Henry Schein, Inc. (HSIC) Earnings Call Transcript & Summary

Good afternoon, everyone. My name is Nathan Rich, and I cover the dental space here at Goldman. Thank you for joining this session with Henry Schein, a leading distributor of products, technology and services to dental and medical practitioners globally. I'm very pleased to be able to introduce Stanley Bergman, Chairman and CEO of Henry Schein for over 30 years now; as well as Steve Paladino, the company's long-time CFO. Steve, I believe you wanted to start with the disclosure statement, and then we'll pass it over to Stanley to share some prepared remarks. Thank you both so much for joining us this afternoon.

Okay. Thank you, Nathan. Yes, I'd just like to comment that this conversation may include certain comments that are forward-looking statements. And as people know, our -- there are risks and uncertainties in our business and those forward-looking statements may differ from actual results. And all of the forward-looking statements are qualified by the cautionary statements contained in Henry Schein's SEC filings as well as certain documents included on our Investor Relation website. So with that, I'd like to turn it over to Stanley, who will give some opening remarks.

Thank you, Steven, and thank you, Nate, for hosting us. I will not go into great details about Henry Schein. Of course, ready to answer any questions that investors will make that you may have. Henry Schein is the largest provider of products and related services to office-based dentists and physicians in their private practice and related services, renal centers, surgery centers, ambulatory surgery centers, dialysis -- dialysis, cancer centers, urgi centers. And so our focus is really outside of the long-term care facility and outside of the acute care facility. We have about 1 million customers around the world, 1.5 million practitioners that we service. We offer practically all the products that are needed, the consumables, equipment, pharmaceuticals, leading player in practice management, electronic medical record type software, demand generation software, some specialty products for oral surgeons, for endodontists, for orthodontists. We have a very nice portfolio in that area. We manufacture a lot of the products ourselves. And essentially, the business is a provider of these extensive array of products but also related value-added services to help practitioners really operate a more efficient practice. We help on the business side, so the practitioners can focus on the clinical aspects. We had our earnings call in early March. And then we started being concerned about the coronavirus. And then, of course, a few weeks later, the virus hit, and we took 3 major steps. The first is we focused on our team and the families of our team members. The second area we focused on was our customers, helping those that had to shut down their practices, deal with that, finances as well. We have a financial services business. And at the same time, we had to help those practitioners that were on the first-line providers obtain the right products, PPE products, to get through their services. And about 80% of the practitioners, a little bit more, closed their practices and did some emergency work. Maybe 20% or so were actually on the front line doing different kinds of work. And the third area we, of course, focused on was to ensure that we preserved our balance sheet. Henry Schein has always had a strong balance sheet relative to earnings. We immediately reduced our expenses. Payroll, in particular, we didn't terminate too many people. We did a few, unfortunately, but probably would have terminated those in the normal course of our annual reorganizational type work. But we furloughed a significant number of our team. We reduced significant expenses like everyone else, reduced capital expenditure, stock buybacks, M&A activity and focused on the balance sheet. During our call earlier, as I said, the last call, we estimated that our dental sales would be likely around 70% to 80% down. Our medical sales, 20% to 30%; and our technology, 30% to 40% down. We've mentioned in the last few weeks on other calls that we have been pleasantly surprised. We have experienced a lot better performance. Our customers in many parts of the world are starting to come back. If you look to China, quite significantly back. Most dentists in China are seeing patients, not all, but most. Not necessarily the full capacity as before, but they're operating. I would say the same in Australia, New Zealand, Germany, the Netherlands. Markets that are still significantly challenged are the U.K., quite a bit, not really open yet in a significant way, Italy and Spain. France is somewhere in between. The U.S. and Canada are starting to come back. As you know, parts of the U.S. are quite a bit back, and others have not really opened. I think New York just started. And we are totally surprised with the reception that the patients are getting -- the dentists are receiving from their patients. Obviously, PPE is a challenge, happy to address that if anybody has any questions. And so I think dentists are, of course, well prepared from an educational point of view on infection control. Dentists were amongst the first to deal with infection control, a sepsis control in the late '80s, early '90s when it was alleged for the first time that a patient contracted AIDS from -- when a dentist was alleged for the first time that a dentist contracted AIDS from a patient and dentists then started wearing mask and gloves, cleaning between patients, sterilizing between patients, et cetera. So dentists had really been educated in this through the dental schools, through their societies, so there have been some changes now dealing with aerosol, environmental issues in the practice. But essentially, people are going to the dentists. Dentists are taking more time between patients, very careful about not letting people into the reception area, the waiting room. There are systems in place to help call the patients in when they are needed. We have a lot of work going on in our practice technology arena. And that, of course, includes the whole reminders, demand generation type software, staying in touch with patients. So Nate, I'll leave it at that. And if there are questions, Steve and I are ready to answer it.

Great. Thanks for the comments. Stanley, maybe going back to May on the first quarter call, you had talked about it potentially taking until the middle of '21 for the industry to kind of get back to where it was before COVID hit. In that time, like you've mentioned, you've seen practices reopen maybe a little bit faster than what we were expecting. A lot of -- they've made changes to their workflows so that they can start to see patients again. You mentioned patients have been receptive to dental practices opening back up. So I guess based on what you've seen at just a high level, how does that impact your view of when you think the industry kind of gets back to where it was coming into the start of this year?

Right. That's a good question. I think there's demand for our kinds of products and services. But I think the mix is going to be a little different. Firstly, the whole area of PPE is going to be significant. And by the way, please don't forget that about 30% of our business is in the medical arena. And so in that area also, there's been a significant demand, and I expect continued demand for PPE products. Remember, our kinds of customers, dentists, hygienists, physicians, PAs were not using N95s or too much of the L3s and the shields. These are now going to be standard of use. Certain devices in the office to take care of the air will become important. So I think there's going to be demand for those kind of products on an ongoing basis. In addition, same-day dentistry just got a big boost. If you can go to a dentist and have your crown replaced right away, it's much less risky than a 3-visit procedure. So I think there's going to be a lot of activity in that area. In the software area, a lot of activity in cloud-based software. I think over the last 6 weeks to 2 months, dentists have become much more familiar with their computers. Our website is much more active. A lot of programs to educate dentists on the importance of digital technology and how to improve on the workflow using digital technology. A lot of those seminars have been listened to. I know it's the same with some of our manufacturers that have put on those seminars. So I think that will be the case. It's been an interesting twist. We've had some good demand for traditional-type equipment: chairs, units, lights. I think dentists want to make sure that their practice looks appropriate, looks modern. And so I think we will -- business will be okay. What I can't tell you, obviously, is exactly when this is going to get back to where it was. But one thing we do know is there's a great awareness amongst the public on the importance of oral care. And I'm surprised with the degree to which dentists are telling us they are being called by or reached out actually digitally now by patients wanting to come back. It's much greater than we thought. So I'm -- my tone, if you can tell, is a lot different to the way it was a few months ago.

That makes sense. And I think yesterday, you had mentioned the path to kind of recovery being a little bit uncertain. I think you had said, described it maybe as like a W-shaped type of recovery. Can you maybe just clarify kind of what you meant by that? And sort of what the factors you're looking at that would influence the shape of the ultimate recovery for the industry?

Yes. I'm glad you actually asked that question, Nate. I don't see a W unless there's a recurrence of the virus in the industry -- in society. But I'm pretty optimistic about dentistry and the recovery. What we can't tell is, is there going to be a recurrence in parts of the world. So we've seen now China has been in this the longest. And there are some areas where you have patients still. But actually, today, I was on the call with one of the dental boards I'm on and the Chair of that Board is a Hong Kong dentist, and they've really got this thing under control. So I think people are very cautious. They're social distancing. People are wearing masks. So I can't tell for sure. Are there states in the United States where people will just be very lax? Or are people going to be cautious? And if you -- we live in New York and people are cautious. You see people on street with masks. People are socially distancing. Now I don't know if that's going to continue. To the extent that, that continues, I don't see a W. But if it doesn't continue and social distancing is not taken seriously, and people are not wearing masks, I think we could be in for a W. So my -- what I meant was -- and I'm not sure if you're referring to -- I had some calls this week, and I've been making statements on this in general, that I'm very optimistic. The only footnote is there could be a W, but I don't think that's particularly related to dentistry. That's if there is a recurrence in the economy. Germany has been up for a while. There was a little bit of a recurrence in a few parts of Germany. But I can tell you that, for example, as a leading indicator, our implant business is doing quite well in Germany. Now we did come up with some new products just before the virus. So maybe there's some demand for those new products. I don't know. But people would not be buying implants if they don't have patients.

Makes sense. And just last one on this topic of the recovery. In markets like Germany or China, which are further along. Stanley or Steve, would you kind of care to comment on kind of where those markets are relative to kind of that pre-COVID baseline? Just to give us a sense of how quickly and to what extent they've recovered.

I think Steven is the best to answer that because he actually has data. So I don't know what we can share and what we can't. But we, of course, monitor this by market daily.

We do look at the activity by market. But, Nate, we've really not given specifics by market other than really to say, as Stanley said in his opening remarks, that we're ahead of where we expected to be in dental offices opening on a global basis as well as patients coming back to dental offices. Now we're not back to where we were pre-COVID, but it's ramping up pretty nicely, and we expect it to continue, but we're not going to give specifics by market at this time.

Fair enough. Stanley, I did want to ask on PPE. The availability, I think, has been an issue in the market. From a supply standpoint, obviously, having to meet the surge in demand that you've kind of seen across the health care system, can you maybe just give us an update on where the supply constraints are now? How those have changed in the past several weeks, and kind of where you are in terms of being able to meet the demand that your customers are seeing?

Yes, Nate. So at the bottom of the trough, we were dealing with really a pretty bad situation. A number of things converged at the same time. First of all, a huge amount of masks are made in China, actually in Wuhan area. And after Chinese New Year, the workers couldn't get back to get those factories up and running. And then there was -- around the world, governments were constraining the movement of masks, not only China, but other governments, too, including the U.S. even, we didn't allow exports for a brief period of time. And so there was the shortage. Then what happened is government's got in to buy product. So they bid us out. They pushed us out of the market. And then, of course, we were requested for a period of time to provide, and correctly so, and we have been involved. I think you know in the FEMA, the federal government FEMA task force, and there are 6 of us, big distributors, I think, account for 80% of the distribution of these kinds of products. We're asked to give priority to acute care settings. And we, of course, pushed to give some to the frontline workers, some dentists as well. And so that absorbed some of the markets. But what has happened now is product is flowing better. There is a slight challenge in that the Chinese government has -- is inspecting product that's leaving because there was an allegation that there was inferior product leaving, so they're checking product that goes out. It's gotten better. They know which manufacturers to trust and which one is not. So I think -- and that, plus the fact that the government, major government contracts are starting to be -- have been fulfilled. So there is product coming through. L3s are what we want. We want N95s, K95s. There's no problem in shields. Gloves are a bit of a challenge but not terrible. There are challenges, but can't be unlimited because we have to make sure that our gloves end up with practitioners and not going to other industries. So we're very careful who we give it to. But I would say we expect the things to improve at the end of May, early June. I would say we were probably a week or so off. But things are getting better, but nowhere near the ability to satisfy our customers. And so they just have to be very, very sparing between patients. They can't necessarily -- may have to, in some instances, use the mask twice for 2 different patients, not, of course, touching the patient with the mask, of course. But -- and there's some protocols on cleaning the masks that the FDA has put out. It's not perfect yet, but it's a lot better than it was months ago -- a month ago.

And I guess how would you assess the kind of financial position that practices kind of on-balance are in right now? I mean, obviously, coming through a very kind of tough period. But it seems like some have been able to get loans. They're kind of able to get the products and restock what they need to start to do procedures. I just -- did you feel like they're in a good financial position relatively speaking kind of coming out of COVID?

Yes. I'll address one aspect, and Steven can address receivables because at the end of the day, the receivables are the thing that tells you what's happening or not. But generally, I would say, dentists are okay because this didn't have to go -- it hasn't gone on too long. A fair amount of dentists got PPP loans, and we can only talk really about our own customers. A lot of our own customers are taking loans through our financial services business. There are various forms of working capital loans. Loans for capital improvement, et cetera. I think more or less, dentists are getting approval. They wouldn't be getting approval if the lenders were worried. I think it's a pretty stable credit. But again, we're talking about what, March, April, May, we're talking about 3 months of issues. If this goes on and it isn't longer, there could be challenges. Obviously, there are some dentists that are saying, you know what, I want to pack it in, I'm almost at retirement. I haven't heard of a lot, but I'm told it's logical that, that would be the case. So more or less, the big groups were okay. Some of them, we thought, had challenges on their balance sheets. But I think they're more or less okay. I don't think there's any -- any that I'm aware of where the sponsors are not providing the capital. But, Steven, you deal with the receivables every day. And by the way, I was referring to physicians and on the medical side -- and medical. Steven?

Yes. Thanks, Stan. I would say that, yes, generally, from our customer base, collections have been better than we expected. So the overall health of our customers, I would say, is good. Of course, there are some that are struggling because they have a little bit more leverage. But generally speaking, they're doing well. They're continuing to make payments. Some are a little bit behind, but we've also taken advantage of the PPP loans. And again, as Stanley said, through our financial services businesses -- business, we gave -- got them access to other loans to be able to pay. So overall, it's actually better than we expected. And once they start getting back doing procedures, I think it should be even better going forward because they now have a new source of cash coming in with new procedures. So again, overall, better than expected.

Great. And, Steve, can you help us think about the kind of incremental margins or decremental margins kind of associated with the lower revenue that you expect to experience in the second quarter? And I think there are a lot of kind of moving pieces to think through, obviously, with the changes in segment mix as well as some of the cost actions that Stanley referenced earlier. So how should we be thinking about the decremental margins on the loss revenue?

Yes. We -- there's a fair amount of fixed expenses. So while we did reduce expenses pretty heavily, we will not be able to maintain our normal margins on the lower base of sales. Remember, there's also a balance in bringing back people. We took advantage of furloughs more than any other device to reduce payroll. And we like the furloughs because it allows for flexibility to bring people back earlier if the business is doing better or to delay bringing them back. And that's -- it's a delicate balance. You can't just bring them back exactly when needed. So typically, you bring them back a little bit earlier. But overall, we feel like the cost-containment efforts that we put in place were very, very good. And you know the balance sheet is very strong, and we fortified the balance sheet by eliminating, at least on a temporary basis, stock buybacks, acquisitions, significantly reducing CapEx and things like that. So I would say that margins won't be comparable, but that's a short-term phenomenon as the business comes back to normal.

And just to follow-up on that. Does that mean the business could potentially still be profitable just given the magnitude of the -- I guess, we're kind of not sure kind of what the magnitude of the furloughs and cost reductions that you've taken, what impact that could have.

Yes. Unfortunately, Nathan, we've stayed away from that level of specifics too because of the flexibility and the uncertainty of how quickly the business comes back or doesn't come back. So we're not going to provide that level of detail again because there's still a fair amount of uncertainty. And while things right now, as Stanley and I both have said, are better than we expected, that needs to continue. Needs to continue through Q3 and Q4 to see the patient demand continue to increase.

Makes sense. And then, Stanley, you guys work with a lot of the larger DSOs in the space. I think you had also talked about potentially there being consolidation as a result of the period that we're going through. Could you maybe just talk about how you potentially see that playing out, and kind of what the dynamics to kind of keep in mind as it relates to Henry Schein's business would be in that case?

Right. I think trajectory we were on will continue. There will be consolidation, further consolidation. I expect the very large groups will continue to have capital to grow. They have had challenges, some of them, in getting staff. Perhaps this will enable them to get staff a little quicker. But the part of the market that has grown significantly and expect will continue to grow significantly will be the midsized practices groups, the larger mid-sized practice groups. They, I think, are a place that is very attractive to a lot of dentists. They get shares in these practices. Doesn't mean that the very large ones do not provide shares, but the midsize is doing quite well. I think this will continue. I assume your next question is pressure on our margins. I think that's what you were asking. And I think we will be very similar to where we were before, which is we have -- yes, there will be pressure on the gross margin unless we change the mix, and we need to make sure that we sell products that of value to our customers that are higher margin. And in that group, their specialty products is our own brands. Very often, we do not need to sell our own brands where manufacturers want to play and want to be competitive. And then we will push the brand because as it is, a huge percentage of our business is on brand -- is in the branded area. And we have no problem with that. But we need to, of course, work with certain manufacturers that are there -- that are going to be there to help us with our margins. And so the whole idea of specialty products, value-added products, our own brand, helping us move the mix in that direction will be helpful. At the same time, we need to be more efficient, and we have been focused on that for several years now, driving efficiency in our systems, in other words, reducing costs. But I will say the big aid that is going to come out of the post-COVID environment is customers are going to be far more comfortable dealing with us digitally. Already, a lot of our orders are coming digitally. But I would say the virus gave us a huge boost in that area. And I would say our website is moving much more from being an ordering site to being a shopping mall. So I think that is good, and that will help with margins as well and help us provide more value to our customers, small, midsize and large.

And when you look at those type of either the own brand products or maybe some of your software products for dental practices, are those kind of underpenetrated within the kind of DSO or group practice customer base that you serve? And so is that an opportunity you can kind of continue to bring up penetration there?

Yes, that's an interesting question. I would look at it at 2 levels. One is the very large practices. Several of them have been looking to replace their systems. In other words, they work with multiple systems as they brought together different practices that they bought. So there's some that are on a common system. I don't think anyone has the perfect cloud system today. There are a few, but I would not say they're perfect. Maybe they get the accounting side done right and not the clinical. So people are -- practitioner -- large group practices are looking at new enterprise systems, cloud-based systems, 1 or 2 that have their home grown, but largely, they've been in the market. We have landed a few. We're hopeful we'll land a few additional. I'm not only talking about the U.S., but I'm talking about some global players outside of the U.S., players that are perhaps in multiple countries in Europe, in Australia, New Zealand. So I think there's a lot of opportunity there. And then there is the midsized practices that largely are -- many of them are Dentrix users, significant number, and there's going to be, I think, a significant migration to our Zahn product, which has matured quite nicely. And so I see lots of opportunity. But the big area of opportunity is in the area of demand generation software. In other words, communicating with the patients. These are the systems that came to us through the merger with Internet brands and our Henry Schein Practice Solutions business to create Henry Schein One. So I think there's a lot of opportunity in that area. Website development for practitioners, a lot of opportunity in that area. So generally, I would say that we're very optimistic about Henry Schein One playing a more important role in the post COVID-19 environment, and I think we're pretty well positioned. And we have had 2 years to bring our businesses together, Henry Schein Practice Solutions, Henry Schein One systems. And I think we're pretty much well positioned now to take advantage of the opportunity that will be presented. Large practices putting in enterprise systems, midsized practices and even the smaller ones.

Great. And maybe just one more before we move over to the medical business. Have you seen any difference in how quickly the DSO or larger group practices, that segment of the market has come back relative to the individual practitioner as they've gotten reopened and started seeing patients?

It's very hard to tell. This data that the ADA publishes every week, it's available, I think -- I mean, it's available to dentists, I'm sure. You can access it in the public. And it shows more or less -- it doesn't show precisely, actually where the practices -- whether the small, midsize and large are coming back at the same rate. But I will say that a lot of the DSOs spent a lot of time during the downtime working on coming back. They may have a jump start, although I cannot say for sure because actually, I was -- as I said, this Board meeting of a dental school today, and there are a lot of independent practitioners that are on that Board, and they were talking about how they spent the last 8, 9 weeks preparing to come back. So I don't think we have the data. But what we do know is some of the group, big large practices were working with us pretty intensely on coming back. But I would imagine a lot of the smaller practices, too. But I've not seen data. May exist, but I'm not seeing it, differentiating.

I wanted to shift over to medical. You had mentioned that, I think on the first quarter call, your medical sales were down in the 20% to 30% range in April. You talked about dental practices reopening faster than expected. I just wonder if you could kind of give us an update on where things stand for the individual physician practice. And you serve a lot of different sites of care. But maybe for the kind of core physician practices, have you seen those kind of open back up faster as well?

Yes. I would say that we had a good 25% of our medical practices that were really open during this period, whether they were urgi centers. I would say, the surgery center is probably not, maybe some, but not really. I think they've come back more or less in the same proportion to the dental world. I think it's a bit regional. But more or less, I think that it's very similar. Though the number that were closed were not as great as in dental, maybe it's a bit less. Maybe -- I don't know, maybe I get estimate, actually not 25%, 30% that were not closed. But they've come back also pretty nicely. Remember, though, in our medical business, we're largely a U.S. business. We have small $100-or-so million business in Europe, but it's the $3 billion or so business is mostly in the U.S.

Okay. Great. And I wanted to ask about the role that you think kind of Henry Schein can play longer term in facilitating kind of COVID testing and, hopefully, ultimately, distribution of a vaccine. Obviously, the diagnostics piece of the market has been a bit of a wild west with all the tests that kind of initially flooded the market. And you've seen kind of the FDA crack down a little bit more recently just to ensure that the tests that are being sold are accurate. Can you maybe just talk about how your approach has evolved over this period? And what role do you think the company can play longer term?

Yes, Nate. We have always had a pretty good business serving physicians. We have clear wave tests or clear tests in their practices, both in terms of machines, units, and we saw a wide variety of those units with the related product that is used to drive those tests. But then we've also had a significant amount of good business in the quick test. I would say -- I don't know exact data. But if we're not the biggest, we're pretty close to the biggest servicing the alternate care market in that space. We continue to offer those kinds of tests -- sorry, we continue to offer the machinery to -- and the related materials to physician offices. But at the moment, the quick tests have been slowed down by the FDA in terms of who can use them. And they can only be -- primarily only be used by laboratories that are set up for moderate complexity or complex labs. We're very hopeful that we'll have the pinprick test back soon, but the FDA is studying these now. We're working with a couple of large suppliers in that area, one being BD. And we're rather hopeful that these tests will be made available to physicians in the quick test form that we anticipated and that the FDA will see its way clear to allowing even a pinprick. Don't know when that's going to come, but we hope that it will come soon because the practitioners want it. As it relates to dentistry, in that field, we're also hopeful, but there is no real simple system yet for dentists, although we think dentists are pretty qualified to administer these tests and work with a physician on the interpretation results. But right now, there is a shortage of product that is available through the machines. It's easing up. It was worse a month ago because the government largely took -- or the government took a large amount of these machines, and it's easing up. And our business has actually picked up in that field. We think the -- whether it's the molecular test, antibody/antigen test should be made available in a pinprick, in a point-of-care simple test without a machine. It's available in certain countries, and we're hopeful that the FDA will see its way clear to approve more of these tests, and we're hopeful.

Okay. Great. Yes. So we'll stay tuned to see what the FDA does there. Just 2 quick ones in the couple of minutes that we have before we wrap up. Maybe both for Steve. Have you talked about the size of PPE in total for the business and how that's split across the medical and dental segments?

We haven't really given specifics. I think we've said it's in the double-digit -- low double-digit range of our sales in total. It's gone up, obviously, and it will continue to go up because it looks like some of these new PPE products or the new -- the PPE products will become standard of care. So how high it goes, it's hard really to judge at this time, but we would expect it to become a greater portion of our sales as people who use more masks, more gloves as well as it's not technically PPE, but disinfecting products also will be used to a much greater extent, we think, going forward.

Okay. And that's a low double-digit percentage of sales?

Correct.

Okay. And then, Steve, just lastly, what do you feel like you need to see in the business before you would be comfortable maybe resuming guidance or starting to look at M&A or share buybacks again? Are there specific things you're kind of looking for before you get kind of back to that kind of normal communication in terms of the P&L?

Yes. I don't know if I have a specific time frame. But, one, for guidance, we need a higher level of predictability because we don't want to be giving guidance if the uncertainties are too high. So I would also say that with respect to stock buyback and M&A, I think as the year progresses and we see the improvement in the markets and how that impacts cash flow, that will be an easier one to be able to make a decision and say, okay, we can go back to allocating certain dollars for those activities. It's still early on because there's still -- while the recovery is doing well, still a lot to go before we're back to where we feel comfortable.

Great. I think we're out of time with that. Stanley and Steve, thank you very much for joining us today. Great to hear your insights as always. And everyone on the line, thanks for joining this session, and have a great day.

Thank you, Nate. Thank you, Steven.

Yes. Thank you, everyone.

Take care.