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

Good morning, good afternoon to all of you. My name is Bob McCooey. I'm the Global Head of Capital Markets here at NASDAQ, and we're so glad that you've joined us for our 43rd Investor Conference. We are delighted to have all of you join us, but one of the highlights for me of this conference is to have our great friends from Henry Schein join us. We have the Chairman and CEO, Stanley Bergman; and the Chief Financial Officer, Steve Paladino. And at this moment, I'll turn it over to Steve, and then we'll get right into some questions.

Sure. Thank you, Bob. Thank you all for joining. I just wanted to mention as we begin that certain comments made during this call may include forward-looking statements. And as people know, there are risks and uncertainties involved in the company's business that may affect those 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 all of these forward-looking statements are qualified in their entirety by the cautionary statements contained in Henry Schein's SEC filings. So with that, I'll turn the call over to Stanley for some opening remarks.

Thank you, Steve. Bob, good to see you. Good to be at the conference. We enjoy coming every year.

Maybe you can join me. As you can see, I'm actually in London, Stan. So maybe next year, you can actually join me here.

Happy to do it. We've been there before. We'll do it again. I'm happy to actually join you on Times Square for another opening but in person. So...

That moment also.

It's actually a pretty historical month. 25 years ago, we went public on your exchange, and it's been a great ride since. So NASDAQ, we're big fans of. You guys do a great job for us. So...

Thank you so much.

Should I give a brief overview? And then...

That will be great, yes...

We can then have any questions? Sure. So Henry Schein is the largest provider of products and related services to office-based physicians and to dentists. So our customers are about 1.5 million practitioners around the world, million customers, million practitioners, essentially any kind of dental practice. And in the physician area, we service the alternate care market, that is physicians outside of the hospital setting. Although today, there are physician practices, separate practices within the hospital, those are customers of Henry Schein, the ambulatory surgical centers, the urgent centers, the cancer centers, the renal dialysis centers. The alternate care setting, which is an area that has been growing for a while, actually got a significant boost during the COVID period, where patients are seeking to have procedures done outside of the hospital, and the ambulatory care centers are undertaking those procedures. Essentially, we carry all the products that our customers need: consumables, equipment, pharmaceuticals, software, a full line of specialty products, endodontics, orthodontics, implants, bone regeneration. These products are our own brand. Many of them are manufactured by ourselves. It's a high-touch model, which means we have about 3,500 field sales consultants around the world. These consultants are actively engaged in helping practitioners operate a more efficient practice so that the physician can or the dentist can focus on the clinical care. And in that area, we have a plethora of value-added services, including the leading practice management software platform in dentistry, the electronic medical record, the leading platform and the leading suite of products that provide interactive services for practitioners from eClaims processing to credit card processing, to patient financing, to recalls, to various forms of reputation management tools, websites, all of the activities that go into managing a great practice. And we, of course, finance the practice as needed. So Bob, I can go on and on speaking about Henry Schein for a long time. Any questions for Steven and I?

Thank you. So obviously, the topic of the day and for the past 11 months for all of us has been COVID. So let's start there, Stan. Can you talk about the current impact on your business from COVID-19? And what's been the resiliency of the dental practices globally? And then also touch on your medical customers in the U.S. since, obviously, your medical business is predominantly a U.S. business.

Yes, Bob, sure. So early April, our customers powered down. We went out to our constituents, first of all, to our team, and we said our big priority is taking care of our team and family members, and so all the office team members started working from home. Actually, it was quite effective through video calls, through cellphone calls with our customers. Our distribution centers stayed open throughout this period, have not closed at all during COVID, and we provided equipment installation and service throughout this period. And then in May, things opened up a bit. So we powered down, powered up for the entire business. On the dental side, most practices in the markets we serve and we service essentially the developed world, we also have a big business in Brazil, in China, most of the practices are back up and running. I would say not at 2019 levels. There are various databases out there, indices showing that it's somewhere around 75% to 80% back to business. But on the dental side, we're finding more extensive procedures undertaking and being undertaken, so the average ticket in our world for billing is a lot higher than it was before. And I would say the hygienists took a little longer to come back into practice. With the current bout, the infection rates going up, we haven't seen much decrease in visits to practitioners, somewhat down in certain markets. But there are other markets like China and Australia, New Zealand that are essentially back to normal with growth, and then it goes all the way to the U.K., where it's been pretty close down, 20% or so of activity compared to '19, maybe 30% and everything in between. On the medical side, of course, similar to dental practices, have powered down, powered up. But I would say it's also back to normal, maybe a higher rate than in dental. But ambulatory surgical centers have been very, very busy. The urgicenters have been busy. We had 2 big challenges that we are faced with. One was global PPE. Happy to talk about it. There's a lot in our transcripts from our investor calls, et cetera. But essentially, we're very focused on providing PPE to our customers. We could not unfortunately service the whole market but to our customers, and we also worked in the early months very closely with governments around the world to even provide PPE to noncustomers in the acute care setting. The other area of significant focus has been testing in the U.S., a little bit in Europe as well, and we work with most of the major providers of tests. We've had a long-term business in the point-of-care rapid test arena and COVID testings. Tests were just natural to go into that area, I believe. We pioneered certain introductions. And unfortunately, there is a shortage of product right now. But for many of our -- I would say for most of our customers, we can satisfy with some allocation, but there is a significant need for testing in the alternate care setting, and we're working on that. Also, workplace health is a big area for us, and testing is important in that area too.

No doubt. So let's dig in a little bit more on the economics and pricing on things that have been going on in your business. Can you talk a little bit about the pricing dynamics associated with COVID-19 that resulted in the need to make some inventory cost adjustments for PPE that you just touched on and the COVID-19-related products during the past couple of quarters, Stan? And also, when do you think that your pricing will begin to normalize again?

So Bob, I don't want to practice pricing without a license. I would let Steve Paladino speak about it because I'm really no expert in this area.

Yes. You're right. I should have known to go right to Steve on that.

Okay. So over the last several months because of short supply of certain PPE products, primarily face masks, pricing that we saw from manufacturers really went all over the map. And we saw many significant increases in prices, and I'm talking where price increases to us were 2, 3, 4x what we would pay in pre-COVID. We made a decision to worry less about what we're paying for it and worry more about getting access to product so we could have product available for our customers. Because the concern was if you don't have PPE when they come to our store, they may go to someone else's store for that PPE and then buy also other things at that time. But because of that, we bought some inventory at some very high prices, and we did take some inventory adjustments related to that. We didn't give the specific number, but we did say that was the biggest part of our gross margin decline year-over-year. Right now, I think pricing is pretty close to being normalized on face masks. But as Stanley just mentioned, we are seeing increased demand of certain examination gloves. Primarily -- there are different types of examination gloves, primarily nitrile, which is the substance is made of, is in short supply. And we haven't seen -- we've seen price increases on that, but we really don't know what the extent that will be. But I would say at least on the face masks, we're pretty close to normalized pricing at this point. We can't really predict what's going to happen with gloves yet. And hopefully, that won't reoccur, but we want to make sure we have access to gloves for our customers also because examination gloves, there's no dental procedure that's done without at least one pair. And many times, multiple pairs of examination gloves being used. So it's really been a little bit of a crazy time. We can't wait to be out of this COVID time so we get back to a more normalized pricing. But I think we're close to it, but not quite there just yet.

So just, Bob, just want to add to what Steve said, if okay. And that is, yes, we are normalized pricing, now more or less for many of the PPE items, but the new norm will be a higher price. There's no question about it, because price of raw materials has gone up, greater demand around the world for masks, et cetera. And of course, gloves is likely to be a shortage in that raw material also for a while forward. So I think where prices have normalized, in most PPE, it's a new norm.

Yes. We guess that certain products are going to be even more important and valuable in each of the offices going forward, PPE being one of them and so certainly would be good. Can you get it, the raw materials and maintain a good margin on that part of the business, Stan?

Yes. I think we need to, Bob, divide this into 2 periods. There was this period, say, April to May, when we went into the market to buy product from whoever could give us approved regulatory product that was a qualitative -- that met our qualitative standards. And we went in and bought these products at a -- even at a very high price to make sure that our customers had them but also to support the FEMA efforts in the United States. So there was dislocation in the market over there, but that was a period of time. We can now access more or less the products we need. There's a shortage in gloves. But I think for our own customers, we should be able to satisfy their needs. We'd love to service the whole market, but it's going to be very, very hard for every -- for gloves, for example. Yes, and the margins have returned to normal. No issues there. There was just this period where we went in, bought a lot of product, and we had to take some adjustments in the second and third quarter.

Well, I think overall, that says a lot about the culture of Henry Schein that you were very focused on the customer more than you were focused on the margin and profitability in the short run as well as being focused on your 3,500 consultants that you talked about earlier, Stan, so that no one should walk away from this not understanding the real focus that Henry Schein has on culture of customer and teammates.

So thank you, Bob. Appreciate it. There's no legal requirement, but FEMA asked us to allocate a lot of our inventory that we had in April to the acute care setting. Those are not generally our customers, and we did that. That, of course, resulted in our dental customers and some of our medical customers not getting all the product they wanted. But I think from a moral point of view, it was the right decision. And then, of course, we worked heavily on getting our own customers' product, but the price was high. So providing PPE was critical to us as well as, of course, tests. And being 100% -- being engaged 100% on the test side, our team, really, trying to understand the dynamics in that market, very focused on it, has helped in advancing tests in the alternate care setting. Very important. If you live in Manhattan, you will see the lines in front of these urgicenters, a lot of those products are coming from us.

So let's get back into -- in the products and strategy. Henry Schein's go-to-market strategy is built on your value-added solutions that you offer to customers to help them run their practices more efficiently. But interestingly, you just recently announced an investment in an online player, tdsc.com. Can you talk about how these 2 channels will work together, be complementary to each other, Stan?

Bob, I'm glad you asked that question because there's a lot that's been written, a lot of confusion. This particular investment relates to a unique set of circumstances. What happened is 3 or 4 years ago, the California dentists got pretty upset because they were not getting good prices, in their mind, compared to some of the large dental service organizations. So they said, "What we need to do is form a buying group." And we went to the California Dental Association, "We will help you set up a GPO, a buying group for your members." And they said, "No, no, no, no. We want to go and actually establish a distributor." Okay. We said, "We'll help you with that distribution operation, but you've got to decide what you want to do this." No, we don't need to help. Okay. We have very good relations with them. Then in about March or April, they called up and said, "We really need your help. This PPE and distribution of dental products is much more difficult than we thought it is." So what we said is, "Okay, we will make an investment in TDSC." We're partners with the California Dental Association. Any dentist that is a member of, I think, about 20 different societies combined to this. Essentially, it is a platform, an e-commerce platform only way of purchasing. But it's products, same products, not all, but many of those products can essentially be bought through Henry Schein, but Henry Schein has a wide of variety of products available as well. So it's just another channel. A lot of commentators have written Henry Schein invested in this space to compete against the e-commerce-only businesses. That was not the reason we invested in this. We have a great e-commerce platform ourselves. We invested in this really to develop this -- continue with our partnership with the California Dental Association. So it wasn't that we were investing as an offense of strategy. It's really a complement. And it so happens that the only way you can order from this particular distributor, which is now integrated into Henry Schein, is through an e-commerce platform.

Thanks for clarifying that, and it's good to get the correct information out there to everyone. And it sounds like it could also be something super valuable to you and your business going forward, but obviously, a very limited capacity focused on those groups, as you said, that are part of those societies. So let's talk about...

Yes. It's very exciting -- sorry, Bob. Very exciting. But put it in perspective, it's a $20 million business we announced. And in 2019, the last full year, we reported we did over $10 billion. So -- but it's a nice, neat e-commerce platform. The Henry Schein platform is much more expensive. I think 70% of our consumable products are sold through our e-commerce platform, but this is a neat product.

So let's talk about consumables, Stan. So what's the importance of your private label brand to your future? And how have private label consumable products played a role during this time of supply constraint during COVID-19?

So Bob, it's a very -- also a very interesting question. So we have our own brands that fall into 2 categories. First of all, the specialty products: the implants, bone regeneration for oral surgeons, the endodontic products and the orthodontic products, traditional wires and brackets and aligners. Those are all sold under unique brands. That's very different to our private brand. Our private brand is a very high-quality brand and generic. And essentially, in the consumable space, we support our national brands. A huge part of our business is national brands. And so when we lead off with customers, we generally lead with the national brands. Having said that, where we have price competition, we are certainly not going to lose the customer and we'll use our private brand to sell products where price is the issue. Having said that, the Henry Schein private brand is a leading brand, perhaps the largest brand under one common brand name in dentistry. And it's very price competitive, high quality. And of course, it's used extensively in the medical world. I don't think the private brand played any particular role that was different in COVID to pre-COVID. Wherever we had access to product on the private brand, we sold that. We also sold the brand. And very often, we had to sell, but whatever was available because of the shortage in the marketplace of product. But the private brand is important to Henry Schein, but it's strategically used where there's price competition. We have a generic equivalent. And then there's, of course, our own brands for these specialty products where our own brands carry weight as brands, not generics.

So there's no chance that we could turn on a television or log on to any news website today without a focus on the COVID-19 vaccine. So is there a potential for Henry Schein to distribute the COVID-19 vaccine at some point? And if so, how would you kind of address some of the very significant cold chain storage requirements for the vaccine that some of the producers of that vaccine are dealing with?

I will give you the headlines, Bob, because this is a very complex area. Essentially, for the initial bout of vaccines in the United States, the government has contracted with manufacturers and have contracted with a specific distributor to handle the logistics, not as a distributor, but as a third-party logistics provider so these products can go free of charge to the public. Some of the products are going through that channel and other products are going directly from the manufacturer to the inoculators. It is our goal to ensure that there's adequate supply eventually available to the office-based physician. And actually, in certain states, the states are providing for dentists through the inoculating. So we expect that once this initial bout of government product is used up that vaccines will go through the normal channel. And we are a significant provider of vaccines that are undertaken in the physician's office, all the plethora of normal vaccines, including the flu. And we expect the corona vaccine to, at some point, be distributed in a similar way to the other vaccines. We, of course, work with most of the vaccine manufacturers in the world that are active in the U.S., and we support those vaccine manufacturers, and we're talking to them about the time when we will need to distribute their vaccines when they're available in general through the commercial channel. There will be many forms of vaccines. Only some will be required to be shipped at a very low temperature. We are engaged in those kinds of products today. But generally, we create the sales, we help the customer with the billing and all of that. But they're sold, they're shipped directly from the manufacturer, in general, to the user versus the less -- the normal cold chain where it's not very cold, that is sold and distributed through our distribution channel.

Understood. So one of the things I noticed is that you've recently restarted your M&A activities, and maybe we'll pull Steve in on this. Can you discuss where your focus will be on your acquisition priorities for 2021 and then on an overall philosophical basis, long term?

Sure.

Steven?

Sure. So we look at acquisitions. So you have to be both disciplined but also opportunistic. And the reason why I say opportunistic is that if we just focus on one particular thing in a year or in a short period of time and none of those opportunities arise, then you potentially could be doing nothing. So we use a broader review. And we have in the following buckets our strategic areas that we look to do acquisitions in, and this is not an order of priority. But first is traditional fold-in or tuck-in acquisitions. So where we have a business presence, we would look to buy smaller competitors, fold that business into our existing infrastructure and integrate it completely into Henry Schein. Second is geographic expansion. Typically, when we enter new markets, it's much easier for us to buy a small or large company in that market rather than us starting up de novo. If you start a de novo, well run operating losses for 2 or 3 years, and there's no need to do that when there are many opportunities to enter a market through acquisition. Third area is to enhance some of our specific growth areas. Dental specialties and technology are 2 of the important areas we want to get bigger in, and so we would look to do acquisitions to expand out our dental specialties businesses as well as our technology practice management and services businesses. So all of those are -- those are really the 4 categories that we would look to focus on acquisitions. The good news is there's still plenty of candidates available, so we have an active pipeline. And while there's no guarantees on when or if we can continue to do acquisitions, I think our track record speaks for itself that we've been able to do acquisitions every year since being a public company.

Even during COVID?

Even during COVID, yes. COVID makes it a little bit trickier because you have to X out some of the unique COVID activity. Some of it is companies underperformed, but some of it is some companies have overperformed because of PPE, and that's a onetime item, and we're looking to make sure that we're not paying a multiple on a onetime item.

Understood. So let's stay with Steve and talk about how you're spending the money that you make at Henry Schein. Have you considered issuing a dividend, Steve, in addition to the share repurchase that -- programs that you engage in every year?

Yes, I would say that once every year or so, we have typically discussed capital allocation at our Board meeting, and dividend does come up from time to time. Now until we're fully out of COVID, I don't think starting a dividend today makes sense because it's really a permanent decision, and we have to make sure that we don't see any spike in COVID that impacts our business to any significant extent. But we look at our capital allocation. Right now, we feel good about the stock buyback, but I would say that it's something that we'll continue to look at longer-term dividends going forward but not in the short term until we're fully out of COVID.

Yes. I think you're absolutely right because you do bring in a brand-new set of shareholders when you bring a dividend and some of the yield shareholders, and then you need to make sure that you can maintain or grow that dividend over some period of time, and so it is thoughtful the way that you're approaching it on a capital allocation basis. But obviously, investors, especially those listening to us now, wanted to hear, I'm sure, your philosophy on share repurchase versus dividend. So...

We'll also have to see what tax law changes are being made. Right now, with current tax law, share repurchases are more tax-efficient, but there's been thought that maybe capital gains would become ordinary income. And tax at the ordinary income rate, at least in the U.S., I don't know if that's going to happen in that, but it's something that is being discussed.

So that, I guess, would be a great topic for us to start off with, and we'll start with you next year at the 44th -- 45th, by that time, European Investor Conference that we host with you. We are so delighted that the Chairman and Chief Executive Officer of Henry Schein, Stanley Bergman; and the Chief Financial Officer, Steve Paladino, have joined us today. Thank you for spending half an hour with potential -- with current and hopefully potential shareholders in your stock. Thanks for sharing us an update on what's happening at Henry Schein, and we hope that the rest of your conference is tremendously successful. Thanks, everyone.

Thanks, Bob.

Thank you, Bob.