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Executives

Susan Vassallo - Vice President, Corporate Communications

Stanley M. Bergman - Chairman of the Board, Chief Executive Officer

Steven Paladino - Chief Financial Officer, Executive Vice President, Director

Analysts

Glen Santangelo - Credit Suisse

Lisa Gill - JPMorgan

John Kreger - William Blair

Jeff Johnson - Robert W. Baird

Derek Leckow - Barrington Research

Larry Marsh - Barclays Capital

Alex Becker - Goldman Sachs

Presentation

Henry Schein, Inc. (HSIC) Q3 2009 Earnings Call November 4, 2009 8:30 AM ET

Operator

Good morning, ladies and gentlemen, and welcome to the Henry Schein third quarter conference call. (Operator's Instructions) As a reminder this call is being recorded. I would now like to turn the call over to our host, Miss Susan Vassallo, Henry Schein's Vice President of Corporate Communications. Please go ahead, Susan.

Susan Vassallo

Thank you, operator, and my thanks to each of you for joining us today to discuss Henry Schein's third 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, Executive Vice President and Chief Financial Officer.

Before we begin I'd 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 forwardly booking statements. As a result, the company's performance may differ from those expressed in or indicated by such forward looking statements. All those forward looking statements are qualified in their entirety by the cautionary statements contained in Henry Schein's Securities and Exchange Commission filings.

The content of this conference call contains time sensitive information that is accurate only as of the date of this live broadcast, November 4th, 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 followup, before retiring to the queue. This will provide the opportunity for as many listeners as possible to ask a question whiten the one hour timeframe we have allotted for this call. With that said I'd like to turn the call over to Stanley Bergman.

Stanley M. Bergman

Thank you, Susan. Good morning, everyone and thank you for joining us on this call. Our performance during the third quarter of 2009 was impacted by a number of unusual items, both on the income and expense side. These unusual items have been detailed on Exhibit B in this morning's earnings release. So I think it's very, very important as you listen to the call that perhaps you pull up the earnings release and specifically Exhibit B because it is a little complex and we will provide clarity on this call as to our numbers. The unusual items are notably, the overseas tax benefits in the 2009 third quarter.

Now, on a normalized basis we are very pleased than in the third quarter our growth in diluted earnings per share from continuing operations excluded these unusual items which include primarily the overseas tax benefit. And if you remove the impacts of the seasonal flu vaccine, then you will see that we had strong earnings per share quarter for the third quarter of 2009 with 18% growth. So if you look at our sales, our sales in local currency were up 7%.

We improved on our operating margin by 62 basis points, resulting in earnings per share excluding the flu vaccine of 18%. In addition, growth in our overall sales in all of our business units results in us gaining market share across the board. So overall if one takes out these unusual items, specifically eliminate the taxes and the impact of seasonal flu, I think you conclude that the 18% earnings per share growth is a good quarter, especially if one marries that with the cash flow which was very good both in the quarter and year to date.

We are today also introducing financial guidance for 2010, based upon prudent assumptions regarding sales growth and ongoing commitment to efficient operations we are expecting growth in diluted earnings per share of 8%-13% compared to the midpoints of our 2009 guidance. And just to clarify, in 2009 we grew taking into account the fourth quarter guidance that Steven will be confirming that we will have grown 8% and that's based on a year that was challenged by the macroeconomics, but also heavily challenged by our availability of seasonal flu which was significantly limited by the government’s orders for H1N1 flu vaccine and absorbed a significant amount of the flu vaccine capacity in this country.

At this point I'd like to ask Steve Paladino to provide an overview of the quarterly financial results and I'll provide some comments on our four business groups.

Steven Paladino

Okay. Thank you, Stan, and good morning to everyone. Before we begin I'd like to point out that during the quarter we divested a small non-core dental wholesale business which had sales of approximately $14 million for the last 12 months. All of our current and prior year information has been restated to report this business as a discontinued operation. We also did report a gain on discontinued operations of $2.4 million after tax or $0.03 per share.

Our prior year results are also restated to reflect the wholesale ultrasound business that we sold during 2008 as a discontinued operation also, as well as the adoption of new accounting regulations regarding interest expense on our convertible debt. The impact of this adoption on Q3 2008 dilated EPS was a reduction of approximately $0.01 per share and was a $0.03 per share reduction on a year to date basis.

Our 2009 third quarter results include a net benefit of $19.8 million or $0.22 per diluted share after tax, and that's related to an overseas tax restructuring and is net of associated expenses for that tax restructuring.

Also, our other income in our P&L for the third quarter of 2009 includes approximately $1.5 million on a pretax basis which represents income from a legal settlement which was partially offset by a negative foreign exchange impact. We've detailed all this on Exhibit B and I will be referring to our income from continuing operations excluding these unusual items as non GAAP. And you can see on Exhibit B of the earnings release we've reconciled our GAAP income and EPS from continuing operations to our non-GAAP income and EPS from continuing operations.

For Q3 of this year, these unusual non-GAAP adjustments totalled $21 million or $0.23 per share and are $18.3 million on a year-to-date basis or $0.20 per share.

Let's now look at our net sales which for the quarter ended September 26th, 2009 were $1.7 billion and that's reflecting a 0.9% increase compared with the third quarter of 2008 and that consists of a 4% growth in local currencies and a 3.1% decline related to foreign currency exchange.

In local currencies, internally generated sales were down 0.6% while acquisition growth was 4.6%. Excluding sales of the seasonal influenza vaccine which declined from 49% room last year's third quarter, our net sales increased by 6.9% in local currencies. You could also note the details of our sales growth that's contained in the press release of Exhibit A that was issued earlier today.

We look at our selling, general, and administrative expenses for the third quarter of 2009. They increased to $362.4 million from $360.2 million in the prior year's quarter. Excluding expenses which are included in that number of $1.6 million that are related to the overseas tax benefit that I just mentioned, as well as sales and expenses related to seasonal influenza vaccine business, our SG&A expenses on a normalized basis as a percentage of sales improved by 69 basis points compared with the prior year quarter.

Looking at the third quarter's operating margin, again, excluding the expenses associated with the overseas tax benefit and expenses related to sales of seasonal influenza vaccine our operation margin for the third quarter of 2009 increased by 62 basis points over the third quarter of 2008. It's very important because of those unusual items to look at the details of our financial information.

Let’s go to our effective tax rate for the quarter. The effective tax rate was 14% for the third quarter and of course this includes the reversal of approximately $21 million of valuation allowances related to foreign net operating losses. Our operating expenses, as I just stated, also includes that $1.6 million of direct expenses related to achieving this benefit. And it's important to note that this tax benefit over the next few years will be realized as positive cash flow for the company over the next few years.

Excluding the overseas tax benefit, the effective tax rate for the third quarter was 32.5% and we also expect our effective tax rate to continue to be in the same range during the near term.

Income from continuing operations attributable to Henry Schein for the third quarter of 2009 was $94 million or $1.03 per diluted share, and both of these figures are up 39% compared to the third quarter of 2008. Our non-GAAP income from continuing operations was $72.9 million or $0.80 per share and that represents an increase of 3.3% and 3.9% respectively when compared to the third quarter of 2008. Again, please note that Exhibit B to our earnings release reconciles the GAAP net income to the non-GAAP net income.

As Stanley just mentioned when also excluding sales of seasonal flu vaccines, our non-GAAP diluted EPS from continuing operations was approximately 18% growth. So again this is our best estimate of the normalized growth excluding all of those unusual items and excluding the negative impact of lower influenza vaccine sales.

We believe that this is the most meaningful measurement of our performance during the quarter because the flu vaccine sales, while they are less this year; we do expect higher flu vaccine sales next year when production lows for such.

As we now provide some details on our sales of the third quarter and we look at our dental sales for the third quarter of 2009, they declined 3% to $622.1 million, consisting of 0.5% decline related to foreign currency exchange and a 2.5% decline in local currencies. Internally generated sales decreased 4.9% while acquisition growth was 2.4%.

Our consumable merchandise sales increased 1.3% in local currencies and that included a 1.8% decline of internal sales growth and a 3.1% growth due to acquisitions. We believe that this market continues to stabilize as our internal dental consumable merchandise sales were down approximately the same amount of 1.7% for the second quarter.

Our dental equipment sales decreased 12.8% compared to the prior year in local currencies and that includes a 13.4% decline internally generated and a 0.6% growth related to acquisitions. As we perviously indicated, this compares favorably with the second quarter of 2009, our last quarter, where that decline was 17.5%. And as we said, the second quarter decline did reflect a difficult comparison related to Q2 '08, but the favorable trends of rate third quarter are still meaningful, we believe.

If we look at our medical sales they were $410.6 million in the third quarter, a decrease of 3.1%. Our internally generated sales decrease was 4.2% and acquisition growth was 1.1%. During the quarter we sold approximately 6.5 million doses of seasonal influenza vaccines and that reprinted net sales of approximately $44 million for the quarter. This compares with approximately 10.5 million doses in the prior year's third quarter which represented sales of approximately $86 million last year.

As of today we have completed selling a total of approximately 8.5 million doses of seasonal influenza vaccine for 2009 and we do not expect to sell any significant amount of additional doses for the remainder of the year.

Excluding the sales of seasonal influenza vaccine, our internal medical sales increased by 8.6% and 7.2% of that growth was internally generated for the quarter. That 7.2% internal sales growth included about 3% which we estimate to be directly related to products related to the H1N1 virus and the balance of the growth was primarily due to strong sales of our medical group of consume products. On an overall basis we believe ether we gained market share in the medical arena and that's even excluding the incremental sales related to H1N1.

If we look to our veterinary customers which is part of our medical group, sales to our visionary customers reprints about 15% of our third quarter medical group sales and they were very strong up approximately 14% for the quarter, all of which was internally generated.

Turning to our international group, sales for the third quarter of 2009 were $583.5 million, up 8.5% compared with the prior year, and this consisted of 16.9% increase in local currencies and an 8.4% decline related to foreign currency exchange. Our internally generated sales increased 7% for the quarter and we had acquisition growth of 9.9% which was primarily related to the acquisitions of Novice in the Czech Republic, DNA Anthos in Italy and Media in Germany. We are very pleased to report very solid sales growth in local currencies in all of our major markets internationally.

We look at our technology and value added services sales for the third quarter of 2009, they were $43.2 million, up 5.4% compared with the rigor year. This consists of a 7.3% increase in local currencies and a 1.9% decline related to foreign currency exchange. Our internally generated sales increased 4.6% while acquisition growth was 2.7% and that acquisition growth primarily relates to an acquisition of the European veterinary software and practice monument business that we completed during the quarter. We also saw during the quarter within this group, strong continued growth in our electronic services business.

If we now turn to the balance sheet and cash flow, our operating cash flow for the quarter was $138.8 million and that compares to approximately $50 million in the prior year's third quarter. So we generated very strong cash flow for the quarter and we continue to expect to achieve operating cash flow for the year in excess of our net income.

We look at accounts receivable day sales outstanding from continuing operations they were 41 days for the third quarter of '09 and that compares to 41.3 days so a slight improvement compared to the third quarter of 2008 during a difficult economy. Our inventory turns from continuing operations for the third quarter were 6.3 turns and that compares to 6.6 turns from last year's third quarter.

We're also updating our 2009 guidance and it is as follows. For the fourth quarter of '09 we expect diluted EPS attributable to Henry Schein to be in the range of $0.89-$0.91 per share. That would bring our 2009 diluted EPS attributable to Henry Schein to approximately $3.14 to $3.16 and that excludes all of the unusual items in Exhibit B. I think it's important to note that this is well within the range of our original guide that we issued for 2009 about one year ago and obviously there were unusual and uncertain times that we issued this guidance and when we achieve this guidance that will represent a growth of approximately 8% compared with the restated 2008 results of $2.92. And last year also excluded the charges related to the Lehman Brothers bankruptcy a well as restructuring costs. So again, on a normalized basis, approximately 8% growth for the current year.

As always our 2009 guidance is for continued operations including completed or previously announced acquisitions and does not include the impact of any potential future acquisitions.

If we look now at our 2010 financial guidance we expect 2010 diluted EPS to be in the range of $3.40 to $3.56 and that represses an acceleration of growth to 8%-13% when compared to the midpoint of 2009 guidance. Our 2010 guidance is also from containing using operations and only includes completed or previously announced acquisitions.

Let me now turn the call back over to Stanley.

Stanley M. Bergman

Thank you, Steven. I'd like to begin my review of our business group’s part starting with the dental group. We continue to believe that the market for dental consumable merchandise has stabilized. More specifically, we believe this market contracted by low single-digit percentages compared with the prior year third quarter, but was largely flat sequentially. Our third quarter dental merchandise results are consistent with this trend. Aesthetic and elective procedures, we believe, continue to be impacted to a greater extent by the macroeconomic conditions. We believe we are beginning to see signs of improvement in the dental equipment market. Although sales are declining versus the prior year, our third quarter equipment sales are up modestly compared to the preceding quarter.

As I mentioned during lat quarter's call, we expected equipment sales declines to moderate somewhat during the third quarter and, of course, they have. In local currencies our third quarter decline of 12.8% compares favorably with a decline of 17.5 in the second quarter, although in the second quarter it was a little higher than it should have been because of the unusually high shipments of E4D in the second quarter of 2008 when we launched the product from a commercial point of view.

We continue to experience correlatively higher demand for lower-priced equipment products. Also, the sales of basic dental equipment continue to be impacted more severely than sales of high-tech dental equipment, specifically areas such as digital which is not as badly impacted, the digital x-ray, and this was both into arms of numbers of units sold and in dentist training down, of course to the lower priced options.

So overall we believe we continue to be gaining market share in a stabilizing dental US market both on the consumable side and on the equipment side and can say the same for our Canadian business. So in total we think we're doing better than others in our North Mercian dental business.

Now let's take a look at our medical group. We are very pleased with the strong results posted by our medical group during the quarter, with growth of 8.6% excluding the sale of seasonal flu vaccines. This included internal growth of 7.2% which consists of growth of 5.9% to our physician customers and 13.9% to our veterinary customers.

During the quartet we have strong sales of consumable products across the board, as well as sales of products related to the treatment and prevention of H1N1 virus and these relies to the visits primarily to physician offices.

During the third quarter we sold approximately 6.5 million doses of seasonal flu vaccine and as of today we have compiled selling approximately 8.5 million doses for the year. As you know, our manufacturers cut us back in terms of available product and so we have sold everything that we've received and are not contemplating, at this point, receiving additional seasonal flu vaccine. At least that's not what's in our guidance.

Now, if you we look at the H1N1 vaccine which has been in the news of course a great deal lately, I'd like to provide you with an overview of the situation and how it might affect Henry Schein. As you know, the H1N1 virus is a distinct strain of the seasonal influenza virus and vaccines now exist for both types of flu, namely the seasonal and the H1N1. The vaccine has been made available in both categories, for the current season.

The McKesson Corporation has previously announced that they will be distributing H1N1 vaccine with their primary role being to distribute the vaccine in bulk to sites designated by the state health departments. We believe that Henry Shin is well positioned to compliment the work of McKesson to ensure prompt delivery of H1N1 vaccine to certain end users, and we have already been awarded business by several US states to do this, including California, the largest.

These armaments are on a C for service basis and will be moderately profitable to us. In other words, the product is being given away free from the federal government and we will just be performing logistic services from McKesson to certain providers in the specific states. We may have the opportunity to work on behalf of additional states as well, although again, the logistics fees for doing this work is rather modest

As you know, earlier this year we entered into an exclusive agreement to market nationwide the All scripts Professional Health Record offering through the Henry Schein national medical sales force. I'm pleased to report that since our midterm launch we have exceeded our target in terms of the number of qualified EHR leads, and those leads are beginning to translate into sales. In addition, North Shore Long Island Jewish Hospital system, one of the nation's largest systems, recently announced it will deploy the EHR, the Electronic Health Record system, which we are partnering with all scripts to sell. Together we will market all scripts EHR Solutions to the more than 7,000 physicals in the New York, and Long Island area.

So the medical business overall, I think we're doing well, if you exclude the fact that we were not given the expected quantities of seasonal flu vaccine. The overall growth rate is 8.6% excluding sales of seasonal flu, and we think about a third of that relates to the sale of H1N1 suppliers. So overall we can see that on the medical side we are gaining market share in the sector focused on the physician practice.

Now let's take a look at our international group. We are pleased to report sales growth in local currencies of 17% with internal growth of 7%. Indeed we are very pleased with this performance. We had double digit local currency sales growth in our dental, medical, and veterinary international businesses during this quarter and believe that as Steve noted earlier on, we're gaining market share in each of the major markets we're active in; dental, medical, animal health.

We continue to leverage our pan-European infrastructure and we're realizing significant operating efficiencies over the coming years. These efficiencies will be increasingly important to our worldwide results as our international group represents a growing share of our company's operations. So here again on the international side we feel that we're gaining market share in all of the major markets. The international business remains an old business with great potential for the future, and so we believe that over time we'll be moving towards a situation where over half of our business will be generated outside of the North American customers.

Let me conclude my review of our business groups with a discussion on our technology and value added services group. This group once again posted positive growth in local currencies up 7%, technology sales were up more than 9%, software sales 5% up in local currencies, while our electronic services business was up 19%. This group is doing well, not only on the numeric side, but is providing terrific value added services to our dental and our veterinary customers providing greater service to those customers from an overall point of view. Of course on the medical side we do have a small company in that area, but are primarily focusing our efforts virtually exclusively through the all scripts relationship.

Our technology plays a key role in the overall business strategy. Not only do the products and services offered by this group help physicals to operate efficient practices and deliver high quality patient care, but oftentimes they are integral to serving advanced technology on the equipment side. They literally provide technology platforms for integrating various aspects of a practice, for storing, retrieving, sharing data, and ideally position Henry Schein for the sale of next generation high technology products.

So again, we are very, very pleased with what is happening in our advanced technology solutions area and very pleased with the management team running that business. So as a closing comment before we take questions, we brought a new senior level executive on board in late September with responsibitlies that affects several of our business group.

Lonnie Scoff joins Henry Schein in the newly created position of President of Henry Schein's Global Healthcare Specialties Group. She has joined our executive management committee and has direct reporting responsibility to me. Lonnie's proven leadership skills honed at Roche Diagnostics will help drive our company's future growth by increasing our focus on the pursuit of businesses that compliments our North American and international groups. Her portfolio will include building our specialty businesses in dental, medical, and animal health, and expanding our exclusive and semi-exclusive products and service offerings.

The newly formed Henry Schein Global Healthcare Service Group that Lonnie will lead reflects the strong entrepreneurial spirit that has driven our company since we were founded in 1932 and in fact, exhibited in the 14 years since we've been a public company, yesterday being the anniversary of us going public 14 years ago. This group will be instrumental as we continue to transform Henry Stein to become even more reliant to our customers around the world and help drive the success of our customers' practices. Lonnie will be responsible for Henry Schein's global dental specialties working closely with George Gut of (ph), President of our group. Lonnie will also have to be responsible for Henry Schein's global exclusive brands and sales on these businesses will, from a fiscal reporting point of view, continued to be reported as part of our dental, medical, and international groups, as well as our technology group.

So with that overview we feel that we're making and we continue to make very good progress, we're growing our market share, we had very good sales growth in our business units from a market share growth point of view. In local currencies we upped our operation margin 62 basis points, and if you take the 7% towline growth in local rerun, the 62% improvement in operation margin, you'll see that excluding flu and these one-time items, 18% earnings per share growth for the company in a time when the macroeconomic challenges are quite evident to all of us. So at this point let me ask if there are any questions that participants would like to ask. Thank you.

Question-and-Answer Session

Operator

(Operator's Instructions) The first question is from the line of Glen Santangelo with Credit Suisse.

Glen Santangelo - Credit Suisse

Yeah. Thanks for taking my questions, guys. I had just two quick questions. The first one, I was trying to understand the impact of currency on the quarter a little bit. I know on revenues it clearly impacted revenues by 5.9%, and Steve I think in your prepared remarks you were kind of going through and talking about some of the things on the expense side because the expenses were a little higher than what I would have thought, and in particular if I look at SG&A, you're kind of back to the levels where you were a year ago prior to all your cost cutting initiatives, so I was wondering if you could just elaborate on that at little bit more and maybe discuss how currency impacted it?

Steven Paladino

Okay. Well, currency definitely negatively impacted that. I know on a bottom-line basis, currency had a negative, just over $0.02 per share impact to our earnings per share. I don't have handy exactly what that did to the SG&A, but obviously that negatively impacted our SG&A lines as well.

There were a couple of other things that I think you should be aware of regarding our SG&A. One I talked about which the $1.6 million of expenses is related to achieving the foreign tax benefit. That's sitting in SG&A expenses. It cannot be netted against the tax line on the P&L. And also, there is expenses related to the change in accounting for acquisition activity and that also negatively impacted our SG&A line as well as our EPS line, and that was about $0.01 per share. And just to remind people, the new accounting rules require certain expenses related to — acquisition activity can now be expenses in the P&L versus historically they were considered purchase price and part of the purchase price so they did not go into your P&L.

So those are the few things that relate to why the expenses at least look like they're a bit higher, but in reality there is some normalization that you need to take into account.

Glen Santangelo - Credit Suisse

And so, Steve, is this a decent run rate or should these one-time items kind of dissipate and we should kind of trend back down to where we were the past couple of quarters?

Steven Paladino

Well, subject to foreign exchange translation which assuming it stays consistent to where it was in Q3 and excluding those expenses that are not expected to reoccur, the M&A expenses, I think were higher this quarter than typical quarters and certainly the tax expenses we expect to reoccur also. So I would say that yes, subject to those qualifications, the expense level should be consistent with this quarter.

Glen Santangelo - Credit Suisse

Great. And then maybe just my last followup, if you could just help us digest the fiscal '10 guidance a little bit more. You're obviously forecasting 8%-13% EPS growth. Are we assuming that you're saying some positive continued momentum on the dental side potentially back into positive territory, maybe a little bit of deceleration in terms of medical and international given how high those sales are. Any kind of details to help us get there would be helpful.

Steven Paladino

Well, I think there are a couple of things. First let's talk about foreign exchange. We are being conservative in our foreign exchange rates that we're using for our guidance. We are using a conversion rate that is less than what we are currently at. As you probably know the dollar has weakened pretty significantly. I think to the euro it's about $1.48, $1.49, something like that. We use a more conservative number for guidance purposes because obviously the predictability of that is difficult and our goal is to give guidance that is realistic and achievable. So that's baked in because that would be some headwind for our growth in 2010.

The other thing is that as far as sales, I think that although we still feel that in our markets that the worst is behind us, that the markets have stabilized, we're not assuming in our guidance any significant increases in sales growth, especially in the dental market. Although we do expect to gain market share, we're trying to be conservative in sales expectations because while we believe the worst is behind us, we believe that the recovery in our markets will be more gradual and it's really difficult to estimate exactly as to what extent the recovery will benefit us. So again there's a lot of uncertainty in the markets and we feel that to be conservative is very appropriate.

And again, we're well within the range of the guidance for 2009 that we gave a year ago and there were a lot of different changes and uncertainties related to the recession that we navigated through and still are expected to deliver an 8% bottom line in a normalized EPS growth. So hopefully that provides you a little bit of color.

Glen Santangelo - Credit Suisse

Okay. Thanks for the comments.

Operator

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

Lisa Gill - JPMorgan

Thanks very much. Steve, just following up on the 2010 guidance, can you maybe talk about what tour expectations are for any type of margin improvement? Historically you’ve talked about some basis point level of margin improvement. Is that built into your guidance? And then secondly, in your experience, how tied are dental sales to unemployment? So if we start to see unemployment somewhat flatten out, do we really need to have job creation before we really see those dental sales come back?

Steven Paladino

Okay. On your first question, we would expect continued operating margin expansion in 2010 and we are targeting a 30 to 50 basis point improvement in 2010. We still think there are significant benefits to be achieved, especially in our international operations, but throughout the whole company. So margin expansion is still something we're very comfortable with going forward for the next several years.

As far as dental and unemployment, we do think that there is a good correlation between unemployment and dental numbers and I would say that at today's level, as long as unemployment doesn't dramatically increase, we think that unit sales will probably be relatively stable on the consumable side.

New equipment we believe has more to do with lack of customer confidence in making capital purchases than the actual economics of what's going on in the dental practice. Because obviously while the dental market is down slightly, maybe low single digits for the year and most dental practices are making slightly less than they were, save some of the high end specialty areas, the average practice is still doing quite well. And to have such a holdback in equipment really is just — and again in our opinion not related to economics, but related to sentiment and lack of confidence.

At some point we believe that that pent up demand for equipment will be coming out and will be a benefit to us.

Lisa Gill - JPMorgan

Will you see any of that in the fourth quarter? I know there are still some tax incentives that are still in place for this year, are you starting to see any demand as we get through October and into November for equipment for tax incentives for this year, or not really?

Steven Paladino

I think there could be some small benefit related to taxes this year because it's always a benefit and there’s reduction planned of tax benefits expected. But I do think it's still a little too early to expect that we're going to see a major turnaround in equipment sales in Q4. I think it's really a sometime in 2010 event.

Lisa Gill - JPMorgan

Okay. And then just one last followup to the 30-50 basis point margin improvement, can you just talk about primarily where that's coming from? Is it a mix of business? Is it that some of the expenses you took out earlier this year — how should we being thinking about modeling that?

Stanley M. Bergman

Well, it's not related to mix to any large extent. It is related to ongoing efforts both internationally and domestically to expand margins. I think people on this call know very well that we had a long-term goal internationally to have our operation margins expand to just over 6%. We've made good progress with that, but still more room to grow on operating margins internationally. That should be a bigger growth in margin expansion than US, but we still believe our expense management, both domestically and holding our cost down, will help contribute to margin expansion in the US. We're always looking to be more efficient and put in technology solutions that reduce expenses so there is an opportunity on sales mix should we gravitate to more higher margin products, but that's not assumed because we don't expect any dramatic changes in sales mix for next year.

Operator

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

John Kreger - William Blair

Hi, thanks very much. Just to followup on Lisa's question, if you kind of look back at '09 it seems like you're going to get about 8% earnings growth on flattish revenue, it seems like at least in part due to some of those cost savings initiatives you put in places about a year ago. You're now telling us you think you'll have better growth in 2010. Steve, can you maybe just expand a little bit more on are you assuming a gradual market improvement during 2010 to drive that earnings growth improvement or will this be more about further cost savings and efficiency improvement within the company?

Steven Paladino

Well, we're not expecting to do any major cost saving initiatives at this time. We do expect that because of the comparables in '09 being lower; we do expect that we'll have sales growth in organic sales growth in 2010. We do expect that the markets will recover slightly from where they are, but we're really trying to be conservative on that, but effectively we do expect to get organic sales growth in 2010 and we really didn't get that in 2009. We're up 0%-1% organically in constant currency.

We do expect continuation of good results in our medical and international businesses. They performed very well and I think sometimes that gets lost when looking at our numbers, so I point that out. And again, we're really going to manage our expenses very tightly because the economy is still what it is and while we think the worst is behind us, it's still not back to normal times.

John Kreger - William Blair

Great. Thanks. And then just a quick followup, gross margin, seemed like the year over year decline was little bit more than what we've seen in the last couple of quarters. Was that mix or anything else driving it?

Steven Paladino

Well it's mix and don’t forget, flu vaccine sales are down almost 50%. Everyone knows that as higher margin product and they're down 50% this year versus last year, partly because of timing because compared to last year, but mostly because of fewer products that we received from our key manufacturer.

John Kreger - William Blair

So if we would ignore flu vaccine would it be reasonable to assume that gross margin performance was pretty comparable to last quarter?

Steven Paladino

I didn't do the math on it. I know that was a bight contributing factor so I don't know precisely, but I certainly know that that was a big contributing factor.

John Kreger - William Blair

Great. Thanks very much.

Operator

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

Jeff Johnson - Robert W. Baird

Thank you. Good morning, guys. Wondering if I can touch on Q4 guide at all? Steve, it looks like you guys are kind of assuming 2%-4% EPS growth and if I back out lower flu vaccine I think Q4 last year it was three or four pennies of flu vaccine and assume maybe a penny this quarter. So if I normalize for that maybe 3%-6% EPS growth in your Q4 guidance, so just trying to figure out or reconcile that with the 18% EPS growth you delivered this quarter on an ex-flu vaccine basis, why the stepdown sequentially?

Steven Paladino

Yeah. We haven't done it yet. We talked about the 18%, but we haven't done it because we typically don’t like to say our flu profits this year are X and last year were Y. And again, while you're running estimates I would ay that a similar thing is true and that that flu is the big driver of why profits on a year over year basis for Q4 aren’t showing up — it's more optics than reality.

And let me just explain a little bit why. While there was a little bit of as shortage in seasonal flu vaccine this year, we also saw our average sell price, and if you do the math on the number of doses we sold, it was about $70 per dose versus $84 per dose last year for Q3. So you have those data points here and you can do same math.

So obviously a low sealing price and the reason for that was we quoted prices well before knowing what amount of flu vaccine we were expecting to receive, and we made a business decision that although we probably have some opportunity to sell at average higher resell price to customers, we felt that the incremental revenue based on what we quoted at versus the long-term customer relationship, it didn't make sense to do that.

So as part of our numbers we're actually seeing a lower average sell price this year than we were originally expecting.

Jeff Johnson - Robert W. Baird

All right. Great, that's helpful. And then the followup to that, and it'll just be this follow-up, I'm assuming you'll quote higher for next year than given the demand that was there this year and what have you. You also talked about maybe some additional flu in 2010 I think you mentioned in the prepared remakes. So how do we think about the impact of influenza vaccine on your 2010 guidance that is the 8%-13% growth? Is that adding a nickel in 2010 relative to 2009 or just can you ballpark that at all for us?

Stanley M. Bergman

Well, let me say it this way because again, we prefer not to give specific net income on specific products, but we do believe that we'll probably be selling somewhere between 12-14 million doses this year versus the 8.5 million this year. So hopefully that will help you on determining the impact of that.

Jeff Johnson - Robert W. Baird

Okay. And just a last clarifying question, the acquisition cost you referred to in SG&A in the quarter, is that related to the European software deal this quarter? I’m assuming that's not related back to the other three deals that were done late '08?

Steven Paladino

No. It's in part related to the European vet deal, it's in part related to in-process transactions. Because today as you’re looking at transactions you have to expense as incurred. So you're expensing items before any acquisitions are completed. So it's a combination of both and it’s just that the activity, as we said recently, the acquisition pipeline continues to be very strong, we continue to see a lot of different opportunities and those expenses or professional fees primarily, in order to evaluate acquisitions have to be expensed when in prior years they were part of purchase price and deferred as purchase price.

Jeff Johnson - Robert W. Baird

Okay. So just so I understand, if you were doing due diligence on a sizable deal that didn't happen this quarter, those expenses of the due diligence would still fall through on the model?

Steven Paladino

That's correct. It's any expense, due diligence, professional eyes, evaluation fees — any expense incurred needs to be expensed when incurred so that the period that you incur it and you can't defer it until the acquisition is completed or not completed.

Jeff Johnson - Robert W. Baird

Understood, thank you.

Operator

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

Derek Leckow - Barrington Research

Thank you, good morning. My question is on the dental equipment sales comments. I mean, I want to make sure I understand your comments relative to the industry commentary that you provided, Stanley, and also some of the more specific items that relate to comparisons of last year. Is there a way you can provide sort of a mix commentary talking about the base equipment versus some of the high-tech products which actually fall into a different category if I look at this correctly?

Stanley M. Bergman

I think without getting to detailed, the decline is much less on the digital side. E4D is in positive territory, BIOLASE is quite a bit down, although the decline is improving quite nicely. On the ISI side there is some decline although it’s to as much as it was. And the area that there is quite a bit of decline is on the high-tech side of laboratory equipment, although we expect to have that moderated quite significantly and probably improved as E4D launches its laboratory version.

The positional side is down more or less in line with the overall market, so I'm not sure if that's —

Derek Leckow - Barrington Research

Yeah, Stanley. That' very helpful. I just wanted to understand your comments relative to market share because you said you were gaining market share, but I just want to make sure I talk about the right categories here because it looks like we're seeing actually some market share go the other way as it creates to some of those digital products.

Stanley M. Bergman

Yeah. There's so little data available and one has to be very, very careful. Some of the numbers that are reported by our competitors or even by the databases are not necessarily apples to apples. There are upgrades involved. So we're comfortless that overall on both the consumable side in North America and on the equipment side we are gaining market share, but I think it's very difficult to pinpoint it to a particular category.

Derek Leckow - Barrington Research

Well, I was trying to separate the basic equipment here which we all know was relatively soft, but still stabilizing, and I think the commentary around some of the financing as well as the tax incentives hopefully will provide some turn and certainly the comparisons will get a little easier in that category. Would you agree with that?

Stanley M. Bergman

Yeah. I think baring nothing unusual like a significant decline in the stock market or something like that; I think the mood out there is a lot better. The ADA meeting in Hawaii wasn't helpful this year because there weren't too many customers, but I think it looks like we're going to have a very good — a greater New York meeting, and we're quite optimistic about the Chicago meeting. So if there's hesitation here it's only because it's so hard to predict the short-term mood. There's demand for output, no question, but are they going to buy it this quarter or next quarter, it's very hard to tell. There is lot of interest.

Derek Leckow - Barrington Research

And are you guys providing any additional financing promotions right now or is there anything in the works that might help to get some of those decisions made a little bit earlier?

Stanley M. Bergman

Well, we always have good financing deals in the fourth quarter. I think the programs we have for the fourth quarter will be as competitive as in the past. I don't think we will lose a deal because of financing. There's a slight decrease in the number of deals that are approved, but nothing material. 100-200 basis points, instead of approving 91%, we're getting approval for 89% or so of deals requested.

Derek Leckow - Barrington Research

Okay. Thanks a lot.

Operator

Y our next question is from the line of Larry Marsh with Barclays Capital.

Larry Marsh - Barclays Capital

Thanks and good morning, and if you addressed any of this, Steve and Stanley, please let me know as I missed the very beginning of the call. First back to seasonal and swine flu, Steve, thanks for the detail about this year. You're communicating 12-14 million doses for next year. I would assume that you're building in some conservative assumptions on margins so that it wouldn't be back to the levels of margins you got in 2008. I just wanted to confirm that. And then if that's the case, even if it was half the margins, it seems like if you back out the effect of flu then you're only guiding to sort of 7%-8% earnings growth apart from that, so just any more clarification on that would be great.

Steven Paladino

Well yeah, I don't want to go through the specifics but certainly we are trying to be conservative on margins on flu vaccine, because quite frankly until sometime mid-next year it's really hard to assess supply and demand and pricing. So it's important to be conservative this way that we don't have any expected downside that if anything we just have some potential upside. So that is the way we put together our guidance for this year.

Larry Marsh - Barclays Capital

I see. And I assume that means you're pretty conservative with what you think average selling price would be as well.

Steven Paladino

That's correct.

Larry Marsh - Barclays Capital

Second question, Stanley, you sort of think about your international markets and certainly the largest single market for many, including yourselves, Germany. In your thinking of 2010, is there any expectation of any reimbursement changes post the election this year or do you feel like based on everything, you know there's not going to be any potential pressure on reimbursement changes there?

Stanley M. Bergman

We don't expect any dental reimbursement changes at all, in fact, at this time. The mood amongst dentists in Germany is pretty good. Our business is pretty good. The manufacturers have good products, both Kayo (ph) and Serono have good products, some of the others too. And overall our business is quite good on the full service side and even on the mail order side. So there's always a possibility on the medical side of some reimbursement changes, but really this is not material to Henry Shine.

Larry Marsh - Barclays Capital

Great, thank you. And just want to confirm, Stanley, I know earlier this year you had called out what you thought would be a trade down phenomenon on equipment, I know a couple of months ago your feeling was maybe a little bit more confident, but do you still have a view that those customers are still looking to trade down or do you think that's really topped?

Stanley M. Bergman

I think the trade down is still there, but it's not as market. I do think we are seeing good bites at the more expensive equipment at least relatively expensive because of course in the US the type of equipment sold is nowhere near as expensive as in Europe, but I think it's more or less stabilized. And I might add, by the way, on the consumer side on the dental side, the switch to private brand is also moderated, not the case on the medical side where it's up gain significantly, but on the dental side it seems like the switch towards private brand is moderated.

Larry Marsh - Barclays Capital

Okay, thank you. And then finally, Steve, you called out a penny of transaction costs that you now have to expense in the quarter, did you say how much of an expense you anticipate that to be for all of 2009 and are you kind of giving any ballpark or what do you think that's going to be, a bit higher or about the same, for 2010?

Steven Paladino

We're probably just assuming a very similar run rate because as you could imagine, it's really difficult to predict because acquisitions are lumpy as far as the timing of when activity occurs. So we're assuming really just a similar run rate for 2010 as 2009.

Larry Marsh - Barclays Capital

But the penny is that quarter or do we annualize that and say about $0.04-$0.05 for 2009?

Steven Paladino

No, I don't think we'd be annualizing it. I think what happened this quarter and the reason why I called it out is where again, the lumpiness just seemed that a lot of costs all hit in Q3 and that all is not expected to be the norm so I would not say that we would expect a run rate of a penny per quarter. Probably a little bit more than a penny for a full year basis, but not annualized at that rate.

Larry Marsh - Barclays Capital

Okay. And just want to clarify, you're saying in your expectations, Steve, that to be conservative you're assuming currency is a headwind for 2010 versus 2009?

Steven Paladino

Yeah. Well, if you look at where the euro is to the dollar today, it's a tailwind, but we're not assuming a tailwind because it's a long time for the year and it's just hard to assume that it's going to stay exactly where it is today. It's possible where it is, but we are assuming a light headwind, yes. And that's again trying to be conservative, because that's something that if you speak to 10 economics you'll get 10 opinions on where the dollar is going to settle on average for the year.

Larry Marsh - Barclays Capital

Right, okay. But again you're saying a little bit of a headwind, maybe a couple of cents, $0.10 versus $0.09?

Steven Paladino

That's correct.

Larry Marsh - Barclays Capital

Okay, thank you.

Operator

We have time for one last question. Your last question comes from the line of Randall Stan icky with Goldman Sachs.

Alex Becker - Goldman Sachs

Hi. It's actually Alex Becker for Randall. Just a couple of quick questions from me. One, I think you guys are actually in a net cash position as of the end of the quarter, can you talk about what the longer-term capital structure targets are and what you have assumed for 2010?

Steven Paladino

Sure. Well remember, our guidance — we would still say that we still see good opportunities in fragmented markets to continue to consolidate in all of the markets that we're in so our cash flow would continue to go to grow the business primarily for acquisitions. We do think that although we haven't lately bought back any stock, we do think that a stock buyback is still in our plans going forward.

So the fact that we have a very strong balance sheet I think is a very good thing in today's market and economy and we would look to continue to use the capital as I just said. We're really not looking to significantly lever the business from where it is although a little bit more use of capital for strategic acquisitions and goring the business would certainly be a good thing.

Alex Becker - Goldman Sachs

Okay. And just to be clear, you have not ass used any share buybacks in your 2010 guidance, correct?

Steven Paladino

That's right.

Alex Becker - Goldman Sachs

Okay. And just a quick followup, do you have any sense for the size of the cash flow benefit that would result from your foreign tax restructuring? I think you alluded to it earlier in the call.

Steven Paladino

Oh yes, well of that $20 some odd million will be realized in positive cash flow, effectively — it's not cash flow in, it's reduction of income tax payments so it's virtually the same thing, over the next few years. So it won't all be one year, but it'll be over the next few years.

Alex Becker - Goldman Sachs

Got it. Do you know when you will begin to see the benefit?

Steven Paladino

Starting in 2010.

Alex Becker - Goldman Sachs

Okay, great. Thank you very much.

Stanley M. Bergman

Thank you everyone for participating in this call. I think you can see that our core business on the dental North American side, the US medical side, including our animal health business, our international group, our practice solutions group, and in general our business is making good progress across the board in terms of local currency sales, in terms of operating margin improvements, in terms of earnings per share excluding the impact of flu and these one-time net benefits on a tax side.

All of that, if you take that into account, 18% earnings per share growth and the cash flow for the year to date is very good. So we feel like we're making good progress, we're very happy with our report, and thank you all for participating in the call. Of course, if you have any questions, Steven can be reached at 631-843-5915, and Susan at the same number except it's 5562 as the last four digits. So thank you very much and we'll be back in about 90 day’s time. And for that shareholder who’s have been with us since we've been public, thank you very much for 14 years of support. Thank you.

Operator

This concludes today's call. You may now disconnect.

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Source: Henry Schein Q3 2009 Earnings Call Transcript
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