Henry Schein's (HSIC) CEO Stanley Bergman on Q2 2014 Results - Earnings Call Transcript

| About: Henry Schein, (HSIC)

Henry Schein, Inc. (NASDAQ:HSIC)

Q2 2014 Earnings Conference Call

August 04, 2014, 10:00 AM ET


Carolynne Borders - VP of Investor Relations

Stanley Bergman - Executive Chairman and CEO

Steven Paladino - CFO, Principal Accounting Officer, EVP and Executive Director


Michael Cherny - ISI Group

Robert Jones - Goldman Sachs

Kevin Ellich - Piper Jaffrey

Jeff Bailin - Crédit Suisse

Jonathan Block - Stifel, Nicolaus

Jeffrey Johnson - Robert W. Baird

John Kreger - William Blair


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, this call is being recorded.

I would now like to introduce your host for today's call, Carolynne Borders, Henry Schein's Vice President of Investor Relations. Please go ahead, Carolynne.

Carolynne Borders

Thank you, and my thanks to each of you for joining us to discuss Henry Schein's results for the second quarter of 2014. 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 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. These forward-looking statements are qualified in their entirety by the cautionary statements contained in Henry Schein's filings with the Securities and Exchange Commission. In addition, all comments about the markets we serve, including growth rates and market share, are based upon the company's internal analysis and estimates.

The content of this conference call contains time-sensitive information that is accurate only as of the date of the live broadcast, August 4, 2014. Henry Schein undertakes no obligation to revise or update any forward-looking statements to reflect events or circumstances after the date of this call. (Operator Instructions)

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

Stanley Bergman

Thank you, Carolynne. Good morning, everyone, and thank you for joining us. Our sales for the second quarter was solid as we posted broad based gains on a global basis. In fact, internal sales growth in local currencies of 4.3% was the highest we have reported since the fourth quarter of 2012.

Our domestic sales rebounded from the effects of the severe winter weather in the preceding quarter. And also this is the quarter that should be compared to the IDS sales of 2013, which was a very good quarter from a Dental equipment and specifically an International Dental equipment growth point of view.

Having achieved year -to-date diluted EPS ahead of our expectations, we are also pleased to be raising the lower end of 2014 financial guidance range by $0.04. So overall we are pleased with our performance in the quarter, a steady growth in market share in all of our business units, and we'll provide further comments as the call goes on.

So, let me start by asking Steven to provide comments on the financial results, and then I'll come back with some comments on the business in general. Thank you.

Steven Paladino

Okay. Thank you, Stan, and good morning to all. I am also pleased to report solid results for the second quarter of 2014. As we begin, I'd like to point out that in 2014 both Easter and Passover holidays occurred in the second quarter, whereas in 2013 they both fell in the first quarter.

The Easter holiday in particular has a more pronounced effect in certain international markets resulting in one less selling day because Good Friday is a national holiday in Canada and many European countries.

So, now turning to our Q2 results, our net sales for the quarter ended June 28, 2014, were $2.6 billion, reflecting a 9.3% increase compared with the second quarter of 2013. This consisted of 7.9% growth in local currencies and 1.4% growth related to foreign currency exchange.

In local currencies, our internally generated sales increased 4.3% and acquisition growth contributed 3.6%. You can see the details of our sales growth that are contained in Exhibit A of our earnings news release that was issued this morning.

Our operating margin for the second quarter of 2014 was 6.9%, that's a decline of 45 basis points compared with the second quarter of 2013. When excluding the impact of acquisitions completed during the past 12 months and related expenses, our operating margin contracted by 27 basis points, and that 27-basis-point contraction includes an improvement in operating expenses as a percent of sales of 32 basis points, offset by a contraction in gross margin of 59 basis points. The gross margin decline is primarily related to changes in sales mix in our businesses across all of our four groups of businesses.

Our effective tax rate for the quarter was 30.8%, which is down from 31.4% in the second quarter of 2013 and is in line with the guidance that we previously gave. The lower tax rate is due to continued implementation of tax planning strategies and also higher earnings in countries with lower corporate tax rate. We expect the effective tax rate for the remainder of the year to be in the 30% to 31% range.

Net income attributable to Henry Schein for the second quarter of 2014 was $116.2 million or $1.35 per diluted share. This represents growth of 7.2% and 9.8% respectively, compared with the second quarter of 2013.

Our foreign currency exchange did not have any material impact on our EPS for the quarter.

Let me provide some detail for our sales results for the second quarter. Dental sales for the second quarter of 2014 increased 8.6% to $1.4 billion. This 8.6% growth consisted of 7.5% growth in local currencies and 1.1% gain related to foreign currency exchange.

If you look at local currencies, internally generated locally currency sales growth was 2.6% and acquisition growth contributed 4.9%, and that's primarily related to both BioHorizons and Arseus acquisitions that were completed.

The 2.6% internal growth in local currencies consisted of 4.3% growth in North America, while international sales were flat. If you look at some detail behind each of North American International, the 4.3% internal growth in local currencies in North America included 2.5% growth in sales of Dental consumable merchandise and 10.8% growth in Dental equipment sales and service revenue.

The internal international growth in local currencies included 2.1% growth in consumable merchandize, but a decline in equipment sales and service revenue of 5.5%. That's again due to the timing of the biennial IDS trade show in Germany, which made for a difficult comparison in the prior year as well as some impact of the Easter and Passover holidays.

If we look at Animal Health sales, there were $754.5 million in the second quarter, an increase of 13.2%, that included growth of 10.7% in local currencies and 2.5% related to foreign currency.

Our internal sales growth and local currencies were 7.3% and acquisitions contributed an additional 3.4%. If we look at the component of that 7.3% internal growth in local currencies, it included 7.9% growth in North America and 6.8% growth internationally.

If you also normalize for the impact of business switching from agency sales to standard or normal sales, our North American sales growth was 5.6%.

Medical sales were $403.3 million in the second quarter, an increase of 4.0%, and that is represented by 3.7% growth in local currencies and a 0.3% growth related to foreign currency.

The 3.7% internal growth in local currencies included 3.9% in North America and a slight decline of 1.4% International. We remain confident that our strategy of focusing on large group practices continue to result in market share growth this quarter in the Medical segment.

Turning to Technology and Value-Added Services sales, they were $89.1 million in the quarter, an increase of 14.2%, and this included 13.2% growth in local currencies and an additional 1.0% growth related to foreign currency.

The local currency internally generated sales increased by 9.3% and acquisition growth was 3.9%. The 9.3% growth internally included 8.5% in North America growth and 14.4% growth in international.

If you again normalize for sales results to account for a switch to agency sales, our internal growth in local currencies was 14.4% in the technology business. We're really very pleased with that double-digit normalized sales growth in the Technology and Value-Added Services businesses, and we had strong growth also in financial services sub-segment of that category.

Related to stock repurchase, we continue to repurchase our common stock in the open market during the second quarter. Specifically, we repurchased 654,000 shares during the quarter at an average price of $116.43, or about $76 million. The impact of this repurchase on the second quarter diluted EPS was not material. And we continue to have money authorized for future repurchases. At the close of the second quarter, we had $148 million authorized and available for future repurchases and we remain committed to our goal of continuing to repurchase and to repurchase somewhere between $200 and $300 million of our stock for the full year.

If we take a brief look at some of the highlights of our balance sheet, operating cash flow for the quarter was $199.2 million that compares to $274.8 million in 2013 second quarter. We believe our full year operating cash flow will continue to be strong.

Some components, accounts receivable days sales outstanding was about 40.2 days compared to 39.5 days last year and inventory returns was 6.0 turns compared to 6.2 turns last year.

I'll conclude my remarks by discussing our 2014 financial guidance. For 2014, we now expect diluted EPS attributable to Henry Schein to be $5.33 to $5.39, and as Stanley said earlier this represents a $0.04 increase in the low-end of our range and our guidance now reflects growth of 8% to 9% compared with 2013 results, when you exclude that onetime item in 2013 and that again compares with our previously issued guidance of 5.29 to 5.39.

As always our current year guidance is for continuing operations as well as completed or previously announced acquisitions, but does not include any potential new acquisitions.

With that, I'd like to turn the call back over to Stanley.

Stanley Bergman

Thank you, Steven. Let me begin my review of business groups with the Dental group. We gained market share in our Dental group with total U.S. dollar growth in North America exceeding 8% and above 9% internationally.

North America internal merchandize sales growth was bolstered by strategic acquisitions and equipment sales of service revenue growth in local currency was quite good, was nearly 11%.

While sales of traditional equipment was strong, growth was even stronger in the high-tech equipment arena and was led by our PlanScan/E4D CAD/CAM product.

International Dental growth also reflects a strategic acquisitions while internal equipment sales and service revenue in local currency declined by few percentage point from a stronger play comparison that of course was driven by the biennial IDS show in Congress and Germany as Steven mentioned earlier on.

During the quarter, we entered into the Brazilian Dental market by a 50% ownership investment in Dental Speed Graph. This is our first operation in South America and bring a number of countries where Henry Schein has operations affiliates on the ground to 27%.

Dental Speed Graph is the largest direct marketing provider of Dental consumable merchandize in Brazil with a robust e-commerce platform, 2013 sales of approximately $28 million. Dental Speed Graph has 170 team members and approximately 55, 000 customers in Brazil.

We have long sort to establish a presence in Brazil which is Latin America's largest economy and the seventh largest economy in the world. Brazil has an estimate 150,000 [assistant] (ph) dentist who serve a market, whose growth is being filled by aging population and extending middle class. That is also a keen awareness in Brazil of the importance of ROK and we're very, very excited about our entry into the Brazilian market and a quite optimistic about opportunities in Brazil in general.

During the quarter we also completed a notable Dental transaction in Europe. In early June we acquired Sirona Direct which is the Dental distribution business of Serino Dental Systems in France. Sirona Direct is exclusive distributor of Dental equipment for Serino Dental Systems in Paris and Normandy, and has annual sales of approximately $14 million.

We also entered into an exclusive distribution agreement with Serino for the promotion and distribution of the full line of Dental equipment to practitioners in most of France including of the CEREC CAD/CAM system.

We finished it by thus other businesses in France with the exclusive regional distribution agreements of products manufacturing in Barcelona. Today, Henry Schein is established as Serino's exclusive distributor to practitioner across most of the France which is one of the largest European markets for Dental products, approximately 36,000 dentists serving a population of almost 66 million people.

We are committed to providing the French Dental community as we are throughout the world actually with the comprehensive offering to meet all of its practise needs. Serino's innovative products are an important part of our connected Dental platform which is designed to bring the latest digital Dental solutions to practitioners we serve in this quickly changing Dental marketplace.

Very pleased that we now have a rounded offering throughout the French market and this is a market that's been good for Henry Schein for well over a decade and half, very, very exciting.

Now on the Animal Health side. We also gained market share in this group in the quarter with internal sales growth in local currencies at its highest level in six quarters. There was a late start to the parasiticide season in the U.S. this year. Of course we know this was in winter but domestic sales growth returned to normal in the second quarter.

On the international front, internal Animal debt sales growth in local currencies was at a multi record high.

We also significantly strengthened our position in the U.S. acquiring products and market with the acquisitions of approximately 60% ownership in SmartPak which is completed early in the third quarter.

SmartPak is the leading domestic provided equine supplements and horse suppliers with sales of 2013 of approximately $105 million and 325 team members [indiscernible].

A really fantastic company, a lot of energy, a lot of sales activity and of course the market leader in its segment. The primary product is patented SmartPak supplement feeding system which provides equine supplements in customized ready dose packaging. The company offers more than 250 branded equine supplements including its proprietary smart supplements brand.

SmartPak also offers a broad range of equestrian supplies and accessories, like a power and lighting equipment, pharmaceutical and other equine and canine focused products.

We are fortunate to have acquired a majority ownership position in this fast growing company with a deep-deep commitment to equine health and a keen expertise in sales and unique expertise in the digital marketing arena too.

So that's the wholesales and digital marketing arena, plus the equine offering that makes us feel excited about those business which has a fantastic management team and organization in general.

In fact, SmartPak is a leading company in this e-commerce environment. SmartPak at Henry Schein share a strong commitment to supporting Animal nutrition and raising awareness of nutrition's, viral impact on overall horse health.

Let me now turn to our Medical business. North America as I think most of our shareholders know represents 95% of the total medical growth, - of total medical sales group – medical group sales.

Sales growth accelerated sharply from the preceding quarter as we have current impacted weather, and more importantly made progress with our strategic focus on large group practises and IDN, Integrated Delivery Networks.

Looking to the upcoming flu season, I'm pleased to report that pre-booking of seasonal influenza vaccines are running in-line with the prior year. We do expect to distribute 8 million to 9 million doses in the upcoming flu season.

During the second quarter we announced its strategic agreement with Athenahealth. Together our two companies will help physicians operate efficient, successful practises, as well as course at using technology and other consultative service to provide high quality care through the delivery and use of athenaOne suite of services.

These services include electronic health records, integrated revenue cycle management and patient communication. We will jointly market the services to Henry Schein's customers as part of our health connect offering, which helps physicians advance the digitalization of the practises.

We are extremely committed to being a trusted advisor to our medical customers. And to help its practitioners operate successful practices distinguished by improved patient outcomes and patient efficiency.

On a forward looking open, cloud-based platform is a great compliment – our platform is a great compliment to many technological driven solutions we currently offer. So, the arrangement with Athena in the end takes our Henry Schein know-how connections with our customers and compliments that with this arrangement we now have with Athena, we believe the leading provider of these kinds of services to the physician practice.

We are very pleased with the progress in our Medical business, specifically the progress we are making with large group practices and the regular gaining recognition we are experiencing amongst IDNs and very, very excited as we move as a company forward in this arena.

Now, let me conclude my business overview with the Technology and Value-Added Services. Sales growth accelerated in North America compared with the preceding quarter due to its highest level in more than a year, with particular strength in software sales and financial services.

Very pleased with this Group. Of course this is a very profitable Group but more importantly our Technology and Value-Added services group provides enormous stickiness to our customers and is the key way in which we provide consultative services supporting in related technology and so to provide a lot of advice and value-added services to compliment our trusted advisor status within the practice.

We continue also by the way to be very pleased with the performance of internationally group with double-digit internal in local currencies for the past six quarters.

So, we'll open the call to questions in a minute. Let me just share two recent corporate developments with you here today. First the 2014 Fortune 500 ranking of America's largest corporation has recently been issued.

Henry Schein is now number 292 on the list up from 296 in last year's ranking. To climb two spots on the Fortune 500 list in less than a decade, - 200 spots in the Fortune 500 list in less than a decade of course and remembering the markets that we serve are not the huge consumer markets et cetera but the office base practitioner market.

So to climb this 200 spots on the Fortune 500 list in less than a decade is testament to Henry Schein's and team Schein's hard work. And to our success implementing a strategic plan that focuses on many customer needs to value added products and services in new technology coupled with our terrific culture and values in the company, putting this all those together leading in the end creates the momentum that has resulted in Henry Schein having such a good track record.

By the way, this marks our 75th call as a public company and we are very pleased and proud of our track record. And let me take this opportunity to thank all of team Schein, and our Board for the tremendous support to our shareholders as well over the last 75 quarters.

So let me also now just give you an update on our Board. In early June, we announced Dr. Dianne Rekow was elected to the Henry Schein Board of Directors. We are truly fortunate to have Dianne Rekow joined us as Director. Of course she is a prominent Dean, quite active in the Dental academic and clinical environment.

But it was Dianne Rekow who played a key role in pioneering, key pioneering role in the field of Digital Dentistry. An expert in the development and performance of new materials and products were used in aesthetic and restorative dentistry and a global sought leader in Dental education.

Dianne Rekow is Dean of Kings College London Dental Institute and a Professor of Orthodontics. She previously was the professor of Orthodontics at NYU, - who was previously an Professor of Orthodontics NYU.

For more than a decade has experience in Management of Dental of educational institutes in general, commercial experience in previous position, so clearly Dr. Rekow brings a wealth of not only Dental experience but global Dental experience and general business experience to Henry Schein. Let me also take this opportunity to thank [indiscernible] for her service on the Henry Schein Board.

So, with that overview of our quarterly financial operating performance, I'd like to thank you for your attention this morning. And Steven and I are now ready to answer any questions which you may have.

Carolynne Borders

And [Julie], we are ready to take questions.

Question-and-Answer Session


(Operator Instructions) Your first question comes from the line of Michael Cherny of ISI Group.

Michael Cherny - ISI Group

Hi, good morning, guys.

Stanley Bergman

Good morning.

Michael Cherny - ISI Group

So, I wanted to dig in a little bit -- obviously there was a release out last week from IDEX related to -- or the week before -- I guess their distribution agreement designed to go direct. You did quantify what you thought the impact would be from a -- specifically pulling that out of your arrangements, but as you think about planning to offset some of that with other items, how far in advance do you start to plan -- do you start the process of identifying partners you want to work with? And how far in advance can you start to actually move some of those additional products or replacement products through your channel?

Stanley Bergman

Thanks for your question. It's a very good question, and Henry Schein is committed and has been committed to providing a full array of products and related services to our customers in all three groups. This is not the first time at all where the manufacturer has decided to change distribution arrangements with us. We are extremely confident that we will not lose our market share in Animal Health globally.

We remain confident that we will provide an outstanding offering of products, in this case products means equipment and consumables and related software to our customers. And I think in the end, Henry Schein will be a much stronger company in the Animal Health space, and I'm quite sure that our customers will be pleased with the offering.

Obviously, I can't discuss today the exact plans we have, but you can remain sure we are comfortable that Henry Schein will have an outstanding offering of products for our Animal Health customers in this country and abroad.

Michael Cherny - ISI Group

Great. And then just one quick question on the CAD/CAM development. As you think about the E4D rollout, obviously you had a very big launch with that product back at the New York Dental Show, at least in December. How -- when you go into these products, are they more replacements for offices that are already doing in-office CAD/CAM, or is this you penetrating what would be more of a greenfield market?

Stanley Bergman

The market for digitalized industry is relatively underpenetrated. On a global basis, it's hard to get an exact number, but it's someway around the higher-single digits, maybe low-double digits, and it is our view and if one speaks to the experts in Dentistry that at some point within the next decade or so, this digital dentistry for prosthetics and the connection of the Dental office digitally to the Dental laboratory, this whole area will become standard of care.

There's a huge amount of activity going on here from software to different forms of devices, the scanner, various kinds of software, different milling solutions, both in-office, in the lab, as well as all sorts of materials.

So, this is a huge market, and one needs to look at the market not in terms of one device, one product, or a couple of devices put together or maybe even the case of chair side CAD/CAM scanner, the software, the mold, but in a much broader sense.

And in that regard, we really are at the beginning of this digitalization of prosthetics. And so, we're very excited. We see a huge opportunity here, and I think you can expect to see lots of developments with many companies coming into this field on the chair side, but more importantly on the connectivity side, the implant side, the lab side, the milling of different kinds of prosthetics, customized prosthetics, it's a whole reinvention of Dentistry. Very excited. Henry Schein has been investing in this space for almost five to six years, and I'm not talking about just the chair side, but I'm talking about the whole reinvention of Dentistry through our global prosthetics group.

And so, the launch of one particular product, maybe the one you referred to, is not as important. It is important as a product but not as important as the overall trends, and we believe we are very well positioned across Dentistry to help Dentists understand the opportunities that are emerging in the digitalization of prosthetics and help them to find solution.

I think our role will be very, very similar to the role we played introducing the PC to Dentistry almost 18 years ago when we went to Dentists and suggested them that they put a PC in their office as there were at that time I think 800 different software companies, and together with the Dental community, the profession, we were able to create the leading brands in practice management software.

So, it's no different to that or the role that Henry Schein played in bringing infection control, reports of infection control to the Dentists in the late 80s.

Henry Schein, I think has a track record of helping Dentists' advance with the most important trends in Dentistry and [oral care] (ph). And I think, digitalization of prosthetics is no different. It's not a product situation, it's a whole solution and I think we are ideally positioned with our various businesses that we earn but more importantly with our talents of management in this arena to help practitioners understand the importance of digitalization of prosthetics and the way Henry Schein can help them.

Michael Cherny - ISI Group


Stanley Bergman

In fact, we have later this week, I think it's on Thursday or Friday, - Friday, we have the start of our Business of Dentistry conference in Vegas, which addresses just this point. And actually, tomorrow we have the opening of our new technology center in Utah, which is significantly devoted to helping practitioners understand the trends in Dentistry and helping them advance their practices taking advantage of these trends.

This is a whole exciting area and Henry Schein is investing heavily in terms of talent and businesses and stringing these businesses together in a very logical way.


Your next question is from Robert Jones of Goldman Sachs.

Robert Jones - Goldman Sachs

Just wanted to transition over to the consumables business. It looks like it was soft in, particularly in North America. I was wondering if you guys could just give us a sense of how that business trended throughout the quarter, so April versus May versus June? And then just your thoughts on the health of dental demand in the back half of the year.

Stanley Bergman

I am not sure if one would view it soft per se , because there are lots of puts and takes. You see one number and overall I think we're gaining market share in the market. I'm not saying the market is robust, but as we have mentioned in several calls now over the last, four, five, six calls, the Dental market is leading in a positive direction, there is some deflation over the few products on the commodity side. There is production of new products.

And overall I think the industry is okay. It's not the best it has been, but I would say it's leading in the positive direction and we believe we're gaining market share.

Remember, sales are not that you see are, not the traditional consumable number that a distributor maybe reporting on but it's a composite of our consumables, our equipment, our specialty product. So, it's a little bit more complex and I would say again that we believe that the market is leaning towards the positive growth on balance and that we're gaining market share.

As to the future, I can't really tell you exactly but we are contemplating that at this point in any event, that the GDP continuous to grow in a slightly positive way. And that Dentistry will follow the GDP in general and that Henry Schein will continue to gain market share and that's our view and that's the way we planned this year and for many years.

Robert Jones - Goldman Sachs

That's helpful.

Steven Paladino

Hey Bob, let me just add one other things if I could please, so. We did talk a little bit about sales rebounding in Q2 and just to quote some numbers for you because we really didn't see it.

If you look at the North American Dental consumable merchandise, Q1 was 0.8% growth and this is constant currency, local internal growth.

But Q2 rebounded to 2.5% and similarly in Animal Health where constant currency growth in Q1 was slightly negative, it rebounded to 7.9% in Q2 of which 5.6% is the normalized number and even in medical it rebounded from 2% in Q1 to 3.9%.

So, we really think that the overall market has normalized. We do think that sales growth trends as Stanley said, given the economy is continuing to improve. We're a bit optimistic that growth trends will continue but at a very gradual pace.

Robert Jones - Goldman Sachs

No, that's actually helpful. And then Steve, actually if I could just ask you on the organic operating margin performance in the quarter, it looks like it was down about 60 basis points year-over-year. The trend hasn't been great there for a couple of quarters. Just was wondering if you could maybe share with us any sense by segment of where that margin pressures are actually coming from?

Steven Paladino

Sure. And I wouldn't really characterize it as margin pressure, but if you look at our report – I'm going to peel the onion, so starting with the reported. The reported operating margin was down 45 basis points year-over-year basis. The biggest contributor to that was acquisitions, which includes amortization and deal cost.

So, if your pull-out the acquisitions as well by the way to inventory step up at the BioHorizons. If you pull all of that out, that was the biggest contributor and contributed almost half of that margin decline.

The other components really are two things. One is, fastest growing businesses, the Animal Health business which was a fast growing also, is leaning as well as some other businesses leaning more towards corporate accounts. And as you know, they carry a little bit lower gross and operating margin. But still very nice profitability and returns on investment. That's a second contributor.

And the third is really in our Dental equipment business. Dental equipment sales carry a little bit lower gross margin than our core dental business. We had very strong E4D/PlanScan sales growth. There was also some upgrades that occurred in that product category. But it's important to note, that even excluding the upgrades, PlanScan E4D was our fastest growing sub-category within Dental equipment.

So, there's a lot of moving parts but overall it's really – I wouldn't characterize it as pressure, it is more as sales mix within business units.

Robert Jones - Goldman Sachs

That's helpful. Thanks.


And next question comes from Kevin Ellich of Piper Jaffray.

Kevin Ellich - Piper Jaffrey

Good morning. Thanks for taking the questions. Hey, Steve, just wanted to follow up on that point. In your prepared remarks, you talked about the gross margin being affected by a change in sales mix. Was that really just the dental equipment and that mix shift in animal health growth or was there anything else that you guys saw this quarter affecting the gross margin?

Steven Paladino

No, there's a lot of moving parts but those are the only real significant ones, the rest were really smaller movements within our organic margin. So, the big ones were the two I just called out, yes.

Kevin Ellich - Piper Jaffrey

Okay, great. And then in the medical segment, just wondering if you guys have noticed any uptick in order growth or utilization from your customers. Are they seeing any volume increases from Medicaid expansion and healthcare reform yet?

Stanley Bergman

I don't think any major trends can be noticed. There are some accounts that are experiencing some additional traffic. Of course do believe and I've been saying this for a while now, that this is a longer trend and I think healthcare reform will in the long run have a positive impact on oral care.

But, I don't think we can say that, we experience significant across the Board increase in business because our customers are seeing more younger people at this stage. So, I don't think the public is aware of this, I don't think companies are fully aware of all the provisions which are just been made clear about the administration.

So, I do think this goes well for Dentistry in general and over time we will see more younger people going to see dentists. Of course dentist would experience some pressure on pricing per procedure, but that I think in the end will result in price pressure but more units.

And we, I think are well-positioned to help those customers deal with practicing, practice management, most dental practitioners can take advantage of Dentrix and Easy Dental and some of other consulting services to really operate more efficient practice. And at the same time increase the quality of care.

So, I think this gives us much more value to consulting one of our consultants in practice management and inevitably good for business model. But I don't think we can point to any specific immediate trends at this point other than there's a lot of buzz, I know that I'll be talking about it my address to the uses at our Business of Dentistry conference in Vegas and so this is something that is more and more important but it's not shifting any numbers in a material way at this point.

Kevin Ellich - Piper Jaffray

Great. And then just going back to Animal Health, other than the diagnostic change you will face in 2015, are you seeing any positive impact from the new products that have been launched this year, like Apoquel, the anti-itch medication for dogs? And then there were a couple of new oral flea and tick medications that had pretty strong demand.

Stanley Bergman

There are so many products that are puts and takes in this Animal Health business. And for us to start commenting on any one item, I think the one of the products you mentioned, we don't see [added] (ph). But suffice this to say, the market in the parasiticide will start a little bit later this year. And we believe that we continue to gain market share. It's a good market for us.

Some of the high volume products are not necessarily the biggest money makers. Some of the slow moving, - some of the smaller products are very profitable. We have very good strategies in place to advance the profitability this market. The overall sales as well and gaining market share.

So, we remain very, very optimistic about our Animal Health business. We have a great global management team. I just actually on Thursday spent time with our team in Poland and our European management team, are more convinced than ever that we have a great, great team that will of course gain sales, market share and profitability for Henry Schein and some very good cash flow.

Kevin Ellich - Piper Jaffray

Excellent. Thank you.


Your next question is from Glen Santangelo of Crédit Suisse.

Jeff Bailin - Crédit Suisse

Morning. Thanks for the question. It's actually Jeff Bailin in for Glen. There has been a lot of discussion in the marketplace around one of the leading premium implant players potentially being for sale. I understand you are probably limited in your ability to discuss any specific properties, but given Henry Schein's investments in the lower and middle end of the implant market, could you just talk about whether a presence on the premium side of the implant market could ever make sense for you?

Stanley Bergman

Obviously we can't comment on this deal that's being touted around Wall Street or any other deal because if we do, that mean we'll have to comment on all sorts of things. So, our policy is generally not to comment on deals that have not been concluded. And so that there can be no inference, as to whether we're interested or not interested.

But, inline with the question that was previously asked, we are most committed to the, the future of Dentistry and particularly the digitalization of Dentistry. And in that connection the implant is important, both the device itself and the prosthetic. And we need to be bigger players in the device and the prosthetics in all its forms, whether the prosthetics are custom milled or they're prefabricated.

And there's a lot of software that's involved in this. So, one must be careful not to look at any particular part of our oral care equation ,the whole area of practice management, clinical and otherwise and pick one piece over the other. It's a whole continuum of care and we are very, very much understanding of the market today and where it's heading. And Henry Schein is committed as the largest provider of Dental products and services in the world to continue to be a place where Dentist look for guidance and the place where the Dentist can find the one stop solution.

So, they will be roomed in the implant market for the high-end as people refer to more expensive implants. The middle high quality and I believe that both BioHorizons and Camlog has the best in implant systems in the marketplace that maybe less expensive.

But if you look at Germany for example, we're selling more implants and may even have more dollars than anyone else in the marketplace. It is debatable how close we are to the number or whether we are the number one but the bottom-line our solution in Germany for example and some other countries is working well. BioHorizons is working well and we will add to that both in terms of the implant, the prosthetic, the software, the biologics, et cetera, so, we are interested in growing our position in the whole prosthetics field and on multiple upfront.

And we believe we are well-positioned through our global prosthetics group to understand the dynamics and have excellent solutions. So, we are committed to the whole area of digital and prosthetics in general.

Jeff Bailin - Crédit Suisse

I appreciate all of that color. Maybe just one follow-up again on the dental market. Appreciate your commentary from earlier. As we look at the international performance, is there anything worth calling out in any specific geographies in terms of either accelerating or decelerating growth that are areas to watch?

Stanley Bergman

Yeah. I would say Europe in general is leaning towards a positive. You have to be very careful in shifting through what was a terrific IDS last year. I would say the market is leaning positive. There are few markets that are not so positive, few there a little bit more positive, but generally the market is positive.

I would point out the one market that is doing exceptionally well at this point and that's Australia. I am not sure, yes, I think that there are probably people on this call that would recall, for sure that last year we spoke about very negative market.

This previous government had withdrawn funding for oral care and that sucked out a lot of sales from the market. This government has reinstituted the support for oral care and providing excess to oral care general, to the underserved, and the mood in the Australian Dental market is exceptional.

I just came back from the international sales meeting and the mood amongst our sales people, amongst our suppliers is excellent. Again, I think we are well-positioned to provide solutions. We have an outstanding consultative salesforce down there. We are the leader in software, and our well-positioned in CAD/CAM and had a number of very exciting products and exclusives that we offer them.

So, I would have to say that if I think through and look around the world that is a very good market outside of Untied States and Canada.

Jeff Bailin - Crédit Suisse

Great. Thanks for the questions.


Our next question is from Jon Block of Stifel.

Jonathan Block - Stifel, Nicolaus

Great. Thanks, good morning. Maybe just to start -it was another solid quarter with North American dental equipment results. And, Steve, you mentioned a couple things before, but any color you can give specific to high-tech growth versus traditional? Then maybe if you could provide an update with where you are with the PlanScan rollout at Aspen practices? Thank you.

Steven Paladino

Sure. I'll give you some detail, the North American equipment growth, the total growth was 10.8%. Again it was across the board in both traditional and high-tech equipments, specifically traditional equipment was about 6.8% growth and high-tech was little over 17% growth.

And within high-tech again, our PlanScan E4D product was the fastest growing category of all equipment traditional or otherwise. So, we're very happy with the performance there. I'll also say that equipment, the backlog continues to be strong. So, we have that strong equipment growth but we continue to have a good backlog at the end of the quarter both domestically and internationally.

With related to, I don't know the particulars on the Aspen roll-out, to be honest with you. But I would say that that was not a major driver in our overall sales growth but I don't really know the particulars on that.

Jonathan Block - Stifel, Nicolaus

Okay, perfect. Fair enough. Then, secondly, just to shift gears, you started the Q&A off talking about Animal Health and specific to IDEX and you have mentioned you have seen other manufacturers go exclusive before. But can you talk to us specifically about your salesforce and your salesforce's ability to move market share and maybe what you've seen in the past when other manufacturers have gone ahead and opted to go down the direct road? Thank you.

Stanley Bergman

I want to be careful not to turn these things, but very good question, and if I were you, I'd be asking or trying to figure this out as well. But I want to be careful not to make this a negative comment.

So, let me just begin with, I think you've seen in the Dental market in the past, that's one manufacturer to deciding to limit distribution, to one distributor or two. And I think you've seen our track record and our ability to respond in a professional way and in fact gain market share.

I think you could see similar trends in the Animal Health space around pet food, nutritional food and I think you've seen that, we've also done okay in that regard.

We've also done very well in explaining to manufacturers that broad distribution is in the interest of the customer as was the case when we made our investment in Butler Schein at the time, now Henry Schein Animal Health.

With that time, Henry Schein was representing five or six manufacturers and Butler at that time was representing one because of market, the market issues, the manufacturers wouldn't allow us to, one manufacturer wouldn't allow us to carry the competitors line or all of the stuff in the end when you open up the market is better for consumer and what's better for the consumer is better for Henry Schein.

So, if you look at all that history, you will see that anytime there's been a strength, generally it's inhibited the market. Any time it has opened up, it is much better for a market, any time you have competition, it's better, I'm a big fan of the free markets and this restriction business in the end doesn't pay off, I think Henry Schein has a long tradition – there are examples where it works better because you may need more resources in one way or other to advance the product.

But I think Henry Schein's history as a outstanding value added distributor has shown that we've always been able to find the right balance of products with. There were restrictions on limiting us to sell dental chairs or there were restrictions at one point to limit us from selling anesthetic, because the leading anesthetic company at the time, with 70% or 80% market share decided to go direct.

In the end we are the largest provider of anesthetic in the world today, with sensors at one point or another. We were restricted us from the leading brand. Today we are the largest provider in sensors. The largest provider of dental chairs. The largest provider of 3D X-ray and all of these things, they're in the end are not good for the customer.

So, I would say they are always exceptions and I am quite sure that our track record if examined carefully, - Steven would be happy to take you through specifics. I don't this is the time today to name particular companies. But this is all public information and you could see that generally Henry Schein has done, okay.

And these thing are sometimes a waste of time but at the end invariably Henry Schein turns out to be a better company.

Jonathan Block - Stifel, Nicolaus

Perfect. Thanks so much for the comments.


Your next question comes from Jeff Johnson of Robert Baird.

Jeffrey Johnson - Robert W. Baird

Thanks. Good morning, guys. Just a couple quick follow-ups here. Steve, was hoping I could go back to maybe Bob's question on the North American dental consumables market. And I hear your answer, things getting better sequentially and obviously you can see that in the numbers, so that's good.

If I adjust for selling days, it seems like you maybe even were up closer to the low end of that, the normalized historical range we think about at 4% to 6% or so. Is it fair to think then as we go through the rest of the year? I know you don't guide by segment and don't guide growth in that, but it feels like if we adjust we get back up to that kind of number. Is it fair to think about that being a reasonable target for the back half of the year?

Steven Paladino

So, again, I don't want to give specifics but I do think that the potential for our sales growth to accelerate on the merchandise, we feel like there is potential for that to occur. If you look it within the quarter, both May and June were stronger than April, so, it did accelerate within the quarter.

July was also a good month for consumable merchandise, for us now one month does not make a quarter, so don't be too much into that. But it's still good directionally.

So we do feel like there is potential for some slight acceleration going forward. But again Jeff, since we don't give specifics, I'd rather not be specific on that.

Jeffrey Johnson - Robert W. Baird

The May, June, July comments are helpful there, so I appreciate that. Then my only other question really is on the cash flow side; a nice rebound here this quarter, at least relative to last quarter. Year-over-year still down. I think that is a comparison issue, if I remember right, from early 2013 where there are some reversals from late 2012.

But bottom line, are you still thinking cash flow both operating cash flow and even it looks like free cash flow here can grow nicely above net income this year and kind of over the next few years? Is that still a reasonable target? One. And, two, CapEx may be a little bit higher than we are thinking so far through this year. Just what should the CapEx target be this year? Thanks.

Steven Paladino

Okay. So, we do feel like if we look forward on operating cash flow, it should grow at similar rates as our bottom line net income growth. So, we do believe that that is very achievable growth for us.

Remember, there's a little bit of a more difficult comparison both in Q1 and Q2 because last year on cash flow we got the reversal of the medical device excise tax, the buy-in that we did in the prior year.

So, it's a little bit of a more difficult comparable related to that. And I'm just trying to remember, your second question on CapEx, yeah, this year the CapEx is a little bit higher than normal. We'll probably be something just north of $60 million of CapEx, maybe in the mid 60 something like that.

So it is a little bit higher than typical this year because of some investments. But we do feel good about organic cash flow overall.

Jeffrey Johnson - Robert W. Baird

Okay. It just sounds like the CapEx run rate can slow down then a little bit from what we have seen in the first half. That's fair?

Steven Paladino

Yeah, like I said, we should be in the mid 60s for the full year.

Jeffrey Johnson - Robert W. Baird

Okay. That's helpful. Thanks.

Steven Paladino



Your final question is from John Kreger of William Blair.

John Kreger - William Blair

Hi. Thanks very much. Stan, you've talked about digital restorative dentistry being a very big trend. Can you just contrast what you are seeing in the North American versus the European markets? Which region are you seeing embrace this trend more aggressively based upon the kind of order flow you are getting?

Stanley Bergman

That's a good question. Look, digital dentistry, digital prosthetic dentistry is much more than chair side, right. I think chair side gets a lot of attention because some owners of public company and Patterson and Schein are public company.

But there's lot more to this. The whole digital prosthetic arena, many of the companies in that space and I forgot to mention, Dentsply and to some extent 3M as well. But for Dentsply and 3M, and particularly 3M, it is not – doesn't come out in the numbers.

So, Wall Street is focused truly I think on the public sector and there's much more behind this, as the whole area of prosthetics is largely, to a very large extent in the hands of small private companies, and some actually larger companies but in the private sector.

So, the area of prosthetics and if you go even further, you'll see that you have the implants. And some of those companies do have, the public companies do have an element of digital prosthetics as well. So, we have to understand this market in a very broad sense and where it's headed.

As far as the chair side, I think Europe of course is little bit more advanced because CEREC was introduced in Europe over a quarter century ago, and particularly in Germany.

So, the goal is of course to find new customers. And then each new customer presents an opportunity for the digital materials et cetera, et cetera.

So, Europe is more advanced than the U.S. it's relatively new in the U.S. I would say primarily because it is only offered through one distributor. Now the market is being serviced by us as well. So, now you have about two-thirds of the dental distributors with digital solutions. There's another, one or two other solutions that are offered by some of our smaller competitors, but the whole awareness of digital dentistry prosthetics is going.

So, I speak to you as the pick-up in this regard off, I think a smaller base per capita, per dentist than Europe. So, I think the opportunities are good in both sides, on both sides of the Atlantic and also in other markets, Australia as well.

I don't want to comment on Japan because we're not in that market yet, so, but I believe that so, the whole area of digital materials is getting very, very exciting. And there are a lot of players that will enter this market and I think you'll see all sorts of exciting tools coming from different players and through Henry Schein.

And I am not only, again, referring to the chair side but the whole laboratory side as well where there is a lot of activity going on. Smaller companies, lot of innovations and the labs are automating in a rather rapid way. There are going to be fewer labs, bigger labs, more capital intensive and so this whole market is very, very exciting.

But I caution, Wall Street not to view this through the lands of just a few companies but to take a look at the whole market and I think for all the dental players this is going to be exciting.

I think, Danaher also just announced their entry into the space. So, this whole world is getting exciting and it's far more complex then just looking at through the lanes of one or two companies.

John Kreger - William Blair

Very helpful, thanks. Maybe just one more. Steve, would you be able to give us your organic growth rates in some of those -- your dental specialty categories? I am curious of those are growing faster or slower than your general consumable trend?

Steven Paladino

The answer is generally yes. This quarter though because of again Camlog is probably the biggest of our specialty group and because of one less selling day in Germany and that's the strongest market, you have to adjust for that. And if you adjust for that, the specialty numbers are growing at a faster rate than the basic dental consumable numbers. Again but you have to adjust for Germany because of that one less selling day.

John Kreger - William Blair

Great. Thank you.

Steven Paladino


Stanley Bergman

Okay. So, thank you everybody for calling in. Appreciate your interest. I think we at Henry Schein are in three very, very exciting markets that are going through transformation, where they are ready to provide value added services, where they, - not only on technology offering but a whole host of value-added services.

The dental market is exciting, going through transformation and we are very well-positioned, the largest provider of dental products and services in the world. Likewise on the Animal Health side, a lot of exciting developments there. I believe, strategically we're well placed. We've made some good decisions along the way and are well-positioned now to execute on those decisions. It's a global positioning. The largest distributor of Animal Health products, very, very exciting.

And then the Medical business, we have been waiting for this transformation now for six, seven, eight years. We created a health care services group almost six years ago, they are doing well, they are doing well with these large accounts of the IDNs.

Of course, this is all a trend and nothing materials is going to happen in one quarter or two but directionally Henry Schein is well placed. And I believe our strategies are good, the morale in the company is good and we're generating good cash flow as a company.

And so, I thank you for your interest. And have a great rest of the summer. And we'll be back again in about 90 days. Thanks.


This does conclude the conference. You may all disconnect.

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