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

Hi, everybody. This is Erin Wright. I cover life sciences tools, diagnostics for Crédit Suisse. I am welcoming everyone to our 2020 health care conference. It's obviously in a virtual format this year, which is a little bit different. [Operator Instructions] Without further ado, I'd like to introduce the management team for Henry Schein. We have the 2 leaders of the company: Chairman and CEO, Stanley Bergman, real pleasure to have you here; and then also Steve Paladino, who is the EVP and CFO, with us today. And I'll first hand it over to Steve to offer some -- as well as then followed by Stanley to talk for some initial remarks.

Okay. Thank you very much, Erin. I just want to state as we begin that I'd like to note that certain comments made during this call may include information that is forward looking. And as people know, that there are certain risks and uncertainties involved in the company's business that may affect the matters referred to in forward-looking statements. Therefore, as a result, the company's performance may differ from those expressed and/or indicated by such forward-looking statements. And all of these forward-looking statements are qualified in their entirety by the cautionary statements contained in Henry Schein's SEC filings. So let me turn it over to Stanley Bergman for some opening comments.

Thank you, Steven. Thank you, Erin, for hosting us. I'll make very few comments because I think it's best to allow for Q&A. So Henry Schein, and I assume people on this conference call today know we're the largest provider of products and related services to office-based practitioners. We have about 1 million customers around the world. It's about 1.5 million practitioners, dentists, physicians, ambulatory care services, governments, anywhere where practitioners are dealing with patients generally outside of the acute care setting, out of the drugstore setting and out of the long-term care setting. Our model is generally a high touch. We have about 3,500 field sales consultants around the world. We break the business down into Dental and Medical. At Dental, we of course provide consumables, equipment, pharmaceuticals, software. We're the largest provider of dental practice management electronic medical records software in the world. We also manufacture and distribute under our own brands specialty products for dentists. On the physician side, the Medical side, we are quite a large player in this alternate care side space. Our business was severely impacted in April and May by lockdowns in the United States. Those lockdowns were generally removed and, in fact, globally by middle -- end of May, June. Generally, our -- there are no parts of the world where there is a physician or dental lockdown where you can't go to a physician or a dentist. Of course, you can go, and our customers are practicing safe distancing. It's very important that infection control, sepsis control has been carefully monitored in our sector for a long time, started in the mid-'80s with AIDS. Different kind of infection, but dentists and physicians are very, very careful. Of course, it drove a lot of PPE sales. We're also, in the Medical business, active in the testing arena, point-of-care tests for the office-based environment. And generally, our third quarter was quite good. Sales in non-COVID-related products, that's PPE and tests, maybe some things like thermometers, was about flat to slightly positive. And we indicated in our recent conference call that similar trends have continued in October. We're quite optimistic about the business. We think our high-touch, high-value-added proposition works. The only thing we can't be certain about now is the impact of the second or maybe some would call it the third wave in the developed world of Europe and the United States. And so that is precluding us from being -- providing guidance. But we're quite optimistic about the business. And clearly, people have gone back to the dentist and to the physician office. So Erin, I don't know if there's anything more specific, but really Steve and I are ready to answer questions.

Great. That was a great intro. And when we think about more broadly the underlying demand trends that you're seeing across both North America and international Dental businesses, I think we've been getting a lot of questions kind of what you saw throughout the most recent quarter in terms of a -- somewhat of a recovery and then also kind of how we should envision that continuing potentially into the fourth quarter and what you're seeing quarter-to-date in terms of demand trends.

Yes. So basically, our core business of dental and medical consumables is relatively flat. If you take out PPE and you take out testing, those are much more significant growth areas. The visits to dental offices in the United States, the ADA has indicated somewhere around 77% of pre -- turns out of pre-COVID period. It's hard to get an exact handle. But generally, most dental practices are open or maybe a little slower in terms of taking a bit more time between patients because of infection control, the procedures. But generally, it's pretty stable. We don't know where this is going to head in terms of an increase in infection rates. But clearly, as I said earlier on, there is a demand for these services. And I doubt, although we'd never know for sure, a general lockdown will happen again as occurred in the United States. In Europe, it's pretty stable, although we've seen an increase in infection rate. Other than the U.K., I would say it's pretty stable. Yes, Italy and Spain are a little bit more of a challenge, but Germany is -- people are going to the dentists. And as I said, Asia, Australia, New Zealand are pretty stable, slightly growing. So that's on the consumables side. On the equipment side, we gave an indication of our backlog. Slightly down in the U.S. because of the Dentsply Sirona World conference -- congress, which will go virtual this year. It won't be as exciting as in previous years. And in Europe, the equipment book is pretty good for the fourth quarter. Steven, I'm not sure if you want to add anything to that. Maybe you should.

Sure. Yes, I think you covered a lot. One of the things that we said on the conference call is that we do expect -- we didn't give a time frame around it, but we do expect that our sales would moderate somewhat going forward. And some of the reasons we said that Stanley covered, I'll go through them again, we are seeing an increase in positive COVID-19 cases both in the U.S. and Europe. Europe has a number of lockdowns. The only good news about the lockdowns is dental and medical practices are still open. But people may not go to their dentists or medical doctor as much with these lockdowns. We'll just have to wait and see. In the U.S., we saw something similar. The ADA that puts out statistics every couple of weeks on patient traffic, slightly -- showed slight declines in patient traffic from about 79% of pre-COVID levels to 77% of pre-COVID levels. So it's hard to tell whether that's just a little bit of an anomaly or a trend, and we'll have to wait and see. And then the last couple of things is we do expect that pricing on PPE and COVID-related items will normalize. Pricing was very much inflated when there was short supply. And now, that pricing is coming down a little bit. And the last thing I'll mention is on the dental specific. We see that the procedures in dental offices are trending much more towards higher-acuity procedures. And I think that's because of pent-up demand, where for a while people really couldn't go or didn't want to go to the dentist. And now when they're coming back, they're doing more acute procedures rather than hygiene procedures. And that's good for us because the higher the acuity level, generally, the more consumables supplies one uses. But over time, we would expect hygiene procedures to normalize, and that will have a little bit of an impact on sales. So for those reasons -- and because the outlook is so uncertain, we just said, let's be a little bit more cautious on sales growth going forward. We're not aware of anything specific. October was good. October was a very strong month for us, and we talked about that on the call. But we do think that it's possible that sales could moderate a little bit in the short to medium term.

Does it seem like you've worked through some of that pent-up demand at this point?

The pent-up demand on PPE products or...

In -- on dental procedures.

I think for the most part, it's been worked through. Dentists have had pretty full schedules. And on myself, I had to have some dental work done recently, and I had to go to 3 different dentists. And each time I had to make an appointment, it was a little bit of a wait. So I think their calendars are pretty full. And we'll see whether that'll slow a little bit like the ADA survey has indicated.

And what have you seen across specialty like the implant business in particular? How has that been impacted? How should we think about growth trends across that business in this environment?

Yes. Going along with -- the more acute procedures are stronger right now. That's helped the specialty side. So we had very strong growth in dental specialty products worldwide, 6.5%, and especially strong in North America with 14.8% sales growth. All of that's organic, so really very strong numbers for the specialty business led by dental implants.

Okay. And then on PPE, it represents, I think, 10% of the dental sales in the second quarter alone and then now mid-single digit -- or versus the mid-single digits, which is like the historical level that we've seen. How -- to what extent, I guess, do you expect the trends to continue across the PPE in terms of the contributions that it's adding from a growth perspective? And thoughts on longer-term utilization here. It sounds like there's sort of a paradigm shift in terms of infection control across this business now. But is -- are you already starting to see some of that? Or is it just hard to tell at this point?

Well, if you're asking -- we think that PPE will stay at very elevated levels from pre-COVID levels. People will continue to wear face masks, gloves. And not just the clinical staff but also the office staff. So we think -- and all the protocols that are needed in disinfecting and cleaning the [indiscernible] will stay. The only thing is it may pull back slightly because of pricing that I just mentioned a little bit earlier.

But we think the mix will -- our PPE and COVID-type products, including testing and thermometers and stuff, will remain pretty high as a percent of our total sales, although there will be some moderating on the prices. But margins will be good.

The -- I did want to kind of dig into the pricing a little bit. How has the mix of PPE maybe changed? Is that a component? Or is there just an underlying price erosion across that segment?

When you say the mix maybe -- I'm just not sure I understand what your...

Within the PPE, like was there higher-priced kind of PPE products that then the mix shifted in terms of demand trends across -- over the course of the pandemic? Or was it just broader kind of price degradation across the group?

Yes. We saw -- the extreme volatility in pricing in Q2 and Q3 was mostly on face masks. And there's -- people think there's just one face mask, but there's a number of different types of face masks. And the pricing literally week to week, what we could buy it for from the same manufacturer changed pretty significantly. That's kind of almost normalized now. That supply is much stronger. And so I think the pricing will stay relatively consistent going forward. We are seeing a little bit of a new dynamic on examination gloves, most specifically nitrile gloves, which seems to be in short supply right now. So we could see some volatility in nitrile gloves and gloves in general going forward. Gloves is the most popular PPE item that we sell. It's a very big item. It's followed by face masks as the second most popular. But it's really -- we understand from the manufacturing community that ramping up production of face masks is easier and takes a shorter time period than examination gloves on a technical reason why, but it will take a little bit longer. So we'll just have to wait and see what happens with examination gloves. But it could provide for a little bit of volatility in the very short term.

Okay. Okay. And so given some of those pricing dynamics, how should we think about underlying margin trends from -- like obviously, the gross margin was a little bit lighter in the most recent quarter. Does that continue into the fourth quarter and beyond given some of those dynamics that you mentioned? Or what are some of the moving pieces there that we should be aware of?

Yes. We didn't really give specific guidance on this, but I'll repeat what we said. The largest item related to the lower gross margin was because of inventory adjustments that we needed to take on PPE. Again, we bought a lot of product in order to satisfy customer demand. And even if the price was high, we felt that having product available for customers was more important because if you don't have the PPE, you may lose more than just a PPE sale. You may lose the entire order, and you may even lose the customer if they go someplace else. So that was the priority for us. I think it made sense to do that. But that was the largest item. And then the second-largest item was supplier rebates. We do get performance-based supplier rebates from our manufacturing partners. And all of those targets were set pre-COVID. And given Q2, with the sharp decline in revenue in Q2, there's no way we can meet any of the annual goals. So we had very little supplier rebates in the current year compared to the prior year. Now hopefully, both of those items will normalize going forward. So we're optimistic about that. But again, there's a lot of moving parts and a lot of volatility. So that's why we didn't give more guidance or more specific guidance than what I just said. Are you still there, Erin? I think we're having a little bit of technical difficulties. [Technical Difficulty] Okay. So for those listening in, we lost our host. So give us a moment and hopefully, we'll get her back and we'll continue along. Stanley, maybe while we're waiting, I know we get this question a lot, so maybe you can comment a little bit about our potential for getting a COVID vaccine in the future and also how we're doing on test kits because I know a lot of people have those questions. So maybe while we're waiting, you can comment on that.

So do you think people can hear us? How do we know? [Technical Difficulty] All right. So on the vaccine, so the initial -- we've been in touch with most of our vaccine manufacturers. I think we do business with all but 1 or 2 of the COVID vaccine manufacturers already. We're a significant distributor of flu and other kinds of vaccines and injectables. And the impression we get is that the initial shipments will be made through a third-party logistics distributor on behalf of the government. But eventually, it is likely that the COVID vaccine will be distributed in a way that is similar to other vaccines. We may not actually physically distribute certain of the vaccines that have to be stored at a very cold temperature. Today, if a vaccine that we sell or injectable is required to be stored at unusually low temperature, the manufacturer usually drop-ships on our behalf, but we take the order and transfer it. So we do expect at some point to be invited into the distribution of the vaccine when it returns to normal distribution channels. As it relates to tests, and Schein has been, like with vaccines, a key distributor of point-of-care rapid tests to physician offices and other alternate care sites. We've been doing this for decades. We started distributing various COVID tests back in March or April. We have a very strong demand from physicians and some of our industrial customers who are seeking to distribute the -- who are seeking to buy the tests. Our challenge right now is we can't obtain enough. The government is still buying a lot of these tests from our manufacturers. But as tests become available, they're being given to us, and we have no problem selling them. I think Steven indicated that -- on our call that we've sold about $90 million of COVID tests during the third quarter. We don't know when the government will open it up. But as soon as the government opens up more testing, which comes in the form of platform devices or -- and consumables, reagents that go with that -- sometimes the manufacturers have the devices and sometimes they only have the reagents. And sometimes a couple may have the devices and not enough reagents. The market is still somewhat dislocated, but we're hopeful that the market will become more perfect in the months ahead and we will have access to the test. We expect these tests to be needed for a while. And our customers view us as a good place to buy these kinds of tests and a good place to be educated on the various tests that are available. But it's been an important area from a public health point of view and from a business point of view for Henry Schein. Steven, what other questions have been asked?

Yes. Maybe we can talk a little bit, Stanley, about we did announce on our call that we are resuming our M&A activities. Well, we put them on temporary pause during the height of COVID in March, April. And maybe you could talk about some of the strategic things we're looking to accomplish through M&A activities.

Yes, Steven, you're a very good interviewer, I have to say that. So our M&A pipeline was very strong in February. We turned it off in March. We restarted the pipeline about a month ago. I don't think we lost too many deals, maybe a deal here or there. Not that we lost it, but maybe there were some challenges or changes in the dynamics in a potential company that we wanted to invest in. And the pipeline has also been added to recently. So we will continue to make acquisitions to strengthen our particular market share on consumables and equipment in any particular market or expand to new markets. We will add additional M&A activity to our practice management business and other value-added services. Lots and lots of opportunity to either expand into new geographies but, more important, to add additional services to our existing platform. We think there's an important opportunity in advancing value-added services, as I noted but also specialty products, dental, medical, both on the dental side -- and both dental and medical on the dental side, in the oral surgery space, specifically implants, bone regeneration products, endodontic products, orthodontic products. And we expect to continue to expand there. Also, we have a smallish device business in the medical arena, primarily in the orthopedic space today, and we are hopeful to add to that. So those are the general areas we -- usually dilutive in the first year because of deal costs. But generally, by the second year, these deals are accretive. And we have a hurdle rate that we utilize for the cost of capital much more than the interest rate, cost that has to be met on each of these transactions, whether it's a total acquisition or an investment in a business that we have a -- own a percentage of the equity.

And sorry about that disruption there.