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EX-31.1 - EXHIBIT 31.1 - HENRY SCHEIN INCexhibit31_1.htm


UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q

(Mark One)
X
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 26, 2009
Or
__
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from ____________ to ____________
Commission File Number:   0-27078

 HENRY SCHEIN, INC.
(Exact name of registrant as specified in its charter)

Delaware
11-3136595
(State or other jurisdiction of
(I.R.S. Employer Identification No.)
incorporation or organization)
 

135 Duryea Road
Melville, New York
(Address of principal executive offices)
11747
(Zip Code)

(631) 843-5500
(Registrant’s telephone number, including area code)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
 
Yes X
 
No  __

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).
 
Yes __
 
No  __

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
 
Large accelerated filer X
 
 
Accelerated filer __
Non-accelerated filer  __
(Do not check if a smaller reporting company)
Smaller reporting company  __
 
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
 
Yes __
 
No  X

As of October 29, 2009, there were 90,483,640 shares of the registrant’s common stock outstanding.

 
 

 

HENRY SCHEIN, INC.
INDEX

       
       
     
Page
       
       
       
   
PART I.  FINANCIAL INFORMATION
 
       
       
ITEM 1.
 
Consolidated Financial Statements:
 
   
3
       
     
   
4
       
     
   
          September 26, 2009
5
       
     
   
6
       
   
7
       
ITEM 2.
   
   
21
       
ITEM 3.
 
36
       
ITEM 4.
 
36
       
       
   
PART II.  OTHER INFORMATION
 
       
       
ITEM 1.
 
37
       
ITEM 2.
 
37
       
ITEM 6.
 
38
       
   
38

 
 

 
2

 
PART I.   FINANCIAL INFORMATION
ITEM 1.   CONSOLIDATED FINANCIAL STATEMENTS

 
CONSOLIDATED BALANCE SHEETS
 
(in thousands, except share and per share data)
 
             
   
September 26,
   
December 27,
 
   
2009
   
2008
 
   
(unaudited)
   
(Adjusted - Notes 1 & 8)
 
ASSETS
           
Current assets:
           
    Cash and cash equivalents
  $ 317,607     $ 369,570  
    Accounts receivable, net of reserves of $47,890 and $42,855
    764,285       734,027  
    Inventories, net
    770,370       731,654  
    Deferred income taxes
    40,747       36,974  
    Prepaid expenses and other
    186,744       193,841  
            Total current assets
    2,079,753       2,066,066  
Property and equipment, net
    257,602       247,835  
Goodwill
    977,054       922,952  
Other intangibles, net
    212,042       214,093  
Investments and other
    176,888       148,264  
            Total assets
  $ 3,703,339     $ 3,599,210  
                 
LIABILITIES AND STOCKHOLDERS' EQUITY
               
Current liabilities:
               
    Accounts payable
  $ 507,462     $ 554,773  
    Bank credit lines
    1,731       4,936  
    Current maturities of long-term debt
    23,933       156,405  
    Accrued expenses:
               
       Payroll and related
    148,665       135,523  
       Taxes
    83,951       69,792  
       Other
    263,392       262,236  
            Total current liabilities
    1,029,134       1,183,665  
Long-term debt
    242,511       256,648  
Deferred income taxes
    107,953       95,399  
Other liabilities
    72,038       58,109  
                 
Redeemable noncontrolling interests
    177,513       233,035  
Commitments and contingencies
               
                 
Stockholders' equity:
               
   Preferred stock, $.01 par value, 1,000,000 shares authorized,
               
       none outstanding
    -       -  
   Common stock, $.01 par value, 240,000,000 shares authorized,
               
       90,448,417 outstanding on September 26, 2009 and
               
       89,351,849 outstanding on December 27, 2008
    904       894  
   Additional paid-in capital
    533,508       492,505  
   Retained earnings
    1,406,199       1,181,454  
   Accumulated other comprehensive income
    71,863       29,721  
   Total Henry Schein, Inc. stockholders' equity
    2,012,474       1,704,574  
   Noncontrolling interests
    61,716       67,780  
            Total stockholders' equity
    2,074,190       1,772,354  
            Total liabilities and stockholders' equity
  $ 3,703,339     $ 3,599,210  


See accompanying notes.

 

 
3

 

 
 
 
CONSOLIDATED STATEMENTS OF INCOME
 
(in thousands, except per share data)
 
(unaudited)
 
                         
   
Three Months Ended
   
Nine Months Ended
 
   
September 26,
   
September 27,
   
September 26,
   
September 27,
 
   
2009
   
2008
   
2009
   
2008
 
         
(Adjusted - Notes 1, 4 & 8)
   
(Adjusted - Note 4)
   
(Adjusted - Notes 1, 4 & 8)
 
                         
Net sales
  $ 1,659,433     $ 1,644,209     $ 4,752,255     $ 4,799,234  
Cost of sales
    1,183,166       1,168,615       3,361,707       3,389,847  
       Gross profit
    476,267       475,594       1,390,548       1,409,387  
Operating expenses:
                               
    Selling, general and administrative
    362,382       360,180       1,060,062       1,094,512  
    Restructuring costs
    -       -       4,043       -  
       Operating income
    113,885       115,414       326,443       314,875  
Other income (expense):
                               
    Interest income
    2,387       4,260       7,674       12,217  
    Interest expense
    (5,171 )     (9,240 )     (18,329 )     (26,816 )
    Other, net
    1,938       (4,863 )     1,595       (5,524 )
       Income from continuing operations before
                               
         taxes, equity in earnings of affiliates and
                               
         noncontrolling interests
    113,039       105,571       317,383       294,752  
Income taxes
    (15,864 )     (34,355 )     (83,402 )     (98,787 )
Equity in earnings of affiliates
    1,200       1,602       3,777       4,020  
Income from continuing operations
    98,375       72,818       237,758       199,985  
    Income (loss) from discontinued operations, net of tax
    2,373       (52 )     2,715       (828 )
Net income
    100,748       72,766       240,473       199,157  
    Less: Net income attributable to noncontrolling interests
    (4,327 )     (5,278 )     (15,728 )     (15,659 )
Net income attributable to Henry Schein, Inc.
  $ 96,421     $ 67,488     $ 224,745     $ 183,498  
                                 
Amounts attributable to Henry Schein, Inc.:
                               
  Income from continuing operations
  $ 94,045     $ 67,548     $ 222,143     $ 184,239  
  Income (loss) from discontinued operations, net of tax
    2,376       (60 )     2,602       (741 )
  Net income
  $ 96,421     $ 67,488     $ 224,745     $ 183,498  
                                 
Earnings per share attributable to Henry Schein, Inc.:
                               
                                 
    From continuing operations:
                               
      Basic
  $ 1.06     $ 0.76     $ 2.50     $ 2.07  
      Diluted
  $ 1.03     $ 0.74     $ 2.45     $ 2.00  
                                 
    From discontinued operations:
                               
      Basic
  $ 0.03     $ 0.00     $ 0.03     $ (0.01 )
      Diluted
  $ 0.02     $ 0.00     $ 0.03     $ 0.00  
                                 
    From net income:
                               
      Basic
  $ 1.09     $ 0.76     $ 2.53     $ 2.06  
      Diluted
  $ 1.05     $ 0.74     $ 2.48     $ 2.00  
                                 
Weighted-average common shares outstanding:
                               
    Basic
    88,796       88,930       88,843       89,216  
    Diluted
    91,513       91,376       90,576       91,908  

See accompanying notes.
 
 

 
4

 


 
CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY
 
(in thousands, except share data)
 
(unaudited)
 
                                           
                                           
   
Common Stock 
$.01 Par Value
   
Additional
Paid-in
Capital
   
Retained
Earnings
   
Accumulated Comprehensive Income
   
Noncontrolling Interests
   
Total
Stockholders'
Equity
 
   
Shares
   
Amount
 
Balance, December 27, 2008 - as previously reported
    89,351,849     $ 894     $ 705,799     $ 1,195,771     $ 29,721     $ -     $ 1,932,185  
Cumulative impact of adopting ASC Topic 470-20
    -       -       19,741       (14,317 )     -       -       5,424  
Cumulative impact of adopting ASC Topic 810-10-65
    -       -       -       -       -       67,780       67,780  
Cumulative impact of adopting ASC Topic 480-10
    -       -       (233,035 )     -       -       -       (233,035 )
Balance, December 27, 2008 - as adjusted
    89,351,849     $ 894     $ 492,505     $ 1,181,454     $ 29,721     $ 67,780     $ 1,772,354  
                                                         
Net income
    -       -       -       224,745       -       15,728       240,473  
Foreign currency translation gain
    -       -       -       -       29,060       4,180       33,240  
Unrealized gain from foreign currency hedging activities,
                                                       
        net of tax of $7,774
    -       -       -       -       14,029       -       14,029  
Unrealized investment gain, net of tax of $42
    -       -       -       -       13       -       13  
Pension adjustment loss, net of tax of $120
    -       -       -       -       (960 )     -       (960 )
     Total comprehensive income
                                            19,908       286,795  
Dividends paid
    -       -       -       -       -       (2,382 )     (2,382 )
Noncontrolling interest of acquired companies
    -       -       (47,533 )     -       -       (23,590 )     (71,123 )
Decrease in redeemable noncontrolling interests
    -       -       55,522       -       -       -       55,522  
Shares issued to 401(k) plan
    100,778       1       5,300       -       -       -       5,301  
Shares issued upon exercise of stock options,
                                                       
        including tax benefit of $1,635
    311,491       3       11,321       -       -       -       11,324  
Stock-based compensation expense
    751,560       7       18,337       -       -       -       18,344  
Shares withheld for payroll taxes
    (67,261 )     (1 )     (2,028 )     -       -       -       (2,029 )
Liability for cash settlement stock option awards and other
    -       -       84       -       -       -       84  
                                                         
Balance, September 26, 2009
    90,448,417     $ 904     $ 533,508     $ 1,406,199     $ 71,863     $ 61,716     $ 2,074,190  
 
 



See accompanying notes.


 
5

 



 
CONSOLIDATED STATEMENTS OF CASH FLOWS
 
(in thousands)
 
(unaudited)
 
             
   
Nine Months Ended
 
   
September 26,
   
September 27,
 
   
2009
   
2008
 
         
(Adjusted - Notes 1 & 8)
 
Cash flows from operating activities:
           
    Net income
  $ 240,473     $ 199,157  
    Adjustments to reconcile net income to net cash provided by operating activities:
               
            Gain on sale of discontinued operation, net of tax
    (2,382 )     -  
            Depreciation and amortization
    60,930       59,183  
            Amortization of bond discount
    4,473       4,214  
            Stock-based compensation expense
    18,344       23,060  
            Provision for losses on trade and other accounts receivable
    2,754       3,711  
            Benefit from deferred income taxes
    (29,633 )     (2,705 )
            Stock issued to 401(k) plan
    5,301       4,662  
            Undistributed earnings of affiliates
    (3,777 )     (4,020 )
            Other
    2,535       (2,132 )
            Changes in operating assets and liabilities, net of acquisitions:
               
                   Accounts receivable
    (12,788 )     (66,751 )
                   Inventories
    (10,234 )     (68,182 )
                   Other current assets
    (806 )     (3,460 )
                   Accounts payable and accrued expenses
    (56,813 )     41,927  
Net cash provided by operating activities
    218,377       188,664  
                 
Cash flows from investing activities:
               
    Purchases of fixed assets
    (38,417 )     (38,119 )
    Payments for equity investment and business
               
        acquisitions, net of cash acquired
    (97,911 )     (25,930 )
    Cash received from business divestitures
    12,716       -  
    Purchases of available-for-sale securities
    -       (35,925 )
    Proceeds from sales of available-for-sale securities
    8,730       1,572  
    Net proceeds from foreign exchange forward contract settlements
    275       9,090  
    Other
    (11,258 )     3,607  
Net cash used in investing activities
    (125,865 )     (85,705 )
                 
Cash flows from financing activities:
               
    Repayments of bank borrowings
    (3,829 )     (5,786 )
    Principal payments for long-term debt
    (153,452 )     (30,139 )
    Proceeds from issuance of stock upon exercise of stock options
    9,689       25,041  
    Payments for repurchases of common stock
    -       (54,945 )
    Excess tax benefits related to stock-based compensation
    2,821       10,635  
    Other
    (2,127 )     (1,856 )
Net cash used in financing activities
    (146,898 )     (57,050 )
                 
Net change in cash and cash equivalents
    (54,386 )     45,909  
Effect of exchange rate changes on cash and cash equivalents
    2,423       (5,135 )
Cash and cash equivalents, beginning of period
    369,570       247,590  
Cash and cash equivalents, end of period
  $ 317,607     $ 288,364  



See accompanying notes.

 

 
6

 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(in thousands, except share and per share data)
(unaudited)


Note 1.  Basis of Presentation

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

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

The consolidated financial statements reflect all adjustments considered necessary for a fair presentation of the consolidated results of operations and financial position for the interim periods presented.  All such adjustments are of a normal recurring nature.  These unaudited interim consolidated financial statements should be read in conjunction with the audited consolidated financial statements and notes to the consolidated financial statements contained in our Annual Report on Form 10-K for the year ended December 27, 2008.

The preparation of financial statements in conformity with U.S. GAAP requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities, and disclosure of contingent assets and liabilities, at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period.  Actual results could differ from those estimates.  The results of operations for the nine months ended September 26, 2009 are not necessarily indicative of the results to be expected for any other interim period or for the year ending December 26, 2009.

Effective December 28, 2008, we adopted the provisions of Accounting Standards Codification (“ASC”) Topic 810-10-65, which requires that a noncontrolling interest in a subsidiary be reported as equity in the consolidated financial statements. Consolidated net income includes the net income for both the parent and the noncontrolling interest with disclosure of both amounts on the consolidated statement of income. The calculation of earnings per share will continue to be based on income amounts attributable to the parent.  As of December 27, 2008, we included noncontrolling interests totaling approximately $67.8 million in Stockholders’ equity within our consolidated balance sheets, as the cumulative impact of adopting ASC Topic 810-10-65.

Effective December 28, 2008, we have adopted the provisions of ASC Topic 480-10.  ASC Topic 480-10 is applicable for noncontrolling interests where we are or may be required to purchase all or a portion of the outstanding interest in a consolidated subsidiary from the noncontrolling interest holder under the terms of a put option or other contractual agreements.   As a result of the adoption of the provisions of ASC Topic 480-10, we have recorded the approximate redemption amount fair value of the put options as Redeemable noncontrolling interests ($177.5 million and $233.0 million at September 26, 2009 and December 27, 2008, respectively) and reduced Additional paid-in capital within the Stockholders’ equity section of our consolidated balance sheets.  The change in fair value of put options at September 26, 2009 compared to December 27, 2008 was primarily due to purchases of additional interests in consolidated subsidiaries offset by changes in the fair value of the put options.  Changes in the estimated redemption amounts of the noncontrolling interests subject to put options are adjusted at each reporting period with a corresponding adjustment to equity.  These adjustments will not impact the calculation of earnings per share.





 
7

 
HENRY SCHEIN, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(in thousands, except share and per share data)
(unaudited)


Note 2.  Segment Data

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

Our dental group serves office-based dental practitioners, schools and other institutions in the combined United States and Canadian dental market.  Our medical group serves office-based medical practitioners, surgical centers, other alternate-care settings, animal health clinics and other institutions throughout the United States.  Our international group serves 21 countries outside of North America.

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

The following tables present information about our reportable segments:

   
Three Months Ended
   
Nine Months Ended
 
   
September 26,
   
September 27,
   
September 26,
   
September 27,
 
   
2009
   
2008 (1)
   
2009 (1)
   
2008 (1)
 
Net Sales:
                       
  Healthcare distribution (2):
                       
      Dental (3)
  $ 622,065     $ 641,487     $ 1,838,240     $ 1,905,206  
      Medical (4)
    410,617       423,675       1,088,875       1,080,084  
      International (5)
    583,540       538,033       1,699,053       1,693,017  
          Total healthcare distribution
    1,616,222       1,603,195       4,626,168       4,678,307  
  Technology (6)
    43,211       41,014       126,087       120,927  
      Total
  $ 1,659,433     $ 1,644,209     $ 4,752,255     $ 4,799,234  
                                 

(1)  
Adjusted to reflect the effects of discontinued operations.
 
(2)  
Consists of consumable products, small equipment, laboratory products, large dental and medical equipment, equipment repair services, branded and generic pharmaceuticals, vaccines, surgical products, diagnostic tests, infection-control products and vitamins.
 
(3)  
Consists of products sold in the United States and Canada.
 
(4)  
Consists of products sold in the United States’ medical and animal health markets.
 
(5)  
Consists of products sold in the dental, medical and animal health markets, primarily in Europe.
 
(6)  
Consists of practice management software and other value-added products and services, which are distributed primarily to healthcare providers in the United States, Canada, the United Kingdom, Australia and New Zealand.
 

   
Three Months Ended
   
Nine Months Ended
 
   
September 26,
   
September 27,
   
September 26,
   
September 27,
 
   
2009
   
2008 (1)
   
2009 (1)
   
2008 (1)
 
Operating Income:
                       
  Healthcare distribution
  $ 98,250     $ 100,887     $ 280,618     $ 272,952  
  Technology
    15,635       14,527       45,825       41,923  
      Total
  $ 113,885     $ 115,414     $ 326,443     $ 314,875  
                                 

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

 
8

 
HENRY SCHEIN, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(in thousands, except share and per share data)
(unaudited)


Note 3.  Stock-Based Compensation
 

Our accompanying unaudited consolidated statements of income reflect share-based pretax compensation expense, recorded in accordance with the provisions of ASC Topic 718, “Stock Compensation,” of $6.0 million ($4.1 million after-tax) and $18.3 million ($12.4 million after-tax) for the three and nine months ended September 26, 2009, respectively, and $6.9 million ($4.7 million after-tax) and $23.1 million ($15.3 million after-tax) for the three and nine months ended September 27, 2008, respectively.

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

Stock-based awards are provided to certain employees and non-employee directors under the terms of our 1994 Stock Incentive Plan, as amended, and our 1996 Non-Employee Director Stock Incentive Plan, as amended (together, the “Plans”).  The Plans are administered by the Compensation Committee of the Board of Directors.  Prior to March 2009, awards under the Plans principally included a combination of at-the-money stock options and restricted stock (including restricted stock units).

In March 2009, equity-based awards were granted solely in the form of restricted stock and restricted stock units, with the exception of stock options for certain pre-existing contractual obligations.

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

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

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

Restricted stock units are unit awards that we grant to certain employees that entitle the recipient to shares of common stock upon vesting.  We grant restricted stock units with the same time-based and performance-based vesting that we use for restricted stock.  The fair value of restricted stock units is determined on the date of grant, based on our closing stock price.

Total unrecognized compensation cost related to non-vested awards as of September 26, 2009 was $54.9 million, which is expected to be recognized over a weighted-average period of approximately 2.4 years.

 
9

 
HENRY SCHEIN, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(in thousands, except share and per share data)
(unaudited)


Note 3.  Stock-Based Compensation (Continued)

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

 
2009
 
2008
Expected dividend yield
0%
 
0%
Expected stock price volatility
28%
 
20%
Risk-free interest rate
1.88%
 
2.75%
Expected life of options (years)
4.5
 
4.5


The following table summarizes stock option activity under the Plans during the nine months ended September 26, 2009:
 
 
   
Shares
   
Weighted
Average
Exercise Price
   
Weighted Average Remaining Contractual Life in Years
   
Aggregate
Intrinsic Value
 
Outstanding at beginning of period
    6,791,828     $  39.85              
Granted
    42,206        38.33              
Exercised
    (311,491 )      31.11              
Forfeited
    (90,427 )      48.53              
Outstanding at end of period
    6,432,116     $  40.16      5.6     $ 99,208  
                               
Options exercisable at end of period
    4,957,845     $  35.76      4.9     $ 95,507  

The following tables summarize the status of our non-vested restricted stock/units for the nine months ended September 26, 2009:

   
Time-Based Restricted Stock/Units
   
Shares/Units
   
Weighted Average
Grant Date Fair Value
 
Aggregate Intrinsic
Value
Outstanding at beginning of period
    285,225     $ 14,771      
Granted
    344,036       12,013      
Vested
    (1,315 )     (49 )    
Forfeited
    (22,783 )     (1,100 )    
Outstanding at end of period
    605,163     $ 25,635  
 33,139

   
Performance-Based Restricted Stock/Units
   
Shares/Units
   
Weighted Average
Grant Date Fair Value
 
Aggregate Intrinsic
Value
Outstanding at beginning of period
    347,141     $ 17,704      
Granted
    780,289       12,110      
Vested
    (179,719 )     (8,503 )    
Forfeited
    (7,980 )     (372 )    
Outstanding at end of period
    939,731     $ 20,939  
 51,460

 
 

 
10

 
HENRY SCHEIN, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(in thousands, except share and per share data)
(unaudited)


Note 4.  Business Acquisitions and Other Transactions

Acquisitions

We completed certain acquisitions during the nine months ended September 26, 2009.  The operating results of our acquisitions are reflected in our financial statements from their respective acquisition dates.  Such acquisitions were immaterial to our financial statements individually and in the aggregate.

Divestitures

On August 5, 2009, we completed the sale of a wholesaler of dental consumables for aggregate consideration of $14.2 million.  Prior results for this business have been presented as discontinued operations in the accompanying consolidated statements of income.  The total pretax income from discontinued operations is $6.5 million ($2.6 million after taxes) consisting of a $6.0 million ($2.4 million after taxes) gain on the sale and $0.5 million ($0.2 million after taxes) income from operations.

Loan and Investment Agreement

On December 12, 2008, we converted $10.4 million of loan receivables and related accrued interest into an equity interest of 15.33% in D4D Technologies, LLC (“D4D”).  Due to the conversion, we now account for our equity interest in D4D under the equity method of accounting prospectively from the date of conversion.
 
 
In addition, under our previous agreement, if certain product specification and performance milestones occurred, we were required to pay additional amounts (as equity contributions) to D4D and certain of its members equal to $16.0 million.  On August 3, 2009, we entered into an amendment whereby we paid D4D and certain of its members approximately $8.0 million and agreed to make two contingent payments in each of 2010 and 2011 of up to $4.0 million each based on D4D’s financial performance.  All payments made under the amended agreement are being accounted for as increases in the carrying value of our investment in D4D and any underlying allocations to intangible assets are being determined at time of payment.


Note 5.  Earnings Per Share

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

For the nine months ended September 26, 2009, our convertible debt was not convertible at a premium and thus the impact of an assumed conversion was not applicable.

For the three months ended September 26, 2009 and the three and nine months ended September 27, 2008, diluted earnings per share includes the effect of common shares issuable upon conversion of our convertible debt.  During the period, the debt was convertible at a premium as a result of the conditions of the debt.  As a result, the amount in excess of the principal is presumed to be settled in common shares and is reflected in our calculation of diluted earnings per share.


 
11

 
HENRY SCHEIN, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(in thousands, except share and per share data)
(unaudited)


Note 5.  Earnings Per Share (Continued)

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

 
Three Months Ended
 
Nine Months Ended
 
September 26,
 
September 27,
 
September 26,
 
September 27,
 
2009
 
2008
 
2009
 
2008
Basic
 88,796,152
 
 88,929,672
 
 88,843,067
 
 89,216,159
Effect of dilutive securities:
             
   Stock options, restricted stock and restricted units
 2,241,503
 
 1,579,672
 
 1,732,922
 
 1,760,015
Effect of assumed conversion of convertible debt
 475,081
 
 866,457
 
 -
 
 932,091
   Diluted
 91,512,736
 
 91,375,801
 
 90,575,989
 
 91,908,265

Weighted-average options to purchase 1,971,851 shares of common stock at exercise prices ranging from $51.10 to $62.05 per share and 1,087,289 shares of common stock at exercise prices ranging from $56.21 to $62.05 per share that were outstanding during the three months ended September 26, 2009 and September 27, 2008, respectively, were excluded from the computation of diluted earnings per share.  Weighted-average options to purchase 2,741,364 shares of common stock at exercise prices ranging from $45.85 to $62.05 per share and 833,041 shares of common stock at exercise prices ranging from $56.69 to $62.05 per share that were outstanding during the nine months ended September 26, 2009 and September 27, 2008, respectively, were excluded from the computation of diluted earnings per share.  In each of these periods, such options’ exercise prices exceeded the average market price of our common stock, thereby causing the effect of such options to be anti-dilutive.


Note 6.  Comprehensive Income

Comprehensive income includes certain gains and losses that, under U.S. GAAP, are excluded from net income as such amounts are recorded directly as an adjustment to stockholders’ equity.  Our comprehensive income is primarily comprised of net income, foreign currency translation adjustments, unrealized gains (losses) on hedging activity and investment and pension adjustments.  The following table presents our comprehensive income:

   
Three Months Ended
   
Nine Months Ended
 
   
September 26,
   
September 27,
   
September 26,
   
September 27,
 
   
2009
   
2008 (1) (2)
   
2009 (1)
   
2008 (1) (2)
 
                         
Comprehensive income
  $ 130,098     $ 17,938     $ 286,795     $ 175,892  
Comprehensive income attributable to
                               
     Henry Schein, Inc.
    122,706       15,836       266,887       161,024  
Comprehensive income attributable to
                               
     noncontrolling interests
    7,392       2,102       19,908       14,868  
                                 
 
(1)  Adjusted to reflect the effects of discontinued operations.
 
(2)  Adjusted to reflect the effects of the adoption of provisions contained within ASC Topic 470-20, “Debt with Conversion and Other Options.”



 
12

 
HENRY SCHEIN, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(in thousands, except share and per share data)
(unaudited)


Note 7.  Fair Value Measurements

Effective December 30, 2007, we adopted provisions of ASC Topic 820, “Fair Value Measurements and Disclosures” (“ASC Topic 820”) as they relate to financial assets and financial liabilities.  ASC Topic 820 establishes a framework for measuring fair value in generally accepted accounting principles and expands disclosures about fair value measurements.  ASC Topic 820 applies under other previously issued accounting pronouncements that require or permit fair value measurements but does not require any new fair value measurements.  The adoption of ASC Topic 820 did not have a material impact on our consolidated financial statements.

ASC Topic 820 defines fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date.  ASC Topic 820 establishes a fair value hierarchy that distinguishes between (1) market participant assumptions developed based on market data obtained from independent sources (observable inputs) and (2) an entity’s own assumptions about market participant assumptions developed based on the best information available in the circumstances (unobservable inputs).

The fair value hierarchy consists of three broad levels, which gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (Level 1) and the lowest priority to unobservable inputs (Level 3). The three levels of the fair value hierarchy under ASC Topic 820 are described as follows:

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

 
 
Level 2— Inputs other than quoted prices included within Level 1 that are observable for the asset or liability, either directly or indirectly.  Level 2 inputs include quoted prices for similar assets or liabilities in active markets; quoted prices for identical or similar assets or liabilities in markets that are not active; inputs other than quoted prices that are observable for the asset or liability; and inputs that are derived principally from or corroborated by observable market data by correlation or other means.
 
 
 
Level 3— Inputs that are unobservable for the asset or liability.

The following section describes the valuation methodologies that we used to measure different financial instruments at fair value.

Cash equivalents and trade receivables

Due to the short-term maturity of such investments, the carrying amounts are a reasonable estimate of fair value.

Available-for-sale securities

The fair value of available-for-sale securities at September 26, 2009 is estimated based on internally generated discounted cash flow models.

Long-term investments and notes receivable

There are no quoted market prices available for investments in unconsolidated affiliates and long-term notes receivable; however, we believe the carrying amounts are a reasonable estimate of fair value.


 
13

 
HENRY SCHEIN, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(in thousands, except share and per share data)
(unaudited)


Note 7.  Fair Value Measurements (Continued)

Auction-rate securities

As of September 26, 2009, we have approximately $22.3 million ($20.3 million net of temporary impairments) invested in auction-rate securities (“ARS”), which are included as part of Investments and other within our consolidated balance sheets.  ARS are publicly issued securities that represent long-term investments, typically 10-30 years, in which interest rates had reset periodically (typically every 7, 28 or 35 days) through a “dutch auction” process.  Approximately $19.6 million ($17.6 million net of temporary impairments) of our ARS are backed by student loans that are backed by the federal government and the remaining $2.7 million are invested in closed-end municipal bond funds.  Our ARS portfolio is comprised of investments that are rated AAA by major independent rating agencies.  Since the middle of February 2008, ARS auctions have failed to settle due to an excess number of sellers compared to buyers.  The failure of these auctions has resulted in our inability to liquidate our ARS in the near term.  We are currently not aware of any defaults or financial conditions that would negatively affect the issuers’ ability to continue to pay interest and principal on our ARS.  We continue to earn and receive interest at contractually agreed upon rates.

During 2009, we have received approximately $4.6 million and $4.2 million of redemptions, at par, for our closed-end municipal bond funds and our student loan portfolios, respectively.

As of September 26, 2009, we have classified our closed-end municipal bond funds, as well as our student loan portfolios, as Level 3 within the fair value hierarchy due to the lack of observable inputs and the absence of significant refinancing activity.

Based upon the information currently available and the use of a discounted cash flow model in accordance with applicable authoritative guidance, our previously recorded cumulative temporary impairment at December 27, 2008 of $2.0 million related to our closed-end municipal bond funds and our student loan portfolios was unchanged during the nine months ended September 26, 2009.  The temporary impairment has been recorded as part of Accumulated other comprehensive income within the equity section of our consolidated balance sheet.

Money market fund

 
As of September 26, 2009, we had an investment of approximately $2.5 million ($2.2 million net of reserves) invested in the Reserve Primary Fund.  This money market fund included in its holdings commercial paper of Lehman Brothers.  As a result of the Chapter 11 bankruptcy of Lehman Brothers Holdings, Inc., the net asset value of the fund decreased below $1.00.  Currently, this fund is in the process of being liquidated.  During 2009, we have received approximately $2.7 million of distributions from the Reserve Primary Fund.  As of September 26, 2009, the value of our holdings in this fund are included within Prepaid expenses and other in our consolidated balance sheets and as Level 3 within the fair value hierarchy, due to the lack of observable inputs and the absence of trading activity.

Debt

The fair value of our debt is estimated based on quoted market prices for our traded debt and on market prices of similar issues for our private debt.  The fair value of our debt as of September 26, 2009 and December 27, 2008 was estimated at $311.4 million and $426.8 million.

 
14

 
HENRY SCHEIN, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(in thousands, except share and per share data)
(unaudited)


Note 7.  Fair Value Measurements (Continued)

Derivative contracts

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

The fair values for the majority of our foreign currency derivative contracts are obtained by comparing our contract rate to a published forward price of the underlying currency, which is based on market rates for comparable transactions and are classified within Level 2 of the fair value hierarchy.

The following table presents our assets and liabilities that are measured and recognized at fair value on a recurring basis classified under the appropriate level of the fair value hierarchy as of September 26, 2009:

   
Level 1
   
Level 2
   
Level 3
   
Total
 
                         
Assets:
                       
       Auction-rate securities
  $ -     $ -     $ 20,353     $ 20,353  
       Money market fund
    -       -       2,234       2,234  
       Derivative contracts
    -       3,773       -       3,773  
              Total assets
  $ -     $ 3,773     $ 22,587     $ 26,360  
                                 
Liabilities:
                               
       Derivative contracts
  $ -     $ 7,416     $ -     $ 7,416  
              Total liabilities
  $ -     $ 7,416     $ -     $ 7,416  


 
15

 
HENRY SCHEIN, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(in thousands, except share and per share data)
(unaudited)


Note 7.  Fair Value Measurements (Continued)

As of September 26, 2009, we have estimated the value of our closed-end municipal bond fund ARS portfolio and our student loan backed ARS portfolio based upon a discounted cash flow model.  The assumptions used in our valuation model include estimates for interest rates, timing and amount of cash flows and expected holding periods for the ARS portfolio.  As a result of these analyses, our previously recorded cumulative temporary impairment at December 27, 2008 of $2.0 million was unchanged during the nine months ended September 26, 2009.

We estimated the value of our holdings within the Reserve Primary Fund based upon the net asset value of the fund as of September 16, 2008, subsequent to the declaration of bankruptcy by Lehman Brothers Holdings, Inc.  The reserve recorded in 2008 of $0.8 million related to our holdings within the Reserve Primary Fund was reduced by $0.5 million during the third quarter of 2009, based upon anticipated collections, and as of September 26, 2009 the reserve is $0.3 million.  The following table presents a reconciliation of our assets measured at fair value on a recurring basis using unobservable inputs (Level 3):

   
Level 3 (Unobservable Inputs)
 
   
Closed-End Municipal Bond Fund and
 
   
Student Loan Backed
 
   
Auction-Rate Securities
 
   
and Money Market Fund
 
       
Balance, December 27, 2008
  $ 33,546  
Transfers to Level 3
    -  
Redemptions (at par)
    (11,514 )
Gains and (losses):
       
   Reported in earnings - Reserve Primary Fund reserve reduction
    500  
   Reported in accumulated other comprehensive income
    55  
Balance, September 26, 2009
  $ 22,587  


Note 8.  Convertible Debt

Effective December 28, 2008, we adopted the provisions of ASC Topic 470-20, “Debt with Conversion and Other Options,” as it relates to our convertible debt.  ASC Topic 470-20 requires that we allocate the liability and equity components of the convertible debt and reflect our non-convertible debt borrowing rate for the interest component of the convertible debt.

In 2004, we completed an issuance of $240.0 million of convertible debt.  These notes are senior unsecured obligations bearing a fixed annual interest rate of 3.0% and are due to mature on August 15, 2034.  The notes are convertible into our common stock at a conversion ratio of 21.58 shares per one thousand dollars of principal amount of notes, which is equivalent to a conversion price of $46.34 per share.  For the nine months ended September 26, 2009, our convertible debt was not convertible at a premium and thus the impact of an assumed conversion was not applicable.

Upon the retrospective implementation of ASC Topic 470-20, we recorded a debt discount of $32.6 million, as of August 9, 2004, representing the difference between the fair value of our $240.0 million 3% convertible debt at the time of issuance and the face amount of the convertible debt.  We also recorded a related deferred tax liability of $12.1 million representing the tax impact of recording the debt discount.  This debt discount is being amortized over a period of six years from the date our convertible debt was issued until August 9, 2010.  An offsetting amount was recorded in Additional paid-in capital to reflect the impact of the debt discount, net of the related deferred tax liability.

 
16

 
HENRY SCHEIN, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(in thousands, except share and per share data)
(unaudited)


Note 8.  Convertible Debt (Continued)

The principal amounts of the outstanding notes, the unamortized discount and the net carrying value at September 26, 2009 were $240.0 million, $5.5 million and $234.5 million and at December 27, 2008 were $240.0 million, $10.0 million and $230.0 million.

As of December 28, 2008, retained earnings includes a cumulative adjustment to interest expense of $22.6 million ($14.7 million, net of taxes) representing the non-cash difference between the stated interest rate (3%) on our convertible debt and our non-convertible debt borrowing rate (5.74%) at the time of issuance of our convertible debt.

For the three and nine months ended September 26, 2009, we recorded additional non-cash interest expense of $1.5 million ($1.0 million, net of taxes) and $4.5 million ($3.0 million, net of taxes), respectively, and for the three and nine months ended September 27, 2008 we recorded additional non-cash interest expense of $1.4 million ($1.0 million, net of taxes) and $4.2 million ($2.8 million, net of taxes), respectively, representing the difference between the stated interest rate on our convertible debt and our non-convertible debt borrowing rate at the time of issuance of our convertible debt.

For the three and nine month periods ended September 26, 2009 and September 27, 2008, contractual interest expense relating to our convertible debt was $1.8 million ($1.2 million, net of taxes) and $5.4 million ($3.6 million, net of taxes), respectively.


Note 9.  Income Taxes

For the three months ended September 26, 2009, our effective tax rate from continuing operations was 14.0% compared to 32.5% for the prior year period.  The difference in our effective tax rates is primarily related to a reduction in the valuation allowance on foreign deferred tax assets during the third quarter of 2009.

During the third quarter of 2009, we were able to substantially complete a planned reorganization outside the United States that will allow us to utilize tax loss carryforwards to offset taxable income beginning in 2010 in certain tax jurisdictions.  As a result, we have determined that it is more likely than not that a portion of deferred tax assets previously fully reserved will be realized.  Therefore, the provision for income taxes includes a $21.0 million reduction of the valuation allowance which is based on an estimate of future taxable income available to be offset by the tax loss carryforwards.

The total amount of unrecognized tax benefits as of September 26, 2009 was approximately $13.9 million, all of which would affect the effective tax rate if recognized.  It is expected that the amount of unrecognized tax benefits will change in the next 12 months.  However, we do not expect the change to have a material impact on our consolidated financial statements.

The total amounts of interest and penalties resulting from unrecognized tax benefits were approximately $2.4 million and $0, respectively, for the nine months ended September 26, 2009.  It is expected that the amount of interest will change in the next twelve months.  However, we do not expect the change to have a material impact on our consolidated financial statements.

The tax years subject to examination by major tax jurisdictions include the years 2006 and forward by the U.S. Internal Revenue Service, the years 1996 and forward for certain states and the years 1997 and forward for certain foreign jurisdictions.

 
17

 
HENRY SCHEIN, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(in thousands, except share and per share data)
(unaudited)


Note 10.  Supplemental Cash Flow Information

Cash paid for interest and income taxes was:

   
Nine Months Ended
 
   
September 26,
   
September 27,
 
   
2009
   
2008
 
Interest
  $ 20,892     $ 28,513  
Income taxes
    114,176       77,516  

During the nine months ended September 26, 2009, we had a $15.4 million non-cash net unrealized gain related to hedging activities.  During the nine months ended September 27, 2008, we had a $0.4 million non-cash net unrealized loss related to hedging activities.


Note 11.  Plan of Restructuring

On November 5, 2008, we announced certain actions to reduce operating costs, which have resulted in the elimination of 430 positions from our operations and the closing of several smaller facilities.  For the nine months ended September 26, 2009, we recorded restructuring costs of approximately $4.0 million (approximately $2.8 million after taxes).  The costs associated with the restructuring are included in a separate line item, “Restructuring costs” within our consolidated statements of income.

The following table shows the amounts expensed and paid for restructuring costs that were incurred during the nine months ended September 26, 2009 and the remaining accrued balance of restructuring costs as of September 26, 2009, which is included in Accrued expenses: Other and Other liabilities within our consolidated balance sheets:

   
Balance at
December 27, 2008
   
Provision
   
Payments
and Other
Adjustments
   
Balance at
September 26, 2009
 
Severance costs (1)
  $ 14,330     $ 2,451     $ (12,289 )   $ 4,492  
Facility closing costs (2)
    3,688       1,531       (2,933 )     2,286  
Other professional and consulting costs
    519       61       (379 )     201  
     Total
  $ 18,537     $ 4,043     $ (15,601 )   $ 6,979  
                                 

(1)  
Represents salaries and related benefits for employees separated from the Company.

(2)  
Represents costs associated with the closing of certain smaller facilities (primarily lease termination costs) and property and equipment write-offs.

We expect that the majority of these costs will be paid in 2009.

The following table shows, by reportable segment, the restructuring costs incurred during 2009 and the remaining accrued balance of restructuring costs as of September 26, 2009:

                         
   
Balance at
December 27, 2008
   
Provision
   
Payments
and Other
Adjustments
   
Balance at
September 26, 2009
 
Healthcare distribution
  $ 18,457     $ 4,043     $ (15,592 )   $ 6,908  
Technology
    80       -       (9 )     71  
     Total
  $ 18,537     $ 4,043     $ (15,601 )   $ 6,979  



 
18

 
HENRY SCHEIN, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(in thousands, except share and per share data)
(unaudited)


Note 12.  Derivatives and Hedging Activities

Effective December 28, 2008, we adopted provisions of ASC Topic 815-10 relating to our derivative and hedging activities.  ASC Topic 815-10 requires enhanced disclosures of our derivatives and hedging activities.  ASC Topic 815-10 does not change the accounting for derivatives and hedging activities, but rather provides more detailed disclosures concerning our objectives for our use of derivatives, the locations within our consolidated financial statements of both the derivative positions existing at period end and the effect of using derivatives during the period and the impact that the use of derivatives and hedging activities had on our consolidated financial statements.

We are exposed to market risks, which include changes in interest rates, as well as changes in foreign currency exchange rates as measured against the U.S. dollar and each other, and changes to the credit markets.  We attempt to minimize these risks by using interest rate swap agreements, foreign currency forward and swap contracts and by maintaining counter-party credit limits.  These hedging activities provide only limited protection against interest rate, currency exchange and credit risks.  Factors that could influence the effectiveness of our hedging programs include interest rate volatility, currency markets and availability of hedging instruments and liquidity of the credit markets.  All interest rate swap and foreign currency forward and swap contracts that we enter into are components of hedging programs and are entered into for the sole purpose of hedging an existing or anticipated interest rate and currency exposure.  We do not enter into such contracts for speculative purposes and we manage our credit risks by diversifying our investments, maintaining a strong balance sheet and having multiple sources of capital.

The value of certain foreign currencies as compared to the U.S. dollar may affect our financial results.  Fluctuations in foreign exchange rates may positively or negatively affect our revenues, gross margins, operating expenses, and retained earnings, all of which are expressed in U.S. dollars.  Where we deem it prudent, we engage in hedging programs using primarily foreign currency forward and swap contracts aimed at limiting the impact of foreign currency exchange rate fluctuations on earnings.  We purchase short-term (i.e., 12 months or less) foreign currency forward and swap contracts to protect against currency exchange risks associated with intercompany loans due from our international subsidiaries and the payment of merchandise purchases to our foreign suppliers.  We do not hedge the translation of foreign currency profits into U.S. dollars, as we regard this as an accounting exposure, not an economic exposure.

The following table presents the fair value of our derivative instruments:

 
Asset Derivatives
 
Liability Derivatives
 
 
September 26, 2009
 
September 26, 2009
 
 
Balance Sheet Location
 
Fair Value
 
Balance Sheet Location
 
Fair Value
 
                 
Derivatives designated as
               
hedging instruments under
               
ASC Topic 815-10:
               
       Interest rate contracts
Prepaid expenses and other
  $ 568  
Accrued expenses other
  $ -  
       Foreign exchange contracts
Prepaid expenses and other
    1,789  
Accrued expenses other
    4,260  
                     
Total
      2,357         4,260  
                     
Derivatives not designated as
                   
hedging instruments under
                   
ASC Topic 815-10:
                   
       Foreign exchange contracts
Prepaid expenses and other
    1,416  
Accrued expenses other
    3,156  
                     
Total derivatives
    $ 3,773       $ 7,416  



 
19

 
HENRY SCHEIN, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(in thousands, except share and per share data)
(unaudited)


Note 12.  Derivatives and Hedging Activities (Continued)

Fair Value Hedges

Our fair value hedges consist of interest rate swaps and foreign exchange contracts.  Gains (losses) associated with these foreign exchange contracts are recorded in Other, net within our consolidated statements of income and totaled $(0.5) million and $7.4 million for the three and nine months ended September 26, 2009.  Forward points related to these foreign exchange contracts, recorded in Interest expense within our consolidated statements of income, totaled $0 and $0.4 million for the three and nine months ended September 26, 2009.

Cash Flow Hedges

Our cash flow hedges consist of foreign exchange contracts.  The amounts recorded in Accumulated other comprehensive income (“AOCI”) primarily represent the change in spot rates at the time of the initial hedge compared to the spot rate when marked to market.  The gain recognized in AOCI (effective portion) for the three and nine months ended September 26, 2009 was $1.5 million and $2.0 million, respectively.

The activity recorded within our consolidated statements of income relating to cash flow hedges include amounts reclassified from AOCI (effective portion) and forward points (ineffective portion).  The following table presents the effect of our cash flow hedges:

   
Gain (Loss) Reclassified from
AOCI into Income (Effective
Portion)
     
Amount of Forward Points
Recognized in Income on
Derivative (Ineffective Portion)
 
Location of Gain
(Loss) Reclassified
from AOCI into
Income (Effective
Portion)
 
Three Months Ended September 26, 2009
   
Nine Months Ended September 26, 2009
 
Location where
Forward Points are
Recognized in Income
on Derivative
(Ineffective Portion)
 
Three Months Ended September 26, 2009
   
Nine Months Ended September 26, 2009
 
Other, net
  $ (2,262 )   $ (370 )
Interest income
  $ 123     $ 140  
Cost of sales
    4,069       4,279  
Other, net
    (1 )     (15 )
 
 
 Undesignated Hedges

Our undesignated hedges consist of foreign exchange contracts.  Losses associated with these foreign exchange contracts are recorded in Other, net within our consolidated statements of income and totaled $3.4 million and $8.9 million for the three and nine months ended September 26, 2009, respectively.  Forward points related to these foreign exchange contracts, which are recorded in Interest expense within our consolidated statements of income, totaled $0 and $0.1 million for the three and nine months ended September 26, 2009, respectively.

 
20

 



Cautionary Note Regarding Forward-Looking Statements
 
In accordance with the “Safe Harbor” provisions of the Private Securities Litigation Reform Act of 1995, we provide the following cautionary remarks regarding important factors that, among others, could cause future results to differ materially from the forward-looking statements, expectations and assumptions expressed or implied herein.  All forward-looking statements made by us are subject to risks and uncertainties and are not guarantees of future performance.  These forward-looking statements involve known and unknown risks, uncertainties and other factors that may cause our actual results, performance and achievements or industry results to be materially different from any future results, performance or achievements expressed or implied by such forward-looking statements.  These statements are identified by the use of such terms as “may,” “could,” “expect,” “intend,” “believe,” “plan,” “estimate,” “forecast,” “project,” “anticipate” or other comparable terms.
 
 
Risk factors and uncertainties that could cause actual results to differ materially from current and historical results include, but are not limited to: decreased customer demand and changes in vendor credit terms; disruptions in financial markets; general economic conditions; competitive factors; changes in the healthcare industry; changes in regulatory requirements that affect us; risks associated with our international operations; fluctuations in quarterly earnings; our dependence on third parties for the manufacture and supply of our products; transitional challenges associated with acquisitions, including the failure to achieve anticipated synergies; financial risks associated with acquisitions; regulatory and litigation risks; the dependence on our continued product development, technical support and successful marketing in the technology segment; our dependence upon sales personnel and key customers; our dependence on our senior management; possible increases in the cost of shipping our products or other service issues with our third-party shippers; risks from rapid technological change; risks from potential increases in variable interest rates; possible volatility of the market price of our common stock; certain provisions in our governing documents that may discourage third-party acquisitions of us; and changes in tax legislation that affect us.  The order in which these factors appear should not be construed to indicate their relative importance or priority.
 
 
We caution that these factors may not be exhaustive and that many of these factors are beyond our ability to control or predict.  Accordingly, any forward-looking statements contained herein should not be relied upon as a prediction of actual results.  We undertake no duty and have no obligation to update forward-looking statements.
 
Executive-Level Overview

We believe we are the largest distributor of healthcare products and services primarily to office-based healthcare practitioners.  We serve more than 575,000 customers worldwide, including dental practitioners and laboratories, physician practices and animal health clinics, as well as government and other institutions.  We believe that we have a strong brand identity due to our more than 76 years of experience distributing healthcare products.

We are headquartered in Melville, New York, employ more than 12,500 people (of which approximately 5,000 are based outside the United States) and have operations in the United States, Australia, Austria, Belgium, Canada, China, the Czech Republic, France, Germany, Ireland, Israel, Italy, Luxembourg, the Netherlands, New Zealand, Portugal, Slovakia, Spain, Switzerland and the United Kingdom.  We also have affiliates in Iceland, Saudi Arabia and the United Arab Emirates.
 
 

 
21

 


We have established strategically located distribution centers to enable us to better serve our customers and increase our operating efficiency.  This infrastructure, together with broad product and service offerings at competitive prices, and a strong commitment to customer service, enables us to be a single source of supply for our customers’ needs.  Our infrastructure also allows us to provide convenient ordering and rapid, accurate and complete order fulfillment.
 
 
We conduct our business through two reportable segments: healthcare distribution and technology.  These segments offer different products and services to the same customer base.  The healthcare distribution reportable segment aggregates our dental, medical (including animal health) and international operating segments.  This segment consists of consumable products, small equipment, laboratory products, large dental and medical equipment, equipment repair services, branded and generic pharmaceuticals, vaccines, surgical products, diagnostic tests, infection-control products and vitamins.

Our dental group serves office-based dental practitioners, schools and other institutions in the combined United States and Canadian dental market.  Our medical group serves office-based medical practitioners, surgical centers, other alternate-care settings, animal health clinics and other institutions throughout the United States.  Our international group serves 21 countries outside of North America and is what we believe to be a leading European healthcare supplier serving office-based practitioners.

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

Industry Overview

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

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

Our current and future results have been and could be impacted by the current economic environment and uncertainty, particularly impacting overall demand for our products and services.

Industry Consolidation

The healthcare products distribution industry, as it relates to office-based healthcare practitioners, is highly fragmented and diverse.  This industry, which encompasses the dental, medical and animal health markets, was estimated to produce revenues of approximately $27.5 billion in 2008 in the combined North American and European markets.  The industry ranges from sole practitioners working out of relatively small offices to group practices or service organizations ranging in size from a few practitioners to a large number of practitioners who have combined or otherwise associated their practices.

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

 
22

 

Supplies and small equipment are generally purchased from more than one distributor, with one generally serving as the primary supplier.
 
We believe that consolidation within the industry will continue to result in a number of distributors, particularly those with limited financial and marketing resources, seeking to combine with larger companies that can provide growth opportunities.  This consolidation also may continue to result in distributors seeking to acquire companies that can enhance their current product and service offerings or provide opportunities to serve a broader customer base.
 
Our trend with regard to acquisitions has been to expand our role as a provider of products and services to the healthcare industry.  This trend has resulted in expansion into service areas that complement our existing operations and provide opportunities for us to develop synergies with, and thus strengthen, the acquired businesses.

As industry consolidation continues, we believe that we are positioned to capitalize on this trend, as we believe we have the ability to support increased sales through our existing infrastructure.

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

Aging Population and Other Market Influences

The healthcare products distribution industry continues to experience growth due to the aging population, increased healthcare awareness, the proliferation of medical technology and testing, new pharmacology treatments and expanded third-party insurance coverage, partially offset by the affects of increased unemployment on insurance coverage.  In addition, the physician market continues to benefit from the shift of procedures and diagnostic testing from acute care settings to alternate-care sites, particularly physicians’ offices.

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

As a result of these market dynamics, annual expenditures for healthcare services continue to increase in the United States.  Given current operating, economic and industry conditions, we believe that demand for our products and services will grow at slower rates.  The Centers for Medicare and Medicaid Services, or CMS,  published “National Health Expenditure Projections 2008 – 2018” indicating that total national healthcare spending reached $2.4 trillion in 2008, or 16.6% of the nation’s gross domestic product, the benchmark measure for annual production of goods and services in the United States.  Healthcare spending is projected to reach $4.4 trillion in 2018, approximately 20.3% of the nation’s gross domestic product.


 
23

 

Government Influences

The healthcare industry is subject to extensive government regulation, licensure and operating compliance procedures.  National healthcare reform is currently the subject of a major Presidential initiative, and legislation expanding coverage and making other significant changes in the healthcare system is expected.  Currently, and for the foreseeable future, a large portion of the total cost of medical care is and will be paid by government and private insurance programs.  The reform effort may substantially modify rules governing such programs, affecting payment methods, rates and limits, as well as other matters.  Additionally, the U.S. Food and Drug Administration (“FDA”) has announced a new enforcement strategy to achieve more effective enforcement through new policies and accelerated procedures.  We continue to work with our suppliers to comply with all applicable FDA rules and regulations.

The Medicare Prescription Drug, Improvement, and Modernization Act of 2003 has been the largest expansion of the Medicare program since its inception, and provides participants with voluntary outpatient prescription drug benefits.  This Act also includes provisions relating to medication management programs, generic substitution and provider reimbursement.

As a distributor of equipment, supplies and drugs for medical, dental and animal health offices, we are subject to numerous federal laws regulating the intersection between healthcare providers and suppliers of goods and services to those providers.  These laws make it unlawful to pay any remuneration, direct or indirect, to induce the referral, recommendation or arrangement of any healthcare services paid by a federal reimbursement program (e.g., Medicare and Medicaid).  A violation may result in criminal or severe civil damages, and recent changes to the federal False Claims Act adopted in 2009 have expanded the potential liability.  Many states have adopted similar laws, and recently, their own state false claims acts.  A number of states have also recently passed legislation regulating interactions between vendors and practitioners, and more states may effect similar laws in the future.

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


E-Commerce

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

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

 
24

 

Results of Operations

The following table summarizes the significant components of our operating results from continuing operations for the three and nine months ended September 26, 2009 and September 27, 2008 and cash flows for the nine months ended September 26, 2009 and September 27, 2008 (in thousands):

   
Three Months Ended
   
Nine Months Ended
 
   
September 26,
   
September 27,
   
September 26,
   
September 27,
 
   
2009
   
2008 (1) (2)
   
2009 (1)
   
2008 (1) (2)
 
Operating results:
                       
Net sales
  $ 1,659,433     $ 1,644,209     $ 4,752,255     $ 4,799,234  
Cost of sales
    1,183,166       1,168,615       3,361,707       3,389,847  
     Gross profit
    476,267       475,594       1,390,548       1,409,387  
Operating expenses:
                               
     Selling, general and administrative
    362,382       360,180       1,060,062       1,094,512  
     Restructuring costs
    -       -       4,043       -  
            Operating income
  $ 113,885     $ 115,414     $ 326,443     $ 314,875  
                                 
Other expense, net
  $ (846 )   $ (9,843 )   $ (9,060 )   $ (20,123 )
Income from continuing operations
    98,375       72,818       237,758       199,985  
Income from continuing operations attributable
                               
     to Henry Schein, Inc.
    96,421       67,488       224,745       183,498  
                                 
Cash flows:
                               
Net cash provided by operating activities
                  $ 218,377     $ 188,664  
Net cash used in investing activities
                    (125,865 )     (85,705 )
Net cash used in financing activities
                    (146,898 )     (57,050 )
                                 

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

(2)  
Adjusted to reflect the effects of the adoption of provisions contained within ASC Topic 470-20, “Debt with Conversion and Other Options.”


Plan of Restructuring

On November 5, 2008, we announced certain actions to reduce operating costs, which included the elimination of 430 positions from our operations and the closing of several smaller facilities.  For the nine months ended September 26, 2009, we recorded restructuring costs of approximately $4.0 million (approximately $2.8 million after taxes).  The costs associated with the restructuring are included in a separate line item, “Restructuring costs,” within our consolidated statements of income. We expect that the majority of these costs will be paid in 2009.

Annual pretax cost savings from this initiative are expected to be between $24.0 million and $27.0 million.


 
25

 

Three Months Ended September 26, 2009 Compared to Three Months Ended September 27, 2008

Net Sales

Net sales from continuing operations for the three months ended September 26, 2009 and September 27, 2008 were as follows (in thousands):

   
September 26,
   
% of
   
September 27,
   
% of
   
Increase / (Decrease)
   
2009
   
Total
   
2008 (1)
   
Total
     $     %  
Healthcare distribution (2):