Dentalcorp Holdings Ltd. (DNTL) Earnings Call Transcript & Summary

All right. Let's get started. Welcome, everyone, to the 20th Annual Morgan Stanley Healthcare Conference. Thank you all for coming. Before we kick off, I want to read the research disclosure. For important disclosures, please see the Morgan Stanley research disclosure website at www.morganstanley.com/researchdisclosure. If you have any questions, please reach out to your Morgan Stanley sales representative. Thank you for coming. I'm joined by Graham Rosenberg, CEO of dentalcorp; and Nate Tchaplia, CFO of dentalcorp. Why don't I pass it over to quick introductory comments?

Great. Appreciate it. Good to be here. Thanks for having us. dentalcorp is just on 11 years old. We are the largest player in the Canadian dental industry, which is an $18 billion industry that is -- still remains ripe for consolidation with only approximately 6% of practices having been consolidated. We are larger than our next 5-plus competitors combined. We're close to double the size of our largest competitor. We completed our second quarter with 525 locations, generating approximately $1.4 billion of revenue and $150 million of EBITDA, and that's on an IFRS basis, about $210 million on a GAAP basis, giving a full year effect to acquisitions. We've generated double-digit growth every year in our history, and we have a growth algorithm that we believe will continue to allow us to drive double-digit growth in all material respects on revenue, EBITDA, and most importantly to us, free cash flow per share. That comes via organic growth of 3% to 4% plus on a sustaining basis, margin expansion of 25 to 50 basis points per annum over the medium term. Combined with a very robust acquisition program, which continues to bear fruit on a quarterly basis, highly predictable is our growth algorithm and we believe we will double and then triple over the next 4 to 7 years as we continue to execute on that plan.

That's great and great growth. I think where I want to start is more on the macro side to kind of lean in there a little -- this environment and the dental sector as a whole. Can you talk a little bit about the macro side of it, this recessionary -- if we are heading into recessionary period or a period of high inflation, it almost feels like you're immune to some of that in the technology to some intermediation. Can you just talk a little bit on that?

Yes, absolutely. Look, over the last 40-plus years, dentistry has outperformed in all cycles. It's outperformed GDP in a -- or CPI, should I say, in inflationary pairs by about 400 basis points. It's proven to be a positive grower in recessionary environments as well. Underpinning that is the high dental IQ of Canadians, about 85% of Canadian adults visited dentists at least once a year. That combined with a strong focus on oral health. Canadians have the highest dental IQ on the planet pretty much compliance around oral health. Those repetitive visits on the hygiene side of things are really making their business such resilient through all economic cycles. We continue to see that today. Second quarter was 3.5% plus of same-store comps driven by a combination of price and volume. We also have a very strong in-sourcing agenda. So in the event that there is a possible drop off, people are concerned about. We don't share those concerns, but a drop-off in discretionary services. The fact that we're actually providing more services than we ever have in terms of aesthetic procedures in design treatments and also implants, we think, positions us really nicely going through whatever the cycle may hold.

Can we spend a minute on the competitive landscape as a whole? There was a big deal that just announced in the Canadian landscape, maybe a second on that? And then also just your perspective on big incumbents, new entrants into that market, how you kind of see that shaping out?

Look, KKR, Canadian dental players, ourselves included, we're probably the first to bring private equity into the Canadian market back in our second year of existence. So that was 2014. L Catterton, which is a large consumer-focused private equity shop out of Connecticut invested in us in 2018. Our next 2 largest competitors, which combined did a deal with KKR and we think that, that brings validation to the dental industry in Canada. We think we're a unique opportunity to participate in dental, as many of you may know, dental in the U.S. and North America, even globally is primarily private equity owned, and so you have an opportunity to participate in a public vehicle, which is otherwise owned by private equity. That transaction -- those 2 businesses have been in business 40 plus years. We've been in business about 11 years. We're close to double this size on an EBITDA basis and revenue basis combined. And we obviously know those 2 players very well. We've chosen a path to put our heads down and continue to execute on what has made us successful over the last 11-plus years and what we believe will make us successful over the next 10-plus years is continuing to execute on single and double acquisition locations. Sometimes multi-site locations more than that, sometimes 10 or 15 locations in the transaction, but doing deals our way with our structure, with our playbook for growth, our integration technology and backlog to drive that.

I want to follow up on that point...

Do you want to add on anything?

Yes. So I think from a competitive landscape perspective, we view it positively as well. It's gone from 3 competitors to now 2. And more interestingly is again, these 3 players, as they announced it, have been around for 30-plus years. They have their own cultures. They have their own way of approaching the market. And bringing this together through an integration process, which is going to take significant time, that's now created confusion in the market for the dentists that are looking for that partner to support their next 20 years of operations. The average age of a partner, a dentist that's joining our network is in their mid-40s and now being approached by this now newly combined entity, there's 5 CEOs there. There's 3 different ways of operating, and albeit they're getting a significant purchase price upfront. They're still continuing in their careers for 20-plus years. And that assurance as to the stability of their partner, the culture of their partner isn't there today. And that's really allowed us to continue to build and flourish our pipeline to a significant degree.

I want to follow up on the M&A point. In this rising interest rate environment, I got to think that's having an impact on valuations for some of these tuck-in acquisitions that you're making. How do you see that playing out? And can you talk a little bit more on the white space within that market?

Yes. Look, we think that the backdrop of higher rates should be constructed over on valuation in terms of reducing headline valuations. Remember, the majority of practices that trade hands in the Canadian market and here too is from one dentist to another. And typically, a purchasing dentist as typically an associated in a practice will buy from the incumbent dentists using leverage. So we think that, that the higher rates obviously have a cooling effect. As it relates to our business, we have such strong free cash flow. Our free cash flow per share continue to grow in Q2 by, I think, 25% to 30% plus. It's not a material impact at the end of the day. And we feel good about participating in the market and continuing to acquire over the next 18 to 24 months.

When you think about new acquisitions, the integration of these newly acquired businesses, you've got dc engage, hellodent, specialty service mix you touched on earlier, like Envista, Align, can you talk about how that integration works and how that layers in?

Yes.

Yes, absolutely. So if we start from really the signing of the LOI, what's allowed us to really scale our acquisitions, and we completed 70 practice location integrations in the first 6 months of the year is that process is contiguous with our closing process from LOI to funding. Generally 45 to 60 days, whereby we're able to work with the vendor and their teams to educate them on our platforms like dc engage, like DC market and hellodent, such that on day 1 of closing, they're fully apprised as to our operating model. They understand how to correspond with our technologies, which ultimately allows us to drive that value they want. They're now ordering all their supplies day 1 through DC market where they're able to avail themselves of 35,000 SKUs of prenegotiated contracts with all the major suppliers, both north and south of the border. And really drive, again, and avail themselves of all that we are to offer. If we fast-forward then 6 to 12 months, that's really when we start working with them on marketing best practices. And bringing their teams into the education process around our in-sourcing initiative, specifically driving our orthodontic acceleration program through our partnership with Align as well as our new implant and sourcing program with Envista and mainly Nobel, which allows us, again, not only to help them drive efficiencies on the cost side of things, but also to really drive and supercharge that organic growth.

And I just want to overlay that as they say day 1, we're able to immediately derive cost savings, such that within 6 months. We see margin expansion of anywhere between 5% and 15%. Primarily through cost savings on the supply side and some labor efficiencies, we're able to garner by applying our technology stack to the back office of that practice and relieving some labor inefficiencies. And then into the broader in-sourcing agenda, marketing agenda, talent agenda, which drives that sustained 3% to 4% plus same-store comps.

And hitting on that same-store growth point, I will shift to growth as a whole, primarily, I guess, on organic growth. When you talk about this 3% medium term kind of overall organic growth profile, what levers do you have at your disposal to achieve that?

Right. So it's everything from price to driving volume of visits, which is generally underpinned by net patient growth, but also driving frequency of visits through optimizing hygiene programs, optimizing recall and leveraging our technology stack to get patients coming back more often on a sustained basis.

And just to build on the frequency side, you mentioned dc engage, which is our proprietary tool, which is technology-driven to bring our existing patients back more often and hellodent really allows us to get the network advantage and ensure that patients, if they are switching a dentist because the largest attrition that happens is a patient either moves where they live or where they work, and that's where they seek a new dentist. But they love their experience in network and they're able to find that new dentist that is either if they're in Toronto, they're moving to Calgary, they're going to find a new dentist in network, which ultimately allows us to keep that patient and minimize that attrition. From a frequency perspective, when we partner with a clinic, on average, a patient comes to the dentist 2.1x on an annual basis. And what's important to note here is the dental clinician is probably the most frequently visited health practitioner that any one of us sees on an annual basis. You're not going to your doctor 2-plus times a year. Hopefully not. And we're able to drive that forward from 2.1% to 2.4%, which is a 25% increase through our engagement tools and technology.

Shifting over to the cost side and the operating leverage you have there. You referenced a 75% to 80% practice level variable cost [ structure ]. The variability of that is interesting to me and those levers you have to pull, can you spend a little bit of time on that?

Yes.

So if you look at our revenue and what's driven or what drives our revenue, there's really 2 main drivers. One is the dentist revenue and one is the hygiene drivers. Dentists, by and large, and that's 70% of our total revenue, are paid on a commission basis. And that's not unique to dentalcorp, that's a standard across the dental industry in Canada, which is roughly 40% of their personal net collections. That, by and large, there immediately now. The largest portion of our provider cost is a percentage. So irrespective of what's happening on the revenue line, we're not protected from that front. Same on the hygiene side. These are all hourly workers depending on the volume throughput in the practice given our scheduling and labor and employment methodologies, we're able to flex based upon, again, the amount of hygiene volumes in the practice. So our total cost of goods that sits in that line item is fully variable. Then as we go down further, our consumable costs are directly correlated to the volume of business. And volume of procedures that are being put through the practice. And if you really distill it down, the only real fixed cost that's in the practice, is truly that administrative team, which is a very small portion as well as the fixed real estate costs of operations. Everything else is truly variable in nature.

When you think about revenue and particularly, revenue visibility, you've got 85% recurring revenue -- or patient visits is what you publicly announced. To me, that's day 1, you've got a high line of sight into about 85% of your revenue stream day 1 at the start of every year. Can you talk a little bit about that, how that helps you from a forecasting perspective when you think about expansion? Anything on that?

So look, it really helps in terms of trying to quantify how we drive and now that we need to push and pull to get to that 3% to 4% plus same-store comps, 85% recurring. We know the plug number of people that -- in that 85% that our move is how we recaptured and the cost due to that. And then it's simply an exercise in applying marketing ROIs and cost of acquisition to plug the gap to get back to 104%, not only through acquiring new patients, net new patients to the network, but also increasing the frequency of visit of those 85%. To Nate's point, it shouldn't be -- we shouldn't cross over. It is -- when we buy a practice, average practice, as their patients visiting them, 2.2x, we're able to increase that between 2.4x and 2.5x. Like that's a significant increase in frequency of visit, which offsets any fluctuations in gross headline patient numbers. So we've got visibility. We know how to plug the gap, we know how to go and acquire from a marketing perspective, new patients and then it just becomes frequency in a bit of price and mix.