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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FOR ANNUAL AND TRANSITION REPORTS
PURSUANT TO SECTIONS 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934.
X ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
- -- ACT OF 1934
For the fiscal year ended December 26, 1998
___ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
Commission file number 0-27078
HENRY SCHEIN, INC.
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(Exact name of registrant as specified in its charter)
DELAWARE 11-3136595
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(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
135 Duryea Road
Melville, New York 11747
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(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code (516) 843-5500
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Securities registered pursuant to Section 12(b) of the Act:
None
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, par value $.01
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(Title of class)
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: ___
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Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K.
--
The aggregate market value of the registrant's voting stock held by
non-affiliates of the registrant, computed by reference to the closing sales
price as quoted on the NASDAQ National Market on March 10, 1999 was
approximately $1,085,000,919.
As of March 10, 1999, 40,560,782 shares of registrant's Common Stock, par
value $.01 per share, were outstanding.
Documents Incorporated by Reference
Portions of the Registrant's definitive proxy statement to be filed pursuant to
Regulation 14A not later than 120 days after the end of the fiscal year
(December 26, 1998) are incorporated by reference in Part III hereof.
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TABLE OF CONTENTS
Page Number
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PART I
ITEM 1. Business 1
ITEM 2. Properties 16
ITEM 3. Legal Proceedings 16
ITEM 4. Submission of Matters to a Vote of Security Holders 17
PART II
ITEM 5. Market for Registrant's Common Equity and Related Stockholder
Matters 18
ITEM 6. Selected Financial Data 19
ITEM 7. Management's Discussion and Analysis of Financial Condition
and Results of Operations 22
ITEM 7A. Market Risks 32
ITEM 8. Financial Statements and Supplementary Data 33
ITEM 9. Changes In and Disagreements With Accountants on Accounting
and Financial Disclosure 67
PART III
ITEM 10. Directors and Executive Officers of the Registrant 67
ITEM 11. Executive Compensation 67
ITEM 12. Security Ownership of Certain Beneficial Owners and Management 67
ITEM 13. Certain Relationships and Related Transactions 67
PART IV
ITEM 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K 67
Exhibit Index 72
PART I
ITEM 1. Business
Recent Developments
Since December 26, 1998, the Company has acquired General Injectibles and
Vaccines, Inc. ("GIV"), through the purchase of all of the outstanding common
stock of Biological & Popular Culture, Inc., and the international dental,
medical and veterinary healthcare distribution businesses of Heiland Holding
GmbH (the "Heiland Group"). GIV, which had 1998 net sales of approximately
$120.0 million, is a leading independent direct marketer of vaccines and other
injectible products to office-based practitioners in the United States. The
Heiland Group, the largest direct marketer of healthcare supplies to
office-based practitioners in Germany, had 1998 net sales of approximately
$130.0 million. These transactions were accounted for under the purchase method
of accounting.
During the year ended December 26, 1998, the Company completed five
acquisitions. The 1998 completed acquisitions included two dental supply
companies, the most significant of which was the H. Meer Dental Supply Co., Inc.
("Meer"), a leading full-service dental distributor serving dentists, dental
laboratories and institutions throughout the United States, with 1997 annual net
sales of approximately $180.0 million. Combined, Meer and the other dental
company had approximately $212.0 million in aggregate net sales for 1997. The
completed acquisitions also included two medical supply companies with aggregate
net sales for 1997 of approximately $37.0 million, and one international dental
distribution business with 1997 net sales of approximately $16.0 million. Of the
five completed acquisitions, four (including Meer) were accounted for under the
pooling of interests method, and the remaining acquisition of a 50.1% interest
was accounted for under the purchase method of accounting. The financial
statements have been restated to give retroactive effect to the Meer
transaction, as the remaining three pooling transactions were not material and
have been included in the consolidated financial statements from the beginning
of the quarter in which the acquisitions occurred. Results of operations of the
business acquisition accounted for under the purchase method of accounting has
been included in the consolidated financial statements commencing with the
acquisition date.
In connection with these acquisitions, and together with certain 1997
transactions, the Company incurred certain merger and integration costs of
approximately $56.7 million and $50.8 million during the years ended December
26, 1998 and December 27, 1997, respectively. Net of taxes, merger and
integration costs were approximately $1.06 and $1.08 per share, on a diluted
basis, for 1998 and 1997, respectively. Merger and integration costs consist
primarily of investment banking, legal, accounting and advisory fees,
compensation, impairment of goodwill arising from acquired businesses integrated
into the Company's recent acquisitions, as well as certain other integration
costs. Excluding merger and integration costs, net of the related tax benefit,
net income and net income per common share, on a pro forma diluted basis, would
have been $57.8 million and $1.39 and $41.0 million and $1.03 for the years
ended December 26, 1998 and December 27, 1997, respectively.
On August 7, 1998, the Company completed the sale of Marus Dental
International ("Marus"), the Company's dental equipment manufacturing operation.
Marus had 1997 net sales of approximately $25.0 million. The operations of Marus
were not material to the Company.
General
The Company is the largest distributor of healthcare products and services
to office-based healthcare practitioners in the combined North American and
European markets. The Company has operations in the United States, Canada,
Mexico, the United Kingdom, The Netherlands, Belgium, Germany, France, the
Republic of Ireland, Austria, Spain, Australia and New Zealand, and conducts its
business principally through two segments; healthcare distribution and
technology. These segments, which are operated as individual business units,
offer different products and services, albeit to the same customer base. The
healthcare distribution segment consists of the Company's dental, medical,
veterinary and international groups. The international group is comprised of the
Company's healthcare distribtution business units located primarily in Europe
and the Pacific Rim, and offer products and services to dental, medical and
veterinary customers located in their respective geographic regions. The
technology segment consists primarily of the Company's practice management
software business and certain other value-added products and services which are
distributed primarily to healthcare professionals in the North American market.
The Company sells products and services to over 300,000 customers,
primarily dental practices and dental laboratories, as well as physician
practices, veterinary clinics and institutions. In 1998, the Company's
healthcare distribution business sold products to over 75% of the estimated
100,000 dental practices in the United States. The Company believes that there
is strong awareness of the "Henry Schein" name among office-based healthcare
practitioners due to its more than 60 years of experience in distributing
healthcare products. Through its comprehensive catalogs and other direct sales
and marketing programs, the Company offers its customers a broad product
selection of both branded and private brand products which includes in excess of
60,000 stock keeping units ("SKU's") in North America, approximately 55,000
SKU's in Europe and approximately 22,000 SKU's in Australia, at published prices
that the Company believes are below those of many of its competitors. The
Company, through its technology business unit, offers various value-added
products and services such as practice management software. As of December 26,
1998, the Company had sold over 28,000 dental practice management software
systems, more than any of its competitors.
For further information on the Company's operating segments, see
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" in Item 7 and Note 12 to the Consolidated Financial Statements.
During 1998, the Company distributed over 12.5 million pieces of direct
marketing materials (such as catalogs, flyers and order stuffers) to
approximately 600,000 office-based healthcare practitioners. The Company
supports its direct marketing efforts with approximately 700 telesales
representatives who facilitate order processing and generate sales through
direct and frequent contact with customers and with approximately 1,100 field
sales consultants, including equipment sales specialists. The Company utilizes
database segmentation techniques to more effectively market its products and
services to customers. In recent years, the Company has continued to expand its
management information systems and has established strategically located
distribution centers in the United States, Europe and Australia to enable it to
better serve its customers and increase its operating efficiency. The Company
believes that these investments, coupled with its broad product offerings,
enable the Company to provide its customers with a single source of supply for
substantially all their healthcare product needs and provide them with
convenient ordering and rapid, accurate and complete order fulfillment. The
Company estimates that approximately 99% of all orders in the United States
and Canada received before 7:00 p.m. and 4:00 p.m., respectively, are
shipped on the same day the order is received and approximately 99% of orders
are received by the customer within two
2
days of placing the order. In addition, the Company estimates that approximately
99% of all items ordered in the United States and Canada are shipped without
back ordering.
Acquisition and Joint Venture Strategies
The Company believes that there has been consolidation among healthcare
products distributors serving office based healthcare practitioners and that
this consolidation will continue to create opportunities for the Company to
expand through acquisitions and joint ventures. In recent years, the Company has
acquired or entered into joint ventures with a number of companies engaged in
businesses that are complementary to those of the Company. The Company's
acquisition and joint venture strategies include acquiring additional sales that
will be channeled through the Company's existing infrastructure, acquiring
access to additional product lines, acquiring regional distributors with
networks of field sales consultants and international expansion. As of December
26, 1998, the Company had five completed and two pending acquisitions, both of
which have since closed. Since December 26, 1998, the Company acquired, in
transactions accounted for under the purchase method of accounting, GIV, which
had 1998 net sales of approximately $120.0 million, and the Heiland Group, which
had 1998 net sales of approximately $130.0 million. The 1998 acquisitions, which
had aggregate net sales for 1997 of approximately $265.0 million, included (a)
two dental supply companies, the most significant of which was Meer; (b) two
medical supply companies and (c) one international dental supply companies. Of
the five completed acquisitions, four were accounted for under the pooling of
interests method, and the remaining acquisition of a 50.1% interest accounted
for under the purchase method of accounting.
During 1997, the Company acquired 24 healthcare distribution businesses.
The 1997 acquisitions, which had aggregate net sales for 1996 of approximately
$558.6 million, included (a) ten dental supply companies, the most significant
of which was Sullivan Dental Products, Inc. ("Sullivan"); (b) four medical
supply companies, the most significant of which was Micro Bio-Medics, Inc.
("MBMI"); (c) two international dental and three international medical supply
companies; (d) three technology and value-added product companies; the most
significant of which was Dentrix Dental Systems, Inc. ("Dentrix"); and (e)
certain assets and the business of IDE Interstate, Inc., a direct
marketer of healthcare products to dentists, doctors and veterinarians. Of the
23 completed acquisitions, six were accounted for under the pooling of
interests method, with the remainder being accounted for under the purchase
method of accounting (fourteen for 100% ownership interest and three for
majority ownership interests).
Corporate Structure Background
The Company was formed on December 23, 1992 as a wholly-owned subsidiary of
Schein Holdings, Inc. ("Holdings"). At that time, Holdings conducted the
business in which the Company is now engaged and, in addition, owned 100% of the
outstanding capital stock of Schein Pharmaceutical, Inc. ("Pharmaceutical"), a
company engaged in the manufacture and distribution of multi-source
pharmaceutical products. In December 1992, Holdings separated the Company's
business from Pharmaceutical by transferring to the Company all of the assets
(including Holdings' 50% interest in HS Pharmaceutical, Inc., a manufacturer and
distributor of generic pharmaceuticals ("HS Pharmaceutical")) and liabilities of
the healthcare distribution business now conducted by the Company. The Company
did not assume any other liabilities of Holdings, including the liabilities
associated with Pharmaceutical's business. In February 1994, the Company,
Holdings and their stockholders entered into a number of reorganization
agreements, and in September 1994, pursuant to such agreements, all of the
Company's Common Stock, par value $.01 per share ("Common
3
Stock"), held by Holdings was distributed to certain of the current stockholders
of the Company (the "Reorganization").
On November 8, 1995, the Company completed an initial public offering of
its Common Stock, and on June 21, 1996, the Company completed a follow-on
offering of its Common Stock. Proceeds from these offerings to the Company,
after expenses, were approximately $72.5 million and $124.1 million,
respectively. The proceeds enabled the Company to pay off certain indebtedness,
with the remaining proceeds available for general corporate purposes, including
subsequent acquisitions.
Customers
The Company, through its healthcare distribution and technology businesses,
serves over 300,000 customers worldwide in the dental, medical and veterinary
markets. The Company's dental customers include office-based dental practices,
dental laboratories, universities, institutions, governmental agencies and large
group and corporate accounts; medical customers include office-based physician
practices, podiatrists, surgery centers, institutions, hospitals and
governmental agencies; and the Company's veterinary products are sold primarily
to office-based veterinarians serving primarily small companion animals.
The Company believes that its healthcare distribution customers generally
order from two or more suppliers for their healthcare product needs, and often
use one supplier as their primary resource. The Company believes that its
customers generally place larger orders and order more frequently from their
primary suppliers. The Company estimates that it serves as a primary supplier to
less than 15% of its total customer base and believes it has an opportunity to
increase sales by increasing its level of business with those customers for
which it serves as a secondary supplier.
Over the past several years the Company has expanded its customer base to
include larger purchasing organizations, including certain dental laboratories,
institutions, government agencies, hospitals, renal dialysis centers and
surgery centers. More recently, as cost-containment pressures have resulted in
increased demand for low-cost products and value-added services, the Company has
targeted specific groups of practices under common ownership, institutions and
professional groups. For example, the Company has an exclusive direct marketing
agreement with an American Medical Association ("AMA") sponsored service and a
veterinarian-sponsored service, pursuant to which member practitioners have
access to the services' lower priced products. In 1998, the AMA-sponsored
service and the veterinarian-sponsored purchasing service accounted for net
sales of over $37.0 million. These services, government institutions and
agencies, hospitals and other large or collective purchasers, require low-cost
pricing and detailed product and usage information and reporting. The Company
believes it is well situated to meet the needs of these customers, given its
broad, low-cost product offerings and its management information systems. No
single customer accounted for more than 1.0% of net sales in 1998.
Sales and Marketing
The Company's sales and marketing efforts, which are designed to establish
and solidify customer relationships through personal visits by field sales
representatives and frequent direct marketing contact, emphasize the Company's
broad product lines, competitive prices and ease of order placement. The key
elements of the Company's program in the United States are:
4
o Direct Marketing. During 1998, the Company distributed over 12.5
million pieces of direct marketing material, including catalogs, flyers,
order stuffers and other promotional materials to approximately 600,000
office-based healthcare practitioners. The Company's principal U.S. dental
catalog, which is issued semi-annually, contains an average of over 450
pages and includes approximately 28,000 SKU's. The number of catalogs and
other materials received by each customer depends upon the market they
serve as well as their purchasing history. The Company's catalogs include
detailed descriptions and specifications of both branded and private brand
products and are utilized by healthcare practitioners as a reference
source. By evaluating its customers' purchasing patterns, area of
specialty, past product selections and other criteria, the Company
identifies customers who may respond better to specific promotions or
products. To facilitate its direct marketing activities, the Company
maintains an in-house advertising department which performs many creative
services, which the Company believes streamlines the production process,
provides greater flexibility and creativity in catalog production, and
results in cost savings.
o Telesales. The Company supports its direct marketing with
approximately 700 inbound and outbound telesales representatives who
facilitate order processing and generate new sales through direct and
frequent contact with customers. Inbound telesales representatives are
responsible for assisting customers in purchasing decisions as well as
answering product pricing and availability questions. In addition to
assisting customers, inbound telesales representatives also market comple-
mentary or promotional products. The Company's telesales representatives
utilize on-line computer terminals to enter customer orders and to access
information about products, product availability, pricing, promotions and
customer buying history.
The Company utilizes outbound telesales representatives and programs to
better market its services to those customer accounts identified by the
Company as either being high volume or high order frequency accounts. The
Company's U.S. dental outbound telesales representatives accounted for
approximately $198.0 million of the Company's net sales in 1998. The
Company has approximately 200 medical and veterinary telesales
representatives many of which make outbound calls in addition to handling
inbound telesales. Outbound telesales representatives strive to manage
long-term relationships with these customers through frequent and/or
regularly scheduled phone contact and personalized service.
The Company's telesales representatives generally participate in an
initial two-week training course designed to familiarize the sales
representative with the Company's products, services and systems. In
addition, generally all telesales representatives attend periodic training
sessions and special sales programs and receive incentives, including
monthly commissions.
o Field Sales Consultants. In 1992, the Company initiated its field
sales consultant program and, primarily as a result of its acquisitions of
Sullivan and Meer, now has approximately 1,100 field sales consultants,
including equipment sales specialists, covering certain major North
American, European and Pacific Rim markets. The field sales consultants
concentrate on attracting new customers and increasing sales to customers
who do not currently order a high percentage of their total product needs
from the Company. This strategy is designed to complement the Company's
direct marketing and telesales strategies and to enable the Company to
better market, service and support the sale of more sophisticated products
and equipment. Once a field sales consultant has established a relationship
with a customer, the representative encourages the customer to use the
Company's automated ordering process or its telesales representatives for
its day-to-day needs. This simplifies the ordering process for the customer
and increases the effectiveness of the field sales consultant.
5
Customer Service
A principal element of the Company's customer service approach is to offer
an order entry process that is convenient, easy and flexible. Customers
typically place orders with one of the Company's experienced telesales
representatives. Orders may also be placed 24-hours a day by fax, mail,
Internet, ArubA(Registered) TouchTone (the Company's 24-hour automated phone
service) or its computerized order entry system. The Company has developed an
enhanced Windows(Registered)-based version of its computerized order entry
system, known as ArubA(Registered), which was introduced at the end of 1995.
The Company focuses on providing rapid and accurate order fulfillment and
high fill rates. The Company estimates that approximately 99% of all items
ordered in the United States and Canada are shipped without back ordering, and
that approximately 99% of all orders in the United States and Canada received
before 7:00 p.m. and 4:00 p.m. respectively, are shipped on the same day the
order is received. In addition, because the Company seeks to service a
customer's entire order from the distribution center nearest the customer's
facility, approximately 99% of orders are received within two days of placing
the order. The Company continually monitors its customer service through
customer surveys, focus groups and daily statistical reports. The Company
maintains a liberal return policy to better assure customer satisfaction with
its products.
6
Products
The following chart sets forth the principal categories of products offered
by the Company's healthcare distribution and technology businesses and certain
top selling types of products in each category, with the percentage of 1998
consolidated net sales in parenthesis:
Healthcare Distribution (97.5%)
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Dental Products (66.3%)
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Consumable Dental Products Dental Laboratory
and Small Equipment (49.8%) Products (3.6%) Large Dental Equipment (12.9%)
- ------------------------------------------------------------------------------------------------------------------------
X-Ray Products; Infection Control; Teeth; Composites; Gypsum; Dental Chairs, Units and Lights; X-Rays;
Handpieces; Preventatives; Impression Acrylics; Articulators; and and Equipment Repair
Materials; Composites; and Anesthetics Abrasives
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Medical Products (28.5%)
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Branded and Generic
Pharmaceuticals; Surgical Products;
Diagnostic Tests; Infection Control;
and Vitamins
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Veterinary Products (2.7%)
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Branded and Generic
Pharmaceuticals; Surgical Products;
and Dental Products
Technological and Value-Added Products and Services (2.5%)
- ----------------------------------------------------------
Software and Related Products; Financial Products;
and other value-added products
The percentage of 1997 and 1996 net sales was as follows: consumable
dental products and small equipment, 51.1% and 52.3%, respectively; dental
laboratory products, 3.3% and 3.6%, respectively; large dental equipment, 13.6%
and 13.2%, respectively; medical products, 26.7% and 25.7%, respectively;
veterinary products, 2.9% and 2.7%, respectively; and technology and value-added
products and services, 2.4% and 2.5%, respectively.
Consumable Supplies and Equipment
The Company offers in excess of 60,000 SKU's to its customers in North
America, of which approximately 45,000 SKU's are offered to its dental
customers, approximately 19,000 are offered to its medical customers and
approximately 21,000 are offered to its veterinary customers. Over 20% of the
Company's products are offered to all three types of the Company's customers in
North America. The Company offers approximately 55,000 SKU's and 22,000 SKU's to
its customers in Europe and Australia, respectively. Approximately 8.6% of the
Company's net sales in 1998 were from sales of products offered under the Henry
Schein private brand (i.e., products manufactured by various third parties and
HS Pharmaceutical for distribution by the Company under the Henry Schein(R)
brand). The Company believes that the Henry Schein private brand line of over
7,000 SKU's offered in the United States and Canada is one
7
of the most extensive in the industry. The Company also distributes certain
generic pharmaceuticals manufactured by HS Pharmaceutical, a 50%-owned
affiliated company. The Company updates its product offerings regularly to meet
its customers' changing needs.
The Company offers a repair service, ProRepair(Registered), which provides
one to two-day turnaround for hand pieces and certain small equipment. The
Company also provides in-office installation and repair services for large
equipment in certain markets in North America, Europe and the Pacific Rim. The
Company had a total of 118 centers open at the end of 1998.
As described above, the Companys' results have been restated retroactively
to include Meer's results for all periods presented as Meer was acquired in a
pooling of interests transaction that was significant. Meer is a leading
full-service dental distributor serving dentists, dental laboratories and
institutions throughout the United States. Meer's net sales included a
proportionately higher percentage of large dental equipment sales then that of
the Company, on a historical basis.
On August 7, 1998, the Company completed the sale of Marus, the Company's
dental equipment manufacturing operation. Marus had 1997 net sales of
approximately $25.0 million.
Technology and Value-Added Products and Services
In an effort to promote customer loyalty, the Company offers certain
technology and value-added products and services. These products and services
include the following:
o Practice Management Software. The Company sells practice management
software systems to its dental and veterinary customers. The Company had sold
over 21,500 and 7,100 units of its Easy Dental(Registered) Plus and Dentrix
software systems, respectively, as of the end of fiscal 1998, and over 3,300 of
its AVImark(Registered) veterinary software systems. The Company's practice
management software products provide practitioners with patient treatment
history, billing and accounts receivable analysis and management, an
appointment calendar, electronic claims processing and word processing
programs, and the Company provides technical support and conversion services
from other software. In addition, the Easy Dental(Registered) Plus and Dentrix
software systems allow customers to connect with the Company's order entry
management systems. The Dentrix system is one of the most comprehensive
clinically-based dental practice management software packages in the United
States. The Dentrix premium software product complements Easy
Dental(Registered) Plus, the Company's high-value practice management
system. During 1997, the Company acquired the rights to distribute the DenTech
practice management system, which is designed to handle the needs of large group
practices. The Company believes the combined software product offerings enhance
its ability to provide its customers with the widest array of system solutions
to help manage their practices.
o Financial Services. In 1997 the Company began to offer its customers
assistance in managing their practices by providing access to a number of
financial services and products at rates which the Company believes are lower
than what they would be able to secure independently. The Company's equipment
leasing programs allow it to fufill a wide variety of practitioner financing
needs. The Company also provides financing and consulting services for all
phases of a physician's practice including practice start-up, practice
acquisition and debt consolidation. The patient financing program provides the
Company's dental and veterinarian customers a method for reducing receivables
and improving cash flow by providing patients access to financing. Through a
partnership with one of the nations largest bank credit card processors, the
Company offers electronic bankcard processing, and offers electronic insurance
claims submission services for faster, cheaper processing of patient
reimbursements, all through a third-party provider for a transaction fee. The
Company does not assume any financial obligation to its customers or their
patients in these programs. The Company also offers practice management
consulting services as well as practice management brokerage services in
selected markets in the United States.
8
Information Systems
The Company's management information systems generally allow for
centralized management of key functions, including inventory and accounts
receivable management, purchasing, sales and distribution. A key attribute of
the Company's management information systems is the daily operating control
reports which allow managers throughout the Company to share information and
monitor daily progress relating to sales activity, gross profit, credit and
returns, inventory levels, stock balancing, unshipped orders, order fulfillment
and other operational statistics. In the United States, the Company is in the
process of expanding and upgrading its order processing information system.
Additionally, worldwide, the Company is in the process of installing an
integrated information system for its large dental equipment sales and service
functions. Such a system will centralize the tracking of customers' equipment
orders as well as spare parts inventories and repair services. (See
"Management's Discussion and Analysis of Financial Conditions and Results of
Operation" in Item 7.)
Distribution
The Company distributes its products in the United States primarily
from its strategically located distribution centers in Eastern, Central,
South Western and Western United States. Customers in Canada are serviced from
distribution centers located in Eastern and Western Canada. The Company
maintains significant inventory levels of certain products in order to satisfy
customer demand for prompt delivery and complete order fulfillment of their
product needs. These inventory levels are managed on a daily basis with the aid
of the Company's sophisticated purchasing and stock status management
information systems. Once a customer's order is entered, it is electronically
transmitted to the distribution center nearest the customer's location and a
packing slip for the entire order is printed for order fulfillment. The
Company's automated freight manifesting and laser bar code scanning facilitates
the speed of the order fulfillment. The Company currently ships substantially
all of its orders in the United States by United Parcel Service. In certain
areas of the United States, the Company delivers its orders via contract
carriers. The Company's European and Pacific Rim distribution centers include
locations in the United Kingdom, the Republic of Ireland, France, The
Netherlands, Germany, Spain, Australia and New Zealand.
Purchasing
The Company believes that effective purchasing is a key element to
maintaining and enhancing its position as a low-cost provider of healthcare
products. The Company frequently evaluates its purchase requirements and
suppliers' offerings and prices in order to obtain products at the best possible
cost. The Company believes that its ability to make high volume purchases has
enabled it to obtain favorable pricing and terms from its suppliers. The Company
obtains its products for its North American distribution centers from over 1,700
suppliers of name brand products; in addition, the Company has established
relationships with numerous local vendors to obtain products for its European
and Pacific Rim distribution centers. In 1998, the Company's top 10 healthcare
distribution vendors and the Company's single largest vendor, accounted for
approximately 23.0% and 9.2%, respectively, of the Company's aggregate
purchases.
9
Competition
The distribution and manufacture of healthcare supplies and equipment is
intensely competitive. Many of the healthcare distribution products the Company
sells are available to the Company's customers from a number of suppliers. In
addition, competitors of the Company could obtain exclusive rights from
manufacturers to market particular products. Manufacturers could also seek to
sell directly to end-users, and thereby eliminate the role of distributors, such
as the Company. Significant price reductions by the Company's competitors could
result in a similar reduction in the Company's prices as a consequence of its
policy of matching its competitors' lowest advertised prices. Any of these
competitive pressures may materially adversely affect operating results.
In the United States, the Company competes with other distributors, as
well as several major manufacturers of dental, medical and veterinary products,
primarily on the basis of price, breadth of product line, customer service and
value-added services and products. In the sale of its dental products, the
Company's principal national competitor is Patterson Dental Co. In addition, the
Company competes against a large number of other distributors that operate on a
national, regional and local level. The Company's largest competitors in the
sale of medical products are PSS World Med, Inc. and McKesson HBOC, Inc., which
are national distributors. In the veterinary product market, the Company's two
principal national competitors include The Butler Company and Burns Veterinary
Supply. The Company also competes against a large number of small local and
regional medical and veterinary distributors, as well as a number of
manufacturers that sell direct to physicians and veterinarians. With regard to
the Company's practice management software, the Company competes against a
fragmented group of competitors, none of which currently have a significant
share of the market. The Company believes that it competes in Canada
substantially on the same basis as in the United States.
The Company also faces intense competition in its international
markets, where the Company competes on the basis of price and customer service
against a large number of dental product distributors and manufacturers in
Mexico, the United Kingdom, The Netherlands, Belgium, Germany, France, the
Republic of Ireland, Austria, Spain, Australia and New Zealand. The Company has
several large competitors in these markets, including ORBIS, Serona Dental and
the GACD Group.
Governmental Regulation
The Company's 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. Among the
Federal laws with which the Company must comply are the Federal Food, Drug, and
Cosmetic Act, the Prescription Drug Marketing Act of 1987, and the Controlled
Substances Act. It is possible that the Company may be prevented from selling
manufactured products if the Company (including its 50%-owned affiliated
company, HS Pharmaceutical, which distributes and manufactures generic
pharmaceuticals) were to receive an adverse report following an inspection by
the Food and Drug Administration (the "FDA") or the Drug Enforcement
Administration, or if a competitor were to receive prior approval of new
products from the FDA. A violation of a law by HS Pharmaceutical could cause its
operations to be suspended. A suspension could have an adverse effect on the
Company's equity in earnings of affiliates and could cause the Company to seek
alternative sources of products manufactured by HS Pharmaceutical, possibly at
higher prices than currently paid by the Company. In response to a Warning
Letter from the FDA regarding its compliance with current Good Manufacturing
Practices (cGMP's) of its dental anesthetic products, HS Pharmaceutical has
temporarily suspended the manufacture and shipment of these products to the
United States. In each of January and February, 1999, HS Pharmaceutical
instituted a voluntary recall of approximately 240 batches, in the aggregate, of
dental anesthetic products sold in 1997 and 1998 under its name and certain
private labels. The impact on 1998 fourth quarter earnings was approximately
$0.04 per share, on a diluted basis. Management estimates the impact to be $0.02
to $0.04 per share, per quarter, on a diluted basis, through the second quarter
of 1999, and possibly beyond that date in the event HS Pharmaceutical is unable
to resolve the issues that led to the recalls. HS Pharmaceutical is cooperating
fully with the FDA to resolve the issues that led to the recalls, however it is
unable to estimate when manufacturing and shipments of these products to the
United States will recommence.
The Federal Food, Drug, and Cosmetic Act generally regulates the
introduction, manufacture, advertising, labeling, packaging, storage, handling,
marketing and distribution of, and recordkeeping for, pharmaceuticals and
medical devices shipped in interstate commerce. The Prescription Drug Marketing
Act of 1987, which amended the Federal Food, Drug and Cosmetic Act, establishes
certain requirements
10
applicable to the wholesale distribution of prescription drugs, including the
requirement that wholesale drug distributors be registered with the Secretary of
Health and Human Services or licensed by each state in which they conduct
business in accordance with federally established guidelines on storage,
handling and record maintenance. Under the Controlled Substances Act, the
Company, as a distributor of controlled substances, is required to obtain
annually a registration from the Attorney General in accordance with specified
rules and regulations and is subject to inspection by the Drug Enforcement
Administration acting on behalf of the Attorney General. The Company is required
to maintain licenses and permits for the distribution of pharmaceutical products
and medical devices under the laws of the states in which it operates. In
addition, the Company's dentist and physician customers are subject to
significant governmental regulation. There can be no assurance that regulations
that impact dentists' or physicians' practices will not have a material adverse
impact on the Company's business.
The Company believes that it is in substantial compliance with all of
the foregoing laws and the regulations promulgated thereunder and possesses all
material permits and licenses required for the conduct of its business.
Proprietary Rights
The Company holds trademarks relating to the "Henry Schein" name and
logo, as well as certain other trademarks. Pursuant to certain agreements
executed in connection with the reorganization of the Company, both the Company
and Schein Pharmaceutical, Inc. are entitled to use the "Schein" name in
connection with their respective businesses, but Schein Pharmaceutical, Inc. is
not entitled to use the name "Henry Schein." The Company intends to protect its
trademarks to the fullest extent practicable.
Employees
As of December 26, 1998, the Company had over 6,000 full-time employees
in North America, Europe and Australia, including approximately 700 telesales
representatives, 1,100 field sales consultants, including equipment sales
specialists, 1,400 warehouse employees, 200 computer programmers and
technicians, 500 management employees and 2,100 office, clerical and
administrative employees. None of the Company's employees are represented by a
collective bargaining agreement. The Company believes that its relations with
its employees are excellent.
Disclosure Regarding Forward Looking Statements
The Private Securities Litigation Reform Act of 1995 provides a "safe
harbor" for forward looking statements. Certain information in Items 1, 2, 3, 7
and 8 of this Form 10-K include information that is forward looking, such as the
Company's opportunities to increase sales through, among other things,
acquisitions; its exposure to fluctuations in foreign currencies; its
anticipated liquidity and capital requirements; competitive product and pricing
pressures and the ability to gain or maintain share of sales in global markets
as a result of actions by competitors; and the results of legal proceedings. The
matters referred to in forward looking statements could be affected by the risks
and uncertainties involved in the Company's business. These risks and
uncertainties include, but are not limited to, the effect of economic and market
conditions, the impact of the consolidation of healthcare practitioners, the
impact of healthcare reform, opportunities for acquisitions and the Company's
ability to effectively integrate acquired companies, the acceptance and quality
of software products, acceptance and ability to manage operations in foreign
markets, the ability to maintain favorable supplier arrangements and
relationships, possible disruptions in
11
the Company's computer systems or telephone systems, the Company's ability and
its customers' and suppliers' ability to replace, modify or upgrade computer
programs in ways that adequately address the Year 2000 issue, possible increases
in shipping rates or interruptions in shipping service, the level and volatility
of interest rates and currency values, economic and political conditions in
international markets, including civil unrest, government changes and
restriction on the ability to transfer capital across borders, the impact of
current or pending legislation, regulation and changes in accounting standards
and taxation requirements, environmental laws in domestic and foreign
juristictions, as well as certain other risks described above in this Item under
"Competition" and "Government Regulation," and below in Item 3 in "Legal
Proceedings" and in Item 7 in "Management's Discussion and Analysis of Financial
Condition and Results of Operations." Subsequent written and oral forward
looking statements attributable to the Company or persons acting on its behalf
are expressly qualified in their entirety by the cautionary statements in this
paragraph and elsewhere in this Form 10-K. Year 2000 readiness disclosures
contained in this Form 10-K are also subject to certain protection and the Year
2000 Information and Readiness Disclosure Act.
The Company's principal executive offices are located at 135 Duryea
Road, Melville, New York 11747, and its telephone number is 516-843-5500. As
used in this Report, the term the "Company" refers to Henry Schein, Inc., a
Delaware corporation, and its subsidiaries, 50%-owned companies and
predecessor, unless otherwise stated.
12
Executive Officers of the Registrant
The following table sets forth certain information regarding the executive
officers of the Company.
Name Age Position
- ---------------------------------------- ---------- -----------------------------------------------------
Stanley M. Bergman...................... 49 Chairman, Chief Executive Officer, President and
Director
Gerald A. Benjamin...................... 46 Senior Vice President--Administration and Customer
Satisfaction and Director
James P. Breslawski..................... 45 Executive Vice President and Director
Leonard A. David........................ 50 Vice President--Human Resources and Special
Counsel and Director
Diane Forrest ......................... 52 Senior Vice President--Information Services
and Chief Information Officer
Larry M. Gibson ........................ 52 President--Practice Management Technologies
Division
Bruce J. Haber ......................... 46 Executive Vice President and President-Medical Group
and Director
Stephen R. LaHood ...................... 51 Senior Vice President--Supply Chain Group
Mark E. Mlotek.......................... 43 Vice President, General Counsel, Secretary and Director
Steven Paladino ........................ 41 Senior Vice President, Chief Financial Officer and
Director
James W. Stahly ........................ 50 President--North American Dental Group
Michael Zack............................ 46 Senior Vice President--International Group
13
Stanley M. Bergman has been Chairman, Chief Executive Officer and President
since 1989 and a director of the Company since 1982. Mr. Bergman held the
position of Executive Vice President of the Company and Schein Pharmaceutical,
Inc. from 1985 to 1989 and Vice President of Finance and Administration of the
Company from 1980 to 1985. Mr. Bergman is a certified public accountant.
Gerald A. Benjamin has been Senior Vice President of Administration and Customer
Satisfaction since 1993, including responsibility for the worldwide human
resource function, and has been a director of the Company since September 1994.
Prior to holding his current position, Mr. Benjamin was Vice President of
Distribution Operations of the Company from 1990 to 1992 and Director of
Materials Management of the Company from 1988 to 1990. Before joining the
Company, Mr. Benjamin was employed for 13 years in various management positions
at Estee Lauder, where his last position was Director of Materials Planning and
Control.
James P. Breslawski has been Executive Vice President of the Company since 1990,
with primary responsibility for the North American Dental Group, the Veterinary
Group and corporate creative services, and a director of the Company since 1990.
Between 1980 and 1990, Mr. Breslawski held various positions with the Company,
including Chief Financial Officer, Vice President of Finance and Administration
and Controller. Mr. Breslawski is a certified public accountant.
Leonard A. David has been Vice President of Human Resources and Special Counsel
since January 1995. Mr. David held the office of Vice President, General Counsel
and Secretary from 1990 to 1995 and practiced corporate and business law for
eight years prior to joining the Company. Mr. David has been a director of the
Company since September 1994.
Diane Forrest joined the Company in 1994 as Senior Vice President of Information
Services and Chief Information Officer. Prior to joining the Company, Ms.
Forrest was employed by Tambrands Inc. as Vice President of Information Services
from 1987 to 1994, KPMG Peat Marwick as Senior Manager in the management
consulting division from 1982 to 1987 and Nabisco Brands, Inc. as Corporate
Manager of Manufacturing Systems from 1978 to 1982.
Larry M. Gibson joined the Company as President of the Practice Management
Technologies Division on February 24, 1997, concurrent with the acquisition of
Dentrix. Before joining the Company, Mr. Gibson was founder, Chairman and CEO
of Dentrix, started in 1980. Prior to his employment with Dentrix, Mr. Gibson
was employed by Weidner Communication Systems from 1978.
Bruce J. Haber has been an Executive Vice President of Schein and President of
Schein's Medical Group since August 1, 1997, the date on which Schein acquired
MBMI. Mr. Haber has been a director of the Company since October 1997. Mr. Haber
has been President of MBMI since 1983.
Stephen R. LaHood joined the Company in 1992 as Senior Vice President of
Distribution Services and is also responsible for purchasing. Prior to joining
the Company, Mr. LaHood was employed by Lex/Schweber Electronics Inc. as Vice
President of Operations and Quality from 1988 to 1991. Mr. LaHood also spent ten
years at Johnson & Johnson Products, Inc., where his last position was Manager
of Corporate Business Planning and thereafter, seven years at Schering-Plough
Corporation where his last position was Senior Director of Manufacturing
Operations.
14
Mark E. Mlotek joined the Company in December 1994 as Vice President, General
Counsel and Secretary, and became a director of the Company in September 1995.
Prior to joining the Company, Mr. Mlotek was a partner in the law firm of
Proskauer Rose LLP, counsel to the Company, specializing in mergers and
acquisitions, corporate reorganizations and tax law from 1989 to 1994.
Steven Paladino has been Senior Vice President and Chief Financial Officer of
the Company since 1993 and has been a director of the Company since 1992. From
1990 to 1992, Mr. Paladino served as Vice President and Treasurer and from 1987
to 1990 served as Corporate Controller of the Company. Before joining the
Company, Mr. Paladino was employed as a public accountant for seven years and
most recently was with the international accounting firm of BDO Seidman, LLP.
Mr. Paladino is a certified public accountant.
James W. Stahly joined the Company in 1994 as President of the North American
Dental Group of the Company. Before joining the Company, Mr. Stahly was employed
by Fox Meyer Corporation for seven years where his last position was Senior Vice
President -- Hospital and Alternate Care Sales. Prior to his employment with Fox
Meyer, Mr. Stahly spent 16 years at McKesson Drug Company.
Michael Zack has been responsible for the International Group of the Company
since 1989. Mr. Zack was employed by Polymer Technology (a subsidiary of Bausch
& Lomb) as Vice President of International Operations from 1984 to 1989 and by
Gruenenthal GmbH as Manager of International Subsidiaries from 1975 to 1984.
15
ITEM 2. Properties
The Company owns or leases the following properties:
Approximate
Own or Square Lease
Property Location Lease Footage Expiration Date
-------- -------- ------ ----------- ---------------
Corporate
Headquarters................. Eastern United States Lease 172,000 December 2005
Distribution Center ......... Eastern United States Lease 413,000 December 2007
Distribution Center.......... Eastern United States Lease 108,000 July 2007
Distribution Center......... Eastern United States Lease 120,000 April 2001
Distribution Center......... Eastern United States Lease 138,000 November 2008
Distribution Center.......... Central United States Lease 225,000 June 2001
Distribution Center ......... Central United States Lease 171,000 November 2011
Distribution Center ......... South Western United States Lease 132,000 July 2008
Distribution Center.......... Western United States Lease 115,500 June 2002
Distribution Center.......... United Kingdom Lease 85,000 August 2005
The Company also leases distribution, office, showroom and sales space in
other locations in the United States, Canada, France, Germany, the Republic of
Ireland, The Netherlands, Spain, Australia, New Zealand, Mexico and the United
Kingdom. Two 50%-owned companies also lease space in the United States and
Canada.
The Company believes that its properties are generally in good condition,
are well maintained, and are generally suitable and adequate to carry on the
Company's business. As a result of the Company's expansion and acquisition
activities, the Company is in the process of consolidating its distribution
facilities.
The Company has additional operating capacity at its listed facilities.
ITEM 3. Legal Proceedings
The manufacture or distribution of certain products by the Company involves
a risk of product liability claims, and from time to time the Company is named
as a defendant in products liability cases as a result of its distribution of
pharmaceutical and other healthcare products. As of December 26, 1998, the
Company was named a defendant in thirty-four such cases. Of the thirty-four
product liability claims, twenty-eight involve claims made by healthcare workers
who claim allergic reaction relating to exposure to latex gloves. In each of
these cases, the Company 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, the
Company is taking steps to implead those manufacturers into each case in which
the Company is a defendant.
16
In addition, the Company is subject to other claims, suits and complaints,
which arise in the course of the Company's business. In Texas District Court,
Travis County, the Company, and one of its subsidiaries, are defendants in a
matter entitiled Shelly E. Stromboe & Jeanne N. Taylor, on Behalf of Themselves
and All Other Similarly Situated vs. Henry Schein, Inc., Easy Dental Systems,
Inc. and Dentisoft, Inc., Cause No. 98-00886. This complaint, which was filed in
January 1998, requests the court to grant class action certification, alleges,
among other things, negligence and breach of contract involving the sale of
software products under the Easy Dental name.
The Company has various insurance policies, including product liability
insurance covering risks and in amounts it considers adequate. In many cases the
Company is provided by indemnification by the manufacturer of the product. There
can be no assurance that the coverage maintained by the Company is sufficient to
cover all future claims or will be available in adequate amounts or at a
reasonable cost, or that indemnification agreements will provide adequate
protection for the Company. The Company intends to vigorously defend all such
claims, suits and complaints. In the opinion of the Company, all such pending
matters are covered by insurance or are of such kind, or involve such amounts,
as would not have a material adverse effect on the financial statements of the
Company if disposed of unfavorably.
ITEM 4. Submission of Matters to a Vote of Security Holders
No matters were submitted to a vote of the Company's stockholders during
the fourth quarter of fiscal 1998.
17
PART II
ITEM 5. Market for Registrant's Common Equity and Related Stockholder Matters
The following table sets forth for the periods indicated the high and low
reported sales prices of the Common Stock of the Company as reported on the
NASDAQ National Market System for each quarterly period in fiscal 1997 and 1998
and for the first quarter of fiscal 1999 through March 10, 1999.
High Low
---- ---
Fiscal 1997:
1st Quarter $39 $24-1/2
2nd Quarter $37 $26-7/8
3rd Quarter $40-1/2 $30-1/4
4th Quarter $37-3/4 $31-1/2
Fiscal 1998:
1st Quarter $41 $29-1/4
2nd Quarter $46-1/4 $37
3rd Quarter $51-1/8 $31
4th Quarter $40-3/8 $24-3/4
Fiscal 1999:
1st Quarter (through March 10, 1999) $28-3/4 $26-5/8
The Company's Common Stock is quoted through the Nasdaq National Market tier of
the Nasdaq Stock Market under the symbol "HSIC." On March 10, 1999, there were
approximately 887 holders of record of the Common Stock. On March 10, 1999,
the last reported sales price was $26-3/4.
Dividend Policy
The Company does not anticipate paying any cash dividends on its Common Stock in
the foreseeable future; it intends to retain its earnings to finance the
expansion of its business and for general corporate purposes. Any payment of
dividends will be at the discretion of the Company's Board of Directors and will
depend upon the earnings, financial condition, capital requirements, level of
indebtedness, contractual restrictions with respect to payment of dividends and
other factors. The Company's revolving credit agreement and the note issued in
connection with an acquisition in The Netherlands limit the distributions of
dividends without the prior written consent of the lenders.
18
ITEM 6. Selected Financial Data
The following selected financial data with respect to the Company's financial
position and its results of operations for each of the five years in the period
ended December 26, 1998 set forth below has been derived from the Company's
consolidated financial statements. The selected financial data and consolidated
financial statements have been restated to give retroactive effect to the
acquisition of the H. Meer Dental Supply Co., effective August 14, 1998, which
was accounted for under the pooling of interests method. The selected financial
data presented below should be read in conjunction with the Consolidated
Financial Statements and related notes thereto in Item 8 and "Management's
Discussion and Analysis of Financial Condition and Results of Operations" in
Item 7. The Selected Operating Data and Net Sales By Market Data presented below
have not been audited.
Years Ended
---------------------------------------------------------------------------
December 26, December 27, December 28, December 30, December 31,
1998 1997 1996 1995 1994
---- ---- ---- ---- ----
(in thousands, except per share and selected operating data)
Statement of Operations Data:
Net sales ................................. $1,921,685 $1,698,496 $1,374,343 $1,090,936 $940,354
Cost of sales ............................. 1,319,861 1,188,098 961,588 751,616 655,398
---------- ---------- ---------- ---------- --------
Gross profit ........................... 601,824 510,398 412,755 339,320 284,956
Selling, general and administrative
expenses ............................. 505,628 447,789 369,642 306,347 252,720
Merger and integration costs(1) ........ 56,666 50,779 -- -- --
Special management compensation(2) ..... -- -- -- 20,797 21,596
Special professional fees(3) ........... -- -- -- -- 2,007
---------- ---------- ---------- ---------- --------
Operating income ....................... 39,530 11,830 43,113 12,176 8,633
Interest income ........................ 6,964 7,353 7,139 3,433 2,512
Interest expense ....................... (12,050) (7,643) (5,487) (8,022) (5,546)
Other income - net ..................... 1,570 1,375 1,177 668 729
---------- ---------- ---------- ---------- --------
Income before taxes on income,
minority interest and equity in
earnings of affiliates .............. 36,014 12,915 45,942 8,255 6,328
Taxes on income ........................ 20,325 17,670 18,606 10,823 4,458
Minority interest in net income (loss)
of subsidiaries ...................... 145 (430) 246 509 561
Equity in earnings of affiliates ....... 783 2,141 1,595 1,537 494
---------- ---------- ---------- ---------- --------
Income (loss) beforcumulative effect
of accounting change ................. 16,327 (2,184) 28,685 (1,540) 1,803
Cumlative effect of accounting change .. -- -- -- -- (60)
---------- ---------- ---------- ---------- --------
Net income (loss) ...................... $ 16,327 $ (2,184) $ 28,685 $ (1,540) $ 1,743
========== ========== ========== ========== ========
Net income (loss) per common share:
Basic .................................. $ 0.42 $ (0.06) $ 0.85 $ (0.06) $ 0.07
Diluted ................................ $ 0.39 $ (0.06) $ 0.81 $ (0.06) $ 0.07
Weighted average shares outstanding:
Basic .................................. 39,305 37,531 33,714 25,719 24,235
Diluted ................................ 41,549 37,531 35,202 25,719 25,319
19
Years Ended
----------------------------------------------------------------------------
December 26, December 27, December 28, December 30, December 31,
1998 1997 1996 1995 1994
---- ---- ---- ---- ----
(in thousands, except per share and selected operating data)
Pro Forma Income Data(4):
Pro forma operating income.............. $ 32,973 $ 32,236
Pro forma net income (loss)............ $ 13,748 $ (1,778) $ 29,023 $ 17,936 $ 18,474
Pro forma net income (loss) per
common share:
Basic ............................... $ 0.35 $ (0.05) $ 0.86 $ 0.70 $ 0.76
Diluted ............................. $ 0.33 $ (0.05) $ 0.82 $ 0.66 $ 0.73
Pro forma average shares
outstanding:
Basic .............................. 39,305 37,531 33,714 25,719 24,235
Diluted.............................. 41,549 37,531 35,202 27,005 25,319
Selected Operating Data:
Number of orders shipped................ 6,718,000 6,064,000 5,127,000 4,571,000 4,211,000
Average order size...................... $ 286 $ 280 $ 268 $ 239 $ 223
Net Sales by Market Data:
Healthcare Distribution:
Dental(5)............................ $1,083,994 $ 999,456 $ 819,721 $ 675,457 $ 602,253
Medical.............................. 515,728 441,015 341,329 245,439 211,393
Veterinary........................... 48,307 40,843 35,329 29,330 27,872
International(6)..................... 230,999 181,239 146,999 107,703 83,927
---------- ---------- ---------- ---------- ----------
Total Healthcare Distribution 1,879,028 1,662,553 1,343,378 1,057,929 925,445
Technology(7)........................... 42,657 35,943 30,965 33,007 14,909
---------- ---------- ---------- ---------- ----------
$1,921,685 $1,698,496 $1,374,343 $1,090,936 $ 940,354
========== ========== ========== ========== ==========
Balance Sheet Data (at period end):
Working capital......................... $ 403,592 $ 312,916 $ 290,482 $ 188,303 $ 160,631
Total assets............................ 962,040 803,946 668,239 481,701 359,753
Total debt.............................. 209,451 148,685 59,404 79,498 92,477
Redeemable stock(8)..................... --- -- -- -- 14,745
Minority interest....................... 5,904 2,225 5,289 4,547 1,823
Stockholders' equity.................... 463,034 424,223 408,877 238,041 127,697
- -----------------
(1) Merger and integration costs consist primarily of investment banking,
legal, accounting and advisory fees, compensation, write-off of
duplicate management information systems, other assets and the
impairment of goodwill arising from acquired businesses integrated into
the Company's medical and dental businesses, as well as certain other
integration costs incurred primarily in connection with the 1998
acquisition of Meer and the 1997 acquisitions of Sullivan, MBMI and
Dentrix, which were accounted for under the pooling of interests method
of accounting. See "Management's Discussion and Analysis of Financial
Condition and Results of Operations - Recent Developments" in Item 7
and the Consolidated Financial Statements and related notes thereto in
Item 8.
20
(2) Includes: (a) for 1995, non-cash special management compensation
charges of $17.5 million arising from final mark-to-market adjustments
(reflecting an increase in estimated market value from 1994 to the
initial public offering price of $16.00 per share) for stock grants
made to an executive officer of the Company in 1992 and other stock
issuances made to certain other senior management of the Company
(because of certain repurchase features which expired with the initial
public offering), an approximate $2.8 million non-cash special
management compensation charge (also based on the initial public
offering price of $16.00 per share) relating to compensatory options
granted in 1995, and a cash payment of $0.5 million for additional
income taxes resulting from such stock issuances; and (b) for 1994,
non-cash special management compensation arising from accelerated
amortization of deferred compensation arising from the 1992 stock
grants to an executive officer of the Company of $17.3 million, which
included a 1994 mark-to-market adjustment (because of the repurchase
features referred to above) of $9.1 million, due to the resolution,
with the closing of the Reorganization, of certain contingencies
surrounding the issuance of the stock grants, non-cash special
management compensation charges of $1.6 million (net of prior accruals
of approximately $1.9 million under an executive incentive plan)
arising from stock issuances to certain other senior management of the
Company, valued at $3.5 million, and cash payments for income taxes of
approximately $2.4 million resulting from these stock issuances and
$0.3 million for additional income taxes resulting from the 1992 stock
grants. See "Management's Discussion and Analysis of Financial
Condition And Results of Operations Overview" in Item 7 herein.
(3) Includes special professional fees incurred by the Company in
connection with the Reorganization. See "Management's Discussion and
Analysis of Financial Condition and Results of Operations - Overview"
in Item 7 herein.
(4) Reflects the pro forma elimination of special charges incurred in 1995
and 1994 for special management compensation of $20.8 million and $21.6
million, respectively, and special professional fees incurred in 1994
of $2.0 million, arising from the Reorganization, and the related tax
effects of $1.2 million and $5.8 million for 1995 and 1994,
respectively, and provision for income taxes on previously untaxed
earnings of Dentrix as an S Corporation of $1.2 million, $0.5 million
and $0.3 million for 1996, 1995 and 1994, respectively, and provision
for income tax (expense) recoveries on previously untaxed earnings of
Meer as an S Corporation of $(0.6) million, $0.4 million, $1.5 million,
$0.3 million and $(0.8) million for 1998, 1997, 1996, 1995 and 1994,
respectively, and the pro forma elimination of a net deferred tax asset
arising from Meer's conversion from an S Corporation to a C Corporation
of $2.0 million in 1998. See "Management's Discussion and Analysis of
Results of Financial Condition and Results of Operations - Overview and
Recent Developments" in Item 7 herein.
(5) Dental consists of the Company's dental business in the United States
and Canada.
(6) International consists of the Company's business (substantially all
dental) outside the United States and Canada, primarily Europe and
Australia.
(7) Technology consists of the Company's practice management software
business and certain other value-added products and services.
(8) Redeemable stock includes stock issued for compensation which was
subject to repurchase by the Company at fair market value in the event
of termination of employment of the holder of such shares, as well as
shares purchased by the trust for the Company's ESOP and allocable to
the ESOP participants. With the completion of the Company's initial
public offering, the stock issued for compensation and the ESOP Common
Stock were no longer subject to repurchase. See "Management's
Discussion and Analysis of Financial Condition and Results of
Operations - Overview" in Item 7 herein.
21
ITEM 7. Management's Discussion and Analysis of Financial Condition and
Results of Operations
The following discussion and analysis of the Company's consolidated
financial condition and consolidated results of operations has been restated to
give retroactive effect to the transactions accounted for under the pooling of
interests method of accounting and should be read in conjunction with the
Company's consolidated financial statements and notes thereto included herein.
Recent Developments
The Company's results of operations in recent years have been significantly
impacted by strategies and transactions undertaken by the Company to expand its
business, both domestically and internationally, in part to address significant
changes in the healthcare industry, including potential national healthcare
reform, trends toward managed care, cuts in Medicare, consolidation of
healthcare distribution companies and collective purchasing arrangements.
Since December 26, 1998, the Company has acquired General Injectibles and
Vaccines, Inc. ("GIV"), through the purchase of all of the outstanding common
stock of Biological & Popular Culture, Inc., and the international dental,
medical and veterinary healthcare distribution businesses of Heiland Holding
GmbH (the "Heiland Group"). GIV, which had 1998 net sales of approximately
$120.0 million, is a leading independent direct marketer of vaccines and other
injectible products to office-based practitioners in the United States. The
Heiland Group, the largest direct marketer of healthcare supplies to
office-based practitioners in Germany, had 1998 net sales of approximately
$130.0 million. The total cash purchase price for these acquisitions was
approximately $113.5 million. Notes issued in conjunction with one of the
acquisitions, due in six months from the closing date, amounted to approximately
$24.0 million. These transactions were accounted for under the purchase method
of accounting.
During the year ended December 26, 1998, the Company completed five
acquisitions. The 1998 completed acquisitions included two dental supply
companies, the most significant of which was Meer, a leading full-service dental
distributor serving dentists, dental laboratories and institutions throughout
the United States, with 1997 annual net sales of approximately $180.0 million.
Combined, Meer and the other dental company had approximately $212.0 million in
aggregate net sales for 1997. The completed acquisitions also included two
medical supply companies with aggregate net sales for 1997 of approximately
$37.0 million, and one international dental distribution business with 1997 net
sales of approximately $16.0 million. Of the five completed acquisitions, four
(including Meer) were accounted for under the pooling of interests method, and
the remaining acquisition of a 50.1% interest was accounted for under the
purchase method of accounting. The financial statements have been restated to
give retroactive effect to the Meer transaction, as the remaining three pooling
transactions were not material and have been included in the consolidated
financial statements from the beginning of the quarter in which the acquisitions
occurred. Results of operations of the business acquisition accounted for under
the purchase method of accounting has been included in the consolidated
financial statements commencing with the acquisition date.
During 1998, the Company issued 2,973,680 shares, 347,063 shares and
121,000 shares of its Common Stock, with an aggregate value of approximately
$151.1 million in connection with three of the pooling transactions.
Additionally, in connection with one of the dental supply company acquisitions,
the Company issued shares of a subsidiary, with rights equivalent to those of
the Company's Common Stock, which are exchangeable into 603,500 shares of the
Company's Common Stock, at each shareholders' option, and had an aggregate value
of approximately
22
$24.0 million. The total cash purchase price for the acquisition accounted for
under the purchase method of accounting was approximately $6.8 million. The
excess of the acquisition costs over the fair value of identifiable net assets
acquired will be amortized on a straight-line basis over 30 years.
The financial statements include adjustments to give retroactive effect to
the acquisition of Meer for all periods presented, as well as for the other
pooling acquisitions described below. Prior to its acquisition by the Company,
Meer elected to be treated as an S Corporation under the Internal Revenue Code,
and accordingly, was not subject to taxation at the corporate level. Pro forma
adjustments have been made to reflect a provision for income taxes for each
period presented and the elimination of a deferred tax benefit arising from
Meer's conversion from the S Corporation to a Corporation. None of the other
1998 completed acquisitions were material.
During the year ended December 27, 1997, The Company acquired in pooling of
interests transactions, all of the outstanding common stock of (i) Sullivan
Dental Products, Inc. ("Sullivan"), a distributor of consumable dental supplies
and equipment, (ii) Micro Bio-Medics, Inc. ("MBMI"), a distributor of medical
supplies and (iii) Dentrix Dental Systems, Inc. ("Dentrix"), a leading provider
of clinically-based dental paractice management systems. Prior to its
acquisition of the company, Dentrix elected to be treated as an S corporation
under the Internal Revenue Code, and accordingly, its earnings were not subject
to taxation at the corporate level. Proforma adjustments have been made to
reflect a provision for income taxes on such previously untaxed earnings for
each period presented.
In addition to these three acquisitions, the Company completed 21 other
acquisitions including; three medical and ten dental supply companies with
aggregate net sales for 1996 of approximately $32.0 million and $41.8 million,
respectively; two international dental and three international medical supply
companies with aggregate net sales for 1996 of approximately $5.3 million and
$18.3 million, respectively; two technology and value-added product companies
with aggregate net sales for 1996 of approximately $10.1 million; and certain
assets and the business of IDE Interstate, Inc., a direct marketer of
healthcare products to dentists, doctors and veterinarians with net sales for
1996 of approximately $50.0 million.
Of the twenty four 1997 completed acquisitions, six were accounted for
under the pooling of interests method of accounting, with the remainder being
accounted for under the purchase method of accounting (fifteen for 100%
ownership interests and three for majority ownership interests). The financial
statements were restated to give retroactive effect to three of the pooling
transactions (Sullivan, MBMI and Dentrix) as the remaining three pooling
transactions were not material and were included in the consolidated financial
statements from the beginning of the quarter in which the acquisitions occurred.
Operations of the 1997 completed acquisitions, accounted for under the purchase
method of accounting, were included in the consolidated financial statements
from their respective acquisition dates.
In connection with the 1998 and 1997 acquisitions, the Company incurred
certain merger and integration costs of approximately $56.7 million and $50.8
million, respectively. Net of taxes, merger and integration costs were
approximately $1.06 and $1.08 per share, on a diluted basis, respectively.
Merger and integration costs for the healthcare distribution and technology
segment were $55.7 million and $1.0 million for 1998 and $43.9 million and $6.9
million for 1997, respectively. Merger and integration costs consist primarily
of investment banking, legal, accounting and advisory fees, compensation,
impairment of goodwill arising from acquired businesses integrated into the
Company's medical and dental businesses, as well as certain other integration
costs associated with these mergers.
Excluding the merger and integration costs, and including pro forma
adjustments, pro forma net income and pro forma net income per common share, on
a diluted basis, would have been $57.8 million and $1.39, respectively, for the
year ended December 26, 1998, compared with $41.0 million and $1.03,
respectively, for the year ended December 27, 1997.
During the fourth quarter of 1998, the Company incurred incremental costs
totaling approximately $0.4 million and reduced earnings from an affiliate
totaling approximately $1.3 million, net of taxes due to a voluntary recall of
anesthetic products produced by Novocol Pharmaceutical of Canada, Inc.
("Novocol"). Novocol is an affiliated company which is accounted for under the
equity method. The impact on 1998 fourth quarter earnings was approximately
$0.04 per share, on a diluted basis. Management estimates the impact to be
$0.02 to $0.04 per share, per quarter, on a diluted basis, through the second
quarter of 1999, and possibly beyond that date in the event HS Pharmaceutical is
unable to resolve the issues that led to the recalls. HS Pharmaceutical is
cooperating fully with the FDA to resolve the issues that led to the recalls,
however it is unable to estimate when manufacturing and shipments of these
products to the United State will recommence.
The Company is a party to a number of claims, suits and complaints arising
in the ordinary course of business, as described in "Legal Proceedings". The
Company is currently unable to estimate what effect, if any, this litigation
might have on its results of operations.
23
Reorganization
From 1992 through 1994, the Company was a party to a series of transactions
leading to the Reorganization that resulted in, among other things, the Company
being separated from Holdings and the distribution of shares of the Common Stock
of the Company to its then current stockholders. In December 1992, an executive
officer of the Company received certain stock grants in the Company and Schein
Pharmaceutical, Inc. valued at approximately $6.2 million and $2.6 million,
respectively, and cash of approximately $5.3 million to pay income taxes on the
stock grants received. These stock grants were subject to the occurrence of
certain future events, including the fulfillment of the employment term by the
executive officer. Accordingly, these stock grants, totaling $8.8 million, were
treated as deferred compensation while the cash payments were charged to
earnings as special management compensation in the year ended December 26, 1992.
During 1993, the Company amortized the deferred compensation relating to stock
grants by the Company to the executive officer resulting in a charge to earnings
of $0.6 million. In 1994, the contingencies relating to the stock granted to the
executive officer were eliminated, such that these shares became fully vested.
Accordingly, deferred compensation of $8.2 million, (net of amortization of $0.6
million,) plus a mark-to-market adjustment (because of certain repurchase
features) of approximately $9.1 million, along with a $0.3 million cash payment
for income taxes relating to the 1992 stock grants, was expensed in 1994 as
special management compensation.
In addition, in connection with the Reorganization, certain senior
management of the Company were issued shares of Common Stock of the Company in
1994 and 1995 to extinguish an obligation under a pre-existing long-term
incentive plan and to provide them with an ownership interest in the Company. In
connection with the issuance of the shares, a cash payment for income taxes
relating to such stock issuances of approximately $2.4 million was paid. This
cash bonus, plus $3.5 million, the fair value of the related stock issued, net
of amounts accrued under the long-term incentive plan of approximately $1.9
million, resulted in an additional special management compensation charge to the
Company of approximately $4.0 million in 1994. Charges to earnings for the year
ended 1995 related to a mark-to-market adjustment (because of certain repurchase
features) for stock grants made to an executive officer of the Company and the
stock issuances of the other senior management of approximately $17.5 million
and cash payments of $0.5 million for income taxes related to the stock
issuances.
Additionally, the Company has granted certain employees options for shares
of the Company's Common Stock, which became exercisable upon the Company's
initial public offering on November 3, 1995, at which time substantially all
such options vested. Non-recurring special compensation charges for the options
issued to employees recorded in the fourth quarter of 1995 amounted to
approximately $2.8 million. In addition, the Company recorded an approximate
$1.1 million related tax benefit.
24
Special charges for special management compensation and special
professional fees incurred in connection with the Reorganization aggregated
$20.8 million and $23.6 million for 1995 and 1994, respectively.
Results of Operations
The following table sets forth for the periods indicated net sales, gross
profit and adjusted operating profit, excluding merger and integration costs, by
business segment for the years ended 1998, 1997 and 1996.
Net Sales by Segment Data: 1998 1997 1996
---------------------------------------------------------------------------------------
Healthcare distribution: $ % $ % $ %
---------------------------------------------------------------------------------------
Dental(1)..................... $1,083,994 56.4% $ 999,456 58.8% $ 819,721 59.6%
Medical....................... 515,728 26.9% 441,015 26.0% 341,329 24.8%
Veterinary.................... 48,307 2.5% 40,843 2.4% 35,329 2.6%
International(2).............. 230,999 12.0% 181,239 10.7% 146,999 10.7%
---------- ------ ---------- ------- ---------- -------
Total healthcare distribution. 1,879,028 97.8% $1,662,553 97.9% $1,343,378 97.7%
Technology(3)................... 42,657 2.2% 35,943 2.1% 30,965 2.3%
---------- ------ ---------- ------- ---------- -------
Total........................... $1,921,685 100.0% $1,698,496 100.00% $1,374,343 100.00%
========== ====== ========== ======= ========== =======
Gross Profit by Segment Data:
Healthcare distribution......... $ 568,071 30.2% $ 484,704 29.2% $ 391,375 29.1%
Technology...................... 33,753 79.1% 25,694 71.5% 21,380 69.1%
---------- ------- ---------- ------- ---------- -------
Total........................... $ 601,824 31.3% $ 510,398 30.1% $ 412,755 30.0%
========== ======= ========== ======= ========== =======
Adjusted Operating Profit (excluding
merger and integration costs) by
Segment Data:
Healthcare distribution(4)...... $ 79,871 4.3% $ 48,881 2.9% $ 43,991 3.3%
Technology(5)................... 16,325 38.3% 13,728 38.2% (878) 2.8%
---------- ------- ---------- ------- ---------- -------
Total........................... $ 96,196 5.0% $ 62,609 3.7% $ 43,113 3.1%
========== ======= ========== ======= ========== =======
- -----------
(1) Dental consists of the Company's dental business in the United States and
Canada.
(2) International consists of the Company's business (substantially all dental)
outside the United States and Canada, primarily in Europe.
(3) Technology consists of the Company's practice management software business
and certain other value-added products and services.
(4) Excludes merger and integration costs of $55.7 and $43.9 million in 1998
and 1997, respectively.
(5) Excludes merger and integration costs of $1.0 and $6.9 million in 1998 and
1997, respectively.
25
1998 Compared to 1997
Net sales increased $223.2 million, or 13.1%, to $1,921.7 million in 1998
from $1,698.5 million in 1997. Of the $223.2 million increase, approximately
$216.5 million or 97.8% represented a 13.0% increase in the Company's healthcare
distribution business. As part of this increase, approximately $84.5 million
represented a 8.5% increase in the Company's dental business, $74.7 million
represented a 16.9% increase in its medical business, $49.8 million represented
a 27.5% increase in its international business, $7.5 million represented a 18.3%
increase in the Company's veterinary business. The increase in dental net sales
was primarily the result of the continuing favorable impact of the Company's
integrated sales and marketing approach (which coordinates the efforts of its
field sales consultants with its direct marketing and telesales personnel),
continued success in the Company's target marketing programs and purchase
acquisitions, offset in part by a reduction in dental equipment sales resulting
from the Company's disposal of its equipment manufacturing subsidiary, Marus in
August 1998 and estimated sales erosion on the Meer acquisition. The increase in
medical net sales is primarily attributable to sales to hospitals, acquisitions,
and the benefits of a new telesales structure, partially offset by a decline in
sales to renal dialysis centers. In the first quarter of 1998 the Company's
largest renal dialysis customer, Renal Treatment Centers, Inc. ("RTC") acquired
by Total Renal Care, Inc., which is not a customer of the Company. In March of
1998, RTC stopped purchasing Epogen from the Company, but continues to purchase
other products. During fiscal year 1997, the Company's sales of Epogen to RTC
amounted to $38.7 million. In the international market, the increase in net
sales was due to increased account penetration in France, the United Kingdom and
Spain and acquisitions, primarily in Germany, the United Kingdom and The
Netherlands. In the veterinary market, the increase in net sales was primarily
due to increased account penetration with core accounts and veterinary groups.
Excluding net sales of Marus and RTC in both periods, as well as the estimated
sales erosion on the Meer acquisition, healthcare distribution net sales would
have grown by 16.1% in 1998 over 1997. The remaining increase in 1998 net sales
was due to the technology business which increased $6.7 million or 18.7% to
$42.7 million for 1998, from $35.9 million for 1997. The increase in technology
and value-added product sales was primarily due to increased practice management
software sales.
Gross profit increased by $91.4 million, or 17.9%, to $601.8 million in
1998, from $510.4 million in 1997. Gross profit margin increased by 1.2% to
31.3% from 30.1% last year. Healthcare distribution gross profit increased by
$83.4 million or 17.2% to $568.1 million in 1998, from $484.7 million in 1997.
Gross profit margin increased by 1.0% to 30.2% from 29.2% last year primarily
due to sales mix. Technology gross profit increased by $8.1 million or 31.5%
to, $33.8 million in 1998, from $25.7 million in 1997. Gross profit margins
increased by 7.6% to 79.1% from 71.5% last year primarily due to increased
sales volume of software systems.
Selling, general and administrative expenses increased by $57.8 million, or
12.9%, to $505.6 million in 1998 from $447.8 million in 1997. Selling and
shipping expenses increased by $37.1 million, or 11.9%, to $348.4 million in
1998 from $311.3 million in 1997. As a percentage of net sales, selling and
shipping expenses decreased 0.2% to 18.1% in 1998 from 18.3% in 1997. This
decrease was primarily due to leveraging of the Company's distribution
infrastructure. General and administrative expenses increased $20.7 million, or
15.2%, to $157.2 million in 1998 from $136.5 million in 1997, primarily as a
result of acquisitions. As a percentage of net sales, general and administrative
expenses increased 0.2% in 1998, to 8.2% from 8.0% in 1997.
Other income (expense) - net decreased by $4.6 million, to $(3.5) million
for the year ended December 26, 1998 from $1.1 million for 1997 due to an
increase in interest expense resulting from an increase in average borrowings
and lower imputed interest income on long term accounts receivable balances.
26
Equity in earnings of affiliates decreased $1.3 million or 61.9% to $0.8
million in 1998 from $2.1 million in 1997. The decline is the result of the
reduced earnings in the fourth quarter of an affiliate due to a voluntary recall
of anesthetic products produced by Novocol.
For 1998 the Company's effective tax rate was 56.4%. Excluding merger and
integration costs, the majority of which are not deductible for income tax
purposes, and including a proforma tax adjustment for Meer on previously untaxed
earnings as an S Corporation, combined with the elimination of a net deferred
tax asset arising from Meer's conversion from an S Corporation to a C
Corporation, the Company's effective tax rate would have been 38.3%. The
difference between the Company's effective tax rate, excluding merger and
integration costs and the Meer tax adjustment, and the Federal statutory rate
relates primarily to state income taxes.
For 1997 the Company's effective tax rate was 136.8%. On a pro forma basis,
adjusting for assumed tax benefits arising from the losses of Meer as an S
Corporation, and excluding merger and integration costs, the majority of which
are not deductible for income tax purposes, the Company's effective tax rate
would have been 39.7%. The difference between the effective tax rate (excluding
merger and integration costs) and the Federal statutory rate relates primarily
to state income taxes.
1997 Compared to 1996
Net sales increased $324.2 million, or 23.6%, to $1,698.5 million in 1997
from $1,374.3 million in 1996. Of the $324.2 million increase, approximately
$319.2 million or 98.5% represented a 23.8% increase in the healthcare
distribution business. As part of this increase, approximately $179.8 million
represented a 21.9% increase in the Company's dental business, $99.7 million
represented a 29.2% increase in its medical business, $34.2 million represented
a 23.3% increase in its international business and $5.5 million represented a
15.6% increase in the Company's veterinary business. The increase in dental net
sales was primarily the result of the continuing favorable impact of the
Company's integrated sales and marketing approach (which coordinates the efforts
of its field sales consultants with its direct marketing and telesales
personnel), purchase acquisitions, continued success in the Company's target
marketing programs and increased sales in the large dental equipment market. Of
the approximately $99.7 million increase in medical net sales, approximately
$16.9 million, or 17.0%, represents incremental net sales to renal dialysis
centers, with a more focused direct mail strategy, large account flu vaccine
sales and acquisitions primarily accounting for the balance of the increase in
medical net sales. The Company's largest renal dialysis customer, RTC, was
acquired by Total Renal Care, Inc. which is not a customer of the Company. In
the international market, the increase in net sales was due to acquisitions,
primarily in Germany and the United Kingdom, and increased account penetration
in France and Germany. Unfavorable exchange rate translation adjustments
resulted in a net sales decrease of approximately $10.5 million. Had net sales
for the international market been translated at the same exchange rates in
effect during 1996, international net sales would have increased by an
additional 7.7%. In the veterinary market, the increase in net sales was
primarily due to increased account penetration with corporate accounts, improved
participation in select purchasing groups, and targeted emphasis on the equine
race track segment. The remaining increase in 1997 net sales was due to a 16.1%
increase in the technology business, which increased by $5.0 million to $35.9
million for 1997 from $30.9 million for 1996. The increase in technology and
value-added product sales was primarily due to increase in sales of Dentrix
software systems and 1997 acquisitions.
27
Gross profit increased by $97.6 million, or 23.6%, to $510.4 million in
1997, from $412.8 million in 1996. Gross profit margin increased by only 0.1% to
30.1% from 30.0% last year. Healthcare distribution gross profit increased by
$93.3 million or 23.8% to $484.7 million in 1998, from $391.4 million in 1997.
Gross profit margin increased by 0.1% to 29.2% from 29.1% last year due to
sales mix. Technology gross profit increased by $4.3 million or 20.1% to $25.7
million in 1998, from $21.4 million in 1997. Gross profit margin increased 2.5%
to 71.5% from 69.0% last year due to increased sales volume of higher margin
software products versus lower margin hardware products.
Selling, general and administrative expenses, excluding merger and
integration costs, increased by $78.2 million, or 21.2%, to $447.8 million in
1997 from $369.6 million in 1996. Selling and shipping expenses increased by
$52.7 million, or 20.4% to $311.3 million in 1997 from $258.6 million in 1996.
As a percentage of net sales, selling and shipping expenses decreased 0.5% to
18.3% in 1997 from 18.8% in 1996. This decrease was primarily due to leveraging
of the Company's distribution infrastructure, partially offset by incremental
shipping, payroll and related costs amounting to $1.4 million resulting from the
Teamsters strike against UPS in the third quarter and an increase in selling
expenses. General and administrative expenses increased $25.5 million, or 23.0%,
to $136.5 million in 1997 from $111.0 million in 1996, primarily as a result of
purchase acquisitions. As a percentage of net sales, general and administrative
expenses decreased 0.1% to 8.0% in 1997 from 8.1% in 1996.
Other income (expense) - net decreased by $1.7 million, to $1.1 million for
the year ended December 27, 1997 from $2.8 million for 1996. The decrease in
Other income (expense) - net was primarily due to an increase in interest
expense resulting from an increase in average borrowings partially offset by a
decline in the average cost of borrowing, and a modest increase in interest
income primarily due to an increase in finance charge income and imputed
interest income arising from non-interest bearing extended payment term sales.
Equity in earnings of affiliates increased $0.5 million or 31.3% to $2.1
million in 1997 from $1.6 million in 1996. This increase in earnings of
affiliates was primarily due to increased sales volume and improved margins for
the products sold by an unconsolidated 50%-owned company.
For 1997 the Company's effective tax rate was 136.8%. On a pro forma basis,
adjusting for assumed tax benefits arising from the losses of Meer as an S
Corporation, and excluding merger and integration costs, the majority of which
are not deductible for income tax purposes, the Company's effective tax rate
would have been 39.7%. The difference between the effective tax rate (excluding
merger and integration costs) and the Federal statutory rate relates primarily
to state income taxes. For 1996, the Company's provision for taxes was $18.6
million, while the pre-tax income was $45.9 million. On a pro forma basis,
adjusting for a provision for taxes on the previously untaxed earnings of
Dentrix and the losses of Meer as an S Corporation, the Company's effective tax
rate would have been 39.8%. The difference between the Company's effective tax
rate and the Federal statutory rate relates primarily to state income taxes
offset by tax-exempt interest on municipal securities.
Year 2000
Management continues to conduct a company-wide program to prepare the
Company's computer systems, applications and software products for the year
2000, as well as to assess the readiness for the year 2000 of critical vendors
and other third parties upon which the Company relies to operate its business.
The Year 2000 issue arises from the widespread use of computer programs that
rely on two-digit date codes to perform computations or decision-making
functions. The inability of computer programs worldwide to correctly process
data after December 31, 1999 can have grave consequences to governments,
businesses and consumers alike.
28
The Company has created a Year 2000 Task Force (the "Task Force") to assess
the business risks associated with all phases of the Company's operations and to
prioritize corrective actions to avoid or mitigate the consequences of each of
the Company's and its critical vendors' and third parties' non-compliant
systems, applications and products so as to minimize potential disruptions to
our business and service to our customers. Consequently, the Task Force's
efforts are divided into three main categories; (i) internal business systems
and services, (ii) critical vendor and other third party businesssystems and
products and services, and (iii) customer business system interfaces.
The Company has completed an inventory of all major business systems and
has made modifications to many of these business critical systems. This process
is expected to continue through the third quarter of 1999 as systems continue to
be modified and tested. At this time all of the Company's software products
currently offered for sale are year 2000 compliant. The Company continues to
work with vendors to remedy products or services considered to be at-risk with
the objective to either correct any potential issues by the end of the third
quarter of 1999, or seek alternative sources. The Company currently ships
substantially all of its orders in the United States by United Parcel Service
("UPS"). UPS has advised the Company that their systems are year 2000
compliant, including those systems used by the Company in its distribution
centers. There can be no assurance that the Company will be able to identify
sufficient alternative supply sources of products and services such that
disruption to the Company's business would not be material.
The Company expects to incur internal payroll costs as well as consulting
costs and other expenses related to customer and vendor relations,
infrastructure, facility enhancements and software upgrades necessary to prepare
the Company's products, services and systems for the year 2000. Management
estimates that the cost of this program will be between $2.0 million and $3.0
million, with approximately $1.5 million representing incremental costs to the
Company. This cost does not include normal upgrading of business and financial
systems that would be year 2000 compliant already. Through December 26, 1998 the
Company has incurred costs on this program of approximately $1.3 million, all
of which have been treated as period costs and expensed as incurred.
The statements contained in this Year 2000 Readiness Disclosure are subject
to certain protection under the Year 2000 Information and Readiness Disclosure
Act.
Euro Conversion
Effective January 1, 1999, 11 of the 15 member countries of the European
Union have adopted the Euro as their common legal currency. On that date, the
participating countries established fixed Euro conversion rates between their
existing sovereign currencies and the Euro. The Euro now trades on currency
exchanges and is available for non-cash transactions. The participating
countries now issue sovereign debt exclusively in Euros, and have re-denominated
outstanding sovereign debt. The authority to direct monetary policy for the
participating countries, including money supply and official interest rates for
the euro, is now exercised by the new European Central Bank.
In 1998 the Company established a Euro Task Force to address its
information system, product and customer concerns. The Company expects to
achieve timely Euro information system and product readiness, so as to
conduct transactions in the Euro, in accordance with implementation
schedules as they are established by the European Commission. The Company does
not anticipate that the costs of the overall effort will have a material adverse
impact on future results.
Inflation
Management does not believe inflation had a material adverse effect on the
financial statements for the periods presented.
Effect of Recently Issued Accounting Standards
In June 1998, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 133 ("FAS 133"), Accounting for Derivative
Instruments and Hedging Activities. FAS 133 is effective for transactions
entered into after January 1, 2000. FAS 133 requires that all derivative
instruments be recorded on the balance sheet at fair value. Changes in the fair
value of derivatives are recorded each period in current earnings or other
comprehensive income, depending on whether a derivative is designated as part of
the hedge transaction and the type of hedge transaction. The ineffective portion
of all hedges will be recognized in earnings. The Company is in the process of
determining the impact that the adoption of FAS 133 will have on its results of
operations and financial position.
29
Risk Management
The Company has operations in the United States, Canada, Mexico, the United
Kingdom, The Netherlands, Belgium, Germany, France, the Republic of Ireland,
Austria, Spain, Australia and New Zealand. Substantially all of the Company's
operations endeavor to protect its margins by using foreign currency forward
contracts to hedge the estimated foreign currency payments to foreign vendors.
The total U.S. dollar equivalent of all foreign currency forward contracts
hedging vendor payments was $10.0 million as of the 1998 fiscal year end.
The Company considers its investment in foreign operations to be both
long-term and strategic. As a result, the Company does not hedge the long-term
translation exposure to its balance sheet. The Company has experienced negative
translation adjustments of approximately $0.4 million and $1.0 million in 1998
and 1997, respectively, which adjustments were reflected in the balance sheet as
an adjustment to stockholders' equity. The cumulative translation adjustment at
the end of 1998 showed a net negative translation adjustment of $2.1 million.
The Company issues a Canadian catalog once a year with prices stated in
Canadian dollars; however, orders are shipped from the Company's United States
warehouses resulting in U.S. dollar costs for Canadian dollar sales. To minimize
the exposure to fluctuations in foreign currency exchange rates, in February
1999 the Company entered into foreign currency forward contracts with a major
international bank to convert part of the first quarter 1999 estimated monthly
Canadian dollar receipts into U.S. dollars. Under this agreement, the Company
has an obligation to sell 3.0 million Canadian dollars at predetermined fixed
rates. The Company anticipates entering into new contracts in the normal course
of its business.
A balloon payment of approximately $3.4 million due to a bank under a term
loan related to a Dutch acquisition came due in October 1997. The Company
settled this loan by entering into a new Netherlands Guilder (NLG) loan in the
amount of 6.5 million NLG. The loan serves to hedge the repayment of an
intercompany loan in the same amount, denominated in NLG, due from a Dutch
subsidiary. The new NLG loan calls for periodic payments and a balloon payment
of 4.1 million NLG in January 2002.
The Company had entered into two interest rate swaps with major financial
institutions to exchange variable rate interest for fixed rate interest. The net
result was to substitute a weighted average fixed interest rate of 7.21% for the
variable LIBOR rate on $13.0 million of the Company's debt. The interest rate
swaps expire in December 2003 and November 2004.
Liquidity and Capital Resources
The Company's principal capital requirements have been to fund (a) working
capital needs resulting from increased sales, extended payment terms on various
products, special inventory forward buy-in opportunities and to fund initial
start-up inventory requirements for new distribution centers, (b) acquisitions,
and (c) capital expenditures. Since sales have been strongest during the fourth
quarter and special inventory forward buy-in opportunities are most prevalent
just before the end of the year, the Company's working capital requirements have
been generally higher from the end of the third quarter to the end of the first
quarter of the following year. The Company has financed its business primarily
through its revolving credit facilities, a private placement loan and stock
issuances.
30
Net cash provided by operating activities for the year ended December 26,
1998 of $2.7 million resulted primarily from net income of $16.3 million,
increased by non-cash charges relating primarily to provision for merger and
integration costs (which includes the write-off and impairment of certain
assets), depreciation and amortization, and allowances on acc