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Henry Schein, Inc. (NASDAQ:HSIC)

Q2 2009 Earnings Call

August 4, 2009 10:00 am ET

Executives

Susan Vassallo - Vice President of Corporate Communications

Stanley Bergman - Chairman and Chief Executive Officer

Steven Paladino - Executive Vice President and Chief Financial Officer.

Analysts

Glen Santangelo - Credit Suisse

Alex Beckler - Goldman Sachs

Derek Leckow - Barrington Research

Jeff Johnson - Robert W. Baird

Lisa Gill - JPMorgan

Larry Marsh - Barclays Capital

Robbie Farah - William Blair

Robert Willoughby - Banc of America

Operator

Good morning, ladies and gentlemen, and welcome to the Henry Schein second quarter conference call. At this time, all participants are in a listen-only mode. Later we will conduct a question-and-answer session and instructions will follow at that time. (Operator Instructions). As a reminder, the call is being recorded.

I'd like to introduce your host for today's call, Susan Vassallo, Henry Schein's Vice President of Corporate Communications. Please go ahead, Susan.

Susan Vassallo

Thank you, operator. My thanks to each of you for joining us to discuss Henry Schein's second quarter results. If you have not received a copy of our earnings news release, you can access it on our website at henryschein.com.

With me this morning are Stanley Bergman, Chairman and Chief Executive Officer of Henry Schein and Steven Paladino, our Executive Vice President and Chief Financial Officer.

Before we begin, I would like to state that certain comments made during this call will include information that is forward-looking. As you know, risks and uncertainties involved in the company’s business may affect the matters referred to in forward-looking statements. As a result, the company’s performance may differ from those expressed in or indicated by such forward-looking statements.

Also, these forward-looking statements are qualified in their entirety by the cautionary statements contained in Henry Schein’s Securities and Exchange Commission filing. The content of this conference call contains time sensitive information that is accurate only as of the date of this live broadcast, August 4, 2009. Henry Schein undertakes no obligation to revise or update any forward-looking statements to reflect events or circumstances after the date of this call.

I ask that during the Q&A portion of today’s call you limit yourself to a single question and a follow-up before returning to the queue. This will provide the opportunity for as many listeners as possible to ask a question within the one hour we have allotted for this call.

With that said I would like to turn the call over to Stanley Bergman.

Stanley Bergman

Good morning. Thank you, Susan. And thank you everyone for joining us for a discussion on our second quarter results. We, as a company and as a management team, are very pleased to be reporting growth in diluted earnings per share from continuing operations of 14% to a record $0.81 and operating margin expansion of 65 basis points to 7.6%.

Our financial results for the quarter demonstrate a strong commitment to efficient operations and prudent cash management. The markets Henry Schein serves are largely as we expected them to be during the quarter. We believe that we continue to gain market share across all of our divisions, both in United States and abroad, and we remain cautiously optimistic about the future and today, are affirming our 2009 financial guidance.

In a moment, I will provide commentary on each of our four business groups, but first let me ask Steve Paladino to provide an overview of our quarterly financial results in some further depth. Thank you, Steven.

Steven Paladino

Thank you, Stan and good morning, everyone. Before we begin, I would like to point out that our 2008 second quarter results are restated to reflect the wholesale ultrasound business as a discontinued operation as well as the adoption of new accounting regulations regarding interest expense on our convertible debt.

The impact of this adoption on diluted EPS for Q2 was approximately $0.01 per share and $0.04 per share on a full year basis. Our net sales for the quarter ended June 27, 2009 were $1.61 billion, reflecting a 1.8% decline compared with the second quarter of 2008. This consists of a 7.1% decline related to foreign currency exchange, offset by a 5.3% growth in local currencies.

Internally generated sales were up 0.7% and acquisition growth was 4.6%.

You can note the details of our sales growth that is contained in Exhibit A of our earnings news release, which was issued earlier today. Our selling, general, and administrative expenses for the second quarter of 2009 decreased to $356.2 million from $374.1 million in the prior year second quarter. This $18 million decline in costs consists of a $12 million from expense reductions and $6 million as the net impact from the favorable impact of foreign currencies and additional SG&A costs from operations that we acquired during the period.

As we have stated last quarter, our guidance for 2009 is based on conservative sales assumptions and aggressive expense management initiatives, and we are pleased that our second quarter and first half results reflect the effectiveness of our strategies.

Our operating margin for the second quarter of 2009 of 7.6% was 65 basis points higher than the second quarter of 2008, as Stanley just mentioned. Our effective tax rate for the quarter was 32.9%, down from 34.1% in the second quarter of 2008. For 2009, we expect our effective tax rate to continue to be in the 33% range.

Our second quarter income from continuing operations attributable to Henry Schein was $73.5 million, which represents growth of 13.1% from the prior year second quarter. Earnings per diluted share from continuing operations attributable to Henry Schein for the second quarter of 2009 was a record Q2 $0.81 per share and reflects an increase of 14.1% over diluted EPS for the second quarter of 2008.

Let me now provide some details on our sales results for the second quarter. Our dental sales for the second quarter of 2009 were $625.8 million and that was a decline of 5.1%, consisting of a 1.5% decline related to foreign currency exchange and a 3.6 decline in local currencies. Internally generated sales decreased 6%, while acquisition growth was 2.4%.

When we look at our consumable merchandise sales, they increased 1.3% in local currency including a 1.7% decline in internal sales and 3% growth due to acquisition. Our dental equipment sales were down 17.5%, compared with the prior year in local currencies.

We believe our dental equipment sales were impacted by three primary factors during the quarter. First, we launched E4D late in the 2008 first quarter, so late in last year's first quarter. So during the second quarter of last year we were filling some pent-up demand. Second, the overall economy was still relatively strong during 2008 second quarter and we had dental equipment growth last year of more than 12% making for a tough comparison. And third, we believe that market conditions for equipment in the second quarter continue to be challenging.

With respect to medical sales, there were $350.9 million in the second quarter, an increase of 8%. Internally generated sales increased 6.7% and our acquisition growth was 1.3%. Of the 6.7% internal sales growth, approximately 3% was due to products related to the H1N1 virus and the balance of growth was due to strong sales primarily of consumable products. On an overall basis, we believe that we gained market share in the medical arena even excluding the incremental sales related to H1N1 virus.

Sales to our veterinary customers, which represent about 18% of our second quarter medical group sales, were up approximately 8.2% in local currencies. All of that was internally generated.

Turning to our international group, sales for the second quarter of 2009 were $591.8 million, which was down 3.8% compared with the prior year. This consisted of a 17.2% decline related to foreign currency exchange and a 13.4% growth in local currencies. Our internally generated sales of local currencies increased 4.1% while acquisition growth was 9.3% primarily due to the acquisitions of Noviko, DNA Anthos and Medka.

We're very pleased to report solid sales growth in local currencies in most of our major marks internationally. Technology and value-added sales services for the quarter was $42.6 million and were 3.5% ahead of Q2 2008. And that consists of a 3.8% decline related to foreign currency and 7.3% growth in local currencies, all of which was internally generated.

During the second quarter, we continue to see strong growth in our electronic services business.

If we now take a brief look at some of the highlights of our balance sheet and cash flow, operating cash flow for the quarter was $106.7 million compared with $125.3 million in the prior year second quarter. We expect to achieve operating cash flow for the year in excess of our net income, which is one of our key goals. Our accounts receivable days sales outstanding from continuing operations was relatively unchanged in the second quarter at 39.7 days compared with 39.6 days for last year's second quarter.

Our inventory turns from continuing operations for the current quarter was 6.1 turns and that compared to 6.7 turns in last year's second quarter.

Let me conclude my remarks by affirming our 2009 financial guidance as follows. Our 2009 diluted EPS attributable to Henry Schein is expected to be in the range of $3.11 to $3.26. That represents a growth of 7% to 12% compared with our restated 2008 results. This guidance excludes the charges related to the Lehman Brothers bankruptcy as well as restructuring costs, and our 2008 adjusted EPS of $2.96 was restated for FASB Staff Position APB 14-1, which requires the recognition of non-cash interest expense related to our convertible debt. The EPS impact of that change for the full year 2008 was $0.04, and therefore, our restated 2008 EPS is $2.92.

Our 2009 guidance also excludes effects of the restructuring costs that was occurred in the first quarter of 2009. And also, as always our 2009 guidance is for continuing operations including completed or previously announced acquisitions, but does not include the impact of any potential future acquisitions.

Let me now turn the call back to Stanley.

Stanley Bergman

Thank you, Steven. Before I review some of the highlights of each of our four business groups, I would like to share with you thoughts on our national sales meetings. Our annual U.S. national sales meetings strengthen supplier partnership and our sales team's ability to help our customers operate more efficient practices, while providing quality care to patients. In July, we held the largest of these meetings, which is our national dental sales meeting. And in June, we held our medical national sales meeting.

In addition to these two, we held our special markets meeting earlier this year and we will hold our animal health meeting in the fall. These four meetings include more than 2,400 team Schein members and nearly 500 supplier partners' participants. In an involved and intensive series of hands-on educational and training sessions designed to ensure that Henry Schein sales force remained the most knowledgeable and best equipped in each of the markets that Henry Schein serves.

These annual meetings underscore the importance of partnership to our company's continued success. In the training sessions, there is significant opportunity for our team to share perspectives on best practices from the territories with their colleagues. Additionally, stronger bonds are forged with strategic suppliers as they have the chance for demonstrate their products' features of benefits directly to our sales force.

But clearly the biggest beneficiaries of our annual sales meetings are customers as we position our sales consultants to provide expert consultative advice in support of our comprehensive offering of the premier dental medical and animal health products and services. This is particularly important today in this economically challenging time when office-based practitioners are seeking ways to increase revenue and reduce costs in their practices. Training sessions at the 2009 meetings held to date have included consultative skills to help customers build more successful practices, electronic health records and how customers can benefit from technology investments incentives under the health care reform initiatives.

Financial services are also discussed to help customers through the challenging times and a wide range of new equipment and product introduction. These meetings were highly successful and have helped us move forward into the balance of the year with significant momentum.

Now let me begin a review of our business group starting with our dental group, which let me remind the listeners is our U.S. dental business and our Canadian dental business, all of the North American dental businesses. We believe the market for dental consumable merchandise contracted by low-single digit percentages during the second quarter, which is consistent with our comments during our last Earnings Call. Aesthetics and elective procedures are, we believe, being impacted to a greater extent by economic conditions and so is the activity taking place in the dental lab.

We also believe Henry Schein modestly outperformed the market during this quarter. While our internal consumable merchandise sales in local currencies declined 1.7%, this figure includes the impact of higher sales of private label products. Sales of such products increased 4% compared to the second quarter.

Overall, we believe second quarter dental consumable merchandise suggested stabilization in the markets. Let me confirm that the bulk of our private brand products are in the commodity areas rather than the technique sensitive products, which are generally branded products. The commodity area is an area where dentists are seeking low-cost alternatives to reduce cost expenses in the practice. And Henry Schein has a highly regarded valued, private brand offering, so it's generic, branded and provides a very comfortable alternative to peg some of the higher priced commodity products. And so, our customers are choosing to purchase more of these products. They, of course, have a lower price than the branded products, but from a bottom-line point of view are approximately neutral.

Early in the current quarter, we announced an exclusive distribution agreement with Dentatus for the Atlas narrow body implant system. This agreement covers not only North America (U.S. and Canada) but also Australia and New Zealand. And in those marks we are now able to offer dental practitioners the full breadth of dental implants.

The Dentatus Alpha system stands apart in this important and growing market with clear benefits that shorten healing time and increase patient comfort. In particular, the procedure requires no surgical incision and no sutures and can be performed using only a local anesthetic in a GP, general practitioner's office, in somewhere around an hour or less.

We believe that in the U.S. alone approximately 50 million people could benefit from this technology and that about 6 million potential new patients enter the market each year. Now let's take a look at our dental equipment. We believe the market was down significantly as dentists continue to be cautious, when committing to purchasing equipment.

Our quarterly decline of 18% in internal dental equipment sales and service revenue, and that is in local currency, also includes impact of higher demand for more moderately priced equipment. This is important. We are seeing a shift towards the demand for less expensive units of comparable functioning equipment. We first noticed this trend in final quarter of 2008 and we have seen it continue throughout the first half of this year.

Our dental equipment sales growth comparison also reflects three factors that Steven mentioned. I just want to stress this. So, namely in the 2008 comparable quarter prior year sales for E4D were quite strong, unusually strong, because there was pent-up demand for the E4D product that shift in the second quarter of 2008 leading to very strong comparables for E4D in the 2009 second quarter.

Also, we had a particularly strong dental equipment growth quarter during the second quarter of 2008. And, of course, in the 2009 second quarter we have the opposite, a challenging market for 2009 dental equipment. Although we are sensing that perhaps we reached the bottom of the declines in the dental marketplace and expect that the negative numbers on dental equipment will not get much worse even adjusting for these unusual matters that I've just described.

As a final topic regarding our dental group, last month we were happy to be awarded a five-year renewal of a longstanding contract for various dental supplies and [web-based ordering systems used] to the U.S. Army, Navy, Air Force and Marine Corps as well as for the federal civilian agencies. This is a long-time contract and I believe the U.S. government is very, very pleased with our service in this area and by the way we have comparable type contracts in other countries as well, specifically in Europe.

Let me now comment briefly on the medical group. We are very pleased with the progress our medical group is making. We outlined several of the major initiatives in previous calls. And the results have been a strong posting of sales, growth in the second quarter. This included internal growth of 6.7%, which consists of growth of 6% to our physician customers and a little more than 8% or around 8% to our veterinary customers.

Now growth was positively impacted by strong sales of consumable products as well as by sales of products related to the treatment and prevention of H1N1 virus, including the antiviral drugs and infection control products. We continue to see strong sales growth in private label and particularly strong, I might add, in the medical world where physicians are very comfortable because of the history in the hospital in converting to a private brand product. And sales were up 18% in the private brand area.

On overall basis, we believe we gained market share in the office-based practitioner market in the second quarter even excluding the incremental H1N1 related sales. So the internal growth in sales in our medical group was about 6% in the physician area and we believe approximately half of that or less than half of that actually was related to the H1N1 increase demand. Apart from that, the business is growing nicely and sales are somewhat depressed because of the conversion from branded to generic, low-selling price similar margins, but overall we believe we are gaining market share in the physician office arena.

In mid-June, we announced an exciting exclusive partnership on the strategic side with Allscripts Professional Electronic Health Record, and we have begun marketing that product to physicians' nationwide, including the Henry Schein customer base of more than 100,000 U.S. practices. This product advances our mission of helping customers operate an efficient practice and develop a high-quality health care and further enables Henry Schein to serve as a one-stop shop provider for physician practice needs.

Also, of course, given the Federal Government's significant focus and providing of financial incentives for physicians to adopt electronic health records, we expect that many of our customers will be looking for a quality solution and they're doing that in significant numbers. And we believe that we have a fine answer to that quest for the movement or addition of electronic medical records into the office-based practice.

We will be acting as a sales agent for these products and as such, we will be recording a fee only, a net fee and not the sales. While we expect to record fees during 2009, we believe that incremental sales are going to start coming in next year when the Federal Government financial incentives kick in. And this agreement positions us well for 2010 and beyond as these incentives, of course, are made available.

Now, let's talk a little bit about the upcoming flu season. We are now expecting to distribute between 8 million and 9 million doses of seasonal influenza vaccine. This is down from our previous expectation of 12 million to 13 million doses. This reduction primarily reflects a cut back in production of GlaxoSmithKline, which the company announced publicly yet despite this reduction we are affirming our 2009 guidance because of some mitigating factors related to flu.

First, we look forward to increased sales of antiviral drugs, Tamiflu and Relenza, and to infection control products including face masks and hand sanitizers, both because of seasonal flu and because of H1N1 concerns. And also, I think it's safe to say that we expect greater price stability this year in the flu vaccine market in part because of strong demand for H1N1 concerns and awareness and part because of reduction in supply.

Having said this, we are reaffirming our full year guidance that we gave back in November of 2008. Of course, the impact on sales resulting from the whole flu arena as I just prescribed will impact our earnings for the year. But at the same time, the overall strength in the business makes us feel comfortable with reaffirming the guidance that was provided back in November of 2008.

Let's now look at our international group, where we are pleased to report growth in local currencies of 13% and most importantly with internal growth exceeding 4%. We saw particular strength in our international dental equipment and veterinary businesses, highlighted by our European dental equipment, up 15%.

Some of that, of course, is related to the fact that the IDS show in Germany was held at the end of the first quarter and shipments therefore took place in the second and there is still some shipments to go, of course. But, overall, our European dental businesses with the exception of Spain and Italy where we have economic challenges continue to do very, very well.

Then there is the European veterinary market and in our context up 22% in local currencies. We have discussed on previous calls our initiatives and targets regarding operating margin expansion in Europe. Among those, is migrating various legacy requiring among the areas that will continue to drive margin expansion in Europe, is the migration of various legacy computer systems gained through acquisitions through a limited number of common platforms including SAP, which is the major system we are using in Europe and JD Edwards in the U.K., which is the system we use in the U.S. as well and Canada.

During the second quarter, we have completed the upgrade to SAP's latest release and we look forward to continuing the European rollout next year. As of today in addition to Italy, we are running SAP in Germany, Austria, Belgium, the Netherlands and Luxembourg. We're planning to convert the remaining countries on the European continent over the coming years. This has all been discussed with investors and shareholders in the past, and we are moving forward in a very, very balanced and progressive way.

I'm very pleased by the way to report that the international group's operating margin expanded 40 basis points during the first six months actually of 2009.

Now let me conclude with the technology and value-added services group. The group once again posted positive growth in local currencies of about 7%. Software sales were up nearly 4% in local currencies, while our electronic services business was up more than 17%. This is the exciting part of this business, and we have a pipeline full of new ideas and upgrades and value-added services for the office-based practitioner.

And let me remind you in that context that the technology group provides products and services across our entire customer base, both in North America and in a number of European countries and Australia and New Zealand.

We strongly believe that advanced technology solutions are critical to maintaining our leadership position and are integral in operating an efficient practice while delivering high-quality patient care. And Henry Schein is committed to leading-edge solutions with, of course, developed internally or solutions that we may acquire distribution rights or outright acquisitions of companies with good solutions.

So as a closing comment, I would like to extend on behalf of the company, our Board and our shareholders our sincere thanks to Dr. Margaret Hamburg, who has served as the Director of Henry Schein Company's Board since 2003. As has been known in public announcements, Dr. Hamburg left our Board following her confirmation as Commissioner of the U.S. Food and Drug Administration. We would like to thank Dr. Hamburg for the insight she shared with the Henry Schein Board throughout the years and wish her continued success.

So with that overview of our second quarter, I would like to thank you for your attention this morning.

Now, operator, Steven and I are ready to respond to any questions that callers may have. Thank you.

Question-and-Answer Session

Operator

(Operator Instructions). Your first question comes from the line of Glen Santangelo with Credit Suisse.

Glen Santangelo - Credit Suisse

Stan, just a couple of follow-up questions to your prepared comments, you sort of suggested on the equipment side that were seeing a trade down into less expensive comparable equipment. Can you maybe give us examples of kind of what you are seeing and maybe how long you think that will persist?

Stanley Bergman

Glen, if you take it at its simplest form, the dental unit, which is the chair and the light, we are seeing a movement from the more expensive units to the less expensive units, maybe even manufactured by the same manufacturer. Likewise, we see the same on the X-ray side. The [ISI type] unit, the 3D unit is moving downwards a little bit at this time towards the 2D and towards the medium field of view.

And so, I think the unit decrease is not as bad as the dollar decrease. I might add this is primarily a U.S. phenomena and a little bit in Canada. As to when it will end, it's hard to tell. But the sense we have perhaps we reached the bottom in terms of a decrease in equipment sales percentage decrease, we see that starting to mitigate. It's hard to give you an exact number because a couple of months is not a trend. I think the equipment sales reflect the sentiment of what people think with respect to the economy in general and the news that is coming out right now seems to be a little bit better than it was nine months ago. So, I think we are sensing a positive feel on equipment market side.

Glen Santangelo - Credit Suisse

So, Stan, if I hear you correctly it's not a credit issue at all. Dentists have no problems getting credit. It's just that they are a little skittish on the economy so they are just trading down temporarily we think?

Stanley Bergman

Yeah. When you talk about credit, it's a tad harder to get credit today than perhaps it was six months ago even. But we are still getting well over 90% approvals on our credit application. The FICO scores are being focused on a little bit more, but over 90% of our customers that are seeking at least are getting pretty quick approval.

Glen Santangelo - Credit Suisse

And then this is a U.S. issue and then you are not seeing it so much internationally, is that what you said?

Stanley Bergman

It's tad of an issue in Canada. But our sales in Canada are a little bit stronger than the U.S. and definitely non-issue outside of the U.S., at least, the credit issue.

Glen Santangelo - Credit Suisse

Lastly, on the flu vaccine you obviously took your guidance down for traditional influenza, because of the GSK, but if I look at the government they have ordered almost 200 million doses of swine vaccine potentially for an autumn vaccination campaign. Could that be an opportunity for you to offset some of those lost doses? Is it anything you are at all considering at this point?

Stanley Bergman

Yes, Glen, we view the H1N1 vaccine anti-virals infection control products to be an opportunity, although we have not baked in much into our expectations and factored much in terms of profit. Neither the manufacturers of H1N1 vaccine nor the U.S. government have publicly discussed the distribution plans for the vaccine. So at this stage I think it's more prudent for us to not expect any incremental earnings in this area.

But obviously, our customers, we do business with 100,000 practices and those customers are in the sweet spot of customers that would use these vaccines because of our traditional position in that marketplace. So I think we could expect some contribution, but really are taking a cautionary approach internally from a budgeting point of view.

Operator

Your next question comes from the line of Randall Stanicky with Goldman Sachs.

Alex Beckler - Goldman Sachs

It's Alex Beckler for Randall, thank you. Just couple of quick ones for me. First, could you provide any color of who you are gaining market share from in the physicians' market and what specifically allows you to gain that share you think?

Stanley Bergman

On the physician side, I would say that we are doing well in the marketplace, in general. I don't believe there is anyone distributor that we are gaining market share from or one particular distributor that is losing market share.

Having said that, we implemented a number of key initiatives over the past year. First of all, we had a number of brands that competed and we brought them all under one brand, under the Henry Schein Medical Group brand, and that took us about a little over a year in terms of systems to combine all these businesses under the Henry Schein Medical One Plan. And I think that's doing very well.

Second, we are doing quite well now on the overall focus on some of these new larger customers that are emerging. And I say larger customers, multiple locations under common management; that's doing quite well. And I'm referring to our key physician business. We did shed a lot of low margin pharmaceuticals in previous quarters. That is no longer impacting our sales.

And overall, our strategy of putting together a well-class field organization working closely with telesales and direct marketing is paying off. I think, strategically, we're focused on some of the specialties and of course, these larger groups that I just mentioned. And overall, this strategy is working out well and we believe that our medical group is heading in the right direction to continue to gain market share in the office-based practitioner field.

There is some other areas that we are not focusing on as much today, but 90% of our business is in the office-based area and that's the sweet spot of focus including, of course, equipment and the digitalization of the office and that includes electronic medical records and software as well. Those are all the areas we are focusing on had paid off and will continue to pay off, we believe.

Alex Beckler - Goldman Sachs

Great. And then, Steven, I wanted to ask about your thoughts on capital structure going forward. Looks like you guys are paying off most of your senior notes next quarter. What's your view on the balance sheet leverage going forward from here?

Steven Paladino

We happen to be in a very good position. We have a strong balance sheet. We did pay off in early into the third quarter about $130 million of senior notes that matured. We paid that out of Treasury. I think we expect our cash flow to continue to be used for primarily acquisitions. I think, longer term, we will continue to do stock buyback, although this quarter we did not buy back any stock during this quarter. We are just being a little bit conservative on cash.

We like having a strong balance sheet. We think it allows us to be opportunistic should there be a good business opportunity that [lies ahead]. And again, primarily for acquisitions would be our cash flow.

Operator

Your next question comes from the line of Derek Leckow with Barrington Research.

Derek Leckow - Barrington Research

In terms of the guidance, I think the upside in the second quarter sounds like it is being absorbed by the lower expectations for flu vaccine in the second half. I wanted to be on those factors, get into the dental consumables internal growth rate expectations and then at the size of the opportunity as it relates to operating margin in Europe. I think that's still operating at well below average, and there is a pretty big opportunity to improve the margin in Europe. So those two factors I wondered if you could spend a little time on those?

Steven Paladino

Derek, let me comment first on overall guidance. When we look at our full year guidance, we did reaffirm our guidance on this press release. And I think there is a couple of things to consider. First, we wanted to continue to maintain a high level of competence of achieving our guidance. Two, as Stanley said in his prepared remarks, we do have a reduced expectation for flu vaccine availability, originally from 12 to 13 million doses and now we were expecting 8 to 9 million doses of flu vaccine.

Another point is our guidance does not assume that the markets are going to improve during the second half of the year although we hope that they will improve and we do believe that we are seeing signs of stabilization and the potential for improvement in the second half. Our guidance also does not assume any potential opportunities that could be from H1N1 either vaccine or related products during the second half.

And the last thing is that we're also being conservative on dental equipment and while we do believe that dental equipment sales growth will be improved in the second half from what we are seeing, our decline will be less in the second half because a couple of the factors that I mentioned impacted Q2 will not continue to exist. That is namely the E4D pent-up demand, which was a one-time event for Q2. And we also believe that the comparables will get a little bit easier, primarily in Q4. So we do believe that dental equipment could be a little bit better.

Specifically as you ask about international, we are pleased with the progress that our international business is achieving and expanding operating margins for the quarter. Our international group had over 4% operating margins, about 4.25%. And again that was a little over 40 basis points of improvement for the quarter. We are getting that steady increase in international. We expect that to continue. Our goal of achieving over 6% operating margins is still intact and we believe that we will be getting there in the next couple of years.

I think that answers the bulk of your questions. I'm not sure if I missed anything, Derek.

Derek Leckow - Barrington Research

Let me just ask one quick follow-up on the dental consumables. So it sounds like you are saying from your point of view the guidance assumes an internal consumables growth rate what we are seeing, but it sounds like the comparison does get a little bit easier. So should we kind of expect a little bit of an improvement in the consumables area?

Steven Paladino

Well, I think we were hopeful that that is a good possibility. But again, our guidance, you know, has been structured all year on trying to be very conservative on sales expectations, so we continue to have that built into our guidance. And again that will give us a high level of confidence in achieving the guidance for the second half of the year and for the full year.

Operator

Your next question comes from the line of Jeff Johnson with Robert Baird.

Jeff Johnson - Robert W. Baird

Great. So Steve, just want to make sure I understand on the guidance here. As I do the math, if you take the influenza vaccine guidance down to 8 million to 9 million doses that probably shaves 3 pennies to 4 pennies out of my model. Are you saying you are not including any expectations for increased consumable supplies, antivirals, infection control, what have you on the medical side from H1N1? You are just leaving that out of the model, so truly it's a 3 to 4-penny reduction in the back half of the year from flu that isn't being offset by anything else in the medical segment?

Stanley Bergman

Well, we were not assuming any continued benefit because of H1N1 related products typically during the summer time when influenza goes dormant. Typically, we would not expect to see it during the summer time, but there is a possibility that in the fall and the winter months, we could see a spike. But again, we're not assuming that in our guidance. We want to maintain realistic and conservative sales growth. And just to remember, Jeff, that the reduction in flu vaccine comes from GSK, which is our most profitable flu vaccine that we sell. Its profitability is greater than the proportionate amount of the reduction.

Jeff Johnson - Robert W. Baird

Fair enough. So safe to say that EPS impact could be a little greater, is what I'm taking there anyway. And then couple other questions, kind of one-off questions. Some talk about nationalized dental care in Australia, and obviously there has been an increase in exposure there. Is that a good thing or a bad thing? And then just also interested just on the Dentatus acquisition, the agreement with Dentatus? I know a year ago or so, we were talking about bringing CAMLOG into the U.S. a little more aggressively, is that not going to happen now because of Dentatus or how can those two coexist in the U.S.?

Stanley Bergman

Jeff, first of all on Australia and New Zealand, we are not expecting an impact from any government reimbursement. In fact, our sales of equipment are quite good in Australia and New Zealand, and we don't expect to see much of an impact there.

Second on Dentatus. The Dentatus product does not compete with the traditional CAMLOG dental implants. It's a narrow body implant, sort of a mini implant, with a particular utility for fastening in dentures and it doesn't compete there with the traditional CAMLOG product, but rather rounds out implant offering.

We think that the Dentatus Atlas system stands apart in this important and growing market. I think the implant market continues to be a good market and we are continuing to grow our implant business in the U.S. I don't think we ever said we were not, but it's relatively immaterial compared to a total of Schein. And so the growth of our implant business in the U.S. as a percentage of the base continues to do quite nicely, but it's relatively immaterial to the whole of Schein.

Jeff Johnson - Robert W. Baird

Great. And just going back to Australia, Stanley, if they went nationalized dental care that would not be an opportunity at all on the consumable side?

Stanley Bergman

Yes, I mean, there maybe an opportunity but I think it's far too soon. We are quite happy with our Australia and New Zealand businesses. They are doing well. We continued to do well on the market share growth, internal growth, we continued to expand our offering. We have an excellent footprint on the software side, continue to invest in that and overall it's turned out to be a very good market for us. But we aren't counting on any special wins from any change in reimbursement at this stage.

Operator

Your next question comes from the line of Lisa Gill with JPMorgan.

Lisa Gill - JPMorgan

Steven, I was wondering if you could walk us through on the guidance, really how you get to that upper end of the guidance range. I heard a lot about what's not included in there. We heard about flu and then it's probably even more than $0.03 to $0.04. What's the expectation of the upper end versus the lower end? Is the upper end of the guidance still achievable this year?

Steven Paladino

Certainly, we believe that the upper end of the guidance is achievable otherwise we would not have our range to include that upper end. It's hard really to specifically say what factors would need to occur. I think we tend to be conservative on our guidance. I think that's something that we want to maintain. There is uncertainty obviously in the market, although we do think the market has stabilized and has the opportunity for improvement.

It allows for if there is changes that are unexpected, should flu vaccine come in even a little bit less than our expectation, should the dollar continue to strengthen? There are a number of uncertainties that are out there that we want to make sure are covered. Again, the short answer is we feel that the top end of our range is also achievable and that's why it's included as part of our range.

Lisa Gill - JPMorgan

Is it mainly driven based on sales expectations? I mean you have done a really good job of controlling costs and we've seen that come through in the numbers. But is that really what the expectation is on the upper end of the range that sales will start to improve in the back half of the year and you are starting to see the signs of the recovery and that's where the upper end comes in to play?

Steven Paladino

Well, it is mostly related to sales impact. Again, even on the high end of our range we are being conservative on sales expectation. So we do not need a significant improvement in sales expectations to achieve the high end of our range. But it is directly related to sales because as you said the expense initiatives that we've completed -- they are already completed and we're seeing that benefit in the first half and will continue in the second half of the year.

Lisa Gill - JPMorgan

So the expense side is down, so now if you can increase the sales you are saying there is more leverage than there historically has been even in the model. I mean, you had leverage in the model before, but because they're taking out those incremental costs, you will have more leverage if the sales start to come back?

Steven Paladino

That's the right thing. Look at what we are doing to the operating margin. The operating margin expansion is above our normal goal of 30 to 50 basis points. We believe that will continue for the second half of the year; that will get very strong operating margin and that's really on a worldwide basis. Internal sales growth is slightly up and it's up 0.7%, local and internal sales growth on a worldwide basis. The margin opportunity on increased sales growth is very significant for us.

Lisa Gill - JPMorgan

Is there anything that we should be thinking about, again not to belabor this, but it is a $0.40 range versus what you did in the first half of the year? So, is there any additional cost cutting or any other big items we should be thinking about from a modeling perspective?

Steven Paladino

No. Right now we feel comfortable that we've done. We're always trying to be efficient on expenses. I don't want to say that we are not always looking to save expenses. Restructuring costs that we completed at the beginning of Q1 is done, and we have no further expectations to do anything like that for the balance of the year.

Operator

Your next question comes from the line of Larry Marsh.

Larry Marsh - Barclays Capital

Just a couple of things. On the H1N1 opportunity, when do you think you will see some resolution around supply chain decisions and product distribution, given the significant amount of purchasing? And maybe could you reflect on the viability of selling a product like that direct as an alternative of going through you and others as a distribution channel?

Stanley Bergman

Well, that's very hard, Larry, to determine when the government is going to be making an announcement. There are quite a few meetings going on, advisory meetings, different kinds of consultative discussions and at this time we can tell that no decision has been made on direction. If the volume or product is in fact available and it’s available in a short window of time, it's hard to believe how any one company can distribute this effectively. In fact, we are hearing from the states that they would like to see several companies be in the distribution channel, including our company. But it's very hard at this stage to get a sense of when the product will be available, will it be available? How many distributers will be in the distribution?

I think it will be hard for the government to sell it directly and bill for it directly. However, I don't think it's even clear whether government is going to give this vaccine away or it's going to be in one way or another selling it through the distribution channel? But I can't imagine the government actually selling and then billing for it.

Larry Marsh - Barclays Capital

Right. But it seems like that decision is to be made in the next two months I would imagine. What do you think?

Stanley Bergman

Sooner the better. Sooner the supply chain can (inaudible) in an efficient way. I think it will be hard to tell the exact week that the products will be made available, even the exact month because of manufacturing challenges and who exactly is going to be the first to market. But I would think that there are a lot of requirements here that needs to be sort through quickly, not only the vaccine but also the supplies that go along, [required] to actually provide inoculation.

Larry Marsh - Barclays Capital

I guess to the point then let's just say there is some sort of announcement that perhaps you are involved. You are saying at this point you wouldn't know whether that might be a small fee associated with your participation. Maybe there is no margin associated with that net of your costs or it might be a more traditional vaccine-type margin that you have seen historically. Is that right or do you think you have a better visibility how it might play out?

Stanley Bergman

No we don't have a visibility. Anything is a guess. But my guess at this point is it's more in the nature of a fee, (inaudible) services rather than the government selling us the product and then us making the market.

Larry Marsh - Barclays Capital

Right. And so if there is a fee that would mean there would be a smaller implicit profit on that than your traditional flu relationships?

Stanley Bergman

Very hard to tell, I'd say so.

Larry Marsh - Barclays Capital

Second. And you started talking about the trade down phenomenon on equipment, I really started hearing from you very early this year and it continues to be the case. At the same time, it seems like your participation and providing financing alternatives to your group of partner banks has expanded. And earlier this year, you talked about a third of all purchase is through your partner banks. Has that changed at all in terms of the mix of where your customers are getting financing and where is that percentage these days?

Steven Paladino

We still have our bank group that is continuing to be in the market and wanting to do more business with our type customers. We have expanded our market share and what we are financing. I don't know the exact percentage off the top of my head, but I know that even on lower revenues with equipment sales declining 18% for the quarter, we increased our financing by 2% or 3%. We are financing more business. I continue to believe that although financing is tougher now than it was a year ago. It is a competitive advantage for Schein because not everyone has access to financing for their customers and we're financing more than ever before.

Larry Marsh - Barclays Capital

Two other quick things. One on the international side. I know you're pleased with how the IDS went early here in March, and it seems like it has filtered down to a good momentum. As you look out in the next year or so, are you concerned at all about reimbursement specifically, say in Germany with election there for sometime in 2010? Or you feel cautiously optimistic that the tone will be reasonable next year?

Stanley Bergman

There are elections sometime next year. Don't expect the government to turn to doing reimbursement that quickly. I think for several quarters out probably four at least the reimbursement won't have any impact at all. I don't think so. It is possible that it might have an impact on the visit to the dentist. The purchase of equipment is very much tied into the sentiment in the market in general, and right now it's not great but it's not that bad. And unless there is an economic shift we don't see much of a change in sentiment towards purchasing of equipment.

Larry Marsh - Barclays Capital

Finally just to summarize, I would imagine you guys have to be pleased here in this kind of environment. Year-to-date you are posting sort of mid-single digit top line and mid-teens earnings growth. So, I hear you on the cautionary statements second half of the year. But I mean, I have to believe you are extremely pleased with your performance in this environment. Is that a fair statement?

Stanley Bergman

I think, Larry, you are correct and we, of course, are optimistic, but these are still uncertain times. I think at least internally we believe we have hit the bottom in terms of decrease in sales. I think some of our strategies particularly in our medical group are starting to pay off. Dental group has always had good strategies. We think we're gaining market share across the board, but I think it's better to remain cautious on the top line at least until we talk to you again next quarter.

It's true that the comparables gets a little bit better say for September and for the other three months of the year and we built our budget and risked on opportunities for the remainder of the year along the lines of cautionary sales. I think that's where we should keep it. Having said that, you watch TV or read the newspaper the sentiment is a lot better than it was perhaps the last time we all spoke.

Operator

Your next question comes from the line of John Kreger with William Blair.

Robbie Farah - William Blair

Hi, good morning. This is [Robbie Farah] in for John today. Guys if you think about the quarterly progression of sales in your different businesses, how did the trends progress from April through June and then even into July?

Steven Paladino

Well, it's not the same for each business. We did see for example in the medical business in part because of H1N1 related sales. We did see strong beginning part of the second quarter, but then a lot of that benefit directly related to H1N1 subsided at the end of the quarter. With respect to dental, I would say that on equipment we saw our backlog continue to grow at the end of the second quarter. So that gives us optimism for the second half of the year.

Obviously, if we turn to international for international perspective, we did see the benefit that we were expecting coming out of the IDS show, but it continues. The consumable business in our European dental markets continues to be good. I don't think I've seen any significant up or down movement since the quarter end. So again we are tracking with slight improvements that we are seeing earlier into the third quarter, but it's still early in the third quarter, so I don't know if it makes a trend just yet.

Robbie Farah - William Blair

Got it. Just as a follow up to your IDS comment, excluding IDS would we have seen dental equipment sales that were comparable to the U.S. and Europe? And should we expect that for the second half?

Stanley Bergman

First of all, we had some pent-up demand from the fourth quarter into the first because of tax reasons then we had the IDS. But the sentiment with respect to dentists buying and even physicians buying equipment in Europe is nowhere near as down as here. So, may not be as robust as a year ago, but I think it's more in line with positive to slightly negative. It's not material. It's about flattish, maybe a tad positive.

Operator

Ladies and gentlemen, we have time for one last question from the line of Robert Willoughby with Banc of America.

Robert Willoughby - Banc of America

Looking at the inventory days they've trended unfavorably. Is there anything structural here or if not what are your initiatives to work those inventory days down?

Steven Paladino

There is nothing structural. We believe that there is good opportunity to work down inventories. Remember, some of the additional inventory because of some of the acquisition activity we did at the end of Q4, so it takes us normally at least a couple of quarters to work down that inventory. But we are hopeful that we will see some improvement in inventory turns for the second half of the year.

Robert Willoughby - Banc of America

I think of the inventory in terms of revenues by business line, did the inventories largely match up as on a percentage basis with the revenues? If your dental sales are X percent of your revenues, will that equate to same amount of your inventories?

Steven Paladino

I would say generally that's true but there are exceptions. For example, on the medical side there are some pharma companies that are delivering product to us in virtually every 10 day or a 2-week period, so that inventory may turn a little bit faster. Depending on grade points for volume discounts, we may need to achieve certain minimum order sizes to get the best possible price. But I would say as a general rule, your statement is correct.

Robert Willoughby - Banc of America

The vet business up 8% percent or so, all organic? Did you have product launch or what drove that performance?

Steven Paladino

It was all organic. I think we're clearly taking market share on our veterinary business because the market is now nearly at 8%. We've seen some strong growth in some of the flea and tick products on our veterinary business, but no acquisition growth is included in that number.

Susan Vassallo

Okay, operator, I think that ends our call at this time.

Operator

Thank you. This concludes today's conference call. You may now disconnect.

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Source: Henry Schein Inc. Q2 2009 Earnings Call Transcript
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