漢瑞祥 (HSIC) 2005 Q2 法說會逐字稿

Good morning, ladies and gentlemen, and welcome to the Henry Schein second quarter conference call. [Operator Instructions]. I would now like to introduce your host for today's call, Susan Vassallo, Henry Schein's director of corporate communications. Please go ahead, Susan.

Thank you, operator. My thanks to each of you for joining us today to discuss Henry Schein's second quarter results. If you have not received a copy of Henry Schein's news release earlier today, please call 631-843-5937 and a copy will be faxed to you immediately. Or, of course, you can obtain a copy on our Web site at henryschein.com.

With us this morning are Stanley Bergman, Chairman and Chief Executive Officer of Henry Schein and teach E. Steven Paladino, execute Vice President and Chief Financial Officer. Before I begin I would like to point out as always certain comments made during the 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. Further these forward-looking statements are qualified in their entirety by the cautionary statements contained in the company'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, today July 26, 2005. The company undertakes no obligation to revise or update any forward-looking statements to reflect any events or circumstances after the date of this conference call. Now I would like to turn the call over to Stanley Bergman.

Thank you, Susan. Good morning, ladies and gentlemen, and thank you for joining us this morning. Our financial results for the second quarter represent record sales, net income and earnings per share. Net sales for the quarter of $1.14 billion represents 21% growth from the previous year. We are particularly proud to continue posting double digit sales growth in our Dental group which we have done now consistently for the past eight quarters.

Total gross of 18.8% includes internal growth in local currencies of 10.1%, which was far in excess of our estimates for the growth in the North American Dental markets indicating that we continue to gain market share. During the quarter, we made significant progress integrating acquired businesses into Henry Schein, including Ash Temple in Canada, the Demedis business in Germany, Austria and the Benelux countries. So we're generally very pleased. We will get into some of these details. The rest of the business is also doing well.

In a moment, I'll speak further about our recent accomplishments and integration progress. But first let me ask Steve to provide you with an overview of our second quarter financial performance. Thank you.

Okay, thank you, Stan. Let me begin by saying that I am pleased to report our second quarter results which exceeded our internal estimates for the quarter. Our net sales for the quarter ended June 25, 2005, were a record for a second quarter of $1.14 billion, reflecting a 20.7% growth over the second quarter of 2004, or 19.1% in local currencies. 3.4% of this growth was internally generated, while 15.7% was acquisition growth, primarily due to the Demedis group in Europe, Camlog our dental implant company, Ash Temple in Canada and the Halas Shalfoon transaction in Australia and New Zealand. This is contained in Exhibit A of our news release.

Operating margin for second quarter was 6.2%, about 50 basis points lower than the operating margin in the second quarter of 2004. The Q2 operating margin was impacted by certain one time items including acquisitions, certain seasonality changes and expenses with the relocation to a new headquarters in Melville, New York as we previously discussed in our first quarter earnings release. We continue to expect 20 to see annual margin expansion for full year 2005.

Our effective tax rate for the quarter was 37.0% improved from second quarter 2004. We expect the tax rate to remain in the 37% range or slightly lower for the remainder of 2005.

Second quarter net income was $40 million which is an improvement of 3.2% from the prior year's quarter. Earnings per diluted share for the second quarter 2005 were $0.45 per share. EPS increased 4.7% from $0.43 per share in the second quarter of 2004.

Note that net income and EPS for the second quarter was also reflecting the impact of the same factors that impacted our operating margin, namely those certain one time items such as acquisitions, the seasonality changes, and the expenses associated with relocating into a new corporate headquarters.

Now I would like to provide some detail on our sales results for the quarter. Dental sales for the second quarter were $462 million, representing 18.8% growth in U.S. dollars, or 18.2% in local currencies. 10.1% of this local currency growth was internally generated and approximately 8.1% was due to acquisitions primarily of Ash Temple in Canada and Barton-Cyker in the United States.

Our consumable merchandise sales were 15.5% ahead of the prior year in local currencies. 8.1% of this growth was internally generated and 7.4% was due to the acquisition. Sales of the Colgate professional office products introduced in May 2004 accounted for about 1.1% of the local internal Dental consumable merchandise growth.

We continue to be very pleased with the 7% internal growth in our remaining Dental consumable product portfolio, once again out pacing market portfolio as we have done consistently for nine quarters. Our dental equipment sales and service revenues were 28.1% of the local currency and 17.6% of this growth was internally generated.

Medical sales were $342 million in the second quarter, down 2.9%. Internal sales declined by 3.9% and 1% of sales growth was due to a small acquisition. Internal sales reflects the shedding of lower margin and nominally profitable pharmaceutical and veterinary sales as part of our marketing strategy. Also I would like to point out this quarter was a difficult comparison since last year's second quarter, our total medical sales were up 24%. Our core position and ultimate care business excluding the impact of the lower margin pharmaceutical products improved by 8.3% of which 6.5% was internal.

Remember, the core position in ultimate care business represents over 80% of our overall medical sales. Our hospital and long-term care sales declined by 8.7% in the second quarter. Here we have also lower margin and lower profitability in this business compared to our core business. And our veterinary sales for second quarter declined 21.3% over the prior year, again reflecting the elimination of the lower margin customer.

Moving to our international group, sales for the second quarter of 2005 were $315 million U.S. dollars, up 71.2% over the prior year. Total international sales growth in local currencies was 64% with 2.4% internally generated and 61.6% due to the Demedis, Camlog and Halas transactions I mentioned earlier. Local internal growth1cgº of 2.4% for the second quarter compared favorably to the 9% growth that we saw in local currencies reported in the first quarter of 2005 as we're beginning to see the government reimbursement issues, specifically in Germany, have begun to ease.

Finally, technology and evaluated services sales were $22.5 million, 9.5% above the second quarter of 2004 and up 9.2% in local currencies. All of this growth was internally generated and it continues to be driven by our strong growth in our electronic service business.

On a balance sheet perspective, some of the highlights there are our operating cash flow for the quarter was $87.9 million. That compares to $72.1 million in last year's second quarter and we still expect to achieve our goal of operating cash flow in the range of net income for the full year.

Accounts receivable day sales outstanding were 45.2 days for the second quarter and that reflects a 2.7 day improvement over last year's second quarter. Our inventory returns for the second quarter were 6.6 turns an increase slightly of .1 turns for the second quarter of 2004. Finally our return on committed capital was 30.4% for the second quarter of 2005 and that compared to 31.6% in the second quarter of 2004.

I would like to conclude my remarks with a comment on our outlook for 2005. On June 15, 2005, Chiron Corporation revised it's production estimates for Fluvirin Influenza Vaccine for the 2005/6 influenza season and estimates 18 million to 26 million doses.

Let me say we remain cautiously optimistic about Chiron's ability to reenter the US market for influenza vaccine in time for the 2005 season. However at this time, there continues to be uncertainty about the number of doses of influenza vaccine that Chiron will produce, how many will be available in the U.S. and the amount Henry Schein will receive, if any, for 2005.

In addition, although pricing to customs for influenza vaccine is expected to increase this year, there remains uncertainty regarding specific pricing and we have not yet announced our influenza vaccine pricing to our customers for 2005. So since we do not have reasonable certainty with respect to these matters, we are not providing specific guidance at this time should Chiron re-enter the influenza vaccine market in 2005.

However we are reaffirming that we expect 2005 diluted EPS in the range of $1.73 to $1.77. Again, that's if Chiron is unable to re-enter the influenza market this year. This represents a mid-teens percentage EPS growth over 2000 now, excluding the one-time charge of $0.10 per share related to the Fluvirin contract in 2004. This guidance also assumes no significant increase of sales of influenza products from other manufacturers over 2004 levels.

Finally, we expect Q3 EPS growth to be in the low to mid teen percentage range depending on the timing of receiving the non-Chiron influenza vaccine and assuming that we receive those products at the same levels as in 2004. This guidance does not include the impact of expensing stock options in accordance with FAZ123R which has been delayed until 2006. And also note that 2005 guidances for our current operation including all completed acquisitions but obviously does not include the impact of any potential future application. Let me now turn the call over to Stanley.

Thank you, Steven. In May of this year, we named Jim Breslawski as President and Chief Operating Officer of Henry Scein. - As many of our investors know, Jim had previously served at president at Sullivan-Schein Dental, and he will now be in a position to build upon his dental accomplishments with overall responsibility for our North American dental, medical and technology businesses as well as our global infrastructure services.

Under Jim's leadership our North American dental operations have become a leading force in the industry. Jim oversaw our successful transition to full service value added partner with our dental customers. He headed the group during a period of completing several acquisitions, securing multiple high product professional exclusives, introducing very successful and innovative programs like privileges, and establishing the industry's Premier sales and training program for our field sales consultants group.

Jim has been a team Schein member for 25 years and has firmly established his credentials as a leader and an astute businessperson among his colleagues here at Henry Schein and within the dental industry.

Let me now focus a little bit on our dental group. About two weeks ago we held our national dental sales meeting which is the largest gathering of its kind in the dental industry. The theme of this year's conference was, The Unstoppables, which is a reflection of the group's enthusiasm as we continue to gain market share in the dental arena. The meeting serves as an important showcase for our vendor partners while providing training and motivation for our field sales consultants. At this year's record attendance includes more than 1,250 team Schein members and more than 135 of our key vendors.

This event attracts the largest number of Dental vendors for a company-sponsored event in our industry.

Performance of our Dental group during the second quarter was excellent. And really, if one thinks of the morale at the national sales meeting in conjunction with the performance of 18.8% growth for our dental group versus the previous year, you put those two together and you see that we are really in excellent shape in our dental business in North America.

Furthermore, not only did we represent good total growth but our internal growth in local currencies was 10.1%, which is more than double our estimates for the market growth. We really are happy with where we are in the dental business and see a great future.

We added over 1,000 Privileges members during the second quarter 2005 bringing the total number of Privileges members to over 18,000. The total program enrollment now reflects the elimination of some duplicate accounts separate ship to addresses as well as non-renewal of certain customers who have not satisfied their commitment.

Privileges continues to be an effective program for us and second quarter sales growth for enrolled members were significantly greater than our nonmembers.

In addition to the program in the class of Privileges and the activities in the marketing area, which have been so successful, a key component of our dental growth strategy is to bring the industry's best products and services to our customers.

We recently entered into an agreement with DEXUS to market, sell, and service a full line of visual radiology products. The DEXA sensor delivers excellent image quality, easy to use, and provides a great degree of patient comfort. So it is understandably an industry leader. And the quality of the product is what has driven its success to date.

This new agreement of DEXUS will further enhance the value we can offer to our more than 100,000 dental practice customers throughout the United States and of course Canada. Let me point out that this is yet another example of the DEXUS product offering, like Pentron and Colgate, of a manufacturer that has previously sold direct and has now decided to take advantage of the Henry Schein proven expertise in marketing to our dental customers.

Next, let me provide you with an update on the rollout schedule of Evolution 4D. I'm referring to the rollout focused on private practitioners, dental practitioners and of course dental laboratories. As you may know, Henry Schein holds exclusive U.S. distribution rights to this new leading edge CAD cam dental restoration product, which will be manufactured by a company named D4D Technologies.

We continue to work very closely with the manufacturer. -- that's with D4D technologies -- nd have been advised they are making good progress with this product. University testing of evolution 4D materials, that's the consumables, is already under way, and the product, the hardware itself is scheduled to begin user testing in the fourth quarter of this year.

This user testing will help gauge customers satisfaction, of course, and product performance. As with any advanced product it's not uncommon to make slight modifications once the testing is complete and fully available of Evolution 4D will be made as soon as is thereafter is practical. Therefore, as we've said in the past, we expect to begin shipping units late in the first or second quarter of 2006.

This timing, of course, has no impact on our financial guidance. We really are excited about this product. It will present huge value to the dental community. We continue to showcase evolution 4D at dental trade shows, with feedback and purchase intent remains rather positive. We believe evolution 4D will be really a feature rich, highly competitive CAD cam product and we look forward to bringing this important piece of dental equipment to our customers on this product exclusive basis that we have arranged with the evolution - or the D4D Technology company.

To complete the discussions on the North American Dental operations, let me provide you with an update on the integration that is largely complete in Canada, that is, the Henry Schein Ash Arcona Canadian operation. In acquiring Ash Temple Limited we doubled our sales force in Canada, strengthened our dental equipment business, gained a strong presence in the dental laboratory markets and in the process became the leading distributor in the Canadian dental market.

The process of integrating Ash Temple's business into existing Henry Schein operations is substantially complete. And this process was carried out in an extremely efficient manner. We are really very, very proud of our Canadian team, both the old Henry Schein Arcona team and the addition of the Ash Temple team. Both teams did a great job as they were bringing these companies together and together have created a profit asset for the company much the systems integration was completed without a hitch.

Where is Ash Temple that ships from five distribution centers, all consumable merchandise and now being shipped from our two previously existing distribution, centers, one near Vancouver, a place called Delta, and the other one in Ontario, just south of Montreal -- just south of Toronto.

And these are two facilities that we invested in some time ago, knowing full well that we have plans to expand our business in Canada. And, of course, putting more volume through this relatively fixed cost infrastructure is really part of the overall strategy of Henry Schein.

Additionally, the consolidation of the equipment sensor location has begun. We anticipate reduction from the current 25 locations to 14 by the end of the year. And while all of this is happening and all of this activity is taking place, we are really happy to report that sales performance for the consolidated business has been very strong. And out of the field sales consultant forces, over 200, it's remarkable we only lost one individual to the competition since the acquisition was announced.

This is really something remarkable and even in a non-consolidated world, we just have a stagnant sales force to lose one out of 200 field sales representatives or consultants is a remarkable accomplishment. The enthusiasm is really terrific in Canada and we're very, very excited about the progress made. Our medical group also held its national sales meeting recently where more than 800 attendees gathered in early June under the theme Profit From the Experience.

This was our largest ever medical conference and was full of energy throughout the two-day event. I wish we would have had all of our shareholders there, because the atmosphere was just electrifying as it was, by the way, with our dental meeting. As many will know over the years, we have successfully strengthened our value and value added proposition in our dental community.

We really believe that the combination of our software and the suite of value-added service products that we offer in the dental world, makes us extremely unique. We don't carry every product line but we have the widest product offering available in the marketplace and then we believe the most extensive value added offering led by the electronic medical records system and related activities.

We at the same time are continuing to enhance our value added offering in the medical world. Specifically focused on our position customers, utilizing bricks, best practices developed in our Dental and other businesses. At this conference, we showcase some of our new value added services and vendor partners. This included our e-commerce group which provides web based solution for customers, such as the ability to read inventory bar codes and electronically scan and transmit orders to Henry Schein.

And for the medical world, we believe we are now way advanced or probably have been for a while of the competition in this specific area. Of course building on our dental capabilities, we highlighted complete care which is a wrap around extended warranty program for large equipment as a solution to give practitioners piece of mind. Also on display was our array of financial service offering, and an expanded repair business to small equipment.

As a further indication of our commit meant, Henry Schein is a partner in providing our customers with valuable practice solutions. During the first half of this year. We added over 30 medical field sales consultants bringing the compliment to nearly 400. As Steven mentioned, the sales performance by our medical group during the second quarter sales reflects the continued shedding of a number of low margin pharmaceutical and veterinary sales. It's worth repeating that excluding the impact of the slower margin pharmaceutical sales volume that we shed, our core position and ultimate care business improved by 8.3% in total, of which 6.5% is internal growth. We're very, very excited with where our medical group is heading.

On the Chiron Fluvirin Influenza Vaccine side and the situation of influenza vaccine in general, Steven covered this but let me just amplify a little bit. Chiron now estimates per its public releases that it will produce between 18 million and 26 million doses of Fluvirin for the 2005-06 influenza season.

Furthermore, Chiron expects the FDA will conduct a facilities inspection in July to determine whether manufacturing deficiencies have been resolved. And we are awaiting, just like I assume everyone on this call, public announcement own the results of this inspection. Our current agreement with Chiron expires at the end of the 2005-2006 flu season, and we remain cautiously optimistic that Chiron will receive FDA approval for the upcoming flu season and that we can complete a new agreement with Chiron for 2006 and beyond.

However, as we have noted repeatedly in the recent past, we have several opportunities for sourcing influenza vaccine including a multi year agreement to distribute through viral products. We also have an exclusive sales agent agreement for the metamine influmus(ph) product and a continued relation ship with SANAFY adventist which includes the delivery of Fluzine products. By the way, the relationship with SENAFY Adventist is a good one where we have introduced new product for them most recently. IDBy medical announce two weeks ago the receipt of fast track decision by the F.D.A for their Fluviral product.

Earlier, this year, ID Biomedical had announced that Fluviral was eligible for accelerated approval and priority review. With it's new fast track designation, ID Biomedical has access to the major regulatory mechanisms put in place by the FDA to facilitate rapid licensure. ID Biomedical also announced that the ongoing expansion of the flu vaccine manufacturing facilities is on schedule. They expect that with FDA they will be able to produce approximately 20 to 25 million doses of the influenza vaccine for the U.S. market and indicate they expect to see introduction in 2006, with increasing production approximately to 40 million doses in 2007. But we also expect an ample supply of Flumist this year and we continue to pursue an expansion of our relationship, as I mentioned earlier on, with the Santa Fe Adventist.

Of course we can't predict with certainty the extent of our presence in the flu vaccine market this year. Long-term, or even shall we say medium term, we expect to be reliable and provider of flu vaccine to multiple manufacturers as we have the last 15 years or so.

Let me give you some concluding remarks on our international business. Sorry the remarks this quarter are so long but there's really a lot of activity that has taken place in the company and there's a lot of very interesting developments that we felt our shareholders would be interested in.

A key component of our international strategy has been close for strategic acquisition as we round out our global presence. In mid May we announced the acquisition of Halas Dental in Australia and Shalfoon Brothers in New Zealand. Both companies are leading full service providers of leading merchandise and equipment within their respective markets with a number of important product exclusives. With this acquisition we are now the market leaderin both Australia and New Zealand. Halas Dental and Shalfoon have long record in the markets and have established a brand identity and excellent customer base.

Together with our preview acquisition operations, Henry Schein is firmly positioned as the leading dental distributor in Australia and New Zealand. We offer a wide selection of products and services design to help practitioners operate more efficient and profitable practices while, of course, helping our customers to deliver high quality dental care.

I returned from Sydney last Sunday where I spent several days with Australian new Zealand management team and the general team, operational team as well. I'm really, really happy with what I saw. The morale is high. These were two major competitors. We launched - or merged equipment initiatives in Sydney with high customer excitement and a lot of cooperation between these two previously competing sales forces.

Through combining our global resources and local expertise, our goal in the months and years ahead is to put this knowledge and these resources to work in every dental office in Australasia. Let me also provide you now with an update on Europe. As Steven mentioned, international group, internal sales growth and local currencies was 2.4% or so.

And this improved from the first quarter of 2005 as the government reimbursement issue in Germany had begun to ease. As we have discussed previously, at the beginning of the year, the German government changed its reimbursement rules relating to health care as a whole and specifically as it relates to the Dental market. This created some initial confusion and caused backlogs in patients' visits during the first quarter of 2005 and a sharp drop, specifically in the dental laboratory business because of lower reimbursement levels for some higher end procedures.

Patients, insurance agencies, dentists are now getting more familiar with the new processes and while there remains some lingering efforts and effects from these issues, we believe that the most difficult period has passed. We think that the market has stabilized and we should see better results from the top line point of view in the remaining part of this year and of course into next year.QQ8X

Integration of the former Demedis operations into Henry Schein are proceeding according to our plan, and we continue to be comfortable with our previously communicated estimate of synergies in a $2-$3million region for 2005 and of course our expectations for greater synergies expanding this synergy number for 2006 on a full-year basis. In Germany and the Benelux countries we are particularly pleased to report the process of aligning sales territories has been successfully completed and, remarkably, only one sales representative also of the several hundred that we now have in Germany, over 200, have left us. Same number as in Canada, by the way. We are merging facilities in seven German facilities where we have duplication and have worked to rationalize inventory, which has allowed us to strengthen relationships to key suppliers and reduce the number of' SKU's we carry.

We also are optimizing the distribution network across central Europe where the two existing distribution centers in Germany will support all Henry Schein businesses in Germany and the Benelux countries. We are closing our distribution center in the Netherlands and this is in - in this connection we will continue to evaluate our entire distribution network throughout Europe. This is an ongoing process and we will continue with it.

By moving to a full service organization in Germany and the Benelux countries that will operate under the name Henry Schein Dental depot. The Demedia name will be phased out in a short amount of time in these markets. This has been well received and in fact encouraged by the sales organizations in Germany and in the Benelux countries.

Following on on that concept in Austria we are merging sales activities into what will become the Henry Schein Dental Austria brand. Also full service Austrian business and will receive significant benefits from improved product acquisition prices through our German operations. So the international side is moving along very nicely, and I think our shareholders will be pleased with the results that we will show going forward.

Just to end here with an interesting touch on what we're doing to not only provide greater help to our customers but also act as a better partner to our suppliers, over the past six months we have complete a vendor survey project where we surveyed several dozen of our vendor partners regarding the experiences with respect to seven core areas in Henry Schein, including sales and executive management sales and sales training, marketing, logistics, supply chain, inventory management, corporate brand and accounts payable. More than 230 individuals from 38 of our small, medium and large dental, medical, and veterinary vendor partners participated. This was the most extensive evaluation study we have ever undertaken to assist the satisfaction and attitudes of our vendor partners. Indeed we believe this is likely the most comprehensive such undertaking in our industry.

As our market share group, we wanted to make sure that our suppliers felt comfortable that we were working in their interests as well. The survey is indicative of identifying opportunities and enhance our value partnership to our partners.

The specific findings of course are proprietary but they will enable us to enhance satisfaction with Henry Schein, who is today the only global distributor in the general medical space and enhance our customers shareholder value. So there's a lot that has happened over at Henry Schein. We very proud of our results today, not only from a fiscal point of view, but the strategic progress we are making.

And we remain extremely optimistic about the second half of this year as we move towards 2006 which should also a very good year for the company. I apologize for the length of the prepared remarks but there was just a lot going on and it's important that our shareholders do appreciate that.

We are ready for questions, operator.

[Operator Instructions]

Your first question comes from Larry Marsh of Lehman Brothers.

Thanks, and this is Steven Postal (ph) for Larry. First Steve, just a couple of housekeeping questions. Can you give us the dental sales force numbers?

I'm sorry, the sales numbers?

The sales force numbers

Oh, sales force numbers. Sorry. Sure. Let me first give you the overall worldwide numbers and I will just go through the major components. At the end of the second quarter we had 2,191 field sales people on a worldwide basis. In the U.S. dental market, we had 882 people. That's up 21 people versus last quarter, the first quarter.

And overall dental which would now include our laboratory and Canadian operations, we have a total of 1,172 people. That includes the 882 U.S. dental people. We also have 391 medical field sales consultants. That's up about 28 people over the first quarter of 2005. And we round out with 627 international people, up about 68 people from the first quarter of 2005. Those 68 people were primarily related to the acquisition activity that we saw, and Halas, as well as Austria. But in total from the first quarter we're up a little over 100 people in our field sales consultant count.

Okay. And then my second question, can you talk about the German reimbursement environment and perhaps elaborate on the comments. How you viewed that market prior to your acquisition of Demedis and how you view that market now?

Yes, we can talk more about the market. I think, from our perspective, the big thing that we look at in Germany as well as with the overall Demedis acquisition is while eventually we will get strong top line growth as the market conditions are improving, really from our perspective when we acquired Demedis, the lower hanging fruit and the big opportunity for us was in integrating these two businesses, Demedis with the Henry Schein business, driving up operating margins, I'm taking out a significant amount of expenses and the combined infrastructure by eliminating activities that are the being done, you know, at both entities on a redundant basis.

As we put them together, we can get more synergy. As I have said in the past, our goal, international as a group is to significantly expand our operating margin and over the next couple or few years to increase the margin by effectively doubling it from a little under 3% to 5% or 6% over the next few years. So that's really the thing that we are keenly focused on right now. The second half of the year, I think the easiest way of putting the German reimbursement issues is really the worst is behind us.

We believe we will be back to normal market growth conditions in Germany in the second half of the year. That should be somewhere in the 3, 4% percent range as normal market growth in Germany. We also believe there's a potential for some of that -- those procedures that were delayed in the first half of the year, have a little bit of catch up in the second half of the year. On that point, it's important to note that there's not enough capacity in the German dental market in order for it to be completely caught up but there may be a little catch up there and we're not really counting on that in our expectations for the second half of the year. But 04 is a good market for us. And everyone on our international team is keenly focused on completing the integration successfully and driving up overall operations margins

One final question for me. Can you explain the cash flow statement being reconfigured and then the sequential decline in interest expense, I was a little confused there when your debt levels remained the same.

Sure. On the interest, it's a company interest that there were changes to but I'm not sure I understand your question on the cash flow. Typically when we report the cash flow, there's a footnote on the bottom of it that we really just made certain declassify indications. There's really nothing major that I'm aware of but we made written classifications in both periods in order to have an apples to apples comparison. To be honest with you, Steve, I would have to go back and look at what these reclasses were if you would like to know that level of details but the way it is presented is apples to apples

Okay, thanks for the comment.

Your next question comes from Glen Santanjelo of Credit Suisse First Boston.

Yes, Stan and Steve, I just had two quick questions. I wanted to talk about what you saw this quarter in terms of Dental equipment sales. It seems like you will 18% organic growth. Stan, can you talk about what two or three product lines do you see as continuing to drive the growth within that segment to help us asses the sustainability of that level of growth. And second question was on the medical side. You said, Steve, in your comments that you saw 24% growth in the medical side in the June quarter of last year. Now if I look in the first quarter of this year, the growth was up 4% and now we're down 4% in the second quarter. Help me reconcile what has happened here year-over-year and how should I think about the rest of the year. Thanks

Hi, Glen. On the dental equipment, first of all, we're gaining market share for a number of reasons. One is our system for delivery and installation, office design etc., is working extremely well. Our sales force, I think, is very confident that today we have an excellent offering of equipment. And can support that with terrific service. So I believe we're gaining market share.

Having said that, the market is doing well, not as well as we are, because I think we're picking up quite a bit of market share, 17.6% internal growth and total of 29%. The difference being primarily the acquisition in Canada. Having said that, I think dentists are looking to improve the efficiency of their practices. So maybe if they had two offertories, they're adding a third to provide more dental care simultaneously, multiple patients at the same time. I think digital X-ray is growing and we expect that to grow.

I think going forward, by the way, DEXUS will give us quite a big boost. We believe that is between DEXUS and the DENTRIX offering and one or two other ones, we will start showing real good market growth in a growing category. So I think that is doing well. And I think our market share growth there is also being driven, as we have said for a long time, by our DENTRIX capabilities. DENTRIX is the leading medical record in the dental software field, and connectivity to digital X-ray is good. So we remain quite optimistic both in traditional equipment area and in the digital X-ray benefits that will be going forward from a market point of view and our ability to gain market share. In the medium to long term, D4D, the CAP cam system should present us with even more excitement. So we're very, very pleased with where we are and they're even more excited about where they will be going in the dental equipment area.

On your second question, I think the answer really is that in the first quarter we began the process of shedding some of this lower margin, pharmaceutical products that we talked about in the first quarter, and we didn't have the full impact of that in the first quarter. It was -- you know really a full impact in the second quarter, and the same products, the oncology, the rheumatoid threats projects are the same projects that the second quarter saw the full impact of that shedding and the first only saw a partial impact

Steve, is it just a function that you can't make the gross margin off the factor so you're not going to direct those products any longer?

It's a little more complicated than that. Really our strategy on those products are that, for customers who use Henry Schein as more than just buying these low large inn products, we will sell low margin products as part of an overall, one stop shop portfolio. But if a customer is just buying a low margin product, we're not really interested in being a low margin distributor. On those customers, pricing really has to support the overall business with the customer and, therefore, you know, since a lot of these products, specifically oncology is so expensive, if there's a small change in pricing, they will go elsewhere. The really the strategy is, we will do it as part an overall product strategy, a one stop shop but not on a stand alone basis. We would rather have other people focus on that pure low margin bills. That's not our interest.

So it's not unreasonable I should see flat to down sales in this category for the next couple of quarters?

Until that annualizes through, that's true. Again, what we will continue to do is to show the core business, what that growth is, and I gave you that detail as part of the prepared remarks as well as the press release. We want to make sure people understand that the core business, it's still healthy. We're still gaining a market share. We're just changing the mix of our products.

Thanks for the comment.

Your next question comes from Robert Willoughby of Banc of America Securities.

This is Matt Jackson (ph) in for Bob. Can you give us an update on that business and also just your overall commitment to the business, i.e., potential acquisitions?

Although the vet market is one of the smaller markets that we participate in, we are admitted to growing our veterinary business to increase some critical mass. I mean, it's less than 2% of our business today in the U.S. We're going to continue to grow our critical mass through internal growth, and we probably will make a strategic acquisition at some point or another, exploring these options. We can't talk about M&A.

Our vet business has a shared infrastructure with our medical group and on the sales and marketing side and with our dental group as well on the distribution side. It's an interesting market to present some opportunities. It's not going to be a key focus. It's infer been a key focus, but if we can add more volume, we will do that. It has to be a profitable business.

There are fixed cost but it's not a key focus for us. We will of course expand the business internally through acquisitions, but having said that, it's an important business for us in Germany and in Spain, for example. Where we do participate in an important way in the food business, the dietary supplement business, and there it's a lot different to the United States so it's quite important there.

But again, it's not material from an overall company point of view. So, it's -- it has interest to us, but it's not something that we focused on, our medical business presents much greater opportunity. So does the Dental and, of course, our equipment businesses in Europe present much greater opportunity and it's not something that is material.

Thanks. That's it.

Your next question comes from David Veal of Morgan Stanley

Thanks and good morning. I wonder if you can talk about the margin profile of the international business and how it's developing. You said the margins are just above 3% and I'm wondering how that is moving and where it night go over time and how the acquisitions of Australia and New Zealand could be changing from there.

We did talk a little bit about that but I will reiterate. Yes, you're correct, the overall international Marge sin a little below 3%. Over on the last 12-month basis. Establishly talked about in his remarks some of the integration efforts. And we announced the closing of our Dutch warehouse. We're looking at the rest of our distribution network. We're putting the meters of Henry Schein all on the same computer system.

That will allow us, once that is complete, to look at facilities like purchasing, accounting, sales, billing, order entrees and allow to us get synergies and not having two separate redundant activities and put them together and hopefully take some of this out of the system to be more efficient.

Our goal over the next few years is to double our operating margin in the international group. We did say also that we expect this year, and it's really weighted towards, you know, the second half of the year, $2 to $3 million of expense energies, specifically for the Demedis acquisition and does not include further synergies with Australia or New Zealand or Canada or any of the other acquisitions and we're on target with that. So overall, we see that as a nice, short to medium term opportunity to improve profitability in our international growth -- group.

I wonder if you could also drill down on the non-recurring charges in the quarter. If you could size for us the amount of what you would characterize as integration costs move costs. And also a little bit more color around what you call the seasonality changes.

That's an area where I really would rather not get into really specific detail. Because when we talk about seasonality, what we are referring to, with the new entities that are a part of the group now, specifically Demedis and other entities, that profitability compared to last year for the second quarter really doesn't compare well. We have certain items that the seasonality of the overall business changed because of equipment being weighted towards the second half of the year.

And really there's probably a number of other factors that getting into that level of detail probably isn't warranted. I think it's important to note, and that -- that probably is the bigger -- the seasonality changes than the one time integration cost and the one-time cost with Melville moving because those, while they were part of the second quarter, didn't have as big an impact.

I think though, David, it's important to recognize that we were out in front of this -- I think at the end of February, when we announced our fourth quarter results that we expected this to happen, and we really internally looked at the overall business and said while there is some opportunity to move experiences around, legitimately, it's not in the best interest of the company so we're going to just let the expenses fall where they fall on a quarterly basis and point people to the fact that these seasonality changes on a full-year basis will go away. I would rather not give X million dollars for this and Y million dollars for this, because a lot of that is judgmental in definition and it all washes out by the end of the year anyway.

Okay. That's fair. Thank you.

Your next question comes from Derek Leckow of Barrington Research

Thank you. Good morning and congratulations on a terrific quarter and congratulations to Jim, if he's out there, on the promotion. My question is about working Capital Management. Steven, as you guys are consolidating DCs in Germany, Australia and Canada, you notice that the turns have moved up here to 6.6 turns. I think you reached a high of about 7 turns in 2003. Where do you see your inventory turnover level going and what do you think is the maximum rate when you're at your optimal inventory level as the current entity exists?

We still see the ability to improve inventory returns. While the second quarter did improve inventory turns, you're still not seeing the full impact of the integrations that have occurred or that may occur in the future. Our goal over the next couple of years is to be somewhere maybe in the 7.5 to 8 turn range.

We won't get there all in the next quarter or two, but over the next couple of years that is our internal goal. We think it is achievable and doable. For example, in Canada, we still have what I would refer to as excess inventory as we work down the inventory levels post the distribution center consolidation. So there's still nice opportunity there over the next year or two.

Okay, Steven. I guess that goal corresponds with your comments about the operating margin opportunity. Looks like I think you said over two years you will get the operating margin up to 8%. Do you still feel that possible?

Well, that would also assume, you know, we do expect obviously to, this year or next, to get back to the profitability lost on influenza vaccine. So I would say that our goal is very consistent. We see --excluding that additional one-time beneficial of getting the influenza vaccine margin pop, we also see, you know, 30 to 50 basis points per year on the core business. Some years it may be a little bit more than that. Some years it may be on the lower end of that. But on average, we see us being able to achieve 30 or 50 basis points per year and, again, the additional benefit of influenza vaccine this year or next when we resume getting that product from our manufacturers.

So that translates into significantly higher cash flow than you've been reporting. What are your plans for uses for that cash. I know that you said that acquisitions are still a priority. You have a share repurchase program but you really aren't executing it at a very significant level at this point. Do you think you might increase that share repurchase? Is that going to be the -- use of the excess cash or what?

I think, one, I like being in a position where we're generating strong cash and we're looking for good opportunities to put that cash to work. We still have about $57 million under the existing stock repurchase plan yet to buy. So I would like to see us, you know, continue that stock repurchase plan. I do think that, if we do further acquisitions, they will continue to be cash, because we still think, while stock in recent history, stock has traded up a little bit, we think there's not a full valuation on the stock. So I would say those are the two primary uses of cash, acquisitions and stock buy back. We also consider other things. We may look at our debt structure and see if there's any opportunity there. But we do have some favorable long-term debt arrangements. So we might just leave the debt outstanding at this time.

Okay. Then, one last question, if I might. On the German reimbursement issue and the consolidation that's going on there, are you seeing any competitive activity in terms of competitors coming in and trying to pick up sales people? What is the competitive environment look like? It seems like everyone's very busy. The doctors are probably overbooked -- you said there's a backlog of patient visits going on. So what does the competitive landscape look like in Germany right now?

As I mentioned in my prepared remarks, I think we lost one out of 200 sales people. We're in a very unique situation. We have a big block of business in Germany. There's unlikely, I think, to be much loss of sales people and I think there's more likelihood of us gaining analysis people. There are still parts of Germany where we're under penetrated. There's a lot of opportunity to bring the Schein offering expanded worldwide offering to Germany from private brand all the way to implants, to our practice management technology. I think that will add additional sales people.

So I think we're in a very, very good shape in what we call central Europe which is Germany, Benelux countries and, for our purposes, Italy. I would expect to us expand into the equipment market in Italy. That's big hole still. We're big players in the consumable field but not in the equipment field and that will require additional sales people.

So we're very, very optimistic with the opportunities in Germany and in particular, we will need to focus on completing the integration taking cuts out of the system. And we have an extremely stable software system -- SAP was installed before we acquired Demedis and so that's going to be presenting a big opportunity and the opportunities to connect the F.A.P. system to the Schein core system so that we can exchange information and generate value from that as we do all over the world. So very, very optimistic about Germany. And I don't see any competitor really bothering us

Okay. Thank you very much. Appreciate it. Congratulations and good luck

Thanks. I think we want to try to end with one more, I think? Operator, who is the -- there was one or. It's almost 11. So one more question.

Your final question comes from Christopher McFadden of Goldman Sachs.

Good morning. I would like to say last but not least thank you for taking the question. A couple of items. Firstly, relative to medical business. Could I get you to just talk about organic revenue growth in the disposable parts of your medical business as differentiated by some of the other product lines that you are involved there?

Secondly, Steven, you mention add couple of times that the opportunity is dropping some of this less favorable business mix in medical is about enhancement. Could you talk about what margin improvements you think you can generate in medical as a function of the process that you're engaged in here.

And finally, and I guess, building on your recent visit to Australia and New Zealand, are there other geographies that you would like to expand your capabilities into, perhaps other emerging markets that you're focused on or other markets where you can continue to kind of build out your geographic platform? Thank you.

Yeah, let's talk about the product mix. I don't think our product mix has significantly changed in the medical world, although I do think that that's probably tilted little bit towards equipment and I think we're doing very well in the equipment area. And what we've elected to do is really move a little bit more focus more towards that, away from REMICADE etc. And I think going forward, I'm not going to say it's going to happen in the next quarter but in the next couple of years our position in the electronic medical records arena, aggregating EMR with digital equipment, I think, is going to become important.

We have an infrastructure in Utah. Specifically, a telephonic customer service program, that lends itself to the small practice digital area. So it's just taking our value added proposition and enhancing it within the medical space that continues to drive that business. On the geography, there are opportunities really within the markets we're in. There are still one or two markets in Europe that we're not in today.

There are parts of Europe that we're not strong in one category or another and that present opportunities. I don't think the developing world is key right now. We do have an export department that ships products to 125 countries. There are opportunities there. But I don't think there's much real focus at this present moment on us establishing a presence on the ground.

But we do participate in bids. We do ship products to many countries. I did mention early on, equipment in Italy is on the radar screen. So we're pretty much in most of the developed world, where our type of formula works, which is small practices that need consulting -- our consulting services and our technology and other value added services. So that's really what we're focused on for the time being.

And Stanley, the margin opportunity improvement you think you can generate in medical as a function of the mix change you're doing now?

Well, of course, yes. I think the limiting of the low margin, high-capital-intensive pharmaceutical activity. Limiting that will, of course, automatically drive up the margins. But in general, Steven always talks about us improving our operating margin by 20 to 50 basis points and that's driven through more volume through relatively fixed cost infrastructure, more of what was done over the years.

And by the way, we have -- for a long, long time, we have been adhering to that formula but for introducing products like REMICADE, which spiked our sales growth in the medical world by something like 30% in one or two quarters. If you pull that out, we have been growing our operating margin by 20 to 50 basis points and, Chris, I think you can continue to expect through all of the various activities that we do, more relative costs infrastructure, more value added capabilities, more tools that our sales people have, margin management, the usual activities that we have been involved with for years

Very good. Thank you.

So thank you everyone. I know there were a couple of more but we want to end the call at 11, but I realize there was a lot of activity. Steven can be reached at 621-843-5915 and Susan at 5562. And they will, of course, be pleased to answer any additional questions. As you can see, we have made good progress and we continue to make good progress. We are extremely enthusiastic about the business. And we look forward to presenting good numbers to you again in 90 or so days. So thank you very much.

Thank you, ladies and gentlemen. This concludes today's Henry Schein second quarter conference call. You may now disconnect.