Henry Schein, Inc. (HSIC) Q2 2015 Earnings Report, Transcript and Summary

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.

Thank you. And my thanks to each of you for joining us to discuss Henry Schein's results for the second quarter of 2015. With me on the call are Stanley Bergman, Chairman of the Board and Chief Executive Officer of Henry Schein, Steven Paladino, Executive Vice President and Chief Financial Officer, who are participating in this call from different locations. 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, July 29, 2015. Henry Schein undertakes no obligation to revise or update any forward-looking statements to reflect events or circumstances after the date of this call. I ask that during the Q&A portion of today's call, you limit yourself to a single question and a follow-up before returning to the queue. This will provide the opportunity for as many listeners as possible to ask a question within the one hour that we have allotted. With that, I would like to turn the call over to Stanley Bergman.

Thank you, Carolynne and good morning, everyone. Thank you for joining us. Our second quarter financial results were solid with internal sales growth in local currencies in each of our four business groups doing well. As it was also the case during the previous quarter, the strength of the U.S. dollar impacted all of our international operation and of course those particularly in Europe. For the second quarter changes in currency exchange rates reduced our total sales growth by 7% and reduced diluted earnings per share by $0.07, that's $0.07 compared to the last year. Overall, the global markets we serve were healthy during the quarter and we believe we continue to gain market share. We are pleased to reaffirm our guidance range for 2015 adjusted diluted EPS and expect that our restructuring activities will continue to favorably impact our ongoing results. In a moment, I will provide some additional commentary on our recent financial performance and business accomplishments. But I just would like to give you a little flavor on two meetings I've just participated in here in Paris. I'm in Paris, and Steven is in New York. I spent seven hours with our international animal health team and would like to let the shareholders and investors know that this team is doing outstanding work as they execute on globalizing our animal health business and, of course, at the same time gaining market share and increasing the profitability of the business. Likewise, our practice solutions software team on the international side, dental, got together in Paris, too. And this was by coincidence they were both in the same city. So I decided to come over, and I can confirm also that this group is doing very well and executing our global practice solutions plan and, of course, increasing profits in that sector, too. So in a one-day period of time I experienced some really exciting activity going on here at Henry Schein. So let me ask Steve to review our quarterly financial results with you, and then I will come back and give you some comments on performance and business accomplishments in general. So Steve?

Thank you, Stan. Good morning to all. I'm also pleased to report solid results for the second quarter of 2015. As we begin, I'd like to point out that our 2015 second quarter results include restructuring costs of $7.2 million pretax or $0.06 per diluted share. We announced this restructuring on our third-quarter 2014 conference call. As we mentioned then, this initiative is expected to continue throughout the remainder of 2015. You could look at exhibit B to this morning's earnings news release, which reconciles our GAAP and non-GAAP income and EPS from continuing operations. I will also be discussing our results as reported and excluding these restructuring costs, as we believe the latter is more reflective of our ongoing performance. So now turning to our Q2 results, net sales for the quarter ended June 27, 2015, were $2.6 billion, reflecting 0.5% increase compared with the second quarter of 2014. This consisted of 7.5% growth in local currencies and a 7% decline related to foreign currency exchange. In local currencies our internally generated sales increased 3.9% and acquisition growth was an additional 3.6%. You can note the details of sales growth that are contained in exhibit A of today's earnings news release. Our operating margin for the second quarter of 2015 was 7.0%, which expanded by five basis points compared to the second quarter of 2014. However, excluding the restructuring costs, which we believe is the more meaningful measure, our adjusted operating margin for the second quarter of 2015 improved by 32 basis points, 7.2%. When also excluding the impact of acquisitions completed during the past 12 months and related expenses, operating margin expanded by 45 basis points compared with the second quarter of last year. The expansion was primarily the result of an increase in sales mix towards higher margin products. Our effective tax rate for the quarter was 29.8%. This is on a non-GAAP basis excluding the restructuring costs, and this compares with 30.8% last year. The slightly lower tax rate is due to the implementation of ongoing tax strategies as well as higher earnings in countries with lower tax rates. We continue to expect that the effective tax rate for the remainder of the year to be in this 30% range. Turning to net income attributable to Henry Schein for the second quarter of 2015, it was $117.9 million or $1.40 per diluted share. This represents growth of 1.5% and 3.7%, respectively, compared with the second quarter. Again, excluding the restructuring costs in the current quarter, net income attributable to Henry Schein was $123.2 million or $1.46 per diluted share, and that represents increases of 6% and 8%, respectively, compared with last year's second quarter. Again, as Stanley mentioned at the onset, our foreign currency exchange had a negative impact of a full $0.07 per share on the EPS for the current quarter. If we now look at some of the detail of our sales results for the second quarter, our dental sales for the second quarter of 2015 declined 3.5% to $1.3 billion, but this 3.5% decline consisted of 4.5% growth in local currency and an 8% decline related, again, to foreign currency exchange. In local currencies internally generated sales was 4.1% and acquisition growth was an additional 0.4%. Of this 4.1% internal growth in local currencies, we saw 3.7% growth in North America and 4.6% growth internationally. I will go through a little bit of detail behind each of these two figures. The 3.7% internal growth in local currencies for North America included a very strong 5.4% growth in sales of dental consumable merchandise and 1.9% decline in dental equipment sales and service revenues. In looking at North American dental equipment results, you should recall that last year's second quarter internal growth in local currencies was 10.8%. That made for a difficult prior-year comparison. If we now turn to the international business, the 4.6% internal growth in local currencies included 2% growth in sales of dental consumable merchandise and a strong 11.8% growth in dental equipment sales and service revenue. Of course, the growth in the international equipment business included a favorable impact on the equipment related to the IDS tradeshow. Animal health sales were $748.6 million for the quarter, down 0.8%. But this included growth of 7.9% in local currencies and an 8.7% decline related to foreign currency exchange again. If we look at the internal sales growth in local currencies, they were 0.6%. Additions contributed an additional 7.3% growth. I will split now that 0.6% growth between North America and international. The North America included a 4.1% decline and international growth was a 4.8% increase. That 4.1% decline in internal sales in local currencies in the North American market was 5.2% growth when normalizing for the results to account for the impact of certain products switching between agency and direct sales as well as the changes to our veterinary diagnostic manufacturer relationships. Again, we believe this normalized growth is a more meaningful reflection of the ongoing performance of our North American animal health business, and for the balance of the year until this annualizes we will continue to review our results both on a reported basis and on a normalized basis. Turning to our medical sales, they were $470.5 million in the second quarter. That's an increase of 16.7%. This is 17.7% growth in local currencies and a 1% decline in foreign currency exchange. Internal sales in local currencies grew almost 10% at 9.9% while acquisitions contributed an additional 7.8% to growth. Our 9.9% internal growth in local currencies in North America was 10.4% and was led again by large group practices and IDN networks growth, and internationally we saw an additional 1.3% growth. Acquisition growth during the second quarter included both agency revenue as well as direct sales growth under our strategic agreement with Cardinal Health. I can say now that the majority of Cardinal Health physician business customers that have been acquired have transitioned to Henry Schein, and we are recording substantially all of those sales under this agreement as direct sales. If you look at technology and value-added service sales, they were $89.5 million in the quarter. That's an increase of 0.4% and this included 3.3% growth in local currencies and a decline of 2.9%, again related to foreign currency exchange. In local currencies we saw internal growth of 2.9% and acquisition growth of 4%. That 2.9% growth, breaking it up between North America and international, was 2.6% growth in North America and 3.9% internationally. If we look at our stock repurchase program, we're continuing to repurchase common stock in the open market during the quarter. We repurchased approximately 267,000 shares during the quarter at an average price of $140.58 per share. That was approximately $38 million, and that impact on our diluted EPS was immaterial. At the close of the quarter we had an additional $187 million authorized for future repurchases, and we remain committed to our goal of repurchasing between $200 million and $300 million of stock for the full year. If we look at some highlights on our balance sheet and cash flow, operating cash flow for the quarter was $207.8 million, up from $199.2 million in last year's second quarter. We continue to believe that we will have strong operating cash flow for the full year. Our accounts receivable days sales improved slightly to 39.3 days compared to 40.2 days last year, and inventory turns were slightly down, 5.8 turns this year, 6.0 turns last year. I will conclude my remarks by reaffirming our 2015 financial guidance as follows. For the year 2015 we adjusted diluted EPS attributable to Henry Schein Inc. to be $5.90 to $6 per share, which represents growth of 8% to 10% compared with the 2014 results. Assuming the strength of the US dollar stays at current levels, we continue to expect that the adjusted EPS may be at the lower end of this range, as we mentioned last quarter. Keep in mind that approximately 35% of our worldwide sales are in currencies other than US dollar, and year to date, we have experienced about $0.13 or $0.14 of negative impact in EPS directly related to the foreign exchange changes. Our 2015 guidance excludes restructuring costs, which are expected to be between $0.29 and $0.33 per share, and that is related, of course, to the planned corporate initiative to rationalize the Company's operations and provide expense efficiencies. And as always, our guidance is for continuing, current continuing operations as well as any completed or previously announced acquisitions, but does not include the impact of any potential future acquisitions. So with that, I'd like to turn the call back over to Stan.

Thank you, Steven. Let me begin my review of our four business groups with dental. In North America, consumable merchandise internal sales growth in local currencies was strong at 5.4%. This growth indicates that patient traffic to dental offices continues to be solid. Indeed, for the past four quarters considerable merchandise internal sales growth in North America has been consistently in the mid-4% to 5% range. Equipment sales and service revenue in local currencies in the second quarter declined 1.9%, however, against a difficult prior-year comparison, as Stephen mentioned. We expect North American dental equipment sales and service growth to accelerate in the second half of the year with a good backlog report at this point. Looking at international dental, consumable merchandise internal sales in local currencies returned to positive growth of 2% for the quarter compared with a decline of 1.6% in the first quarter. Equipment sales and service internal growth in local currency was 11.8%, was a multiyear high and included favorable impact from the biannual International Dental Show, the IDS, which took place this past March in Germany. So now let's spend a few minutes or a minute, actually, on the animal health side. Growth in this group was aided by strategic acquisitions in North America and internationally. Our normalized internal sales growth in North America continues to be very solid. We recently announced two acquisitions in the animal health space that will expand our global direct presence while bringing market leaders to Henry Schein . First, we announced plans to acquire a majority interest in Jorgen Kruuse. Kruuse is a leading distributor of the veterinary supplies in the Nordic countries with sales in 2014 of approximately $19 million. Kruuse will extend Henry Schein 's direct presence in Denmark, Norway, and Sweden. We expect this transaction will close later in the third quarter of 2015. Kruuse offers a comprehensive portfolio of proprietary products and branded consumable merchandise as well as pet accessories, capital equipment, and pet food to veterinary clinics and retail pet stores. We plan to expand the Kruuse line of proprietary products to animal health customers across Europe, North America, Australia and New Zealand as well as Asia. Kruuse serves customers in more than 100 countries through a network of distribution partners. We are delighted to enter the Nordic animal health market with a well-recognized family company. Kruuse enjoys deep customer loyalty and satisfaction as well as a reputation for quality products and strong brand awareness. Also during the second quarter we acquired a 50% ownership investment in Maravet, a leading animal health distributor in Romania. Maravet has annual sales of $23 million. And, like Kruuse, we have purchased our interest from the founding family, which continues to own the balance of the company. Our investment in Maravet adds to our East European presence, which we established in the Czech Republic in 2009 and later expanded to Poland with their acquisition of Medivet last year. With the recent acquisition of Kruuse, Maravet and scil, our animal health business continues to thrive while gaining market-share through a combination of organic growth and, of course, through strategic transactions. When the Kruuse acquisition closes, Henry Schein animal health business will expand to 23 countries including United States, Australia, New Zealand, Canada, China, Malaysia, and 17 other countries in Europe. Now let me talk a bit about the medical business. Internal sales growth in our North American medical business continued at a double-digit pace as we made further progress with large group practices and IDNs, integrated delivery networks. During the quarter we recorded sales and our strategic agreement with Cardinal Health as agency sales and direct sales as we integrated the business. Our transaction with Cardinal continues on plan with the majority of Cardinal Health acquired customers now successfully transitioned to the Henry Schein platform. We remain optimistic about our ability to win new customers with Cardinal by being uniquely positioned to jointly serve the entire continuum of healthcare. So, let me conclude now with an overview of our technology and value-added services. Internal sales growth in this group in North America was 2.6% in local currencies and international internal growth rate was 3.9% in local currencies. So in North America 2.6% and internationally 3.9% in local currencies. The advanced technology products and services we offer supports our commit to the efficiencies of delivery of healthcare services and a platform for further enhancement of sales opportunities across the entire business. The group also serves to differentiate Henry Schein from our competitors while deepening and strengthening our relationship with our customers. The software and value-added services component on this business does very well, and we had some strong numbers that we were up against on our equipment side of this business. So overall, this business, again, continues to do very well. So before we open the call to questions, let me give some highlights of some recent news. As we continue to advance our strategic plan, we have named Peter McCarthy President of the Global Animal Health Group. Peter has provided important leadership in the growth of our international animal health operations, most recently as President of our animal health international group. In addition, Henry Schein recently appointed Francis Dirksmeier, Fran, as President of Henry Schein Animal Health North America, reporting to Peter. Fran brings more than 30 years of commercial leadership experience, most recently serving as General Manager of GE Healthcare in Global Asset Management and Hospital Operations. Fran's background, by the way, is significant distribution in healthcare and also software and the connection between distribution and software, resulting in the value-added services that have made a difference in the businesses he has supported over the years and now bringing that know-how to Henry Schein animal health as well. Now, just a key component part of Henry Schein 's success is our relationship with our constituents, our suppliers, our teams, and our customers in the social outreach area. During the second quarter Henry Schein once again stepped up to support relief efforts with several disaster situations. Together with our supplier partners we committed $0.5 million in product donations to support victims of the devastating earthquake that struck Nepal. And here in the US we were active; we activated our disaster relief hotline to support customers affected by severe storms and flooding in the South Central region of our country while also providing support to our nongovernmental organization partners and their need for healthcare products to assist in relief efforts. So these are but two examples but are key in driving morale, customer support, supplier support and, of course, morale generally in the Company and amongst all of our constituents. Educating future generations of dentists and supporting advanced technology are both ongoing commitments of Henry Schein. We combine these two passions. We are proudly announcing the creation of the Henry Schein Digital Center of Excellence at the Kornberg School of Dentistry at Temple University in Philadelphia. Expected to open in the next 12 months, this center will serve as the digital dentistry training lab for students, faculty, and alumni, and will be equipped with the latest innovations of digital technology from Henry Schein and our supplier partners. We are committed to advancing our position, our global position in digitalized dentistry and, at the same time, combining that with closer relations with our customers and educational institutions that graduate our customers in the dental, medical, and veterinary space. In late June we were honored to be selected as Corporation of the year by the Association of Hispanic Healthcare Executives, in recognition of our commitment to increase diversity and cultural competency in healthcare professions. And last, we continue to climb up the Fortune 500 list of America's largest companies. We have been named to this list for the past 11 years and now rank 287th, up from 292 a year ago. Our inclusion in this prestigious listing is testament to this shared commitment and value of the more than 18,000 Henry Schein members across the globe, all of whom are dedicated to helping practitioners improve the efficiency of the practice and provide quality care. And the fact that we were ranked and have been ranked, really, since we have been listed as a Fortune 500 company as one of the Most Admired Companies in health care distribution, being ranked number one this past year again, is really a testament to our team, our customers, and our suppliers. So with that overview of our quarterly financial operating performance, Steve and I are ready to take questions.

[Operator Instructions] And your first question comes from the line of Glen Santangelo with Credit Suisse.

Thanks and good morning. Stan, just curious about some of your comments on the medical segment, it's clear the Company continues to post pretty impressive growth there. For a number of quarters you've highlighted a focus on large group practices and integrated delivery networks. I'm kind of curious. Can you maybe comment on the Cardinal Health relationship? And Steve, I don't know if there's any way to maybe roughly quantify how much of that added and we should think about as we think about modeling going forward, like when you may anniversary that benefit, and just some overall sense for maybe how fast the market may be growing organically.

Steven will give you the financial aspects. But the relationship, which is really a three-pronged relationship, has done quite well for Henry Schein and, in our belief, for Cardinal as well. On the first line of the equation is the fact that we have taken over distribution of Cardinal's product line and, of course, it's sales to customers that are small practitioners. Then, on the other side is the IDNs, the large group practices, the large multiple locations managed by IDNs as well as group practices. And that has also gone very, very well for us. That business has primarily transitioned to us. But this is all built on a relationship where we are securing product, owned brand product from Cardinal and doing some joint procurement. And that is also working quite well for us. So the customers that are being serviced by Henry Schein , former Cardinal customers, I believe, are very happy with the service we are providing and at the same time will be benefiting from the Cardinal brand [products], and our pricing opportunities in this marketplace will also help our customers and help drive operating margin at the Henry Schein side. I hasten to also add that the internal growth from the Henry Schein core business, which is significantly now focused on IDN large group practices, is also performing very well when you exclude the impact of Cardinal, which in itself was also doing well.

So, Glen, just on the second part of your question, so really Q2 was the first quarter that we recorded direct sales from the transaction. At Q1 we were recording effectively agency sales, but as we started the integration process during Q2, as we integrate sales onto our platform we record direct sales. You can see that the acquisition sales growth was 4.6% for the quarter. It will annualize. We are continuing to integrate. We would expect that the integration will continue probably through the better part of Q3. At that point we should have all or virtually all of the sales on our platform. The run rate that I would use for modeling going forward is something north of maybe $250 million but I don't have a more precise number at this time. And that will get phased in, starting with Q4 we will probably be at that rate. And that's on and all direct sales basis, assuming that there's no more agency sales at that point. And there should be some growth to that, of course, as we continue to add product assortment and we continue to drive growth to those customers.

Okay, that's helpful. Maybe if I just ask one quick follow-up on the dental equipment, obviously appreciate that you had a difficult comp this quarter. And Stan, if I heard you correctly, I think you are assuming that that business should start to get a little bit better in the back half as you focus on what your order book may look like. Then I'm kind of curious -- did you mean that you think the overall equipment business is getting stronger or you think just the growth rate will look better in the back half due to perhaps easier comparisons? So just any clarity in terms of what you were saying would be helpful.

Yes. On Steven's comments on the growth rate per se, to the extent that we have that information, because it will be talking about a future situation -- having said that, I can comment on the fact that our backlog is up quite nicely in North America and that we also have similar view of our backlog internationally. So we are quite optimistic about the sale of equipment in the second half of the year. And I assume that some of that is because the market is good but some of it is also because of the Henry Schein operate and our effectiveness in gaining market share.

So yes, so we feel that again, Stanley said a couple of the key points. Our backlog at the end of the quarter both domestically and internationally is up very nicely, so we feel good about that for future growth. Remember, that backlog covers primarily traditional equipment, not the high tech equipment. But that's a good indicator of the traditional equipment. Remember we are going through a little bit of transition. We added the A-dec line, so there is a learning curve. And there is that that we're focusing on in the U.S. I would say that if you look at the components in North America, I think the bright spot of the equipment was traditional equipment, was the bright spot for us. We were a little bit soft on technology, in large part because PlanScan had upgrades last year but still soft in technology despite that. But we are feeling good, like equipment is going to be a good driver for us for the second half of the year.

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

Steve, just one or two quick follow-ups on the equipment comments you just made -- I guess one with A-dec. Is that driving kind of upside to your equipment numbers right now? Is it drawing out purchase decisions as your sales reps go and take that line in front of clients? Just wondering kind of any color on how that's working into your portfolio at this point?

Well, it's really very early on. We just started, we just got access to the line, as I think you know, late in Q2. So we went through a training program with our sales force. I would say that we would expect a net improvement in overall traditional equipment sales by adding this line. But it's really too early to really try to quantify it at this point. Maybe in Q3 or certainly in Q4 we can give a little bit more color on that.

All right, and then just one question on the European dental comments or on the international dental business. The recovery on the consumable side that you saw the plus 2% last quarter it was down some. I mean as you kind of look in hindsight now over a trailing six-month period, is market getting a little bit better there? Was there just something weird going on in the first quarter? I mean what do you think contributed to that first quarter decline, a little recovery now? Is there really any change in end market dynamics going on, or was there just some funky timing issues in there, anything like that?

Well, I think the market is slowly improving in Europe, not quite as quickly, obviously, as the U.S. If you recall last quarter, we specifically called out three markets that saw declines in the international dental market -- Germany, Australia and the UK. And we did say at that time we don't believe they are trends; it's a little bit, as you said, that kind of funky, quirky ebbs and flows. And for the current quarter we have positive sales growth in each of those markets, so our estimate was correct that we talked about last quarter. And I think we’re expecting -- again, European markets are not doing as well, again, as the U.S. But we do think they are very slightly improving year-over-year.

Next question comes from John Kreger with William Blair.

Stan, since you have been spending a lot of time with your international group, can you just give us your sense how many countries are you in at this point? And of those, maybe what the top three or four opportunities are that you think are most substantial over the next, say, three years?

So first of all, with the closing of Kruuse we will be in 33 countries now. And of course we do service, especially on the dental side, dentists throughout the world through, as I mentioned, 33 -- we are actually on the ground in distribution centers, call centers, and fuel sales people in 33 countries. I will say to you that Europe presents a good opportunity for us. We are going to be going against lower comps as the year progresses and I think we will be seeing some good growth in a couple of markets as the year progresses and I think, going into next year. So in Europe as a basket, which took a bit of a hit last year, is, I think, recovering as you saw, the German equipment numbers and the equipment numbers in general were pretty good, driven largely by Germany but not exclusively by Germany. So I think equipment appetite is good. I think there is a growing demand for digitalized dentistry both in the dentist's office, chair side dentistry, chair side digitalized prosthetics, and in the laboratory, which is not only interested in ensuring that the customers have scanners to submit the prosthetics but also, within the lab, where there is a lot of opportunity for digitalized equipment. We are seeing this quite nicely coming out of the Arseus acquisition but not only out of that acquisition, which in itself leads to block sales, where we see good margin and some unique opportunities for Henry Schein in that space. So that leaves, of course, into consumables. And I think it is fair to say that, although the markets in Europe are a little bit anemic, they are getting stronger. And Henry Schein , I think, will continue to gain market share. There is nice opportunity in Australia and New Zealand on the dental side, and I would say on the animal health side too. And let me just go back. I think our European animal health business is also in very good shape. We've got good products, great management, and some really good opportunity. And if you go around the world, I have to say that the dental business in Australia presents Australia and Brazil presents really nice opportunity as well. If you go out the longer I think we are quite optimistic about our business in Asia, although there's a lot more work to be done in establishing the platform. And we are hopeful that over time we will be able to extend our presence in Japan and China. So we are quite optimistic about our international business.

Thanks very much, maybe one quick follow-up. If you look at the order flow that you got out of IDS, were there any surprises in that, any categories that did better or worse than what you might have anticipated?

No. I think the order book was good, traditional business, CAD CAM. And I think the halo of IDS is continuing to drive some of our CAD CAM business around the world both in terms of sensors and when I say around the world, I mean in Europe, in Germany particularly that I would say the whole of Europe, in terms of sensors and mills and related software. So I think this was more or less all the areas that usually we expect to grow, the traditional and CAD CAM. But I think we will see extra momentum during the rest of the year from the CAD CAM side.

Great, thank you.

Your next question comes from Jon Block with Stifel.

Great, thanks and good morning. Well, if I can just start maybe on the vet side, Steven, I think I've got these numbers correct. Obviously there's a lot of adjustments but I think you said the adjusted North American vet sales was, I believe, 5.2%. It's a solid number but it is a notable step down versus, I think, what was it, 13.6% adjustment last quarter. And clearly, the overall industry momentum seems to be continuing. So is there anything to call out in North American vet? I just bring it up because we've heard chatter of overall in-clinic pricing pressure. Are you guys seeing that? Is that reflected in the step-down in the growth rate? Or is this just more bouncing around and the volatility in the near-term?

So we don't think it's a change in, A, market conditions; B, any unusual or significant pricing issues in the market. As I think, in the animal health market with weather, when people or when the veterinarian is buying certain products, there are always a little bit of fluctuations there. So we are not reading anything into I agree it is a step down. We are not reading anything into the overall change. We still think the markets are healthy. We still think that we can see acceleration of the markets as the flea and tick season continues. So we are feeling like there's no major similar to what we talked about just a minute or two on dental. And I said we saw Q1, where a couple of markets in Europe were down. We didn't think it was something market related, and the consumable merchandise in those three markets were up in Q2. So hopefully that's clear.

Okay. No, that's very helpful. And just to shift gears, Stanley, I might be asking this a different way than Glen earlier. But you called out the solid consumable growth in North America now for a number of quarters, maybe arguably four quarters plus. It seems like you need some decent growth in the back half of the year to get to the low to mid-single digits. But can you just reflect, in the past when that better consumable growth starts to seep into the mind of the dentists, they feel better, want some better efficiency in their practice and then you see that reflected in the equipment numbers, what sort of lag has that been historically? And can we see as a result of that a step up in equipment in North America in 2016 and beyond? Thanks, guys.

Yes, good question. I think the psychology in the down markets in North America specially U.S. I was going to say the US; I am referring to the whole of North America is a positive one. And I think dentists are realizing it's a good place, their practice is a good place to invest. So if you look at some of the technology out there, which helps increase the efficiency of the practice, improves on the workflow, resulting in a better experience for the customer and better productivity, you put the mindset together, the optimism that technology can bring to the practice and the ultimate efficiency and productivity, it leads to a good mindset in technology-driven products. And so, I think that's where we will see quite a bit of upside. In addition, I think dentists are feeling pretty good and should be in a position, we think, for the remainder of the year to invest in some of the traditional equipment. I think our expanded line will help us in that regard from a pure Henry Schein point of view. So I think it's less to do with a specific uptick, couple of basis points here or there, and more to do with the mindset, which is pretty good right now in dentistry. Having said that, the traffic is improving and I think from a pure Henry Schein point of view we are gaining market share as well.

Your next question comes from Michael Cherny with Evercore ISI.

Good morning, guys. I want to follow up a little bit on the animal health questions. I know it's not your protocol to give revenue guidance, by any means. But in terms of the headwinds you saw relative to the agency change and also the diagnostic shift, is there any way to give a sense on a next six-month basis how those headwinds, roughly, do you think will impact you? I know you reiterated guidance, so clearly that's baked into the numbers. But just trying to understand, again from a modeling perspective, how should we think about that area within North American animal health on a go-forward basis?

Well, again, we would prefer not to give specific revenue guidance on that. But I think we are comfortable enough to say that we do think that we will see some degree of improvement for the second half of the year in North American animal health as adjusted for the normalized growth. But save that comment, I don't think we really want to give a specific metric on growth there.

No, that's fine, Steve. Figured I'd try. And then just relative to the M&A landscape, as crazy as this sounds, by my count it seems like you have actually slowed down on the total number of deals you have been executing on. Have you seen any changes in terms of the dynamics, in terms of what types of valuations or what types of opportunities that these sellers are looking for in terms of the type of assets that you are pursuing?

Well, one, I'm not sure I would characterize it as a slowdown at all. You know the way acquisitions work. They have a timeline all their own and they bunch up sometimes, and they take a little bit more time sometimes. So I would say our pipeline is as full as it's ever been. I would say that I know the market has seen some very unusual pricing, very, very high pricing in a couple of properties. But that's not indicative of the overall market. The overall market the pricing is much more stable. So I would say that, no, there is no slowdown, A. And there is no major change in pricing.

Got it, just timing related. Understood, thanks.

Next question comes from David Larsen with Leerink.

Congratulations on a very good quarter. Steve, can you talk about the pipeline for animal health deals? It looks like maybe an 11% contribution there this quarter. It has been very high for the past four quarters. Just any thoughts on what that is going to look like going forward?

Well, there's a lot of activity. I don't like to really predict what's going to close and when it's going to close because it's absolutely very difficult and maybe not even possible. But we haven't closed the Kruuse deal, as Stanley mentioned. We expect to close later in the current quarter. There is activity with other animal health, also dental and medical acquisitions. So as I just said, I think the acquisition pipeline is good, is strong. It's probably as strong as it's ever been. But again, it's hard really to say, okay, add X million dollars of revenue for next quarter when the timing is really not predictable.

Okay, great. And then with North America, again a very good number, I think it is 10% internal sales growth this quarter, 12% last quarter. These are very robust growth rates, significantly higher than 1Q of 2014. Just, Stanley, any thoughts on what is driving that? Is it the Affordable Care Act, increases in coverage? Thanks.

Yes, so I think we've discussed this in past calls, and let me reemphasize it because it's working. Six or seven years ago we commissioned two studies. One is the area that is likely, the part of healthcare that is likely to be moving the most rapidly, and we determined that to be the alternate site, and the physician provider, because of the anticipated healthcare reform implications, namely wellness and prevention. So we decided to focus on the physician side of healthcare. And we said to ourselves as part of that, what kind of physician providers? And we determined it's likely to be larger groups, so consolidation of practices into larger groups and, at the same time, IDN, integrated delivery networks would be expanding their presence into this large group arena. So we set up our healthcare services group, I think it's seven years ago, to focus on this part of the medical business. And we focused very deeply on it. We were not distracted with acquisitions. There were some very large properties available that service the smaller practitioner groups or some of the single practitioners and one, two, three practitioner. We focused on the large group practices and the IDNs through our healthcare services group. And that has done very well. At the same time we said to ourselves, what are the specialties that are going to be the most productive from sales point of view and more importantly from a margin point of view? And we determined which specialties we wanted to focus on. And we did that as well. If you take the two together, it's resulting in top-line growth, internal growth and of course operating margin expansion in our medical group. You put that together with our cardinal alignment, and it's an acquisition of their sales in the space. But then you add to that the procurement opportunities that we had to procure costs under their brand and to jointly advance better procurement between our two businesses, and the net result is top-line growth and margin expansion for our medical business.

Next question comes from Kevin Ellich with Piper Jaffray.

Steve, just wanted to see if you could give us some more color on how the diagnostic change in animal health is going. I think your sales reps are selling both Abaxis and Heska, wondering which products are doing better, how are the sales reps doing in terms of getting traction with those products?

Sure. Well, I'd rather not say which one is doing better or not better; they are both actually doing well. We feel that both product lines are very strong product lines. My understanding is the sales force has quickly moved and understands the product lines. Compared to what our goals are internally, we feel very good about this whole transition. But I just want to be clear. This is not a one or two quarter transition. Remember, as people, especially with the diagnostic equipment, as people replace diagnostic equipment and as leases and other things come up over a multiple year period, that's when you have an opportunity to convert customers. So only this is the second quarter out of the box, and when this initially came to light I immediately said this is not a one or two quarter process, this is a one or two-year process. So right now, in the early innings, if you will, we feel good about what we have accomplished. But there is still a lot more activity, and there is still a lot more that we need to accomplish.

And then just another one, for Stan, we've seen some good M&A activity out of you guys in Europe for animal health, but in the U.S. one of your competitors made a big move into the livestock distribution business. From a strategic standpoint, is the production animal market something that you want to get bigger in? Just wondering what your thoughts are on livestock?

So we believe the animal health business is a good business because of demographics. The elderly, the baby boomers spending more money on their pets. So that's one. And the middle class in the rest of the world, the developing world, et cetera is growing. And that results also in pet advancements. But within there lies the demand for protein as well. So we believe that is an opportunity. Not sure if distribution of branded pharmaceuticals is necessarily the best play in that space. It may be. But there is opportunity for niche products with high margin. And so, for example, I think the Kruuse opportunity will be very, very good for us. The scil opportunity will be very, very good for us on the equipment side. And the veterinary instrumentation offering in the instruments side will be very good for us. We're adding resource in that space, expect to add more products over time, getting more margin, and have a very profitable business that will be focused on the large animal side as well. But I'm just not sure if the tonnage, lots and lots of sales in branded pharmaceutical, is the way to go and whether that's the place to put capital. And certainly not the place, in our view, to put capital at a very expensive cost to put that capital to work. But we do see opportunity in the space and we do business in a number of countries in the large animal space and dairy space and the various other areas and remain quite optimistic about that. But I think our play will be a little bit different, given our strengths in the business today and the opportunities ahead of us. Going back to the question on the diagnostics, we were of course taken by surprise in this space. But I believe that our team has come together quite quickly in putting together an excellent offering, a global offering of diagnostics. We are working very well with Abaxis and Heska. And in combination with our practice solutions business, the software business here in the United States and abroad, and our big data opportunity will, I think, have some really exciting opportunities for our customers and our suppliers going forward. So, although we were quite surprised by what happened, considering that we had what we thought was a good relationship with the supplier, we remain very, very optimistic, specifically with our Axis-Q bidirectional integrated solution that improves workflow and reduces missed patient opportunities in the practice. So, we have added good resources in that area, have really good management, good team in the diagnostics space, more to follow and remain very, very excited both in the equipment arena and with the rapid test. It's amazing how many suppliers have come to us from around the world to say, now we see an opportunity for you in the space. But our anchor, of course, in the model is Abaxis and Heska.

Your next question comes from Dave Francis with RBC Capital Markets.

Hi. Good morning. Stanley actually walked into the area I wanted to ask about. You guys have talked in the past about the opportunities that you have in terms of the data that you have collected relative to your customers' ordering patterns and tying that in with some of the technology offerings that you have as well. I was wondering if you could talk a little bit about where you guys stand in terms of accelerating some higher-level marketing activities and being able to lever some of those data assets into higher revenue growth rates in the near to intermediate term.

Right, very good question. We have had database marketing really going back to almost 25 years ago when we launched our mail-order business. And really we have, in the markets we serve, the finest database relative to products, customer specialty, etcetera, and have done good with that opportunity, leveraged it quite nicely for the benefit of our suppliers and our customers over the last 25 years. It's a key driver in our success. We combine that data, of course, with tele sales and field sales consultants and e-commerce marketing. Having said that, about a month ago we actually launched our big data division to capitalize on the opportunity of the data we had in our practice management world but also in the Henry Schein databank, our products and related services that we sell. So we have brought on a very senior executive to manage that for us and are very excited with that opportunity on the general medical and vet side. And it will, of course, be a division that is focused on driving stickiness with our customers. But actually we expect this to be a business that will generate profits as well to the bottom line, positioning us to capitalize on our data but also, of course, to drive growth, effective growth through ecommerce and other ways in which we sell.

That's very helpful. As a quick follow-up, Steve, I want to turn it back to the animal side. You specifically called out in the press release, talking about the North American business, shifts between agency salesand direct sales.Can you peel back the onion there a little bit and just talk a little bit more about the dynamics there? What are the shifts one way or the other, and how that might be impacting revenue growth rates in that line of business and how we ought to think about that over the next few quarters?

Sure. Well, so that was just part of two comments. Right? We normalized for the shift in agency as well as the diagnostic manufacturer change, as well as the, those two items. The smaller of the two was the agency to direct sales. The impact on animal health was about 1% because of the shift in the second quarter. So the bigger impact, obviously, for the normalization was the diagnostic manufacturer change. So we don't expect going forward, we don't expect really it's hard, really, to predict. But we don't really expect that to change that much. It will still be a small, maybe 1% or less than 1% impact to our normalized sales growth.

Understood. Okay, thank you.

Your last question comes from Steven Valiquette with UBS.

Hello. Thanks good morning. Stan and Steve. So I guess, as you guys touched on earlier, the internal growth in medical obviously is very strong. But just curious, without naming any names, are there any key competitors that might he losing share for any specific reasons that you are capitalizing on? Or is it just generalized market share gains for Schein within these larger group practices?

Well, I'm not sure about who is losing business or who is not because what we are seeing is a massive consolidation amongst solo practitioners going to three, four, five in the practice, the 5s to 10s, the 10s to bigger. And so, bigger business is coming from all over. And we see even further consolidation in this marketplace with fewer distributors, stronger distributors, and distributors that have the software, the intelligence, information intelligence to service these accounts. And so, I would imagine in the future as we go forward, and also in the animal health and dental space, economies of competency will drive the business and, in order to have competency specialization you need large sales basis to amortize this competency. So I think I can leave it up to your imagination where the business is coming from. But I would say we are getting it across the board.

Okay. And then for what it's worth, obviously we hear about some of the medical distributors to the hospital and/or IDN market expanding into distribution of more sophisticated SKUs that previously may have been marketed directly by some of the manufacturers or suppliers. I'm just curious; is there any sort of dynamic at play within the IDNs that you service where you may be expanding to categories or products that you distribute that might be driving extra growth? Or is that not really a factor for you guys in your medical programs?

I would say that to take any five-year period and I would expect us to go forward in our dental, medical, or vet business, you will see the movement from direct manufacturers to distribution. And this is -- we have had one particular example in vet where it went the other way. But generally, I think the smarter manufacturers understand the value that distribution brings, of course, in the logistics. But that's not the area; it's in the value-added services. And in our particular cases, we have 4,000 field sales consultants around the world that are specialists in practice management, understand how a practice should be run, and help our customers operate a more efficient business so that they can provide better clinical care. And that drives manufacturers moving towards us, and I believe that's the case in all three businesses.

Okay, great. Okay, thanks.

Okay. So thank you, everyone, for calling. I think you can get a feel that we are quite excited about our business. Of course, we have challenges like every single business does. And, in particular, the biggest challenge we have right now is the relative exchange rate between the US dollar and the euro. And we are working very hard and expect to be successful in mitigating that conversion risk with other areas of increased profitability in the business. We are advancing our strategies in geographic expansion, market share growth, margin expansions through advancing product that present greater value to our customers, greater margin, and are managing our expenses, expecting to reap some benefits from the restructuring that we announced last year. So we remain optimistic about the business. And so thank you for calling. Again, if you have any questions you can call Steven Paladino at 631-843-5915, or Carolynne Borders at 631-843

It's actually 390-8105.

390-

8105. Thank you very much.