HSIC

Business Context and Reporting Period

Company: Henry Schein, Inc.
Filing Type: Form 10-Q (Quarterly Report)
Period Ended: September 27, 2008
Business Overview: Henry Schein is a leading distributor of healthcare products and services to office-based practitioners (dental, medical, animal health) and institutions in North America and Europe. Operations are divided into two segments: Healthcare Distribution and Technology.

Key Financial Metrics

Material Changes vs. Prior Period

• Revenue Growth: Net sales increased 14.7% year-over-year for the nine months ended September 27, 2008. This was driven by a 32.4% local currency increase in International sales (largely due to acquisitions) and a 30.9% increase in Technology sales.
• Segment Performance:
  • International: Sales rose 43.8% ($515.3 million increase), fueled by acquisitions and foreign currency exchange.
  • Medical: Sales declined 5.3% due to a reduction in lower-margin pharmaceutical products.
  • Dental: Sales increased 7.6% driven by internal growth in consumables and equipment.
• Profitability: Operating income increased 20.1% for the nine-month period. Gross margins remained stable at 29.4% for the nine months, though the Technology segment margin dipped slightly to 74.1% from 75.0%.
• Other Expenses: "Other expense, net" increased significantly to $16.3 million (from $1.3 million expense in the prior year) primarily due to reserves related to the Lehman Brothers bankruptcy (see below).

Outlook, Risks, and Unusual Items

Lehman Brothers Impact

The filing discloses significant financial impacts resulting from the Chapter 11 bankruptcy of Lehman Brothers Holdings, Inc. in September 2008:

• Derivatives: The company fully reserved approximately $3.7 million related to open foreign exchange contracts with Lehman Brothers Special Financing, Inc.
• Money Market Fund: Recorded a charge of approximately $0.8 million due to the decline in net asset value of the Reserve Primary Fund, which held Lehman Brothers commercial paper.

Liquidity and Auction-Rate Securities (ARS)

As of September 27, 2008, the company held approximately $34.9 million in Auction-Rate Securities (ARS). Due to failed auctions since February 2008, these assets are classified as long-term and Level 3 (unobservable inputs). Management states these investments are rated AAA and continue to pay interest, and the lack of liquidity is not expected to impact operations.

Expense Reduction Initiative

On November 5, 2008 (subsequent to the period end), the company announced a cost-reduction plan involving the elimination of approximately 300 positions (2.5% of the workforce) and facility closures. This is expected to result in a one-time pretax charge of $22 million to $25 million in the fourth quarter of 2008.

Capital Resources

The company entered into a new $400 million revolving credit facility in September 2008, replacing a $300 million facility. As of the period end, there were no borrowings outstanding under this new facility. The company also continues its share repurchase program, with $85.6 million remaining available.

Investor Verification Checklist

• Lehman Exposure: Verify the final recovery amounts on the $3.7 million derivative claim and the $0.8 million money market fund loss.
• ARS Liquidity: Monitor the status of the $34.9 million in Auction-Rate Securities and any potential impairment charges if the market remains frozen.
• Q4 Charges: Confirm the exact amount of the $22–$25 million restructuring charge in the upcoming Q4 2008 results.
• Medical Segment: Assess the long-term impact of the strategic reduction in lower-margin pharmaceutical sales on the Medical segment's revenue trajectory.
• Convertible Debt: Review the impact of the new FASB Staff Position (FSP APB 14-a) on the $240 million convertible debt, which may require a $32.6 million debt discount and increased interest expense starting in 2009.