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

Hello, and thank you for joining us for Piper's 32nd Annual Healthcare Conference this year coming to you virtually. I'm Sarah James, healthcare services analyst at Piper. And with us today here, we're very pleased to have Henry Schein, a global distributor of medical and dental supplies, including vaccines, pharmaceuticals, financial services and equipment. With us, we have Stan Bergman, Henry Schein's CEO; and Steve Paladino, Henry Schein's CFO. Steve, I'm going to pass it off to you to make some opening comments.

Okay. Thank you, Sarah. As we begin, I'd like to note that certain comments made during this call may include information that is forward-looking. As you know, risks and uncertainties involved in the company's business may affect the matters referred to in forward-looking statements. As a result, the company's performance may differ from those expressed in or indicated by such forward-looking statements. And these forward-looking statements are qualified in their entirety by the cautionary statements contained in Henry Schein's filings with the SEC. So with that, I'd like to turn the call over to Stanley for some brief opening remarks.

Thank you, Steven. Sarah, good to see you, and hopefully, a lot of our friends that have followed us for many years are watching today. Sorry, we can't meet on the floor of the Greater New York Meeting at the Javits Center, but we'll be there next year. In fact, right now, our team is participating in a virtual conference, the Greater New York Meeting is hosting a virtual meeting. We have our own pavilion of all the Henry Schein products and actually are conducting business in the same way, by the way, as we did it for the Dentsply Sirona meeting that was virtual this year. And we have a conference in January at Henry Schein, European Conference Dentology that will be offering our complete offering of products through a virtual convention. And I'm actually quite surprised we are getting orders and business is taking place. So it's just a very brief overview. Henry Schein is the largest provider of products to dental and medical office-based practitioners and, of course, includes ambulatory surgical centers. The -- we provide products to renal centers, the cancer centers, to community centers. We're also providing product to governments around the world. Essentially, whatever a practitioner may need, sit in a dental chair, look around, practically everything can be bought from us from the consumables, to the pharmaceuticals, to the equipment, to the software, to the chairs, traditional equipment, digital equipment, software, of course, and a host of value-added services, we finance the practice in various forms, patient financing, education. All sorts of services that all relate to helping practitioners operate a more efficient practice so that the practitioner can focus on the clinical aspects of the practice. I think people know this that in the second quarter, essentially sometime around the middle of March to the middle of May, 80% of our practices around the world were closed. It was a very sharp V, went down. We powered down quickly and we powered up exceptionally fast. And today, our businesses around the world are already operating, and I would say, basically, quite normally. Infection control in dentistry has always been quite strong and likewise, in the medical world, there's always been good infection and to the sepsis control. And so I think the public is feeling comfortable going into practices today. Of course, the resurgence in certain parts of the world has resulted in some caution. But we can -- so happy to answer specific questions. But essentially, our practices are up and running. If you go and look at our practices, our business in China, Australia, New Zealand, Hong Kong, it's pretty much back to normal. In fact, there is growth all the way to the U.K., but because of reimbursement, our practitioners really are not seeing many patients, I think, 20% or 30% of what they were seeing before. And then everything in between. Parts of the U.S. are pretty good. Other parts are challenged. And essentially though, we reported in our third quarter, we had a strong third quarter, 13% growth in sales, essentially flat if you take out COVID-related products. That's PPE and the tests. I think it's important. We're a big player in the physician space in point-of-care tests, specifically rapid tests. Happy to clarify what we did, there's lots of confusion. You can get a PCR test in a rapid test form, and there's lots of confusion as to which tests work and don't. Happy to talk about it, but we are a big player in that. But I think for the purposes of understanding the state of the Henry Schein business, I'm happy to give you information on PPE and, of course, tests. It's better to look at it without. Basically, in the third quarter, our dental business was up 6.5%; our medical, 28%. On dental, the consumable in North America was up about 6% -- 8%, the equipment was flat to slightly positive. In Europe, we were up 11%, and the equipment was down somewhere around mid-single digits. If you look at the October, essentially again, on the dental side, it's been flat if you take out PPE and COVID-related products; and on medical, it's up mid-single digits, we covered this in our call. Our backlog at the time, the last time we provided guidance information was that the U.S. was slightly down in terms of equipment and that's because the DS, Dentsply Sirona World occurred at a different time, last year it was third quarter, this time fourth quarter. And our International Equipment business was up low single digits from a backlog point of view. Happy to answer questions and ready to answer any questions you may have, so don't be shy. And I know you never are.

And just a reminder to anyone in the audience, you also have the option to participate in Q&A. I think you use the hand raise and the chat function. So we'll see that if you send in questions. Maybe we could start off with something topical, vaccines. That's always a big question that I get. Can you level set us by telling us how big are vaccines to your current business? What are you expecting with maybe increased demand for flu, if any, this year? And then what could be your involvement and more importantly, when with the COVID vaccine?

So Sarah, germane to today's environment, there are 3 big areas of our medical business. The one are the med-surg supplies. The second are the pharmaceuticals, of which -- and remember, we're selling to office-based practitioners of which vaccines is an important part, and then we have the tests. If you look at the vaccines, it's a pretty stable business. It grows -- a new vaccine, it grows. But it's pretty stable. On the basic flu vaccine, we upped our purchases a bit from last year. And essentially, for all customers of Henry Schein, they got their flu vaccine from us. Most of it is already being delivered. We may go into spot market a bit, but that's not our business. Our business is to satisfy the needs of our customers that buy flu vaccine from us every year. So that -- we satisfied that need more or less already. And if a customer, as I said, is a customer for flu vaccine, there will be no shortage for our customers. Now you asked about the COVID vaccine. From what we understand is that the government has contracted with another distributor to undertake third party logistics, not to act as a distributor, but to act as a third-party logistics provider. There are programs in place to allocate those vaccines to different parts of the community, essentially early stage to healthcare workers, essential workers, and then there will be other ways in which it will go. We expect the first wave of these vaccines to go through the channel I've just described and be given to the public free of charge. As the market opens, we expect that the manufacturers that we do business with that have COVID vaccine would distribute those through Henry Schein. Of course, we don't know today. There will be a new administration. We don't know what changes that new administration will bring. But one thing is important, there is right now a challenge in acceptance of the vaccine, and I think physicians who are our primary customers are critical in educating the public on the importance of these vaccines and the differentiation between one manufacturer and another. Remember, with traditional flu, there's one kind of flu vaccine, it's the normal one, is an adult -- is -- one for the elderly and there's one for pediatrics, I'm simplifying. With this, there's going to be multiple sources, and there will be confusion. And our view is that the best way to get acceptance is to use the office-based practitioner, and we're hopeful that, that will be understood. That's our market. We've played a very important role in the past in flu shortages and worked with the CDC, and we have good relations. And I believe that people within the government understand that companies like Henry Schein, who have done government work for years, would be in a position to be of help.

I guess for our listeners, I'm sure they're always going to be trying to size this. But I think we have Schein down is about $400 million generally in vaccines, and I think flu might be a large portion of that. So as we think about the COVID vaccine being something that exists in the marketplace, probably for a few years at least, where you'd have the opportunity to participate in it, could it be an additional source of revenue that's similar in size to your current flu revenue stream?

I don't want to practice numbers without a license. Steven should answer that question. And I think our business is actually a little bit bigger in vaccine. But go ahead, Steve.

Yes, vaccines and injectables, this as one grouping, runs a little over 30% of our medical business total revenues. It's a little bit lower as a percentage of sales because of PPE most recently and test kits. But on a normalized basis, it normally runs a little over 30%. We expect to sell, and we said this previously, somewhere between 6 million and 7 million doses of flu vaccine in the current year. Now there's an opportunity to do more if the season turns out to be very strong from a vaccine perspective to go into the spot market, but what we're committed to sell is the 6 million to 7 million doses. Each dose runs, I don't know, somewhere around $20 per dose plus or minus. So it is a nice revenue item for us. Yes, it's really difficult to project what we'll sell, if any, in vaccines. We think that we should be a good candidate to distribute the vaccines because we're going to the primary care market, and that's our strength. So it should be something that you would think makes sense for us to sell. But whether we get it or not and at what price it will be selling at, is still really to be determined. So we can't really size it, but obviously, it could be significant.

Got it. I wanted to talk a little bit about TDSC, because I think that there's some confusion in the marketplace around why and why now? So what can you tell us about that decision?

Very good question, Sarah. I'm glad you asked that question. So the -- a group of dentists in California 4, 5, 6 years ago went to see the California Dental Association and said, look, Henry Schein and others are providing these DSOs with good deals. We need to do the same. We need to achieve these good deals, expand together and see if we can get a good deal. We have always been in the buying group business. Any time a group comes together and can give us a confirmed amount of orders, we're happy to work with manufacturers, set up a GPO for them and get them business, whether it's in dental or medical business field for decades, happy to do that. The California Dental Association Society said to us they were doing that. And we said to them, "Sure, we're happy to work with you." And then they came back and said, "No, no, no, we want to set up our own distributor to do this." We said to them, "That is a lot of work. But you know what, if that's what you want to do, do it. And at any point in time, when you figure out that distribution is a little difficult, call us." So in the middle of COVID, they realized it is not so easy. Because not all PPE, for example, is equal. PPE is regulated. There's quality issues, and they realized they just could not service their customers. So they came to us and said, "You were right, will you become our partner or will you buy the business and service our customers?" And that's exactly what we did. We bought the business, which provides a deal for California Dental Association members as well as members of other dental associations that have signed up. And the business has to be conducted on its Internet platform. It's actually not a bad digital platform, it's got to be used. Basically, our sales people are commissioned, our field sales consultants, regardless of which channel is used to buy the products, whether it's a digital channel of Henry Schein or the TDSC channel. Where the confusion is, I think, is because TDSC only has a digital platform. So we did not buy this business to build a ring around our business to go out against digital-only customers, the suppliers that are servicing our market, very big ones and small ones. We bought this business and invested in this business alongside the California Dental Association to help provide their customers with very good service and a particular pricing formula that if they want to go through that pricing formula, they're welcome to do that. We offered this to them 6, 7 years ago, I'm very happy that they chose us to do this -- enter this relationship. And it just proves, by the way, that not all PPE is equal. There's a lot of challenges in running a business of this kind. Quality is important and regulatory is important.

Absolutely. And I appreciate the way that you kind of stepped into that story, because it brought up another question that I get a lot around DSOs. As they begin to consolidate more and get larger, to what degree do they go direct to manufacturer? What's unrealistic? And then how can you help them and continue that relationship?

So, Sarah, as you know, DSOs are the least expensive customer we have to service. We don't need to send a salesman in, a salesperson. We would send a salesperson into their headquarters and they negotiate a deal. The deal has various components. Whether it's specific manufacturers where we act almost like a GPO and get a deal for those DSOs or it's our private brand, or it may be other products that we sell, including software, that we're able to bundle and make a deal with that DSO so they get the Henry Schein quality of service, and at the same time, we get incremental business that helps us in our negotiation with suppliers and drives more volume through our relatively fixed cost infrastructure. So that's what our theory has been. I think we've been, for many years, the largest player in this space. Every now and again, we'll lose a contract because we're not prepared to go below a certain price. We have value-added services that others don't have. And so we have had very good relationships with DSOs. Some have left us, some have come back, and it's worked overall. You asked me whether manufacturers will sell direct. There are certain manufacturers already sell direct. But we provide terrific value. If you take equipment, it's not simply shipping the product to the DSO. The equipment has to be installed. The DSO opens a new practice. It's a lot of work. In fact, we have an operation in Virginia that has a special area just for helping DSOs set up a new practice. So all the stuff is collected there and it's shipped on a particular day, 1 or 2 days, bingo and the whole facility is up and running. There's a lot of work in that. And one has to be very careful in taking a simplified view that we're in the widget shipment business. If it were the case, I believe, the California Dental Association wouldn't have come to us. And certainly, DSOs will go direct to do all they can to cut us out. Of course, we can be cut out, but we provide tremendous value, and I believe our DSO customers understand that.

Okay. Let's dig into value-added services. It's always a favorite topic of mine. So how have software sales and value-added services sales been in a COVID environment? How has this year changed the relationship or the understanding of your customers of this product?

Well, what's very interesting is that, first of all, when you look at our sales of value-added services, you've got to pull out the financial services because that's all the services. Then you have to pull out -- we do a lot of work for the government. For example, we are -- our software system is in the U.S. military. It's going to the VA. Payments can be very lumpy. You take that out and you look at the last, I don't know, 6 months or so since COVID, what's very interesting is our cloud-based system is doing extremely well. We have Ascend which we believe is a very powerful cloud-based system. That is doing very well. And by the way, a couple of DSOs have realized it's a pretty good system. So that's doing well, our basic sales of software. What you need to peel out is the transaction revenue that we receive. We receive revenue and quite a bit of it for claims processing, for credit card processing and patient financing. Those particular transactions have fluctuated generally with the market. And what is interesting in dentistry is that although the sales may be good, the billings in many respects, there are fewer transactions, because the billing per procedure has gone up. It relates to the fact partially that people don't want to go to the dentist as much as they wanted to -- they wanted for a particular procedure, they want to get it all done at once. So there'll be less claims for a given volume. And so if you ex that out, the business is doing quite well. If you ex out the value-added services for financial services, you ex out the large contracts for the government, DSO contracts, and the core business of selling, our Schein software is doing quite well. And of course, generally, the claims are in line with the business. There are parts of the world where it's not doing so well. We have a very large software business in the U.K., that's not doing well. On the other hand, we have a very large installed base in Australia and New Zealand, that's doing well.

Got it. Can you talk about the -- I guess, the financial health of your customer base, how that impacts equipment demand and how your financial services might influence the timing on that as your customer base kind of builds back up their cash?

So let me talk about the general financial state of our customers. And on the financing, I must say, that Steven, that's his problem. So generally, dentists are doing okay and physicians are doing okay. Our bad debts, although we increased the reserve quite a bit, a couple of -- I think it was in the second quarter, we're probably overly conservative. I don't think we're -- maybe there's a slight increase in bad debts and for a period of time, there was certainly a slowness in payment to us. You would expect that. But generally the state -- the financial state of practitioners is pretty good and they remain quite bankable. Steven, do you want to feel young and get more specific?

Sure. So clearly, if you look at our Q3 cash flow, it was very strong and in part because the slowness that we were getting from customers paying a little bit later in Q2 reversed and it started catching up, and we expect really in Q4 that to continue and really be caught up and current. Traditionally, our bad debt expense is very low. It's less than 0.2% of credit sales. So it's very low. Equipment is an opportunity for financing. We have point-of-sale financing programs for our customers where rather than them spending, make up a number, $100,000 for a piece of equipment, we could set them up for lease or loan for X dollars on that. We use third-party banking institutions. So we don't want to be a bank. We don't want to use our capital for that. But we act as an agent for the bank. And what we do is we make a little bit of money on it. We get certain points for each deal that we bring to the bank that they approve. The bank will then pay us directly with no recourse back and provide that financing to our customers. It's very attractive. In the U.S., excluding the large DSOs, because they have separate financing arrangements, we financed close to 40% of all the equipment that we sell. So it's very attractive. And today, with very low interest rates, that monthly payment is as low as it's probably going to get. So we think there's an opportunity for equipment to increase over the next few quarters or so.

Got it. I wanted to squeeze in one about margins, about where they might go long term? I know you guys have a couple of different levers available to you, both in growing your scale and also thinking about shifting your product mix. So can you talk about your view on long-term margins? And any details on those different levers, whether you have the assets you need to pull them now or what you might need to do?

Sure. So as you know, we suspended guidance like many companies a little while ago. So we're not giving specific guidance on this. But what I can say is once we're completely out of the COVID period, we do see the opportunity for continued margin expansion like we were getting prior to COVID. It comes in a few different respects. The first is leveraging expenses further and being more efficient on incremental sales, but 2 other bigger opportunities are shifting to higher-margin products and services. And the 2 big areas there are continued accelerated growth in dental specialty products, which has a higher margin profile than general dentistry products, as well as technology products and services that also has a higher profile. And just to point out to people who may not have studied our numbers, on technology, we show it as a separate segment and it runs 4% of revenues, but 12% to 14% of operating income. So if you see, it's a lot higher margin. And the goal is to expand also other practice services and solutions that come with, again, higher-margin opportunities. So we still think there's opportunity. Once we get out of COVID and we go back to giving guidance, we could be more specific as to how much we think we can get on an annual basis.

Great. Well, I'd love to let you guys just have one quick comment to wrap this up on the message that you want us to walk away with today?

Well, that's a good question. No one's asked that kind of question. But here is my answer. Steven, think about it while I'm speaking. Bottom line is dentistry is alive and well. We've seen in parts of the market where the virus has stabilized, it's doing well, Asia, Australia, China, in particular, Australia and New Zealand. We had an amazing third quarter in our implant business in Germany. People went to the -- to take care of the implants. The German market was doing good, it was stabilized, quite stable, the same as France. And parts of the U.S. are doing extremely well as the virus has stabilized. Having said that, people are going to the dentist. The number jumps up and down, somewhere between 75% and 80%, but people are going to the dentists. And our focus on making our distribution business more efficient, getting greater market share there is paying off. I think we did a good job in servicing our customers during the COVID period. So they understand it's important to have a relationship with Henry Schein in times of shortage, in times of confusion as it relates to what's a good product, what's not. Our value-added service portfolio is very good. We expect to grow that. It's growing rapidly, that business. And then at the same time, our specialty businesses are highly profitable businesses, and they're all doing well. What is often overlooked is our medical business. It's well over 1/3 of our business today, much higher in the third quarter, and we are growing market share in that space too, both with the smaller practitioners and with the large IDMs, many of them are feeling very comfortable doing business with Henry Schein. Steven, what can we add?

You covered a lot, and we're running out of time. So I'll just say briefly, I would say that our business model is still intact. We still think there's a long runway for growth. We feel that in dental, patient traffic is only somewhere slightly below 80% on an overall basis. So there's opportunity for that to continue to accelerate. And we think PPE products will continue at a high rate and will be the new standard of care going forward. So we're very optimistic about long-term prospects. We just got to get out of this COVID period, and that's something we're not trying to forecast at all.

Well, thank you, guys, both so much for joining us. This has been very helpful as always. And everyone else, enjoy the rest of the conference.

Thank you, Sarah. Thank you, everyone.

Thanks.