarily to healthcare professionals in
the United States and Canada.
Three Months Ended
--------------------
March 29, March 30,
2003 2002
--------- ---------
Operating Income:
Healthcare distribution ................... $ 35,161 $ 29,856
Technology ................................ 7,044 5,342
--------- ---------
Total ..................................... $ 42,205 $ 35,198
========= =========
March 29, March 30,
2003 2002
---------- ----------
Total Assets:
Healthcare distribution ............................... $1,527,329 $1,280,671
Technology ............................................ 114,037 96,124
---------- ----------
Total assets for reportable segments ............. 1,641,366 1,376,795
Receivables due from healthcare distribution segment .. (89,050) (65,875)
Receivables due from technology segment ............... (1,034) (1,401)
---------- ----------
Consolidated total assets ........................ $1,551,282 $1,309,519
========== ==========
7
HENRY SCHEIN, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(In thousands, except employee and share data)
(unaudited)
NOTE 3. STOCK-BASED COMPENSATION
The Company applies Accounting Principles Board Opinion No. 25, "Accounting
for Stock Issued to Employees", ("APB 25"), and related interpretations in
accounting for its employee stock options. Under APB 25, no compensation expense
is recorded so long as the quoted market price of the stock at the date of the
grant is equal to the exercise price.
Pro forma information regarding net income and earnings per share has been
determined as if the Company and its acquired subsidiaries had accounted for its
employee stock options under the fair value method of Financial Accounting
Standards Board Statement No. 123, "Accounting for Stock-Based Compensation",
("FAS 123"). The weighted average fair value of options granted during the three
months ended March 29, 2003 and March 30, 2002 was $21.56 and $24.81,
respectively. The fair value for these options was estimated at the date of
grant using a Black-Scholes option pricing model with the following weighted
average assumptions for the three months ended March 29, 2003 and March 30,
2002: risk-free interest rates of 3.8% and 5.1%, respectively; volatility factor
of the expected market price of the Company's Common Stock of 45.3% and 49.6%,
respectively, assumed dividend yield of 0% for both periods, and a
weighted-average expected life of the option of 10 years.
Under the accounting provisions of FAS 123, the Company's net income and
net income per common share would have been adjusted to the pro forma amounts
indicated below:
Three months ended
---------------------
March 29, March 30,
2003 2002
--------- ---------
Net income as reported ...................................... $ 24,766 $ 19,730
Deduct: Total stock-based employee compensation expense
determined under fair value method, net of related taxes... (2,509) (2,284)
-------- --------
Pro forma net income ........................................ $ 22,257 $ 17,446
======== ========
Net income per common share - as reported:
Basic ....................................................... $ 0.56 $ 0.46
======== ========
Diluted ..................................................... $ 0.55 $ 0.45
======== ========
Net income per common share - pro forma:
Basic ....................................................... $ 0.51 $ 0.41
======== ========
Diluted ..................................................... $ 0.49 $ 0.40
======== ========
8
HENRY SCHEIN, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(In thousands, except employee and share data)
(unaudited)
NOTE 4. GOODWILL AND INTANGIBLE ASSETS
The changes in the carrying amount of goodwill for the three months ended
March 29, 2003 are as follows:
Healthcare
Distribution Technology Total
------------ ---------- ---------
Balance as of December 28, 2002 .................... $ 302,352 $ 335 $ 302,687
Adjustments to goodwill:
Acquisition costs incurred during the three
months ended March 29, 2003 ............... 693 89 782
Foreign currency translation .................. 2,169 -- 2,169
--------- ------- ---------
Balance as of March 29, 2003 ....................... $ 305,214 $ 424 $ 305,638
========= ======= =========
The acquisition costs incurred during the three months ended March 29, 2003
related to contingent earnout payments relating to acquisitions in prior years
and the acquisition of a dental equipment repair and service business that was
not considered material.
Other intangible assets as of March 29, 2003 and December 28, 2002 were as
follows:
March 29, 2003 December 28, 2002
----------------------- -----------------------
Accumulated Accumulated
Cost Amortization Cost Amortization
-------- ------------ -------- ------------
Other intangible assets:
Non-compete agreements... $ 11,836 $ (3,741) $ 10,826 $ (3,549)
Other ................... 1,456 (764) 986 (602)
-------- -------- -------- --------
Total ...................... $ 13,292 $ (4,505) $ 11,812 $ (4,151)
======== ======== ======== ========
Amortization of other intangible assets for the three months ended March
29, 2003 and March 30, 2002 was approximately $271 and $227, respectively. The
annual amortization expense expected for the years 2003 through 2007 is $999,
$876, $655, $442, and $406, respectively.
9
HENRY SCHEIN, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(In thousands, except employee and share data)
(unaudited)
NOTE 5. CONTINUING OBLIGATIONS
In connection with acquisitions made in prior years and the Company's plan
of restructuring announced on August 1, 2000, the Company incurred certain
merger and integration and restructuring costs.
The following table shows amounts paid against the accruals for these costs
during the three months ended March 29, 2003:
Balance at Balance at
December 28, Payments March 29,
2002 2003
------------ -------- ----------
Facility closing costs (1) ................. $ 2,150 $ (145) $ 2,005
Severance and other direct costs (2) ....... 558 (102) 456
Direct transaction, professional and
consulting fees and other integration costs.. 336 (18) 318
------------ -------- ---------
$ 3,044 $ (265) $ 2,779
============ ======== =========
- ----------
(1) Represents costs associated with the closing of certain equipment
branches (primarily lease termination costs) and property and equipment
write-offs.
(2) Represents salaries and related benefits for employees separated from
the Company. For the three months ended March 29, 2003, two employees
received severance payments and were still owed severance pay and
benefits at March 29, 2003.
NOTE 6. EARNINGS PER SHARE
A reconciliation of shares used in calculating basic and diluted earnings
per common share follows:
Three Months Ended
-----------------------
March 29, March 30,
2003 2002
---------- ----------
Basic .................................................. 44,008,098 42,791,113
Effect of assumed conversion of employee stock options.. 1,061,111 1,278,286
---------- ----------
Diluted ................................................ 45,069,209 44,069,399
========== ==========
Options to purchase approximately 83,643 and 10,000 shares of common stock
at prices ranging from $41.85 to $54.00 and $42.75 to $46.00 per share that were
outstanding during the three months ended March 29, 2003 and March 30, 2002,
respectively, were excluded from the computation of diluted earnings per common
share for each of the respective periods because the options' exercise prices
exceeded the fair market value of the Company's common stock.
10
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
CAUTIONARY NOTE REGARDING FORWARD-LOOKING STATEMENTS
Except for historical information contained herein, the statements in this
report (including without limitation, statements indicating that we "expect",
"estimate", "anticipate", or "believe", and all other statements concerning
future financial results, product or service offerings or other events that have
not yet occurred) are forward-looking statements that are made pursuant to the
safe harbor provisions of the Private Securities Litigation Reform Act of 1995,
Section 21E of the Securities Exchange Act of 1934, as amended, and Section 27A
of the Securities Act of 1933, as amended. Forward-looking statements involve
known and unknown factors, risks and uncertainties which may cause our actual
results in future periods to differ materially from those expressed in any
forward-looking statements. Those factors, risks and uncertainties include, but
are not limited to, the factors described under "Risk Factors" below.
OVERVIEW
We are the largest distributor of healthcare products and services to
office-based healthcare practitioners in the combined North American and
European markets with operations in the United States, Canada, the United
Kingdom, the Netherlands, Belgium, Germany, France, Austria, Spain, Ireland,
Portugal, Australia and New Zealand.
We sell products and services to over 400,000 customers, primarily dental
practices and dental laboratories, as well as physician practices, veterinary
clinics and institutions. Through our comprehensive catalogs and other direct
sales and marketing programs, we offer customers a broad product selection of
both branded and private brand products.
We conduct our business through two segments: healthcare distribution and
technology. These operations offer different products and services to the same
customer base.
The healthcare distribution segment consists of our dental, medical
(including veterinary), and international groups. The international group is
comprised of our healthcare distribution business units located primarily in
Europe, and offers products and services to dental and medical (including
veterinary) customers located in their respective geographic regions.
The technology segment consists of our practice management software
business and certain other value-added products and services which are
distributed primarily to healthcare professionals in the United States and
Canada.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
Securities Exchange Commission Financial Reporting Release No. 60 requires
all companies to include a discussion of critical accounting policies or methods
used in the preparation of financial statements.
11
We believe that the following critical accounting policies affect the
significant judgments and estimates used in the preparation of our financial
statements:
Management's Estimates
The preparation of consolidated financial statements requires us to make
estimates and judgments that affect the reported amounts of assets, liabilities,
revenues and expenses, and related disclosure of contingent assets and
liabilities. On an ongoing basis, we evaluate estimates, including those related
to sales allowance provisions, as described below, volume purchase rebates,
income taxes, inventory and bad debt reserves, and contingencies. We base our
estimates on historical data, when available, experience, industry and market
trends, and on various other assumptions that are believed to be reasonable
under the circumstances, the combined results of which form the basis for making
judgments about the carrying values of assets and liabilities that are not
readily apparent from other sources. Actual results may differ from these
estimates.
Revenue Recognition
Sales are recorded when products are shipped or services are rendered to
customers, as we generally have no significant post delivery obligations, the
product price is fixed and determinable, collection of the resulting receivable
is probable and product returns are reasonably estimable. Revenues derived from
post contract customer support for practice management software are deferred and
recognized ratably over the period in which the support is to be provided,
generally one year. Revenues from freight charged to customers are recognized
when products are shipped. Provisions for discounts, rebates to customers,
customer returns and other adjustments are provided for in the period the
related sales are recorded based upon historical data.
Accounts Receivable and Credit Policies
The carrying amount of accounts receivable is reduced by a valuation
allowance that reflects our best estimate of the amounts that will not be
collected. In addition to reviewing delinquent accounts receivable, we consider
many factors in estimating our general allowance, including historical data,
experience, customer types, credit worthiness, and economic trends. From time to
time, we may adjust our assumptions for anticipated changes in any of those or
other factors expected to affect collectability.
Allowances for accounts receivable, comprised primarily of the allowance
for doubtful accounts and the allowance for sales returns, were $37.8 million
and $36.2 million at March 29, 2003 and December 28, 2002, respectively.
Long-Lived Assets
Long-lived assets, other than goodwill, are evaluated for impairment when
events or changes in circumstances indicate that the carrying amount of the
assets may not be recoverable through the estimated undiscounted future cash
flows from the use of these assets. When any such impairment exists, the related
assets are written down to fair value.
Other intangible assets are amortized over their estimated useful lives. We
12
have reassessed the estimated useful lives of our intangible assets, which
primarily consist of non-compete agreements, and no changes were deemed
necessary.
Goodwill
In accordance with Statements of Financial Accounting Standards No. 141,
"Business Combinations", ("FAS 141"), and No. 142, "Goodwill and Other
Intangible Assets", ("FAS 142"), goodwill and intangible assets deemed to have
indefinite lives are no longer amortized but are subject to annual impairment
tests.
At March 29, 2003, we had recorded approximately $314.4 million in goodwill
and other intangible assets, net of accumulated amortization, primarily related
to acquisitions in prior years. The goodwill is substantially related to our
healthcare distribution segment.
We estimated the fair value of our reporting units in accordance with the
new standard and compared these valuations with the respective book values for
each of the reporting units to determine whether any goodwill impairment
existed. In determining the fair value, we consider past, present and future
expectations of performance. We completed our annual test as of the first day of
the fourth quarter of 2002 and determined that there was no impairment of
goodwill.
As required by FAS 142, we will complete subsequent goodwill impairment
tests at least annually. On a quarterly basis, we review changes in market
conditions, among other factors, that could have a material impact on our
estimates of fair value in order to reassess the carrying value of our goodwill
and no charges were deemed necessary.
Stock-Based Compensation
We account for stock option awards to employees under the intrinsic
value-based method of accounting prescribed by Accounting Principles Board
Opinion No. 25, "Accounting for Stock Issued to Employees". Under this method,
no compensation expense is recorded so long as the quoted market price of the
stock at the date of grant is equal to the exercise price.
We make pro forma disclosures of net income and earnings per share as if
the fair value-based method of accounting (the alternative method of accounting
for stock-based compensation) had been applied as required by Statement of
Financial Accounting Standards No. 123, "Accounting for Stock-Based
Compensation", ("FAS 123").
Had we elected to use FAS 123 to account for stock-based compensation under
the fair value method, we would have been required to record compensation
expense, and as a result, diluted earnings per common share for the three months
ended March 29, 2003 and March 30, 2002 would have been lower by $0.06 and
$0.05, respectively.
13
THREE MONTHS ENDED MARCH 29, 2003 COMPARED TO THREE MONTHS ENDED MARCH 30, 2002
For the three months ended March 29, 2003, our net sales increased $90.9
million, or 14.0%, to $738.0 million, from $647.1 million for the three months
ended March 30, 2002.
Of the $90.9 million increase, approximately $88.2 million, or 97.0%,
represented a 13.9% increase in our healthcare distribution business. As part of
this increase, approximately $45.7 million represented a 19.8% increase in our
medical business, $23.8 million represented a 22.5% increase in our
international business, and $18.7 million represented a 6.3% increase in our
dental business. The increase in medical net sales was primarily attributable to
increased sales to physicians' office and alternate care markets. In the
international market, the increase in net sales was primarily due to favorable
exchange rates to the U.S. dollar and increased account penetration in France,
Spain, and Australia. Had net sales for the international market been translated
at the same exchange rates in 2002, net sales would have increased by 3.4%. In
the dental market, the increase in net sales was primarily due to increased
dental equipment sales and services, and increased account penetration to
existing customers driven by our Privileges loyalty program. Net sales of dental
consumable merchandise increased by 4.8%, while net sales of dental equipment
increased by 13.2%. The remaining increase in first quarter 2003 net sales was
due to our technology business, which increased $2.7 million, or 18.9%, to $17.3
million for the three months ended March 29, 2003, from $14.6 million for the
three months ended March 30, 2002. The increase in technology and value-added
product net sales was primarily due to increased sales of software products and
related services. As part of a new marketing initiative, MarketOne, certain
technology and equipment products were sold directly to end-user customers
beginning with the third quarter of 2002, rather than through resellers, which
resulted in a higher growth rate for the technology business. Had MarketOne been
in effect for the three months ended March 30, 2002, the increase in our
technology business net sales for the three months ended March 29, 2003 would
have been 12.4%.
Gross profit increased by $23.0 million, or 12.9%, to $201.4 million for
the three months ended March 29, 2003, from $178.4 million for the three months
ended March 30, 2002. Gross profit margin decreased by 0.3% to 27.3%, from 27.6%
for the same period last year.
Healthcare distribution gross profit increased $20.6 million, or 12.3%, to
$188.1 million for the three months ended March 29, 2003, from $167.5 million
for the three months ended March 30, 2002. Healthcare distribution gross profit
margin decreased by 0.4% to 26.1% for the three months ended March 29, 2003,
from 26.5% for the three months ended March 30, 2002, primarily due to changes
in sales mix in our medical business.
Technology gross profit increased by $2.4 million, or 22.0%, to $13.3
million for the three months ended March 29, 2003, from $10.9 million for the
three months ended March 30, 2002. Technology gross profit margins increased by
2.0%, of which 1.6% was attributable to the MarketOne initiative referred to
above, to 77.1% for the three months ended March 29, 2003, from 75.1% for the
three months ended March 30, 2002.
Selling, general and administrative expenses increased by $16.0 million, or
11.2%, to $159.2 million for the three months ended March 29, 2003, from $143.2
million for the three months ended March 30, 2002.
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Selling and shipping expenses increased by $11.2 million, or 12.7%, to
$99.2 million for the three months ended March 29, 2003, from $88.0 million for
the three months ended March 30, 2002. As a percentage of net sales, selling and
shipping expenses decreased 0.2% to 13.4% for the three months ended March 29,
2003, from 13.6% for the three months ended March 30, 2002. The decrease was
primarily attributable to leveraging of our expenses.
General and administrative expenses increased $4.8 million, or 8.7%, to
$60.0 million for the three months ended March 29, 2003, from $55.2 million for
the three months ended March 30, 2002. As a percentage of net sales, general and
administrative expenses decreased 0.4% to 8.1% for the three months ended March
29, 2003, from 8.5% for the three months ended March 30, 2002. The decrease was
primarily attributable to leveraging of our infrastructure with increased sales
volume.
Other income (expense) - net decreased by $(1.3) million to $(1.7) million
for the three months ended March 29, 2003, from $(3.0) million for the three
months ended March 30, 2002. The net decrease was due primarily to a
non-recurring gain on the sale of a building in the first quarter of 2003 and a
non-recurring loss on an insignificant divestiture of a subsidiary in the first
quarter of 2002.
Equity in earnings of affiliates increased by $0.1 million, to $0.2 million
for the three months ended March 29, 2003, from $0.1 million for the three
months ended March 30, 2002.
For the three months ended March 29, 2003, our effective tax rate was
37.5%. For the three months ended March 30, 2002, our effective tax rate was
37.4%. The difference between our effective tax rates and the Federal statutory
rates for both periods relate primarily to state income taxes.
SEASONALITY
Our business is subject to seasonal and other quarterly influences. Net
sales and operating profits are generally higher in the fourth quarter due to
timing of sales of software and equipment, year end promotions and purchasing
patterns of office-based healthcare practitioners and are generally lower in the
first quarter due primarily to the increased purchases in the prior quarter.
Quarterly results also may be materially affected by a variety of other
factors, including the timing of acquisitions and related costs, timing of
purchases and/or sales, special promotional campaigns, seasonal products,
fluctuations in exchange rates associated with international operations and
adverse weather conditions.
E-COMMERCE
Traditional healthcare supply and distribution relationships are being
impacted by electronic on-line commerce solutions. Our distribution business is
characterized by rapid technological developments and is highly competitive. The
rapid evolution of on-line commerce will require us to provide continuous
improvement in performance, features and reliability of Internet content and
technology, particularly in response to competitive offerings.
Through our proprietary technologically-based suite of products, we offer
15
customers a variety of competitive alternatives. We believe that our tradition
of reliable service coupled with our name recognition and large customer base
built on solid customer relationships makes us well situated to participate in
this growing aspect of the distribution business. We are exploring ways and
means of improving and expanding our Internet presence and will continue to do
so.
INFLATION
Management does not believe inflation had a material effect on the
financial statements for the periods presented.
LIQUIDITY AND CAPITAL RESOURCES
Our principal capital requirements have been to fund (a) working capital
needs resulting from increased sales and special inventory forward buy-in
opportunities, (b) capital expenditures, (c) repurchases of common stock, and
(d) repayments on long-term debt. Since sales tend to be strongest during the
fourth quarter and special inventory forward buy-in opportunities are most
prevalent just before the end of the year, our working capital requirements have
generally been higher from the end of the third quarter to the end of the first
quarter of the following year. We have financed our business primarily through
operations, our revolving credit facilities, private placement loans and stock
issuances.
Net cash used in operating activities for the three months ended March 29,
2003 of $14.1 million resulted primarily from a net increase in the use of
working capital of approximately $51.5 million, offset by net income of $24.8
million and non-cash expenses of approximately $12.6 million. The increase in
the use of working capital was primarily due to a decrease in accounts payable
and accruals of $41.0 million, mostly due to payments made to vendors for year
end inventory buy-ins, a $12.5 million increase in accounts receivable, and an
$8.8 million increase in inventories, offset by a $10.8 million decrease in
other current assets. Our accounts receivable days sales outstanding ratio
improved to 46.3 days for the three months ended March 29, 2003, from 50.8 days
for the three months ended March 30, 2002, primarily due to continued focus in
this area. Our inventory turns improved to 6.5 turns for the three months ended
March 29, 2003, from 6.4 turns for the three months ended March 30, 2002. We
anticipate future increases in our working capital requirements as a result of
continued sales growth, extended payment terms, and special inventory forward
buy-in opportunities.
Net cash provided by investing activities for the three months ended March
29, 2003 of $5.1 million resulted primarily from maturities of United States
government and government agency bonds, municipal bonds and corporate bonds of
$26.4 million, offset by capital expenditures of $13.5 million, purchases of
United States government and agency bonds, corporate bonds and commercial paper
with maturities of more than three months of $4.1 million, and business
acquisitions of $2.3 million, of which $2.1 million represented contingent
earnout payments associated with acquisitions made in prior years. Our
investments in corporate bonds consist of debt securities rated AAA by Moody's
(or an equivalent rating) and investments in commercial paper consist of debt
securities rated P-1 by Moody's (or an equivalent rating). The fair values of
our investments are determined by quoted market prices. We expect to invest more
than $35.0 million during the year ending December 27, 2003 in capital projects
to modernize and expand our facilities, on computer infrastructure systems and
to integrate operations.
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Net cash used in financing activities for the three months ended March 29,
2003 of $3.7 million resulted primarily from our repurchases of common stock of
$6.5 million, offset primarily by proceeds from the issuance of stock upon
exercise of stock options of $4.6 million. On March 12, 2003, we announced that
our Board of Directors had authorized the repurchase of up to two million shares
of our common stock, which represented approximately 4.5% of shares outstanding
on the announcement date. During the first quarter, we repurchased and retired
152,500 shares at an average price of $42.51 per share.
Certain holders of minority interests in entities we have acquired have the
right at certain times to require us to acquire their interest at a price that
approximates fair value pursuant to a formula price based on earnings of the
entity.
Our cash and cash equivalents as of March 29, 2003 of $187.0 million
consist of bank balances and investments in money market funds. These
investments have staggered maturity dates, none of which exceed three months,
and have a high degree of liquidity since the securities are traded in public
markets.
We have a revolving credit facility of $200.0 million that is a four year
committed line scheduled to terminate in May 2006. We also have one uncommitted
bank line of $15.0 million. There were no borrowings under either credit
facility at March 29, 2003. As of March 29, 2003, certain subsidiaries of ours
had revolving credit facilities with approximately $29.2 million available for
borrowing. At March 29, 2003, $3.2 million had been borrowed.
On June 30, 1999 and September 25, 1998, we completed private placement
transactions under which we issued $130.0 million and $100.0 million,
respectively, in Senior Notes. The $130.0 million notes come due on June 30,
2009 and bear interest at a rate of 6.94% per annum. Principal payments totaling
$20.0 million are due annually starting September 25, 2006 on the $100.0 million
notes and bear interest at a rate of 6.66% per annum. Interest on both notes is
payable semi-annually.
We believe that our cash and cash equivalents of $187.0 million, our
investment in short-term marketable securities of $14.4 million as of March 29,
2003, our ability to access public and private debt and equity markets, and the
availability of funds under our existing credit agreements will provide us with
sufficient liquidity to meet our currently foreseeable short-term and long-term
capital needs.
17
RISK FACTORS
Stockholders and investors should carefully consider the risks described
below and other information in this quarterly report. Our business, financial
condition and operating results, and the trading price of our common stock could
be adversely affected if any of these risks materialize.
o The healthcare products distribution industry is highly competitive,
and we compete with numerous companies, including major manufacturers
and distributors that have greater financial and other resources than
us. Competitors could obtain exclusive rights to market particular
products or manufacturers could increase their efforts to sell directly
to end-users, thereby bypassing distributors like us. Consolidation
among healthcare products distributors could result in existing
competitors increasing their market position. In addition,
unavailability of products, whether due to our inability to gain access
to products or interruptions in supply of products from manufacturers,
could adversely affect our operating results.
o In recent years, the healthcare industry has undergone significant
change driven by various efforts to reduce costs, including the
reduction of spending budgets by government and private insurance
programs, such as Medicare, Medicaid and corporate health insurance
plans; trends toward managed care; consolidation of healthcare
distribution companies; electronic commerce; and collective purchasing
arrangements among office-based healthcare practitioners. If we are
unable to react effectively to these and other changes in the
healthcare industry, our operating results could be adversely affected.
o Our technology segment, which primarily sells practice management
software and other value-added products, depends upon continued product
development, technical support and marketing. Failures in these and
related areas could adversely affect our results of operations.
o Our business is subject to requirements under various local, state,
Federal and foreign governmental laws and regulations applicable to the
manufacture and distribution of pharmaceuticals and medical devices,
including the Federal Food, Drug, and Cosmetic Act, the Prescription
Drug Marketing Act of 1987 and the Controlled Substances Act. There is
no assurance that current or future government regulations will not
adversely affect our business.
o Our business involves a risk of product liability and other claims in
the ordinary course of business, and from time to time we are named as
a defendant in cases as a result of our distribution of pharmaceutical
and other healthcare products. We have insurance policies, including
product liability insurance, and in many cases we have indemnification
rights from manufacturers with respect to the products we distribute.
There is no assurance that insurance coverage or manufacturers'
indemnity will be available in all of the pending or any future cases
brought against us, or that an unfavorable result in any such case will
not adversely affect our financial condition or results of operations.
o Our business is dependent upon our ability to hire and retain qualified
sales representatives, service specialists and other sales agents. Due
to the relationships developed between our field sales representatives
and their customers, upon the departure of a sales representative we
face the risk of losing the representative's customers, especially if
the representative becomes an employee of one of our competitors.
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o Our business has been subject to seasonal and other quarterly
fluctuations. Net sales and operating profits generally have been
higher in the fourth quarter due to purchasing patterns of office-based
healthcare practitioners and year end promotions. Net sales and
operating profits generally have been lower in the first quarter,
primarily due to increased purchases in the prior quarter.
o Our international operations are subject to inherent risks, which could
adversely affect our operating results. These risks include
difficulties in opening and managing foreign offices and distribution
centers; difficulties in establishing channels of distribution;
fluctuations in the value of foreign currencies; longer payment cycles
of foreign customers and difficulty of collecting receivables in
foreign jurisdictions; import/export duties and quotas; and unexpected
regulatory, economic and political changes in foreign markets.
o Our expansion through acquisitions and/or joint ventures could result
in a loss of customers, diversion of management attention and increased
demands on our operations, information systems and financial resources.
o We rely on third parties to ship products to our customers. Increases
in shipping rates or interruptions of service could adversely affect
our operating results.
o Changes in e-commerce could affect our business relationships and could
require significant resources. The evolution of on-line commerce,
including business-to-business exchanges, will require us to
continuously improve the performance, security, features and
reliability of Internet content and technology.
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ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
There were no material changes to the disclosures made in our Annual Report
on Form 10-K for the year ended December 28, 2002, on this matter.
ITEM 4. CONTROLS AND PROCEDURES
Evaluation of Disclosure Controls and Procedures
The Company's Chief Executive Officer and its Chief Financial Officer,
after evaluating the effectiveness of the Company's disclosure controls and
procedures (as defined in the Securities Exchange Act of 1934 Rules 13a-14(c)
and 15d-14(c) as of a date within 90 days of the filing date of this quarterly
report on Form 10-Q (the "Evaluation Date")), have concluded that as of the
Evaluation Date, the Company's disclosure controls and procedures were adequate
and effective to ensure that material information relating to the Company and
its consolidated subsidiaries is recorded, processed, summarized and reported by
management of the Company on a timely basis in order to comply with the
Company's disclosure obligations under the Securities Exchange Act of 1934 and
the SEC rules thereunder.
Changes in Internal Controls
There were no significant changes in the Company's internal controls or in
other factors that could significantly affect the Company's disclosure controls
and procedures subsequent to the Evaluation Date, nor any significant
deficiencies or material weaknesses in such disclosure controls and procedures
requiring corrective actions.
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PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
Our business involves a risk of product liability claims and other claims
in the ordinary course of business, and from time to time we are named as a
defendant in cases as a result of our distribution of pharmaceutical and other
healthcare products.
As of March 29, 2003, we were named a defendant in approximately 55 product
liability cases. Of these claims, 45 involve claims made by healthcare workers
who claim allergic reaction relating to exposure to latex gloves. In each of
these cases, we acted as a distributor of both brand name and "Henry Schein"
private brand latex gloves, which were manufactured by third parties. To date,
discovery in these cases has generally been limited to product identification
issues. The manufacturers in these cases have withheld indemnification of the
Company pending product identification; however, we have impleaded or filed
cross claims against those manufacturers, subject to jurisdiction, in each case
in which we are a defendant.
On January 27, 1998, in District Court in Travis County, Texas, we and one
of our subsidiaries were named as defendants in a matter entitled "Shelly E.
Stromboe and Jeanne Taylor, on Behalf of Themselves and all others Similarly
Situated vs. Henry Schein, Inc., Easy Dental Systems, Inc. and Dentisoft, Inc.",
Case No. 98-00886. The Petition alleges, among other things, negligence, breach
of contract, fraud, and violations of certain Texas commercial statutes
involving the sale of certain practice management software products sold prior
to 1998 under the Easy Dental(R) name. In October 1999, the trial court, on
motion, certified both a Windows(R) sub-class and a DOS sub-class to proceed as
a class action pursuant to Tex. R. Civ. P. 42. It is estimated that 5,000
Windows(R) customers and 10,000 DOS customers were covered by the class action
that was certified by the trial court. In November of 1999, we filed an
interlocutory appeal of the trial court's determination to the Texas Court of
Appeals on the issue of whether this case was properly certified as a class
action. On September 14, 2000, the Court of Appeals affirmed the trial court's
certification order. On January 5, 2001, we filed a Petition for Review in the
Texas Supreme Court asking the Court to find that it had "conflicts
jurisdiction" to permit review of the trial court's certification order. The
Texas Supreme Court heard oral argument on February 6, 2002. On October 31,
2002, the Texas Supreme Court issued an opinion in the case holding that it had
conflicts jurisdiction to review the decision of the Court of Appeals and
finding that the trial court's certification of the case as a class action was
improper. The Supreme Court further held that the judgment of the court of
appeals which affirmed the class certification order must be reversed in its
entirety. Upon reversal of the class certification order, the Supreme Court
remanded the case to the trial court for further proceedings consistent with its
opinion. On January 31, 2003, counsel for the class filed a Motion for Rehearing
with the Texas Supreme Court seeking a reversal for the Supreme Court's earlier
opinion reversing the class certification order. On May 8, 2003, the Supreme
Court denied the Motion for Rehearing, letting stand its opinion dated October
31, 2002 which decertified both sub-classes in their entirety. At this time, it
is not possible to determine whether the trial court will certify a different
class upon motion, if any, or the possible range of damages or other relief
sought by the plaintiffs in the trial court.
21
In February 2002, we were served with a summons and complaint in an action
commenced in the Superior Court of New Jersey, Law Division, Morris County,
entitled "West Morris Pediatrics, P.A. and Avenel-Iselin Medical Group, P.A. vs.
Henry Schein, Inc., doing business as Caligor", Case No. MRS-L-421-02. The
plaintiffs' complaint purports to be on behalf of a nationwide class, but there
has been no court determination that the case may proceed as a class action.
Plaintiffs seek to represent a class of all physicians, hospitals and other
healthcare providers throughout New Jersey and across the United States. This
complaint, as amended in August 2002, alleges, among other things, breach of
oral contract, breach of implied covenant of good faith and fair dealing,
violation of the New Jersey Consumer Fraud Act, unjust enrichment, conversion,
and promissory estoppel relating to sales of a vaccine product in the year 2001.
We filed an answer in October 2002. Because damages have not been specified by
the plaintiffs, it is not possible to determine the range of damages or other
relief sought by the plaintiffs. We intend to vigorously defend ourselves
against this claim, as well as all other claims, suits and complaints.
We have various insurance policies, including product liability insurance,
covering risks and in amounts we consider adequate. In many cases in which we
have been sued in connection with products manufactured by others, we are
provided indemnification by the manufacturer. There can be no assurance that the
coverage we maintain is sufficient or will be available in adequate amounts or
at a reasonable cost, or that indemnification agreements will provide adequate
protection for the Company. In the opinion of the Company, all pending matters
are covered by insurance or will not otherwise seriously harm the Company's
financial condition.
22
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits.
10.27 Henry Schein, Inc., Management Team 2003 Performance Incentive
Plan Summary
31.1 Certification Pursuant to Section 302 of the Sarbanes-Oxley
Act of 2002
31.2 Certification Pursuant to Section 302 of the Sarbanes-Oxley
Act of 2002
32.1 Certification Pursuant to Section 906 of the Sarbanes-Oxley
Act of 2002
(b) Reports on Form 8-K.
None.
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this Report to be signed on its behalf by the
undersigned, thereunto duly authorized.
Henry Schein, Inc.
(Registrant)
By: /s/ Steven Paladino
----------------------------------------
Steven Paladino
Executive Vice President,
Chief Financial Officer and Director
(principal financial officer and
accounting officer)
Dated: May 09, 2003
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