Henry Schein Inc

NASDAQ:HSIC

Earnings Call Transcript 2018-Q3

[Operator]

Good morning, ladies and gentlemen, and welcome to the Henry Schein Third 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. As a reminder, this call is being recorded.

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

[Carolynne Borders, Henry Schein, Inc.]

Thank you, Clinicia, and thanks to each of you for joining us to discuss Henry Schein's results for the 2018 third quarter. With me on the call today are Stanley Bergman, Chairman of the Board and Chief Executive Officer of Henry Schein; and Steven Paladino, Executive Vice President and Chief Financial Officer.

Before we begin, I would like to state that certain comments made during this call will include information that is forward-looking. As you know, risks and uncertainties involved in the company's business may affect the matters referred to in forward-looking statements. As a result, the company's performance may materially 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 end market 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, November 6, 2018. Henry Schein undertakes no obligation to revise or update any forward-looking statements to reflect events or circumstances after the date of this call. Please limit yourself to a single question and a follow-up during Q&A to allow as many listeners as possible to ask a question within the one hour that we have allotted for this call.

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

[Stanley M. Bergman, Henry Schein, Inc.]

Good morning, everyone. Thank you, Carolynne, and thank you all for joining us this morning. We are pleased with our third quarter financial results which demonstrate, of course, continued solid growth in each of our business groups. We believe that the end markets we serve are stable, in fact, leading to improving and that we have continued to gain market share with our value-added solutions approach to servicing customers. And we believe that we continue to gain market share in all of our business units.

We also are pleased with our progress relative to our long range long-term strategic goals with a balance of organic growth, resulting from our consultative approach and close relationship with our customers, augmented by growth from acquisitions. We have a focus on adding a greater proportion of higher margin products across our businesses and deepening the breadth of our value-added solutions across the globe.

We are fulfilling these goals with our investment in higher margin dental specialties and software capabilities which we'll talk about more later in the call and, of course, very pleased to answer specific questions.

So we continue to believe we have a healthy business. We are well positioned to take advantage of many opportunities we have for investing in long-term growth of the business. The strategic plan, we believe, is the most solid in all this time in Henry Schein's history. And we are confident that we will continue the track record of good planning, good execution as we enter into our 23rd year as a public company.

So at this time, I'll ask Steve to review our financial results and to provide some further guidance on the numbers. And then I'll provide additional commentary on our recent business performance and our accomplishments. So, Steven, please.

[Steven Paladino, Henry Schein, Inc.]

Okay. Thank you, Stanley, and good morning to all. As we begin, I'd like to point out that I will be discussing our results as reported on a GAAP basis and also on a non-GAAP basis. Our Q3 2018 non-GAAP results exclude certain items that are detailed in Exhibit B of today's press release, which can be found and is available in the Investor Relations section of our website.

We believe the non-GAAP financial measures provide investors with useful supplemental information about the financial performance of our business, enable the comparison of financial results between periods where certain items may vary independent of business performance and allow for greater transparency with respect to key metrics used by management in operating our business.

These non-GAAP financial measures are presented solely for informational and comparative purposes and should not be regarded as a replacement for corresponding GAAP measures. For a reconciliation of GAAP to non-GAAP, again you could see Exhibit B in today's earnings release, as well as it's included on the Investor Relations section of our website.

So turning to our results. Our net sales for the quarter ended September 29, 2018, were $3.3 billion, reflecting a 3.8% increase compared with the third quarter of 2017 with internally generated sales growth in local currencies of 3.2%. When you also exclude the impact of certain products switching from direct sales to agency sales, our normalized internal sales growth in local currencies was 4.1%. You can see the details of our sales growth on Exhibit A of our earnings news release.

On a GAAP basis, our operating margin for the quarter – our third quarter of 2018 was 5.1% and contracted by 170 basis points compared with the third quarter of 2017. However, on a non-GAAP basis, which excludes restructuring costs, transaction costs related to the Animal Health spin-off, as well as the litigation settlement expense, our operating margin was essentially flat on a year-over-year basis.

You can see the reconciliation of GAAP operating income to non-GAAP operating income in the appendix and our corporate slide set, which is posted on the Investor Relations page of our website.

As we have previously mentioned, we have a continued focus on increasing sales of higher margin products to drive gross margin improvements across all of our businesses.

Our reported GAAP effective tax rate for the third quarter of 2018 was 19.6%. This compares to 29.0% GAAP effective tax rate for the third quarter of 2017. On a non-GAAP basis, which excludes certain items detailed in Exhibit B of today's press release, our effective tax rate was 23.2%. And that compares to 29.0% in the third quarter of 2017 also on a non-GAAP basis. We believe our full year 2018 GAAP effective tax rate will be in the range of 24% for the full year.

Moving on, our net income attributable to Henry Schein for Q3 of 2018 was $121.5 million or $0.79 per diluted share on a GAAP basis and represents declines of 12% and 9% respectively compared to the third quarter of 2017. However, again, non-GAAP net income attributable to Henry Schein for the third quarter of 2018 was $158.0 million or $1.03 per diluted share. This represents growth of 14.5% and 18.4% respectively compared with the third quarter of 2017 GAAP results.

Providing additional detail on our results for the quarter. Amortization from acquired intangible assets was $30.4 million pre-tax or $0.15 per diluted share for Q3 2018 and compared to $29.3 million pre-tax or $0.13 per diluted share in the same period last year.

For the first nine months of the year, our amortization from acquired intangible assets was $91.7 million pre-tax or $0.45 per diluted share. I'll also note that foreign currency exchange did not have a material impact on our diluted EPS for the quarter.

Let me now provide some details on our sales results for the third quarter. Dental sales increased 2.4% to $1.5 billion with internal growth in local currencies of 3.5%. Our North American internal growth in local currencies was 4.7% and included 4.3% growth in dental consumable merchandise as well as an increase of 5.9% in dental equipment sales and service revenues. Our sales growth was primarily driven by market share gains.

Our equipment sales result was bolstered by growth of approximately 23% in the overall high-tech equipment category. A highlight of our dental equipment performance was in sales of total CAD/CAM solutions. Internal sales in local currencies were up 43% in North America during Q3, while digital imaging sales, which includes 2D and 3D imaging, grew by approximately 14%. Also our digital impression scanner sales increased by more than 50% in Q3 for North America.

Our international Dental internal sales growth in local currencies was 1.6% and included 3.5% growth in sales of dental consumable merchandise. Our dental equipment sales and service revenue declined by 4.2% versus the same period last year. And this is generally due to softer end markets, primarily in Germany.

Animal Health sales were $899.3 million for the quarter, an increase of 1.9% with internally generated sales growth in local currencies of 1.1%. The 1.1% internal growth in local currencies included 0.4% growth in North America. However, it's important to note when normalizing for the impact of the manufacturer switching from direct sales to agency sales, our North American sales growth was 6.7%.

International Animal Health internal sales growth in local currencies was 1.8%. We reported lower sales, primarily associated with the decline in parasiticide sales, as well as clinic visits internationally primarily due to weather.

Our Medical sales was $721.9 million in the third quarter, an increase of 4.5% with internally generated sales growth in local currencies of 4.4%. The impact from foreign exchange was not material this quarter. The 4.4% growth included 4.4% growth in North America and 5.7% growth internationally. We are pleased with our overall Medical sales results which were primarily driven by solid organic growth from existing large customers.

Turning to Technology and Value-Added Services sales. They were $143.9 million in the third quarter, an increase of 32% with internally generated sales growth in local currencies of 7.8%. We are very pleased with the strong growth driven by Henry Schein One along with solid organic growth both in North America and internationally.

In North America, Technology and Value-Added Services internal sales growth was 7.8% in local currencies, which is the highest quarterly growth rate in more than two years. This growth was bolstered by a sale to the U.S. Department of Defense of approximately $6.2 million, along with strong growth in the financial services business.

Our international markets' internal sales growth in local currencies was 7.6% and driven primarily by dental software sales. We continue to repurchase common stock in the open market during the third quarter. Specifically we repurchased approximately 777,000 shares during the quarter at an average price of $78.19 per share or approximately $61 million. The impact of the repurchase of shares for this third quarter was not material to our EPS.

At the close of the third quarter, we had approximately $86 million authorized for future repurchases of our common stock. If we take a brief look at some of the highlights of our cash flow. Our operating cash flow for the quarter was very strong at $173.9 million. And that compares to $131.4 million in the third quarter of last year. We continue to believe we'll have ongoing continued strong operating cash flow for the full year.

Our previously disclosed restructuring initiatives is progressing as planned and will continue for the remainder of the year. As I mentioned last quarter, this initiative will allow us to execute on our plan to reduce our cost structure and fund new initiatives that we believe will drive future growth under our 2018 to 2020 strategic plan.

As previously noted, we expect to record a onetime restructuring charge in 2018 between $45 million and $55 million in total on a pre-tax basis or $0.22 to $0.27 per diluted share. This restructuring charge primarily includes severance, facility closing costs and certain outside professional and consulting fees directly related to the restructuring plan. We plan to provide more detail on anticipated cost savings associated with the restructuring at a later date.

I'll now conclude my remarks by noting, we are reaffirming our 2018 non-GAAP diluted EPS guidance range. At this time we are not able to provide estimates for the impact of total costs related to the Animal Health spin-off on a full year basis. Therefore we cannot provide GAAP guidance at this time.

Note that the 2018 guidance is based on current revenue recognition standards. Although, the new revenue recognition standard ASC 606 will not have a material change to our earnings results.

The 2018 non-GAAP diluted EPS attributable to Henry Schein is expected to be in the range of $4.06 to $4.14 reflecting both the 13% to 15% compared with the 2017 non-GAAP diluted EPS of $3.60. This guidance exclude certain items in 2018 for the year-to-date that are noted in Exhibit B in today's press release and provides a reconciliation of GAAP net income to EPS to non-GAAP net income and EPS.

2017 non-GAAP results excluded costs related to taxes associated with the U.S. tax reform legislation as well as a loss associated with the divestiture of the equity ownership in E4D and certain litigation settlement expenses. We assume in our guidance that the end markets will continue to remain stable and are consistent with current market conditions.

The guidance for 2018 diluted EPS attributable to Henry Schein is for continuing operations as always, but does not include any future potential acquisitions. The guidance also assumes foreign exchange rates are consistent with current levels.

I'll also note that, due to the complexities and timing of the planned Animal Health spin-off, we plan to provide 2019 guidance at a later date as some of those uncertainties become clearer.

With that, let me now turn it back over to Stanley.

[Stanley M. Bergman, Henry Schein, Inc.]

Thank you very much, Steven. Let's review some business highlights for our third quarter 2018. In Dental, we were pleased, actually very pleased with our 4.3% internal sales growth in local currencies in our North American dental consumable merchandise business. This is market driven by growth – this was driven by, to a large extent, market share gains. But the market is growing and actually we believe leading in a positive direction. So one could conclude in our view that the end markets are stable and generally healthy.

Our mid-single digit North American dental equipment sales growth was driven by several manufacturers with strong growth in high-tech equipment sales. As Steven mentioned, we continue to see solid demand for the Dentsply Sirona equipment in North America and Europe and in particular in CAD/CAM.

We're also seeing good growth with other manufacturing partners with digital prosthetics solutions as many clinics elect to purchase digital scanners to improve imaging accuracy and patient comfort. Sales of these products in North America grew by more than 50% during the third quarter.

So, overall very, very pleased with our North American Dental business. As you may recall, in late September we announced investments in three implant companies Intra-Lock, Medentis Medical and Pro-Cam Implants with combined annual sales of approximately $45 million.

Intra-Lock offers innovative dental restoration solutions including proprietary surface, connection, biomaterial and small diameter implant technologies, very important addition of products know-how to our overall implant business. With Medentis, we are expanding into the lower priced segment of the dental implant markets. And with our investment in Pro-Cam, CAMLOG's exclusive distributor in the Netherlands, we are strengthening our geographic footprint in Europe.

These companies complement our existing solutions for implant based tooth replacement and are expected to broaden our geographic reach, add innovative technologies as noted, enhance our manufacturing footprint and solid our commitment to serve both the value premium and the lower priced segment of the implant market.

Related to the dental specialties, we are quite pleased with the reception to our SLX Clear Aligner System which we soft launched in May to the specialist community in North America, that's orthodontic specialty community. And we expect to begin targeting general practitioners in the New Year.

This unique solution was designed to reduce overall treatment time while improving practice efficiency. We make it easy for clinicians to submit cases through a broad range of intraoral scanners including our TROIS (20:30), 3Shape, 3M, Planmeca, and CEREC.

Generally we're a big fan of open technology. We're in early stages of educating the market on the benefit of our competitive solution and are optimistic that our system will help advance our orthodontic product line over time. And generally, the orthodontic business has been very good at coming out with unique products.

Now, let's move on to the Animal Health business. Here we are pleased with the global Animal Health sales growth in the third quarter, particularly, in North America with normalized internal local currency growth of 6.7%. I think it's very important to understand that the Animal Health sales need to be normalized for a switch between regular GAAP booking of sales, agency sales, and back again. And we have provided consistent reporting on this over the years and so I think the 6.7% growth is reflective of our real achievements in the marketplace.

We believe our continued solid sales growth reflects a healthy end market and demonstrates that veteran clinics rely on our commitment to offering a wide range of products, software, and value-added solutions for their practices only to be magnified with the merger with VFC, more about that later.

Our Medical business also continued to perform well with mid-single digit growth in local currencies, which is above estimated end market growth rates by quite a bit. We believe our Medical business benefits directly from our strategy focused on understanding and meeting the needs of a diverse set of customers ranging from large integrated delivery networks to ambulatory care centers and, of course, the general practitioners.

Our go-to-market strategy represents a proven combination to help our customers drive successful patient outcomes, include the promotion of contract compliance, lowering cost, navigating reimbursement, and delivering value-based care. We remain committed to providing the products and services and consulting solutions that help our customers efficiently manage their enterprise. And again, we said this over the years, whether it's large or small, we are ready to provide solutions to our customers and position our customers to best serve their patients.

Moving on to our Technology and Value-Added Services businesses. We are pleased with the progress of Henry Schein One dental technology, the dental technology business of Henry Schein One. We see many possibilities to enhance practice success through this unique dental software platform, which delivers one connected technology offering for innovative software, hardware, and services. We are excited about these capabilities working together to enable dental teams to be better business managers, clinicians to be more efficient, and patients to be more loyal to the practice.

We, let me stress, are big proponents of open architecture in this space and do all we can to help our customers succeed with whatever technology choices they may have.

We recently released Dentrix G7 and Dentrix Smart Image, which is the first significant product release for the Henry Schein One joint venture. Dentrix Smart Image represents the next generation of practice management and imaging software all in an intra-operable way. This product suite received Cellerant's Best Of Class Technology Award, a coveted recognition in the dental community for products aimed at improving digital clinical workflow.

Henry Schein One also released enhanced Dentrix service bundles including Optimum Pro for payment management services and Ultimate Service Bundle with demand for some off-site (24:48) solutions, providing enhanced patient engagement and digital marketing capabilities.

We launched our online booking for Dentrix and Dentrix Ascend, our next-generation cloud-based practice management system. In addition, we released the Dentrix Ascend Quick Exam module, offering clinical decision support that helps a doctor focus on treatment plans relevant for the diagnosis. This is a first-of-its-kind solution in the dental industry.

We're very, very pleased with the progress that the joint venture is making. And the R&D work, development work and the actual introduction of upgrades to the marketplace.

Finally, we deployed our cloud-based solution Dentrix Ascend in the UK, expanding its global footprint beyond the U.S. and Australia.

As we look ahead, we expect to release the next generation patient relationship management, PRM, platform later in the fourth quarter of 2018, bringing together several PRM solutions in the Henry Schein One portfolio.

So before we open the call to questions I would like to offer some perspective on the value-added solutions approach, which is focused on four key elements: education, one; service and support, two; software, three – and innovation, three; and strong customer relationships. This model is one that we believe has worked well for us, withstood the test of time. And as we advance our business will remain as the four pillars of our business, namely education, service and support, software and innovation, and strong customer relationships.

Last quarter we discussed examples of the high-touch approach to enabling our customers to provide best quality patient care, while optimizing efficiency in their practices.

Today, we'd like to take that step one step further. Henry Schein recently launched our Rely On Henry Schein brand campaign, featuring three dental practices and the unique story that reflect our mission. When we say unique, they're unique to those practices, but are stories that are repeated every day in the dental environment, thanks to Henry Schein.

Our unique story reflects our mission to help clinicians be more efficient, more successful, so that they can focus on delivering the best quality care. Visit henryschein.com/relyonus for specific examples of what would argue is the – what we would argue is the invaluable consultation and timely service and support we deliver to our customers.

And this is, of course, day-in and day-out. It is really important for our investors to understand the value-added service that we provide to our customers, which is the reason why we have the stickiness and, in the end, the reason why we have gained market share for decades.

So this includes our strong crisis support capabilities, including the triage-like response when a practice owned by one of our Canadian customers burned to the ground. And the customers lost all the patient records with no cloud-based backup, as well as losing all equipment office supplies.

You will see how we helped establish temporary operating space for this group of doctors and helped them build a new nine – sorry, paperless state-of-the-art facility. When our customer was asked about Henry Schein's role in their recovery, the customer answered, they helped us. Somebody gives you a hand and tells you, when you're all down, come, I'm going to help. You get up.

A typical response to a customer – from a customer who was helped in an environment where the customer experienced some form of unanticipated damage in their practice.

Next you'll see a fast action from multi-operatory practice in Maryland that had a perfect storm and multiple pieces of critical X-ray equipment failed the same day, causing half of the operatories to be down.

Our customer spoke that Henry Schein – of Henry Schein reassuring them and immediately focusing on next steps, including a temporary repair of equipment so that these doctors could still see patients that day and facilitating a quick turn on ordering replacement units.

To quote our customers, Henry Schein is the company to go to that offers supplies, tech support and HR support, continuing education. If I had to take the time to research and find the lowest price, it would take manpower and dollars. It's just not worth it. As a clinician, I'd rather spend my time with my patients.

Having said that, we believe our pricing is competitive. And therefore the combination of value-added services and solid good pricing is the winning formula as delivered by our highly educated and most efficient sales organization.

Finally, in a great example of our day-to-day consulting experience, you will meet a doctor in Queens, New York who relied upon Henry Schein as he concentrated opening a new practice in an emerging underserved location. Our team helped this customer from start to finish, as he built his practice including scouring of sales, of sites, selecting of contracts, the designing of the office, choosing the right equipment, accessing financing and marketing to new patients. The customer knows, dental school does not prepare you for this business – for the business aspects involved in dentistry. He learned as you go. Henry Schein is reliable, it finally helps to have someone to guide you towards what your vision is.

We believe our high-touch full-service value proposition makes a difference in the lives of our customers enabling them to focus on our providing quality care. And we think of no better way to convey that message than to have our customers tell their stories in their own words.

With that operator, we'd like to open the call to questions.

[Operator]

Your first question comes from Jeff Johnson with Baird.

[Carolynne Borders, Henry Schein, Inc.]

Jeff, are on the line?

[Jeff D. Johnson, Robert W. Baird & Co., Inc.]

I am. Can you hear me okay, Carolynne?

[Carolynne Borders, Henry Schein, Inc.]

Yes, now we hear you.

[Jeff D. Johnson, Robert W. Baird & Co., Inc.]

Okay. I'm sorry about that. So a number of questions but let me just focus here on the Dental side and hope the others get picked up throughout the Q&A here. But Steve maybe you could flesh out just a little better what you're seeing in the Dental end market. And if you could provide any color on the specialty market versus the general consumable market, maybe the growth rate you saw in each of those, or in general commentary there that would be helpful.

[Steven Paladino, Henry Schein, Inc.]

Sure. I would say that when we look at the North American Dental market, we feel like the market is stable to improving. We saw a really nice consumable sales growth in our North American Dental side as well as very solid equipment sales growth.

With respect to dental specialty, dental specialty did grow a bit faster than our overall sales growth for consumables in the mid-single digits. When we look at international, we did see internationally, at least this quarter, some softer markets, especially on the equipment side. We're not sure that it's really a trend. We just think sometimes the ebbs and flows of each quarter, it was just a soft equipment sales market. So we're hopeful that we'll see improvements in the fourth quarter when we see our strongest quarter. So overall, Dental, I'd tell you is stable to improving with the slight exception of international equipment sales.

[Jeff D. Johnson, Robert W. Baird & Co., Inc.]

All right. That's helpful. And then maybe if I could follow-up just on the CAD/CAM comments you made on some of those big growth rates. I think last year you said in the third quarter that you saw very little impact in that quarter from your newest CAD/CAM relationship as you were just coming off that meeting in Vegas. So I guess my question is, once you anniversary now starting in fourth quarter kind of into a full relationship or a full year year-over-year relationship with your newest product there. How are you thinking about CAD/CAM growth versus DI growth? Just on a normalized basis kind of how do you see the growth in each of those technologies playing out over the next few years?

[Steven Paladino, Henry Schein, Inc.]

Well, we think there's going to be very strong growth in both categories. There are a big part of the market that wants full systems. But there's also part of the market that wants the digital impressioning today because they are transitioning and they can get into CAD/CAM at a lower price and then over time they can get the milling machine.

So overall, we feel good about the overall CAD/CAM market for us. And we think it'll continue to be a nice grower for us. But clearly some of these growth rates are impacted by the fact that we took on the Dentsply Sirona CEREC line last year during Q3.

Important also to note Jeff that we saw a reversal of digital imaging, we said last quarter that digital imaging was very soft. But this quarter we saw a rebound and we saw very strong growth in digital imaging also.

[Jeff D. Johnson, Robert W. Baird & Co., Inc.]

Yeah. That's helpful. Thank you guys.

[Operator]

Your next question is from David Larsen with Leerink.

[David Larsen, Leerink Partners LLC]

Hi. For the North America Dental growth rate of 4.7%, I mean, how sustainable are these trends? I mean, they seem very robust to me. What do you think is driving that? And then I'm sorry, I didn't catch the CAD/CAM year-over-year growth rate in the scanners or the CAD/CAM machines. What was that again please?

[Steven Paladino, Henry Schein, Inc.]

Sure. Overall CAD/CAM was over 40% growth in the quarter year-over-year. On consumables, David, again we think the market may have improved slightly, but it's slight improvement in the North American consumable market. And really as we've said in the conference call script, we believe that the bulk of the growth is really coming from us executing competition and growing our market share.

[David Larsen, Leerink Partners LLC]

Okay. And then what has the market's response been to the deal with Vets First Choice and Animal Health? How do they view the transaction? Do they view it favorably or not? What do they expect to gain from it once the deal closes? Thanks

[Stanley M. Bergman, Henry Schein, Inc.]

David, I think generally from customers I would say it's overwhelmingly positive. Sales force is excited. At the end of the day in the vets space, the big need is for compliance, in other words with prescriptions issued, in other words making sure prescriptions that are issued are actually used, making sure that prescriptions are renewed. And generally we believe that VFC solution is the best in the marketplace.

There are others that have solutions, but no one has the comprehensive offering that they have combined with the practice management systems, the PIMS system. So generally I think it's very well-received. The morale in the company is quite good. It's a massive undertaking internally to separate these companies and specifically the infrastructure in Europe. We're making good progress.

The filings have been made with the SEC which responded to first questions. We don't see really much of an issue. And I think generally this is a good strategy for overall Henry Schein. It allows us to focus on human and animal health. And I think for the Animal Health team it provides an opportunity to expand the value-added services in probably a very unique way. I think we have something here that's unique and actually needed by the marketplace both needed by the suppliers and the customers.

[Steven Paladino, Henry Schein, Inc.]

And I would just add on the Animal Health spin, we remain confident that the timing of the spin will be either late this year, very late this year or early in Q1. Again, we're making very good progress in filings and separation agreements and all of that. So everything seems to be on target at this point.

[David Larsen, Leerink Partners LLC]

Okay. Thank you.

[Operator]

The next question is from John Kreger with William Blair.

[John C. Kreger, William Blair & Co. LLC]

Hi. Thanks very much. Steve, I know you said that the VFC spin kind of prevents you from giving 2019 guidance at this point. But can you maybe just talk a little bit generally if you think about the Dental and Medical businesses in 2019? Would it be reasonable to expect higher or lower growth than what you're generating now? And any kind of early outlook on your ability to drive margin leverage next year in those two businesses? Thanks.

[Steven Paladino, Henry Schein, Inc.]

Yeah. There's really a lot of moving parts to providing guidance including the exact timing of the spin-off looking at the benefit that we will be receiving, we still haven't fully quantified all of our restructuring costs. There may be some offset in some stranded cost although we don't expect stranded cost to be material.

We're still negotiating the TSAs, the Transitional Services Agreement with SpinCo. So that will have some impact. I would say though we still feel with all of those and that's why we elected not to provide guidance because we (39:53) providing guidance. If this happens this is our guidance. If this is the timing, this is our guidance. And we thought, it would be too confusing to do that. So we're just going to wait a little bit longer until there's more clarity on that.

With respect to Dental and Medical, we still feel like the businesses are performing well. We feel like top line growth rates should be similar although we are looking at different initiatives as we've said a couple of times and ramping up growth in both our higher margin products and so things like the specialty businesses, things like technology and financial services. So the goal really is to get some margin expansion in next year's guidance. But again, it's premature and I don't want to give guidance before I'm giving guidance at this time.

[Stanley M. Bergman, Henry Schein, Inc.]

But to just follow-up on Steven's point here. It is this gap period until everything is settled down. The big thing is that we don't know when it begins. And we kind of know how many months after it begins it ends. So we're in this period now where we are finalizing putting to bed all the key items in this spin and we just need to settle down for a quarter or two. And then, I think you will see pretty good results. At least, we expect good results from the focus on the human side, medical and dental, prevention and wellness all those areas that we've articulated adding to the value-added service component and of course the higher margin areas in Dental and Medical. And I think on the other side of the ledger the Vets First Choice team are really also poised for good growth. So overall we're very optimistic.

[John C. Kreger, William Blair & Co. LLC]

That's helpful. Thanks. And maybe one quick follow-up. I believe the FTC hearing within Dental took place last month. Can you give us any update on what happened or maybe what the next steps will be in that dispute? Thank you.

[Steven Paladino, Henry Schein, Inc.]

Sure. Remember, there are no monetary damages being sought in the FTC dispute. The trial is still ongoing. It's hard to tell how long it will last, it could be weeks, it could be longer. But based on how the trial is going, we feel good about our comments that we feel like we've done nothing wrong. But we still have to wait through the process.

[John C. Kreger, William Blair & Co. LLC]

Okay. Thank you.

[Operator]

Your next question is from Kevin Ellich with Craig-Hallum.

[Kevin Ellich, Craig-Hallum Capital Group LLC]

Good morning. Thanks for taking the questions. Stan, I guess, wanted to go back to the strong high-tech dental equipment growth you're seeing in the U.S. Wondering what's really driving that. Is it really the interoperability of the equipment and the new product offering? And then how sustainable is that growth that we're seeing?

[Stanley M. Bergman, Henry Schein, Inc.]

So it's a good question. And yes, you hit the nail on the head. I think – I don't want to go back to far in history but in 1990s we went to the dentists in this country and said what you want to do is put in a PC to help you run a more efficient practice. And we said to them about a decade later what you want to do is you want to put in electronic medical records to help you manage the clinical aspects of your practice more efficiently. And then, if you fast forward that and we went to the dentist about five or six years ago and said what you now want to do is digitalize your practice, change the flow so that you can replace analog with digital dentistry.

And my view is that our discussions with the dentists have gained credibility and that more and more dentists are understanding the importance. Of course, we're working with a number of manufacturers in this area that are aligning with Sirona – Dentsply Sirona in advancing the idea of interoperable digitalization of the practice is gaining momentum.

I still believe we're in early stages of this. I think, we'll gain even more momentum. First you've got the DI part that will continue to grow. And then the fully integrated system will also gain momentum.

One area that I think is not necessarily always understood by investors is the fact that this same exercise is taking place in parallel in the dental labs. And so there's a lot of opportunity there in the dental labs for the digitalization of the labs, interoperability between the labs and the dentists. And this is all an area that Henry Schein One is significantly focused on.

So I think the technology will advance. I think that the interoperability will advance. And the overall digital work stream will become far more understood, far simpler to use. And as with any technology advancement, will become part of the day-to-day operations of the practice.

We're not there yet. And there's probably 70% of dentists that still haven't begun this journey. And we think we're in the right position to help dentists advance in this journey of interoperable digital dentistry. And are very, very excited that this is a key strategy that we've put in place in our last strategic plan. We executed well and think that there's a huge opportunity for this strategic plan of 2018, 2019 and 2020 to advance on the strategy.

Very, very happy with our team and very happy with the attention we're getting in the marketplace, but actually think we're still pretty early in the game.

[Kevin Ellich, Craig-Hallum Capital Group LLC]

Okay. That's very helpful, Stan. And then just wanted to switch over to the Animal Health business, kind of, wrapping a question in for Steve. Wondering if you're seeing any increased competition from kind of the online retailers? And any changes from the manufacturers?

And then on top of that, when you finish the Animal Health spin, can you remind us what the capital deployment strategy will be from the capital – the cash that you're going to get? What do you plan to do with it, Steve? Thanks.

[Steven Paladino, Henry Schein, Inc.]

Sure. So I would say that online players in Animal Health, as well as in other areas of our business, have been in the market. There really is no major changes in the market penetration. They still can't provide a lot of the services and value-add that we provide in Animal Health. So they're out there. But nothing really of a major change.

Similarly with manufacturers, I would say that while sometimes manufacturers flip from agency to traditional and vice versa, other than that, really no major changes in the major manufacturers' plans on Animal Health.

The last part of your question, so as part of the spin-off, SpinCo will pay a dividend of somewhere between $1 billion and $1.2 billion to Henry Schein. That dividend will be tax free for Henry Schein. So there is no taxes paid on it.

We'll use that money initially to pay down our revolving credit facility. There are some restrictions on what can be done with the money immediately. But once we pay down our existing debt, then all those restrictions go away. And we can use it for any purpose.

That dividend will allow Henry Schein to have a very strong balance sheet, probably slightly over one turn of debt to EBITDA.

And our capital allocation strategy will remain consistent with what you've seen. We'll continue to look to grow the business through strategic acquisitions. And we'll continue to look at opportunities for buying back our stock to return cash on a tax-advantaged way back to our shareholders.

[Kevin Ellich, Craig-Hallum Capital Group LLC]

Sounds good. Thank you.

[Operator]

Your next question is from Jonathan Block with Stifel.

[Jonathan David Block, Stifel, Nicolaus & Co., Inc.]

Hey, guys, good morning and thanks for taking the questions. Maybe the first one just to circle back to North American Dental, you guys have done a really good job accelerating the North American consumable number to 4-and-change the past couple quarters.

Just looking forward, the comp gets more difficult entering 2019. Stanley or Steven, how do we think about that number longer term? I guess do you still think you've got the market share gains? And the market is on better footing where we can continue to see you post that 4% plus handle? Or is this somewhat the beneficiary of an easier comp that we've seen the past couple of quarters? And then I've got a follow-up.

[Stanley M. Bergman, Henry Schein, Inc.]

I'm not sure if it's directly related to the easier comp. I mean every quarter is slightly different. But generally, we're feeling pretty good about the consumable side of our business. I think our model, as we discussed at length in the conference call, of value-added services are really helping the practitioner operate a better business, so that they can provide better clinical care works.

The investment in our infrastructure, our e-commerce, Henry Schein One, and the training of our field sales consultants, all of that, I believe, adds to the value we bring to the marketplace and positions us to gain market share.

So we can't obviously predict with precision each quarter going forward. But what I think we're pretty comfortable with is that the market is growing slightly. And that we will add to that market growth a couple of hundred basis points each year. And that's sort of been our position for a while. And we remain confident with that, both growing in the small practices, the medium-sized practices, and the large practices.

Obviously, we're a bit more bullish – not a bit more, we're quite bullish on the specialty areas. Having said that, the specialty areas will not necessarily contribute to moving the needle significantly on sales, because it's relatively small compared to the entire consumable market but will drive margin as the specialty areas tend to be much more profitable and also will drive connectivity on the sale of equipment and software.

So, I think to answer your question, we are quite bullish still on the consumable side, in general consumables. I think there's a big opportunity for us in the specialty areas. These two combined with the value-added services, I think, will increase our overall sales of consumables, equipment, and yes, margin.

[Jonathan David Block, Stifel, Nicolaus & Co., Inc.]

That's a great color and actually a really good segue to my next one which is, you guys have talked recently about some of the company's initiatives for margin expansion. It looks like some of those may have already started to take hold. Your 3Q GMs were up versus the contraction we saw in the first part of the year. So Stanley, are we seeing that starting to flow through the P&L? Or the margin – the GM expansion that we saw specific to 3Q, is that more just the ebbs and the flows? I guess, are you feeling like some of the heavy lifting that the company started to do around gross margins are starting to take hold? Thanks, guys.

[Stanley M. Bergman, Henry Schein, Inc.]

Yeah. I'm not sure if you could judge each quarter in a standalone segment. Having said that, we feel pretty comfortable that we will continue to drive gross margin, the Henry Schein One opportunity is helpful. The specialty areas are helpful. We made some acquisitions now, some one-time step-up in inventory.

If once that flushes through, I think the specialty areas will show increase margin as well on a consistent basis. And so I think and, in general, we are managing our margins as carefully as possible as we have done. So this all adds to margin management.

I think that you will see on the expense side also good management. Obviously, the restructuring is helping but at the same time we are investing in technology in the businesses. I don't think we are investing in massive ERP type investments.

Having said that, there are parts in Europe, where we are standardizing systems. We are adding a CRM in North America, upgrading what we have. There's a lot of investment going into e-commerce, we're making – we believe we have a very good website already in most countries but we are investing in that area. We've put in a new equipment sales and service system, quite expensive. It's almost installed, very expensive in terms of P&L cost but I think will be very profitable over time as the efficiencies increase in our equipment sales and service network.

And I think we will see some pay-off not only because the Henry Schein One margins are higher but because those margins increased as the cloud-based system becomes more popular. So I'm quite bullish about our margins, our gross margins and our ability to leverage a relatively fixed volume of business or a growing volume of business on the sales side with a relatively fixed cost infrastructure or reducing cost infrastructure. So you add all that stuff up and we remain quite comfortable that we can increase gross margins and operating margins. Taking all those factors into account.

[Jonathan David Block, Stifel, Nicolaus & Co., Inc.]

Great. Thanks, gentlemen.

[Operator]

Your next question is from Steven Valiquette.

[Steven Valiquette, Barclays Capital, Inc.]

Thanks for taking the question. So you guys highlighted the deals for the dental implant manufacturing asset towards the end of the quarter. Just curious at a high level if Henry Schein overall is making any strategic effort to increase the manufacturing asset mix in Dental and/or Medical which may allow for just more pricing power versus peers, or do you just continue to look at each M&A opportunity on an individual basis without worrying too much about your distribution versus manufacturing mix? Thanks.

[Stanley M. Bergman, Henry Schein, Inc.]

We have been very clear as to when we invest in manufacturing. Our focus has been primarily on the specialty areas where our manufacturers have not given us access to lines. We began this process 14 years ago with investing in CAMLOG in advancement of the investment in BioHorizons with some other equipment properties.

Likewise on the orthodontic side and on the endodontic side. So there's lots and lots of opportunity on the specialty side in Dental. Similar opportunities although much earlier in the cycle on the Medical side. And those are the areas we plan on focusing on.

We will continue to advance our private brand, our generics if you will, but we'll be very circumspect about how we do that. Bottom line is, we have adequate – more than adequate sourcing of products and manufacturers are tending to work with us where we can help them grow market share and where manufacturers work with us and they see the value, there is no real reason to vertically integrate.

We'd rather have the manufacturers put the capital to use on the manufacturing and us advance the value-added services and market share for those manufacturers who want to work with us.

Having said that, when we cannot access a product, we will make it, whether it's a dental chair that we couldn't access some years back and we brought to market a dental equipment offering. We sold the business. There was no need for that.

We couldn't access scanners and digital equipment, aperture equipment. So invested in E4D when we took on the line, the Dentsply Sirona line, we were able to exit that market too. So generally it's a careful balancing of what we need, products we need with opportunities that manufacturers think to us, advancing our private brand with pricing is an issue. And so this is the kind of stuff we've been managing for decades and feel that we can balance the needs of everyone.

Our goal is to help those manufacturers that want to work with us succeed and at the same time make sure that every product that dentist may need or physician may need is available through Henry Schein.

[Steven Valiquette, Barclays Capital, Inc.]

Okay. Just on the implant market overall right now, are you seeing big differences in growth rates in the market between the lower-priced generic implant growth versus the higher end branded? Is there a big dichotomy there right now in growth rates that you're seeing?

[Stanley M. Bergman, Henry Schein, Inc.]

The lower priced is growing in terms of units. But the upper end is doing well. We think that the value upper end is where we need to be. I will say that there are parts of the world where growth is faster, certainly in Asia, the developing world and say in parts of Europe. But setting aside the geographic variations, I would say generally, the higher priced implants where there's a lot more R&D and service behind the product line those are generally doing well. But the clones and the generics are growing and in certain markets slightly more in terms of units.

But overall, we believe the impact market, the bone regeneration market, the products around the implant and the equipment focused on the oral surgeon are all good markets and we are doing well. I believe we have the widest variety of products under one roof and we'll continue, I believe, to do very well in these markets.

This is a carefully thought-through strategy. There's been building blocks that we've built on for over a decade and pretty comfortable with this marketplace with our management team, we believe we have an excellent management team in this space and continue to be very, very excited about the oral surgery space.

[Steven Valiquette, Barclays Capital, Inc.]

Okay. Great. Thanks.

[Operator]

And we have reached the allotted time for questions and answers. Speakers, do you have any closing remarks?

[Stanley M. Bergman, Henry Schein, Inc.]

Thank you, operator. Thank you very much everybody for calling in. We remain very, very optimistic about the future of Henry Schein, the morale in the company is very good. We have been able once again to develop a very solid strategy for this strategic plan almost one-third of the way through the plan, made some very significant moves.

The spin-off of VFC, the Henry Schein One creation, the investments in implants, efficiencies in our systems, adding appropriate senior management, middle management, entry level management where needed. I think the organization is finely tuned to continue to execute on our plans. And so we're very, very excited with where we are and where we're heading.

If anybody has any questions, please feel free to reach out to Carolynne Borders and Investor Relations, 631-390-8105. If you want to speak with Steven, Carolynne can connect you through. So thank you very much. And I'm not sure if we're going to any more investor conferences this year, so.

[Carolynne Borders, Henry Schein, Inc.]

We'll be at Credit Suisse on November 13.

[Stanley M. Bergman, Henry Schein, Inc.]

So Credit Suisse November 13. And then we'll be on the West Coast in January. So thank you very much and appreciate your interest.

[Operator]

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