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

Good morning, and thank you all for joining us today as we kick off day 3 of the JPMorgan Healthcare Conference. My name is Michael Minchak, and I'm a member of the Healthcare Services Equity Research team here at JPMorgan. With us for this next session is the management team from Henry Schein. The company is one of the leading providers of products and services to office-based practitioners in the dental and medical markets on a global basis. So it's my pleasure to introduce CEO, Stanley Bergman; and CFO, Steve Paladino. Thank you both for joining us today. We're going to be doing a fireside chat format today. But before we do that, I'm going to hand it over to Steve, who's going to give us the forward-looking statement, and then Stan will make some introductory comments, and then we'll get into Q&A. [Operator Instructions] So with that, I will turn it over to Steve.

Okay. Thank you very much, Mike, and good morning to everyone. 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 SEC filings as well as on its website. So with that, I'll turn it over to Stan for some brief introductory remarks.

Thank you, Steve. And thank you, Mike, for hosting us. Good morning, everyone. Henry Schein, I believe that most participants on this call know, is the largest provider of products and related services to office-based health care practitioners, that's dentists, physicians, labs and related practitioners. We operate on a global basis, primarily sales come out of the developed world, but we also have a developing world business. Our business is focused on the dental side, consumable products, equipment products related to the practice of dentistry, complete array of pharmaceutical products and then a wide variety of value-added services, including Henry Schein, the largest provider of practice management, electronic medical record, demand generation software, also with a global footprint in many countries, and then, of course, a complete offering of specialty products: implants, bone regeneration products, endodontic products and orthodontic products. On the medical side, practically everything that's needed to manage an office-based practice, including much of what's needed in an ambulatory surgical center. We provide both the products, the consumables, the equipment, the pharmaceuticals. And our offering is based on the notion of helping practitioners operate a more efficient practice so the practitioner can focus on providing quality clinical care. That's what we've been doing for almost 90 years. We stick within that domain, that area of focus. There is so much opportunity to expand geographically to increase our market share, but also to add new products and services to our platform. We have what we call a hybrid model. Of course, we have data. We reach out to customers digitally, and of course, through paper, through the telephone. But we have what we call field sales consultants who work with practitioners on practice management, and then in that context, bringing all of our various specialty providers, whether it's equipment or financial services or practice management, software and work on what we call One Schein, providing the one-stop shop of the full variety of products and value-added services to help the practitioner in operating the efficient practice so that they can provide clinical care. You will see that our business is really focused on 3 major-sized customers with demographics. These smaller practices used to be solo, but those are very few and far between, but smaller practices, 3, 4, 5, 6, 7, 10 practitioners operating together. And then there's the midsized practices, which generally are owned by individuals, managed by a group of practitioners. And then the very large is what we call DSOs that are managed very often by professional managers, not necessarily clinicians, who operate the business in a very similar way to any large enterprise and are very often financed by private equity. We've been asked how the dental market is going. And we're very much -- I would answer that question very much in a consistent way to the way we provided information in our last call. And by the way, Mike, I assume you know and I think you noticed, we're in our quiet period now for the fourth quarter, so we can't get into anything specific as much as we'd love to. But essentially, the dental market for a while has been operating in the range of 75% to 80% of previous patient visits. Obviously, as one would expect, towards the end of the year, that number probably was a little higher. And this data is also available from American Dental Association and other sources. But the volume of dental services is quite a bit higher than that. In particular, specialty product services are doing a little bit better. And it's very much geographic-dependent. If you look at our businesses in Asia, Australia, New Zealand, it's pretty much back to normal. If you go to Europe, parts of Europe are close to normal. Specialties are maybe above normal. And in the U.S. and Canada, it varies according to regions. So essentially, we're cautiously optimistic about where dentistry is going. We're certainly optimistic in the medium to long run. There's a direct correlation. Many -- much data has been published on that, showing the direct correlation between good oral care and good health care. This is being understood to a greater extent than ever before. And this bodes well for dentistry. Our medical business, of course, continues to grow as well. A lot of the business growth in both businesses has come from PPE, but I would say not exclusively. And so with that, Mike, ready to answer any specific questions you may have.

Okay. Thanks for the introductory comments. I appreciate it. Maybe just to start off with just looking at the end market demand in the U.S. Dental business on sort of a more normalized basis, if we kind of look through the impacts of COVID. In the past, you talked about the underlying market being in the sort of flat to slightly up range. If we do look through COVID, PPE, do you think we're still sort of in that general range? And do you think that we should see a reacceleration of growth in that part of the business? And are there sort of any catalysts that you can point to?

Yes, Mike. I think as the vaccine kicks in around the world, and it's moving at different paces in different regions of the world. And in the U.S., of course, it's very much state and region-dependent. But as that sinks in, and hopefully, in the -- at the end of the first quarter, a lot of -- the first 6 months, a lot of people will be vaccinated, I think we will get closer to where we were in 2019. I do think one thing. Dentists are really appreciated. One of the first places people went back to when they were allowed to leave their houses or the apartments was the dentist. I'm not going to say that the hygienist is anywhere near where they were. But the dentist is appreciated, and in many respects, is a frontline health care worker because they are preventing people from going into hospitals, and if possible, one should avoid hospitals. So I think there's a great appreciation of the role of the dentist. I don't think we're going to go back to a shutdown of dentists. I think public health officials around the world have understood that's not a good idea. So I think there is confidence in going to the dentist. Dentists have had -- the public has had their confidence in dentists for a long time, going back to the mid-80s when it was alleged for the first time that a dentist contracted AIDS from a patient. So I think infection control is appreciated as it relates to the dentist. So I think we're going to go through this rough patch now until people are inoculated. But I think we will return sometime this year to, as you refer to it, normalcy. And I'm quite optimistic about the dentistry in the long run.

Great. On the third quarter, you talked about seeing increased acuity when the dental offices reopened due to pent-up demand and people had put off going to the dentist. Has that increased acuity worked its way through at this point? And sort of have we normalized with respect to the mix between acute procedures and hygiene visits?

Well, firstly, the hygiene business hasn't come back yet. I would say that it's not -- when you say acuity, I would say that the specialty parts of the business and basic restorative is not back to where it was. And I still think there is quite a bit of pent-up demand from the public. Dentists could not [ necessarily see in ] parts of the country all the volume [ and part of the world ], all the volume they would have wanted to because it's a little bit slower now to actually get patients through the practice. Although I might add, efficiency has picked up. There's more comfort now with the availability of air management type systems. So productivity is going up. But there's still quite a bit, I think. There's no hard data but my sense is there's still quite a bit of demand, pent-up demand, sitting there.

Great. You had mentioned PPE earlier. As it relates to that, can you talk about what you're seeing in terms of availability of supply? Do you have enough supply to fill existing customers' orders in full? And then I guess, if you maybe could talk a little bit about the pricing environment. Price has increased significantly in the early part of the pandemic. Have they returned to prepandemic levels? And I guess within that, could you also maybe address the shortage in exam gloves separately from things like face masks, shields, gowns?

That's three questions. I don't go more than 3. So the first is the general -- I'm only kidding, Mike. The availability of PPE, I would say, generally, there's adequate availability. The big run on masks that we saw in March and April, I think, is behind us. We had some extra challenges at Henry Schein because we were asked by FEMA to make product available to hotspots, particularly hospitals. And we, to a large extent, emptied our warehouses in the United States. I thought it was the right thing to do from a public health policy and responsibility point of view. And then we were able to build up some inventory. But generally, I would say the availability of PPE is there. Actually, we have pretty good availability on most of the PPE. We were building up our inventory, of course. It's the right thing to do. And maybe not every brand is available in the way the customers would want that every day, but there's plenty good alternatives that substitute. So no issue. I'm going to deal with your third point next. There are 2 exceptions. One is gloves and the other one is wipes. So let me deal with the last one first. I'm not referring to the wipes that you get in the supermarket, there's no problem there. I'm talking about essentially medical-approved, 510(k)-approved in the U.S. wipes. There's a shortage. We have more or less enough to give all of our customers something. We do not have the ability to give new customers much or at all. And we prioritize on our existing customers. Now the same with gloves, with surgical gloves. There are various kinds of surgical gloves. Some are more available than others. Not every brand is available in the quantity people would want. And generally, for our existing customers, we have, more or less, enough product. If somebody got 100 units last year, we probably can give them 110, 120 units this time around. But if people want to build up the inventory or buy significant quantities and somebody has not been buying from us in the past, it's hard to satisfy the demand. That is the case today. It could change, of course. There have been some challenges in some of the countries with quality, with allegations of inappropriate social standards being administered in some of these countries and these places. But generally, I would say, it's okay. It's not terrible. And the third is as it relates to price. So price has gone up for 2 reasons. One is the underlying cost of the raw materials has gone up, and labor in parts of the world is a challenge because of COVID. I don't expect these underlying issues to change much. I think we will have a permanent increase in the underlying cost of most of PPE. Now having said that, we made the decision to prioritize availability of PPE over anything else, over any financial considerations for our customers. So we went into the market to buy product. Of course, the big overriding concern was regulatory compliance and quality of product. These were big issues and remain a big issue. There's plenty of product floating around that's not regulatory-approved or quality is a challenge. But that was a big issue for us. So we went into the market and bought stuff to ensure that we had availability for our customers. I think we delivered on that mission. But of course, it did cost us. We paid more than the market price for some of these products or we paid the spot price for it. But I think we did the right thing for our customers. Maybe a couple of quarters of challenge. But after that, I think our customers will appreciate what we've done. And we're not passing on these costs necessarily to our customers.

One of the headwinds that you had discussed more recently is related to performance-based supplier rebates. As those targets were set prior to the onset of the pandemic, you didn't earn those in 2020. Is there any way to sort of quantify the magnitude of that impact? And then how should we think about 2021? Do those targets get renegotiated annually? And sort of would they take into account what's going on in the current environment? Or do they generally just sort of remain consistent with historical levels?

Right, Mike. Steve is much closer to this than I am, and he can give you specifics.

Yes. Mike, we haven't disclosed the specific dollar amount of supplier rebates. But I can say that, with respect to 2021, they are negotiated annually. So we do believe that a lot of the lost supply rebates for 2020 will come back in 2021. It will be a tailwind. Although it's still difficult determining targets in this uncertain time for 2021, we do believe it will be a nice tailwind for us going forward.

Okay. Great. Maybe just to ask about the recent shift in the Heartland contract. Just was wondering if you could comment at all on that. And then, I guess sort of related, any change that you're seeing in sort of the level -- the overall level of competitive intensity within the industry?

So Mike, first of all, we do not comment. We made that decision 3 years or so ago, maybe 4 years ago, on any specific contract because you win a contract then you file; when you lose a contract, you file. But I will add that generally, we, I think, do quite well on the overall relationship with customers based on value. In other words, the equation of price versus the broad array of products and services that we offer. So I think very often customers leave, and they come back and they ask, is there an opportunity to work together on some basis that fits in with the needs of both sides? So I would say that the market is, of course, intense from a competitive point of view. It's been that way for the 40 years I've been in the industry. I don't recall a year when there wasn't intense fighting on large customers, small customers. It is a very, very competitive market. But I think the value-added service offering for all 3 layers of customers: the large, the midsize, the small. And I might add for institutional and government, it's pretty good, and we're confident in our proposition and we're confident in continuing to grow our market share. Now much has been written about this. And all I can say is we've consistently grown our business as a public company now that's for our 26th year.

Okay. Great. Maybe just moving on to the dental equipment business. There's been a lot of discussion regarding the ongoing digitization of the dental office. Can you first talk about where we are in the innovation cycle? And as you look in -- at your backlog and the pipeline, are you seeing COVID and uncertainty around the economy driving any change in dentists' demand for equipment?

Well, first of all, again, we're in our quiet period now. But we did talk about this quite intensively on our last investor call. And we mentioned a couple of things. First, that visualization in dentistry is gaining a snowball effect. And practices understand that in order to provide optimal dental care, you need to have digital prosthetic capabilities and digital imaging, all of this connected in an interoperable way to practice management software and electronic medical records. So that is, I think, being accepted generally in most of the Western world, most of the developed world and even in the developing world. So we've got an extra boost, I think, during COVID, and now with the demand for same-day dentistry going up. I myself recently went to the dentist. I had a chipped crown, and it got replaced, and I was offered the opportunity to stay at the office for a couple more hours or come back. And I made the decision to cancel my appointments thereafter just to stay and get it done. I think -- and it was the right decision. Great crown and I got in and out quickly and didn't have any exposure in the street to whatever. I don't think that bothered me in particular because I do wear a mask. But bottom line is there is a greater demand for digital dentistry. There are many products available. I think we have a very good offering, and we've grown our market share in that area intensely over the last few years. But generally, that's an area where dentists are investing. I will also say that dentists are investing in some of the traditional products. They want their practice to look good. They want to give the impression, and rightly so, that they have good quality product. Perhaps some of the imaging areas, the demand is good for units, but pricing has come down. I can't tell you whether it's favorable or not, I just -- we just don't have that kind of data yet. But I will say also that in aspects of the equipment market, a manufacturer exited, and there is a bit of a capacity-constrained situation right now. I expect this to be resolved in the months ahead. But right now, there is an issue with capacity in certain parts of the market. But I will add also that if a customer really needs something, we'll get it for them.

Let me just drill down a little bit further into the equipment opportunity. Can you talk about CAD/CAM, which I think is your largest -- one of your largest categories? As we think about sort of full CAD/CAM and digital impressioning, what's the current penetration? And where do you think they can ultimately go? And over what time frame?

Yes. On CAD/CAM, I can't give you specific data. I mean there's so much information available. But if we said that 40% of the dentists have some kind of DI, 50%, that may be high. And so there's opportunity there. But I think dentists are also understanding that it's not good enough necessarily to have one unit in the practice, you should have one in each operatory, maybe you should have a backup. And the state of technology improvement in this area continues to warrant replacement. So I think the DI area, and again, we have a pretty good selection, carry a good offering value. There's features versus price. That option is -- those options are readily available with us. And the big thing is we have good capabilities of advising the practitioner on what's best for the practice, and then installing and teaching and all of that kind of stuff, training so and then connectivity to Henry Schein One. I think all of that bodes well for the market and for us. The chairside full mill capabilities, I think we continue to gain momentum. The labs are rapidly transforming themselves. That's also a big area to focus on. Lots of upside to us from the various digital machineries in the lab. And then the big thing for us is the connectivity between the dentist practice management, electronic medical record system and the lab. We have DDX, which is the leading channel for that. And there's a lot that's happening in that world, including connectivity to align us. So I think the whole digital area will continue to be an exciting space. And many, many component parts that are warranting following, but I've given you a general overview that it's quite a dynamic collage of opportunities for the commercial side, but also for the dentists in providing more efficient and clinically better dentistry.

Great.

I would add just a quick item that, if you think about the new protocols that dental practices had to put in place for COVID, that made their efficiency to see the same amount of patients in the same time period not realistic. So dentists are looking for things to improve efficiency. And CAD/CAM and other digital products are really, I think, more important now than pre-COVID because, as they look to improve their efficiency, those are really good areas to be able to achieve that efficiency gains.

Great. Maybe just a focus on dental specialties and the opportunity there. You talked about it -- that category as an important driver going forward. Can you remind us how big the category is relative to your overall Dental business? How fast it's growing? And maybe talk about the margins on those types of products.

Yes. Steven will give you the specifics on what we actually talk about. But I would say that the margins here are much greater than the margins in our core business. And so $1 of specialty sales is, of course, worth a lot more than $1 of regular consumable on the equipment side. But Steven can provide you with context on relativity to the rest of our business.

Yes. On an annual run rate basis, the dental specialty business runs about $700 million, plus or minus, depending on foreign exchange of our business. So it's -- does have some nice scale to it. Last quarter, we noted that the growth rate -- the organic growth rate for that business was -- I think it was 6.5%, has been running mid to high single-digits in recent history. So it is growing faster than the core general dentistry business. And given our market share is lower there than the core general dentistry business, there is opportunity for faster growth organically and through acquisitions. And the last thing, I'll just reiterate what Stanley said, the margins are obviously significantly higher on these businesses. Even though we haven't quoted the margin, if you look at some comparables out there, in the implant space, in the orthodontic space, we're reasonably comparable to what their margins are.

Understood. I was wondering if we could shift to your software and technology offerings under Henry Schein One. Can you talk a little bit more about some of the new products that are driving growth there? And highlight any opportunities around the rollout of new products and whether the business has been impacted at all by COVID-19.

Yes. Mike, there's a lot that has happened there. Of course, like with every part of commerce, digitalization, and therefore, practice management, software, electronic medical record, various communications practices and their patients, has all escalated as they say, 5 years of progress in a few months on the digital side. I think that's very much applicable here. There's a lot that's happened. But I would say, if we had to pick one area that is important, and that is, we believe we have the leading cloud-based native system in dentistry. There are many systems that are in the cloud that are really taking a traditional system using one of the traditional platforms and just simply putting them in the cloud. That's not what we have. We have a unique cloud-based system with terrific interoperability to, for example, digital imaging and CAD/CAM. So that's an area that has grown in demand. I believe that it's clear, the value of that is clearly understood by small practitioners, midsize and growingly by DSOs. It is expensive to move a DSO, for example, to the cloud, but I think the DSOs are understanding the value of doing that. And I think they appreciate the experience we have with our cloud-based system. None of these systems are perfect yet. They're moving along and adding features. But I think credit is given to the fact that Henry Schein's cloud-based system has been around for 7 or 8 years, 6, 7 years, and it's a pretty stable product. But there's a huge amount going on, including online booking, patient booking. There's another feature that has been well received, it's the system to stagger patients actually coming into the office and aligning when the patient should actually physically walk into the office when the operatory is ready. So that, together with all the features we have which enable the practitioner to stay in contact with the patient digitally, have all been well received. In terms of new units, I think it's -- I think I'm not sure we mentioned in the last call, but it's not material in the context of the entire Henry Schein. I think it's pretty strong. Where it's slightly down is on the transactions because we do a lot of business in terms of claims processing. And if there are less claims, there are less transactions. But we also know that the average claim, we mentioned this in the last call, did go up compared to the previous year. So there are a few more -- few less claims, not in dollars, but claims than there were. But this is really not material in the scheme of things to the whole of Henry Schein. Our value-added services also includes our financial services, and that's been pretty good in terms of financing of equipment, credit card processing, patient financing. And generally, I think we've played an important role in helping dentists and physicians deal with the government PPP availability, and I think we've been helpful. Some of that is profitable. Some of it is just the free service. And then we're also in the business of practice transitions, and that has been, I would say, consistent. There's many questions about whether practitioners are retiring. I don't see a massive movement of that. There is a decent flow of practices on the market, and they are selling pretty quickly.

Great. I just wanted to shift gears. One of the questions that we've been getting a lot around the sort of our broader coverage universe is around the opportunity around vaccines. Henry Schein is already a key distributor of flu vaccine to the physician's office. Can you just talk about the opportunity around COVID-19 vaccine as we think about, going forward, obviously, it's sort of with a centralized distributor initially. But do you see an opportunity over time? And are you having conversations with manufacturers or the government around that opportunity?

Right. So we're at the early stages, Mike, of the COVID vaccine distribution. Limited availability and what we have been told is that, first of all, that the vaccine will be made available free of charge in the United States. I expect that will be for a period of time, maybe permanently, I don't know. We don't know, will it be put in the class of, for example, renal services, where Medicare covers renal services for everyone. I don't know. But what we do know is that the current system is based on states getting allocations. There is a distributor that is doing the third-party logistics, not the distribution in the distribution sense. And there are other logistics companies providing services on the actual logistics. What we don't know is if we're going to move towards a more national plan versus a regional plan with the new administration. But what we do know is that we work with most of, if not all, of the vaccine manufacturers. We do know that about 60%, just a little higher than that, of all vaccines in the United States take place in the office space setting. We are a leader in that space. So I would imagine that at some point, we'll be called upon to play a role. I don't think as a regular commercial distributor because that may not be the model that will be used, but in some form of connectivity between manufacturers and office-based practitioners, it is likely that our support will be called upon at that time. We do have very good business activities going on and this scale has happened for decades with government agencies around the world, particularly in the U.S., with all sorts of services that we provide, including, by the way, Henry Schein's One system is now being used by the military and will be installed in the VA as well. So there's a lot of good activity going on. And I'm sure we'll be asked to play a role. Exactly what role, I can't tell you. But this market will at some point for vaccines normalize from a logistics point of view.

Got it. Just going to take a question that came in from the website. You said you think patient volumes would be back to pre-COVID levels in the second half of '21. Is that still the case? And if so, given the incremental benefit that you're getting from COVID on PPE and testing, should we conclude that 2021 EPS would be at least at 2019 levels, if not significantly above? Or are there other factors that we should think that would sort of offset some of those tailwinds?

Yes. My level of return to normal is as much a guess as anyone else's. We're in a -- we cautioned the last few investor calls, there's -- the business is stable, but we don't know what the impact would be of the W. We're now, some would argue, into the third part of the W. So W and a new V or 3 Vs. We can't tell you for sure that things will return to normal in the second half. That's a guess. But at some point, they will return to normal. So we're not providing guidance, and Steven can address that specifically. But I would say that on PPE, although price variations will continue to occur, that will stabilize, the degree of ups and downs will go into a narrower range. I think there will be a permanent need for more PPE versus 2019. We've been a leader in the PPE world for dentists and physicians since the mid-80s. We played a key role in helping set up the guidelines in the AIDS period, in the early AIDS period, shall we say. And we play a key role in that area today. So I would imagine that, that will continue. Can't tell you the total volumes, no one knows. But there is a heightened demand for these products. Of course, price will vary, and so -- but units is what I'm talking about. And we have a leading position in the office-based point-of-care testing, not only for COVID, but in general. I think there's a movement, a strong movement to point-of-care testing in general. We have done well in this area, and we expect to continue to do well. And I can't tell you when and if there's going to be a reduction in demand for COVID testing, but I think it's going to be around for a while. The price may come down, will come down for sure, as these tests become more efficient. So the price will come down. But at the moment, we are significantly volume-constrained. There is -- in the U.S., the government has through its DPAs taken up a large part of the production, which is therefore not going to our customers who would like it. Hopefully, that's going to get resolved. But we are at the moment constrained. But Steven can give you information on what we have discussed relative to PPE, tests, and in general, guidance for the future.

Yes. So I'll tackle guidance first. We're not giving guidance now at this time. So to give specifics on 2021 probably is inappropriate or isn't appropriate. But I can tell you, Mike, that our goal is to get back to giving guidance as soon as we can. We feel it's very difficult for buy and sell-side people to estimate going forward given this environment of uncertainty. And that's supported by when you look at the consensus estimates and the range of consensus estimates out there, the range is very wide for both Q4 as well as 2021. So we think it's to everyone's advantage to go back to giving guidance, but we can't do so until we feel comfortable with the ability to do that. What was this -- the second part of it was on PPE. We did say that PPE represented somewhere in Q3 around $400 million of revenue for us, that excluding PPE sales. And the definition for us is PPE and what we call COVID-related products, which primarily includes test kits in the medical group and heat thermometers that people are using these days. So that totaled around $400 million. Test kits by itself for Q3 was $100 million, so a meaningful number. We did say at that time with Q3 earnings that test kits were on pace in Q4 to exceed that $100 million number. And we haven't provided an update to that, but that was what we said back then, and it was subject to availability of supply. The only other thing I'd mention on PPE is that, while units will probably stay at these elevated levels, I think pricing may come down a little bit from what we purchased for that, what we, in turn, resell it at. So sales dollars may not be as significant as units, but it'll still be very meaningful. And we believe that PPE, for the most part, is here to stay and is now really standard of care that will continue at elevated levels.

Greatly appreciate that. So with that, it looks like we've come to the end of our time. I wanted to thank Stan and Steve for participating and the great insights that they provided today. And then to wish everyone good luck with the rest of their conference this week. So have a good day, everybody. Thank you.

Thank you, Mike. Appreciate it.

Thanks, Mike.