UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

 

(Mark One)

 

For the quarterly period ended March 29, 2008

OR

 

For the transition period from ____________ to ____________

 

HENRY SCHEIN, INC.

(Exact name of registrant as specified in its charter)

 

 

 

 

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:

 

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

 

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

 

 

As of May 1, 2008, there were 90,263,973 shares of the registrant’s common stock outstanding.

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HENRY SCHEIN, INC.

INDEX

 

 

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PART I. FINANCIAL INFORMATION

ITEM 1. CONSOLIDATED FINANCIAL STATEMENTS

 

 

 

See accompanying notes.

 

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See accompanying notes.

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See accompanying notes.

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HENRY SCHEIN, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(in thousands, except share and per share data)

 

Note 1. Basis of Presentation

 

Our consolidated financial statements include our accounts, as well as those of our wholly-owned and majority-owned subsidiaries. Certain prior period amounts have been reclassified to conform to the current period presentation.

 

Our accompanying unaudited consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States (“U.S. GAAP”) for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnote disclosures required by U.S. GAAP for complete financial statements. The December 29, 2007 consolidated balance sheet information was derived from audited consolidated financial statements as of that date.

 

The consolidated financial statements reflect all adjustments considered necessary for a fair presentation of the consolidated results of operations and financial position for the interim periods presented. All such adjustments are of a normal recurring nature. These unaudited interim consolidated financial statements should be read in conjunction with the audited consolidated financial statements and notes to the consolidated financial statements contained in our Annual Report on Form 10-K for the year ended December 29, 2007.

 

The preparation of financial statements in conformity with U.S. GAAP requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities, and disclosure of contingent assets and liabilities, at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. The results of operations for the three months ended March 29, 2008 are not necessarily indicative of the results to be expected of any other interim period or for the year ending December 27, 2008.

 

Note 2. Segment Data

 

We conduct our business through two reportable segments: healthcare distribution and technology. These segments offer different products and services to the same customer base. The healthcare distribution reportable segment aggregates our dental, medical (including animal health) and international operating segments. This segment consists of consumable products, small equipment, laboratory products, large dental and medical equipment, equipment repair services, branded and generic pharmaceuticals, vaccines, surgical products, diagnostic tests, infection-control products and vitamins.

 

Our dental group serves office-based dental practitioners, schools and other institutions in the combined United States and Canadian dental market. Our medical group serves office-based medical practitioners, surgical centers, other alternate-care settings, animal health clinics and other institutions throughout the United States. Our international group serves 18 countries outside of North America.

 

Our technology group provides software, technology and other value-added services to healthcare practitioners, primarily in the United States, Canada, the United Kingdom, Australia and New Zealand. Our value-added practice solutions include practice-management software systems for dental and medical practitioners and animal health clinics. Our technology group offerings also include financial services and continuing education services for practitioners.

 

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HENRY SCHEIN, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(in thousands, except share and per share data)

 

Note 2. Segment Data (Continued)

 

The following tables present information about our reportable segments:

 

 

United Kingdom, Australia and New Zealand in 2008 and the United States and Canada in 2007.

 

 

 

 

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HENRY SCHEIN, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(in thousands, except share and per share data)

 

Note 3. Stock-Based Compensation

 

Our accompanying unaudited consolidated statements of income reflect pretax share-based compensation expense, recorded in accordance with the provisions of FAS No. 123(R), “Share-Based Payment,” of $9.3 million ($6.1 million after-tax) and $4.1 million ($2.6 million after-tax) for the three months ended March 29, 2008 and March 31, 2007.

Stock-based compensation represents the cost related to stock-based awards granted to employees and non-employee directors. We measure stock-based compensation at the grant date, based on the estimated fair value of the award, and recognize the cost as compensation expense on a straight-line basis (net of estimated forfeitures) over the requisite service period. Our stock-based compensation expense is reflected in selling, general and administrative expenses in our consolidated statements of income.

 

Stock-based awards are provided to certain employees and non-employee directors under the terms of our 1994 Stock Incentive Plan, as amended, and our 1996 Non-Employee Director Stock Incentive Plan, as amended (together, the “Plans”). The Plans are administered by the Compensation Committee of the Board of Directors. Awards under the Plans principally include a combination of at-the-money stock options and restricted stock (including restricted stock units).

 

Grants of restricted stock are common stock awards granted to recipients with specified vesting provisions.  We issue restricted stock that vests based on the recipient’s continued service over time (four-year cliff vesting) and restricted stock that vests based on our achieving specified performance measurements (three-year cliff vesting).

 

With respect to time-based restricted stock, we estimate the fair value on the date of grant based on our closing stock price. With respect to performance-based restricted stock, the number of shares that ultimately vest and are received by the recipient is based upon our earnings per share performance as measured against specified targets over a three-year period as determined by the Compensation Committee of the Board of Directors. Though there is no guarantee that performance targets will be achieved, we estimate the fair value of performance-based restricted stock, based on our closing stock price.

       The Plan provides for adjustments to the performance-based restricted stock targets for significant events such as acquisitions and new business ventures. Over the performance period, the number of shares of common stock that will ultimately vest and be issued is adjusted upward or downward based upon our estimation of achieving such performance targets. The ultimate number of shares delivered to recipients and the related compensation cost recognized as an expense will be based on our actual performance metrics.

 

Restricted stock units, or RSUs, are unit awards that we grant to certain non-U.S. employees that entitle the recipient to shares of common stock upon vesting after four years for time-based awards or three years for performance-based awards. The fair value of RSUs is determined on the date of grant, based on our closing stock price.

 

Total unrecognized compensation cost related to non-vested awards as of March 29, 2008 was $66.1 million, which is expected to be recognized over a weighted-average period of approximately three years. There were no significant capitalized stock-based compensation costs as of March 29, 2008.

 

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HENRY SCHEIN, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(in thousands, except share and per share data)

 

Note 3. Stock-Based Compensation (Continued)

The following weighted-average assumptions were used in determining the fair values of stock options using the Black-Scholes valuation model:

		2008			2007
Expected dividend yield		0	%		0	%
Expected stock price volatility		20	%		20	%
Risk-free interest rate		2.75	%		4.75	%
Expected life of options (years)		4.5			4.5

 

The following table summarizes stock option activity under the Plans during the three months ended March 29, 2008:

 

		Shares			Weighted Average Exercise Price			Weighted Average Remaining Contractual Life in Years		Aggregate Intrinsic Value
Outstanding at beginning of period		6,829,453			$	34.67
Granted		1,101,801				59.91
Exercised		(304,617	)			27.63				$	9,659
Forfeited		(19,620	)			36.82
Outstanding at end of period		7,607,017			$	38.61		6.7		$	141,109
Options exercisable at end of period		5,109,983			$	31.75		5.7		$	127,540

 

The following table summarizes the status of our non-vested restricted shares/units for the three months ended March 29, 2008:

 

 

 

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HENRY SCHEIN, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(in thousands, except share and per share data)

 

 

Note 4. Business Acquisitions and Other Transactions

 

Acquisitions

 

We completed certain acquisitions during the three months ended March 29, 2008. The operating results of our acquisitions are reflected in our financial statements from their respective acquisition dates. Such acquisitions were immaterial to our financial statements individually and in the aggregate.

 

Loan and Investment Agreement

 

As of March 29, 2008, we loaned D4D Technologies, LLC (“D4D”) $13.5 million and, if certain milestones are achieved, up to an additional $16.4 million of loans may be made in increments by May 2010. We have also advanced certain amounts to fund D4D’s operating needs without regard to the milestones. The loans, a portion of which can be converted to equity investments, are repayable on various dates through July 2013. We expect to account for any such equity investments under the equity method prospectively from the date of our first equity investment. We are in discussions with D4D to amend the terms of some or a portion of the D4D loans, including provisions relating to further amounts that may be payable and those relating to conversion of certain amounts to equity.

 

Note 5. Earnings Per Share

 

Basic earnings per share is computed by dividing net income by the weighted-average number of common shares outstanding for the period. Our diluted earnings per share is computed similarly to basic earnings per share, except that it reflects the effect of common shares issuable upon vesting of restricted stock and upon exercise of stock options using the treasury stock method in periods in which they have a dilutive effect.

 

For the three months ended March 29, 2008 and March 31, 2007, diluted earnings per share includes the effect of common shares issuable upon conversion of our convertible debt. During the period, the debt was convertible at a premium as a result of the conditions of the debt. As a result, the amount in excess of the principal is presumed to be settled in common shares and is reflected in our calculation of diluted earnings per share.

 

A reconciliation of shares used in calculating earnings per basic and diluted share follows:

 

 

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HENRY SCHEIN, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(in thousands, except share and per share data)

 

Note 5. Earnings Per Share (Continued)

 

Weighted-average options to purchase 333,927 shares of common stock at exercise prices ranging from $59.89 to $62.05 per share and 270,773 shares of common stock at an exercise price of $51.23 per share that were outstanding during the three months ended March 29, 2008 and March 31, 2007, respectively, were excluded from the computation of diluted earnings per share. In each of these years, such options’ exercise prices exceeded the average market price of our common stock, thereby causing the effect of such options to be anti-dilutive.

 

 

Note 6. Comprehensive Income

 

Comprehensive income includes certain gains and losses that, under accounting principles generally accepted in the United States, are excluded from net income as such amounts are recorded directly as an adjustment to stockholders’ equity. Our comprehensive income is primarily comprised of net income and foreign currency translation adjustments, but also includes unrealized gains on hedging activity and pension adjustments. Comprehensive income totaled $86.2 million and $42.0 million for the three months ended March 29, 2008 and March 31, 2007.

Note 7. Fair Value Measurements

 

Effective December 30, 2007, we adopted SFAS No. 157, “Fair Value Measurements,” (“FAS 157”) as it relates to financial assets and financial liabilities. FAS 157 establishes a framework for measuring fair value in generally accepted accounting principles and expands disclosures about fair value measurements. FAS 157 applies under other previously issued accounting pronouncements that require or permit fair value measurements but does not require any new fair value measurements. The adoption of FAS 157 had no impact on our consolidated financial statements.

 

FAS 157 defines fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. FAS 157 establishes a fair value hierarchy that distinguishes between (1) market participant assumptions developed based on market data obtained from independent sources (observable inputs) and (2) an entity’s own assumptions about market participant assumptions developed based on the best information available in the circumstances (unobservable inputs).

 

The fair value hierarchy consists of three broad levels, which gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (Level 1) and the lowest priority to unobservable inputs (Level 3). The three levels of the fair value hierarchy under FAS 157 are described as follows:

 

     • Level 1 - Unadjusted quoted prices in active markets for identical assets or liabilities that are accessible at the measurement date.

 

     • Level 2 - Inputs other than quoted prices included within Level 1 that are observable for the asset or liability, either directly or indirectly. Level 2 inputs include quoted prices for
           similar assets or liabilities in active markets; quoted prices for identical or similar assets or liabilities in markets that are not active; inputs other than quoted prices that are
           observable for the asset or liability; and inputs that are derived principally from or corroborated by observable market data by correlation or other means.

 

     • Level 3 - Inputs that are unobservable for the asset or liability.

 

 

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HENRY SCHEIN, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(in thousands, except share and per share data)

  

Note 7. Fair Value Measurements (Continued)

 

       The following section describes the valuation methodologies that we used to measure different financial instruments at fair value, including an indication of the level in the fair value hierarchy in which each instrument is classified.

 

Available-for-sale securities

 

       As of March 29, 2008, we have approximately $36.0 million invested in auction-rate securities (“ARS”). ARS are publicly issued securities that represent long-term investments, typically 10-30 years, in which interest rates reset periodically (typically every 7, 28 or 35 days) through a “dutch auction” process. Approximately $24.0 million of these securities are backed by student loans that are backed by the federal government and the remaining $12.0 million are invested in closed end municipal bond funds. Our auction-rate security portfolio is comprised of investments that are rated AAA by major independent rating agencies. Since the middle of February 2008, these auctions have failed to settle due to an excess number of sellers compared to buyers. The recent failure of these auctions could result in our inability to liquidate these securities in the immediate future.

 

       We are currently not aware of any defaults or financial conditions that would negatively affect the issuers’ ability to continue to pay interest and principal on the collateralized securities. We continue to earn and receive interest at contractually agreed upon rates. Recently, there has been refinancing (at par) activity in the student loan and closed end municipal bond fund markets. Based upon the information currently available and in accordance with applicable authoritative guidance, we do not believe that our ARS are currently impaired. If auctions continue to fail and if the credit quality of these investments were to deteriorate in the future, we may be required to record an impairment charge on these investments.

 

       We believe that the current lack of liquidity related to our auction-rate security investments will have no impact on our ability to fund our ongoing operations and growth opportunities.  We will continue to classify our ARS as available-for-sale securities, in current assets, in accordance with SFAS No. 115, as we believe our portfolio will be liquidated at par within the next twelve months.

 

       We use quoted prices for identical or similar assets or liabilities in markets that are not active to determine the fair value of our available-for-sale securities. These financial instruments are classified as Level 2 within the fair value hierarchy.

Derivative contracts 

 

       Derivative contracts are valued using quoted market prices and significant other observable and unobservable inputs. We use derivative instruments to minimize our exposure to fluctuations in interest rates and foreign currency exchange rates. Our derivative instruments include interest rate swap agreements related to our long-term fixed rate debt and foreign currency forward and swap agreements related to intercompany loans and certain forecasted inventory purchase commitments with foreign suppliers.

 

       The fair values for the majority of these derivative contracts are based upon current quoted market prices. These financial instruments are typically exchange-traded and are classified within Level 2 of the fair value hierarchy.

 

 

 

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HENRY SCHEIN, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(in thousands, except share and per share data)

 

Note 7. Fair Value Measurements (Continued)

 

       The following table presents our assets and liabilities that are measured and recognized at fair value on a recurring basis classified under the appropriate level of the fair value hierarchy as of March 29, 2008:

 

	Level 1			Level 2			Level 3			Total
Assets:
Available-for-sale securities	$	-		$	35,925		$	-		$	35,925
Derivative contracts		-			2,198			-			2,198
Total assets	$	-		$	38,123		$	-		$	38,123
Liabilities:
Derivative contracts	$	-		$	10,457		$	-		$	10,457
Total liabilities	$	-		$	10,457		$	-		$	10,457

 

 

 

The total amount of unrecognized tax benefits as of March 29, 2008 was approximately $12.3 million, all of which would affect the effective tax rate if recognized. It is expected that the amount of unrecognized tax benefits will change in the next 12 months. However, we do not expect the change to have a material impact on our consolidated financial statements.

 

The total amounts of interest and penalties were approximately $2.3 million and $0, respectively, as of March 29, 2008. It is expected that the amount of interest will change in the next 12 months. However, we do not expect the change to have a material impact on our consolidated financial statements.

 

The tax years subject to examination by major tax jurisdictions include the years 2004 and forward by the U.S. Internal Revenue Service, the years 1996 and forward for certain states and the years 1997 and forward for certain foreign jurisdictions.

 

 

Note 9. Supplemental Cash Flow Information

 

Cash paid for interest and income taxes was:

 

 

During the three months ended March 29, 2008 and March 31, 2007, we had $1.9 million and $0.8 million non-cash net unrealized gains, respectively, related to hedging activities. As of March 29, 2008 and March 31, 2007, we recorded a $1.2 million and a $7.3 million receivable, respectively, for the net cash proceeds related to the exercise of stock options with a corresponding adjustment to stockholders’ equity.

 

 

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ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

Cautionary Note Regarding Forward-Looking Statements

 

In accordance with the “Safe Harbor” provisions of the Private Securities Litigation Reform Act of 1995, we provide the following cautionary remarks regarding important factors that, among others, could cause future results to differ materially from the forward-looking statements, expectations and assumptions expressed or implied herein. All forward-looking statements made by us are subject to risks and uncertainties and are not guarantees of future performance. These forward-looking statements involve known and unknown risks, uncertainties and other factors that may cause our actual results, performance and achievements or industry results to be materially different from any future results, performance or achievements expressed or implied by such forward-looking statements. These statements are identified by the use of such terms as “may,” “could,” “expect,” “intend,” “believe,” “plan,” “estimate,” “forecast,” “project,” “anticipate” or other comparable terms.

Risk factors and uncertainties that could cause actual results to differ materially from current and historical results include, but are not limited to: competitive factors; changes in the healthcare industry; changes in regulatory requirements that affect us; risks associated with our international operations; fluctuations in quarterly earnings; our dependence on third parties for the manufacture and supply of our products; transitional challenges associated with acquisitions, including the failure to achieve anticipated synergies; financial risks associated with acquisitions; regulatory and litigation risks; the dependence on our continued product development, technical support and successful marketing in the technology segment; our dependence upon sales personnel and key customers; our dependence on our senior management; possible increases in the cost of shipping our products or other service trouble with our third-party shippers; risks from rapid technological change; risks from potential increases in variable interest rates; possible volatility of the market price of our common stock; certain provisions in our governing documents that may discourage third-party acquisitions of us; and changes in tax legislation that affect us. The order in which these factors appear should not be construed to indicate their relative importance or priority.

       We caution that these factors may not be exhaustive and that many of these factors are beyond our ability to control or predict. Accordingly, any forward-looking statements contained herein should not be relied upon as a prediction of actual results. We undertake no duty and have no obligation to update forward-looking statements.

Executive-Level Overview

 

We believe we are the largest distributor of healthcare products and services primarily to office-based healthcare practitioners in the combined North American and European markets. We serve more than 550,000 customers worldwide, including dental practitioners and laboratories, physician practices and animal health clinics, as well as government and other institutions. We believe that we have a strong brand identity due to our more than 75 years of experience distributing healthcare products.

 

We are headquartered in Melville, New York, employ more than 12,000 people (of which over 5,000 are based outside the United States) and have operations in the United States, Australia, Austria, Belgium, Canada, the Czech Republic, France, Germany, Ireland, Italy, Luxembourg, the Netherlands, New Zealand, Portugal, Spain, Switzerland and the United Kingdom. We also have affiliates in Iceland, Israel and the United Arab Emirates.

 

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        We have established strategically located distribution centers to enable us to better serve our customers and increase our operating efficiency. This infrastructure, together with broad product and service offerings at competitive prices, and a strong commitment to customer service, enables us to be a single source of supply for our customers’ needs. Our infrastructure also allows us to provide convenient ordering and rapid, accurate and complete order fulfillment.

 

We conduct our business through two reportable segments: healthcare distribution and technology. These segments offer different products and services to the same customer base. The healthcare distribution reportable segment aggregates our dental, medical (including animal health) and international operating segments. This segment consists of consumable products, small equipment, laboratory products, large dental and medical equipment, equipment repair services, branded and generic pharmaceuticals, vaccines, surgical products, diagnostic tests, infection-control products and vitamins.

 

Our dental group serves office-based dental practitioners, schools and other institutions in the combined United States and Canadian dental market. Our medical group serves office-based medical practitioners, surgical centers, other alternate-care settings, animal health clinics and other institutions throughout the United States. Our international group serves 18 countries outside of North America and is what we believe to be a leading European healthcare supplier serving office-based practitioners.

 

Our technology group provides software, technology and other value-added services to healthcare practitioners, primarily in the United States, Canada, the United Kingdom, Australia and New Zealand. Our value-added practice solutions include practice-management software systems for dental and medical practitioners and animal health clinics. Our technology group offerings also include financial services, e-services and continuing education services for practitioners.

 

Industry Overview

 

In recent years, the healthcare industry has increasingly focused on cost containment. This trend has benefited distributors capable of providing a broad array of products and services at low prices. It also has accelerated the growth of HMOs, group practices, other managed care accounts and collective buying groups, which, in addition to their emphasis on obtaining products at competitive prices, tend to favor distributors capable of providing specialized management information support. We believe that the trend towards cost containment has the potential to favorably affect demand for technology solutions, including software, which can enhance the efficiency and facilitation of practice management.

 

Our operating results in recent years have been significantly affected by strategies and transactions that we undertook to expand our business, domestically and internationally, in part to address significant changes in the healthcare industry, including consolidation of healthcare distribution companies, potential healthcare reform, trends toward managed care, cuts in Medicare and collective purchasing arrangements.

 

Industry Consolidation

 

The healthcare products distribution industry, as it relates to office-based healthcare practitioners, is highly fragmented and diverse. This industry, which encompasses the dental, medical and animal health markets, was estimated to produce revenues of approximately $25.5 billion in 2007 in the combined North American and European markets. The industry ranges from sole practitioners working out of relatively small offices to group practices or service organizations ranging in size from a few practitioners to a large number of practitioners who have combined or otherwise associated their practices.

 

Due in part to the inability of office-based healthcare practitioners to store and manage large quantities of supplies in their offices, the distribution of healthcare supplies and small equipment to office-based healthcare practitioners has been characterized by frequent, small-quantity orders, and a need for rapid, reliable and substantially complete order fulfillment. The purchasing decisions within an office-based healthcare practice are typically made by the practitioner or an administrative assistant. Supplies and small equipment are generally purchased from more than one distributor, with one generally serving as the primary supplier.

 

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We believe that consolidation within the industry will continue to result in a number of distributors, particularly those with limited financial and marketing resources, seeking to combine with larger companies that can provide growth opportunities. This consolidation also may continue to result in distributors seeking to acquire companies that can enhance their current product and service offerings or provide opportunities to serve a broader customer base.

 

Our trend with regard to acquisitions has been to expand our role as a provider of products and services to the healthcare industry. This trend has resulted in expansion into service areas that complement our existing operations and provide opportunities for us to develop synergies with, and thus strengthen, the acquired businesses.

 

As industry consolidation continues, we believe that we are positioned to capitalize on this trend, as we believe we have the ability to support increased sales through our existing infrastructure. In the U.S. dental market, we estimate that there are currently more than 300 smaller distributors holding approximately 27% of the market. In the U.S. medical market, we estimate that more than 500 smaller distributors hold approximately 38% of the market, and in the European dental market, we estimate that more than 200 smaller distributors hold approximately 80% of the market.

 

As the healthcare industry continues to change, we continually evaluate possible candidates for merger or acquisition and intend to continue to seek opportunities to expand our role as a provider of products and services to the healthcare industry. There can be no assurance that we will be able to successfully pursue any such opportunity or consummate any such transaction, if pursued. If additional transactions are entered into or consummated, we would incur merger and/or acquisition-related costs, and there can be no assurance that the integration efforts associated with any such transaction would be successful.

 

Aging Population and Other Market Influences

 

The healthcare products distribution industry continues to experience growth due to the aging population, increased healthcare awareness, the proliferation of medical technology and testing, new pharmacology treatments and expanded third-party insurance coverage. In addition, the physician market continues to benefit from the shift of procedures and diagnostic testing from acute care settings to alternate-care sites, particularly physicians’ offices. As the cosmetic surgery and elective procedure markets continue to grow, physicians are increasingly performing more of these procedures in their offices. The elder-care market continues to benefit from the increasing growth rate of the population of elderly Americans.

 

The January 2000 U.S. Bureau of the Census estimated that the elderly population in the United States will more than double by the year 2040. In 2000, four million Americans were aged 85 or older, the segment of the population most in need of long-term care and elder-care services. By the year 2040, that number is projected to more than triple to more than 14 million. The population aged 65 to 84 years is projected to more than double in the same time period.

 

As a result of these market dynamics, annual expenditures for healthcare services continue to increase in the United States. The Centers for Medicare and Medicaid Services, or CMS, published “National Health Expenditure Projections 2006 – 2016” indicating that total national healthcare spending reached $2.0 trillion in 2005, or 16.0% of the nation’s gross domestic product, the benchmark measure for annual production of goods and services in the United States. Healthcare spending is projected to reach $4.1 trillion in 2016, approximately 20.0% of the nation’s gross domestic product.

 

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Government Influences

 

The healthcare industry is subject to extensive government regulation, licensure and operating compliance procedures. National healthcare reform has been the subject of a number of legislative initiatives by Congress. Additionally, government and private insurance programs fund a large portion of the total cost of medical care. The Balanced Budget Act passed by Congress in 1997 significantly reduced reimbursement rates for nursing homes and home healthcare providers, affecting spending levels and the overall financial viability of these institutions.

 

The Medicare Prescription Drug, Improvement, and Modernization Act or the Medicare Act, is the largest expansion of the Medicare program since its inception, and provides participants with voluntary prescription drug benefits through an interim drug discount card. The Medicare Act also includes provisions relating to medication management programs, generic substitution and provider reimbursement.

 

There have been increasing efforts by various levels of government, including state departments of health, state boards of pharmacy and comparable agencies, to regulate the pharmaceutical distribution system in order to prevent the introduction of counterfeit, adulterated or mislabeled pharmaceuticals into the distribution system.  An increasing number of states, including Florida, have already adopted laws and regulations, including drug pedigree tracking requirements, that are intended to protect the integrity of the pharmaceutical distribution system. Regulations adopted under the federal Prescription Drug Marketing Act, effective December, 2006, require the identification and documentation of transactions involving the receipt and distribution of prescription drugs, that is, drug pedigree information. Other states and government agencies are currently considering similar laws and regulations. We continue to work with our suppliers to help minimize the risks associated with counterfeit products in the supply chain and potential litigation.

 

E-Commerce

 

Traditional healthcare supply and distribution relationships are being challenged by electronic online commerce solutions. Our distribution business is characterized by rapid technological developments and intense competition. The advancement of online commerce will require us to cost-effectively adapt to changing technologies, to enhance existing services and to develop and introduce a variety of new services to address the changing demands of consumers and our customers on a timely basis, particularly in response to competitive offerings.

 

Through our proprietary, technologically-based suite of products, we offer customers a variety of competitive alternatives. We believe that our tradition of reliable service, our name recognition and large customer base built on solid customer relationships position us well to participate in this growing aspect of the distribution business. We continue to explore ways and means to improve and expand our Internet presence and capabilities.

 

 

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Results of Operations            

 

The following table summarizes the significant components of our operating results from continuing operations and cash flows for the three months ended March 29, 2008 and March 31, 2007 (in thousands):

 

 

(1)     Adjusted to reflect the effects of discontinued operations.

 

 

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Three Months Ended March 29, 2008 Compared to Three Months Ended March 31, 2007

 

Net Sales

 

Net sales from continuing operations for the three months ended March 29, 2008 and March 31, 2007 were as follows (in thousands):

 

 

 

 

 

 

 

The $215.5 million, or 16.4%, increase in net sales for the three months ended March 29, 2008 includes increases of 12.0% local currency growth (3.0% internally generated primarily due to volume growth and 9.0% from acquisitions) and 4.4% related to foreign currency exchange.

 

The $49.2 million, or 8.7%, increase in dental net sales for the three months ended March 29, 2008 includes increases of 7.2% local currency growth (5.5% internally generated primarily due to increased volume and 1.7% from acquisitions) and 1.5% related to foreign currency exchange. The 7.2% local currency growth was due to dental consumable merchandise sales growth of 6.0% (4.3% internal growth and 1.7% from acquisitions) and dental equipment sales and service growth of 11.1% (9.8% internal growth and 1.3% from acquisitions).

 

The $13.0 million, or 3.7%, decrease in medical net sales for the three months ended March 29, 2008 includes a decline in internal growth of 4.4% and acquisition growth of 0.7%. This decrease was due to a reduction of sales of certain lower-margin pharmaceutical products. Excluding sales of these products, internal medical net sales growth was 4.5%.

 

The $168.9 million, or 45.5%, increase in international net sales for the three months ended March 29, 2008 includes increases of 32.2% in local currencies (5.6% internally generated and 26.6% from acquisitions), and 13.3% related to foreign currency exchange.

 

The $10.4 million, or 36.5%, increase in technology net sales for the three months ended March 29, 2008 includes increases of 35.9% in local currency growth (10.2% internally generated and 25.7% from acquisitions) and 0.6% related to foreign currency exchange. The increase in internal net sales growth was primarily driven by growth in our electronic and financial services businesses.

 

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Gross Profit

 

Gross profit and gross margin percentages from continuing operations by segment and in total for the three months ended March 29, 2008 and March 31, 2007 were as follows (in thousands):

 

 

(1)   Adjusted to reflect the effects of discontinued operations.

 

For the three months ended March 29, 2008, gross profit increased $60.2 million, or 15.4%, from the comparable prior year period. As a result of different practices of categorizing costs associated with distribution networks throughout our industry, our gross margins may not necessarily be comparable to other distribution companies. Additionally, we realize substantially higher gross margin percentages in our technology segment than in our healthcare distribution segment. These higher gross margins result from being both the developer and seller of software products combined with the nature of the software industry, in which developers typically realize higher gross margins to recover investments in research and development.

 

Healthcare distribution gross profit increased $53.5 million, or 14.5%, for the three months ended March 29, 2008 from the comparable prior year period. Healthcare distribution gross profit margin decreased to 28.4% for the three months ended March 29, 2008 from 28.8% for the comparable prior year period primarily due to changes in the product sales mix.

 

Technology gross profit increased $6.7 million, or 30.9%, for the three months ended March 29, 2008 from the comparable prior year period. Technology gross profit margin decreased to 73.3% for the three months ended March 29, 2008 from 76.4% for the comparable prior year period primarily due to changes in the product sales mix.

 

Selling, General and Administrative

 

Selling, general and administrative expenses from continuing operations by segment and in total for the three months ended March 29, 2008 and March 31, 2007 were as follows (in thousands):

 

 

 

Selling, general and administrative expenses increased $48.7 million, or 15.3%, to $366.0 million for the three months ended March 29, 2008 from the comparable prior year period. As a percentage of net sales, selling, general and administrative expenses decreased to 24.0% from 24.2% for the comparable prior year period.

 

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As a component of selling, general and administrative expenses, selling expenses increased $38.4 million, or 18.1%, to $249.9 million for the three months ended March 29, 2008 from the comparable prior year period. As a percentage of net sales, selling expenses increased to 16.4% from 16.1% for the comparable prior year period.

 

As a component of selling, general and administrative expenses, general and administrative expenses increased $10.3 million, or 9.8%, to $116.1 million for the three months ended March 29, 2008 from the comparable prior year period. As a percentage of net sales, general and administrative expenses decreased to 7.6% from 8.1% for the comparable prior year period.

 

Other Expense, Net

 

Other expense, net, from continuing operations for the three months ended March 29, 2008 and March 31, 2007 were as follows (in thousands):

 

 

 

Other expense, net, increased $1.4 million for the three months ended March 29, 2008 from the comparable prior year period. This increase was primarily due to increased interest expense due to higher interest rates and foreign currency exchange losses.

 

 

For the three months ended March 29, 2008, our effective tax rate from continuing operations was 34.0% compared to 35.5% for the prior year period. The difference between our effective tax rates and the federal statutory tax rates for both periods primarily relates to state and foreign income taxes.

 

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Liquidity and Capital Resources

 

Our principal capital requirements include the funding of working capital needs, purchases of available-for-sale securities and fixed assets, funding of acquisitions, repayments of debt principal and repurchases of common stock. Working capital requirements generally result from increased sales, special inventory forward buy-in opportunities and payment terms for receivables and payables. Since sales tend to be stronger during the third and fourth quarters 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 finance our business primarily through cash generated from our operations, revolving credit facilities, debt placements and stock issuances. Our ability to generate sufficient cash flows from operations is dependent on the continued demand of our customers for, and access to products and services from our suppliers. Given current operating, economic and industry conditions, we believe that demand for our products and services will remain substantially consistent with recent trends in the foreseeable future.

 

Net cash flow provided by operating activities was $13.3 million for the three months ended March 29, 2008, compared to $33.9 million used in operating activities for the comparable prior year period. This net change of $47.2 million was primarily due to a decrease in net working capital outflows, increased net income, increased stock-based compensation expense and changes in deferred income taxes.

 

Net cash used in investing activities was $60.1 million for the three months ended March 29, 2008, compared to $45.0 million for the comparable prior year period. The net change of $15.1 million was primarily due to an increase in purchases of available-for-sale securities and a decrease in sales of available-for-sale securities and an increase in purchases of fixed assets, offset by lower payments for business acquisitions. We expect to invest approximately $37.0 million to $42.0 million during the remainder of the fiscal year in capital projects to modernize and expand our facilities and computer systems and to integrate certain operations into our core structure.

 

Net cash provided by financing activities was $5.3 million for the three months ended March 29, 2008, compared to $15.2 million used in financing activities for the comparable prior year period. The net change of $20.5 million was primarily due to the absence of repurchase activities of our common stock during the three months ended March 29, 2008, partially offset by increased repayments of bank borrowings, as well as a decrease in cash proceeds received and tax benefits related to stock option exercises.

 

The following table summarizes selected measures of liquidity and capital resources (in thousands):