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

Good morning, everyone, and thanks again for joining us for this session of the BofA Healthcare Virtual Healthcare Conference. I am Michael Cherny, the Healthcare Tech and Distribution Analyst. Very pleased with me today to have Henry Schein's senior management team. We have Stan Bergman, CEO; Steve Paladino, CFO. We're going to have a bit of a fireside chat, go back and forth on questions. Anyone who wants to submit anything, please do it through the website. But before we kick off, I believe, Steve has some instructive comments as does Stan. So Steve, I'll turn it over to you.

Okay. Thank you very much, Michael, and good morning to everyone. I would just like to note that certain comments made during this call may include information that is forward-looking. As people know, the 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 and/or indicated by such forward-looking statements. These statements are qualified in their entirety by the cautionary statements contained in Henry Schein's filings with the SEC. So with that, I'm going to turn it over to Stan, maybe for some quick opening remarks.

Thank you, Steve. And Matt, thank you for hosting us. I'll be very brief, so we allow most of the time for Q&A. We just came off and reported on our, of course, first quarter 2021 earnings. We had strong sales, about 20% top line. Details on internal growth and FX and acquisition growth are included in our public filings. We had $1.24 in EPS, non-GAAP, it's up 32%. Strong margins, 8.4%, also up about 100 basis points. PP&E was strong, but we're quite comfortable that we will meet, certainly in units, continued demand for PP&E. We did sell about $180 million in COVID-19 tests through our Medical business. We think the test market will continue, specifically rapid tests for COVID and other kinds of rapid point-of-care tests, but the unit price is going to come down. The worldwide PP&E market is quite stable right now. Pricing is down, but units are flowing. We don't really -- we have practically all the products we need. And we remain, as we've said now for many years, quite optimistic about the future of Henry Schein. We have a strong moat around our business. It's a business of consumables and equipment, and pharmaceuticals, specialty products, whole series of value-added services, including a large installed base. Our practice management software and related digital services to the office-based dentists and government, large group practices in dentistry. A very strong presence in the medical world as well. We focus on ultimate kits for up to the care sites, physician practices, renal centers, cancer centers, urgi centers, ambulatory surgical centers. Our Dental and Medical specialty businesses have done well, particular our Dental, orthodontics, endodontics, oral surgery. Our tech -- our value-added services do provide this very strong stickiness. And we've been happiest committed to doing well by doing good. So ESG, this whole movement of ESG is something that we have been subscribing to for decades before it was even called ESG. We have sustainability report, reporting on our metrics. And so with all of that, Mike, happy to answer any questions. Steve and I are here.

Great. Thanks for the intro. And I guess maybe let's level set a bit. When we did this conversation last year, a lot of your customers were closed, and they didn't know when they'd be reopening. Clearly, the world's in a different place. So to call the last year since our last health care conference wild, I think it would be a bit of an understatement. Maybe level set on where you think your clients, your customers are now. Where do you think the demand level is? How have the types of procedures that they're currently doing and demand from customers changed? And where do we sit at this current state?

Yes. So Mike, of course, that's the big question. The ADA publishes data and I'll just point to the ADA. Patients' visits, the visits are 87% of what they were 2019. That is a few weeks old. We have cleansed processing data that more or less substantiates that. We think we're probably a little bit further than 87% right now. Qualitatively, I think the more treat procedures were what was focused on. I think that's continuing. There's quite a lot of strength in the high-end implants, for example, endodontic procedures. But there is a growing return to hygiene, preventative work. I think that's started to come back. So generally, I think -- and I'm referring to, of course, the U.S. and Canada and the developed world of Europe. Australia and New Zealand is actually back to normal, so are big parts of Asia. I would say that results have challenged; having said that, we continue to do very well there because our competitors are struggling. And that generally dentistry is quite strong in Brazil. So generally, patients have returned on the dental side, and we expect that to continue strengthen. On the Medical side, in the first quarter, wellness and prevention was down. People were a little bit behind on getting their vaccines. And elective, every surgical center business was a big challenge. I think in April, that moved along. CEO of CIGNA issued a report today that stated that wellness and prevention visits are back to normal. I cannot confirm that yet, but we'll be able to confirm that, I think, in our next quarter call. But directionally, we're heading in a good place on the Medical side as well.

And along those lines, you mentioned the concept of PP&E demand continuing, which we tend to agree with. What are your customers, both on the dental and Medical side, telling you about how they want to change their workflows, the differences on a long-term basis, unless we get into whatever the "new normal" is, will be in terms of how they use PPE, how they use other infection-prevention solutions inside their practices?

Well, Mike, dentistry was always at the forefront of infection control, of sepsis control going back to the AIDS period, in the '80s. So dentists, from their early education in dental school, are very, very aware of prevention from an infection control point of view. So I think it's in the mindset. Having said that, I think there will be more masks used and gloves. Masks, for example, will be changed more frequently. I think same with gloves. There'll be a lot more cleaning in the practice, wipes used. Very similar to that, the units, therefore, will be strong. The price will not be what it was last quarter and it is starting to moderate. It will not go back to 2019 levels because the cost of certain raw materials has gone up. But there is an abundance of product for most PP&E product, around the world. And so I think prices will come down, per unit will remain low. But the basic unit volume will go up. Some products, such as N95s, I don't think are going to be as important as perhaps we thought 6 or 9 months ago. I think the big item in PP&E from our point of view [indiscernible] is the mask. So I think sort of the L3s regular face masks will be the popular one, but it will be used more frequently.

Got it. And maybe sticking within the offices and especially the dental office, in particular. Your equipment results, I think, were quite strong. I would say, a lot more resilient than maybe an outsider would think about. There's been a lot of innovation across the equipment side, broadly speaking. Where are you seeing the greatest areas of interest and demand, especially in what may still be a somewhat tight CapEx environment for your dental customers in particular?

Yes. I think, first of all, as it relates to the numbers, we did indicate in the call related to the fourth quarter that there was, in our estimation, some movement of product from the fourth quarter to the first quarter. First of all, the dentist practices [indiscernible] Show that didn't happen around the world. Second, for tax reasons, there were certain dynamics making it more interesting for practitioners to get a tax deduction '21 versus '20. And also, there were a couple of -- there was a challenge in the units and lights; manufacturer went out of business. But having said all of that, we also mentioned in our call that we have -- we believe we have a strong backlog of equipment and certainly at the end on April, as we mentioned on our last call. So you're asking specifically about the areas of interest. I think generally, all equipment is of interest. Practitioners want to invest in their practices as their practices look at high tech-ish and that those fields and it is an environment that the cash control is handled in a very good way. But there is a particular interest is what we shall call the high tech, and that relates to the DI, the scanning units and where we have a whole series of different manufacturers we work with. I think they have all done well with us. And I would say the chairside units has also done well in this period. And these are areas that are likely to continue to do well going forward.

And maybe sticking as well on some of the growth dynamics, it feels to me, and maybe this is just a perception thing, but it feels to me that you've started to give more specific color around some of your specialty areas over time, especially as those scale in terms of contribution. So maybe compare and contrast what you're seeing in terms of the health of the specialty provider versus the health of the general practitioner. And how you think about the expansion on some of the various different specialty areas that you service going forward.

Yes, Mike. We have been focused on the specialty area for a while. Our initial focus a decade ago was on the implant side. We have a very good offering of what is referred to in trade as premium implants. We have CAMLOG, which is the leading brand, we believe, in Germany. A couple of -- also has a very good position in a couple of other European markets [indiscernible]. And then we have BioHorizons, which has a very good presence in the U.S. and in Canada, plus a couple of other markets. So we think this premium market and our positioning of premium products at a competitive price has helped us. In addition, we have a very good offering of bone-regeneration products, carrying the emerald, the bone [ mine ] product, these remain in the synthetic. We carry the human tissue products. All have done extremely well over the last few years and we believe will continue to do well. We have a very good endodontic range. And while our business in orthodontics is small, we continue to do well on the traditional orthodontics and our aligner business. It's small, but it's doing quite well, growing off a small base, but growing nicely. Just to point out, we, of course, focus on specialists, but we also provide these products to GPs that are interested in specialty products. That is an area that we're investing and have been investing in R&D. We're not as strong in the developing world where the growth has been and some of our competitors have had much better growth in those areas off a bigger base. But in the developed world, we're doing quite well. We will expand to some of the developing world countries. But we're very optimistic about our specialty business going forward, and the margins, as you know, are quite good.

And just pulling on one thread there on the orthodontic side that you mentioned as well. I remember, I think it was maybe 3 years ago now, I apologize on timing when you launched your first aligner. As you think about what's been a completely explosive growth market, how do you see your private label aligners positioned in the market? What are the biggest selling features that you use to differentiate yourself in order to drive that growth that you mentioned?

Yes. I think we're helping orthodontists and GPs into this market. There are a lot of direct players that threaten this market. Practitioners, I think we're very patient in helping practitioners enter, understand how to get into this business. We have competitive pricing compared to the direct-to-consumer companies. So I think that has all added. We have quite some decent software. We will have even better software as the year goes by. This is CAT software to help display the outcomes to the patient and manage the case load. And I would say we've done pretty well with DSOs, long-standing Henry Schein DSOs, some orthodontics DOSs. And we don't want to jump in and say we're going to get massive market share, maybe one day we will. Our goal is just to continue to grow this business as one of our specialty businesses. And we've been moving along quite nicely.

And turning a bit, you mentioned DSOs and your strength there. And I think at times, there can be a bit of a misnomer about DSOs and that -- the Heartlands and Aspens of the world don't necessarily represent the average DSO. And so when you think about DSOs, can you give us a sense on the differentiation in service levels you have? And in particular, how you think about the compare and contrast of the types of costs you have to put into a DSO and the types of products they buy versus what a smaller practice might look at?

Yes, Mike. We focus on 3 broad categories of dentists. First, these smaller ones, smaller practices. The 1, 2, 3 practices has not entered that for long. It's about small practices of 4, 5 6 practitioners, often specialties. There's the mid-market practices. These are anywhere from 10 to maybe 60 practices. This is a big strength of Henry Schein. We help these practitioners with a lot of practice management advice. Look, each of these categories have a specialty sales force or a specialty sales force that focuses on medium-sized practices. And then there's the very large DSOs. Each of these different categories of customers have different needs. For example, with the large DSOs, they have formularies with sophisticated software needs, formulary management. A lot of the services that we offer at our medical world have been transferred to the dental world over the last couple of decades, as said, the formulary management. And they all have different price structures. And when you look at the very large DSOs, of course, we do not have additional salespeople calling on these offices, much lower costs. There's an extremely efficient ordering system. It's all done digitally. There's no marketing involved in these accounts. So the structure, the profit structure for all 3 of these different categories is somewhat different and the needs are different. But basically, we're satisfying the customers' consumables, the equipment, pharmaceutical, service -- various equipment sales and service, practice management software and other kinds of services. All of this goes into 1 package and each of these 3 groups, as I said, has different needs. And I think we're pretty good at satisfying these needs. Periodically, we lose a customer, but very often, they'd come back.

And thinking on the margin line, I guess maybe this ties back a bit to what we've seen recently on all the COVID dynamics, the -- like a roller coaster dynamic that you've seen on margins last year and some of the inventory adjustments you had, some of the cost cuts you made and the prudent investment approaches. And clearly, you saw a really nice rebound in the first quarter. I guess maybe a question for you, Steve. Where do we sit right now in terms of what should be the traditional natural progression of where Henry Schein's margins on a, I guess, operating basis, but gross margin as well, should sit?

Yes. So I gave a little bit of color on this because we haven't really given specific guidance on margins other than to say 2 things. First, we expect that the Q1 gross margins will be relatively consistent with what we saw in Q1. I don't see any major change to that in the near term. But we did say that the operating margins, don't expect 8.4% as the new norm. We need to see what the new base will be on margins. But we still feel very confident that once we achieve that new base, that there's still a significant opportunity long term to expand operating margins like we have been doing historically. So we haven't given that level of guidance as to how much annually we expect we can do. And we'll probably give more guidance around that once we get through 2021 and into 2022, when we see as more of a normal year. But suffice just to say is, so far, we're seeing very strong operating margins, which certainly know investors have focused on and appreciate.

So maybe to stick with that topic, and again, I don't want to get into something you haven't gone to, but maybe looking back versus what had changed, especially during COVID. Where -- what do you think has fully caught up? And what are the areas we've talked qualitatively that are still coming back on both the upside and downside?

Yes. And just to name a few. So on the market, we hope that the market will continue its progression to closer to 100% of pre-COVID levels. But exactly when that occurs and the slope of that progression, yes, I don't think anyone really can tell. We do expect a couple of headwinds. We do expect on the dental side, more normalization from non-acute procedures to hygiene and other procedures that have a little bit less consumable supplies usage. On the Medical side, we believe that COVID test kits will come down in sales, that volume because of lower prices and probably less units. Similarly, on PPE, we probably -- you're going to see a little bit more decline in pricing as the prices normalizes on PPE. A lot of these things, Mike, they're very difficult to predict with any certainty around timing or the magnitude of it. So that's why we still gave guidance of just a floor and not a traditional range guidance. Hopefully, later this year, we'll go back to traditional guidance to help investors understand what we're thinking. We also expect on the expense side to increase expenses and technology investments. We talked about a couple of conference calls ago that the global e-commerce platform is one big initiative that the investment spend is really starting now through the end of the year and continuing as we go through that project. But there are some other projects we'd like to continue to invest in. We feel that there's good opportunities there to continue to make sure we're positioned, not only for the short term, but for the long term. So again, a lot of moving parts. I'm trying to think if I missed any. I think I covered the major ones that are impacting our business.

Yes. I think you got all of our list. And to your point, I know there was a lot, so it's definitely helpful to come back and level set, especially when so many of them clearly have been out of Schein's control. Maybe you guided back in on the value-add services side. It's an area where sometimes you see a line item and you look at it as a smaller piece of business, but it clearly has a component, not only of incremental profit contribution given the margins, but also clearly strong growth. And just this morning, I saw another press release today looking at integration that you're doing on the data side between medical and dental records. So using that as an example, can you give us a sense now of where are some of the most in-demand areas that your customers, both on the dental and Medical side, are focused on? And especially on the dental side, from a competitive perspective, who else is out there that can be coming from what will close to selling against you with some of these tech platforms?

So Mike, that's a very good question because I think this whole area is significantly overlooked. Dollar of sales of Henry Schein One is worth a lot more than distributing the dollar of, say, cotton balls. It's highly sticky and it's quite profitable. The big areas of interest are, of course, practice management software. But it's electronic medical record and the interoperability with devices, whether it's prosthetic devices, imaging devices, other transactions, medical, software, there correctly, we announced another factor, an important milestone in connecting our systems, in particular our Exan system, which is in most dental schools in the United States and medical software, it's the medical -- electronic medical record. So intraoperability is very important. I believe we have amongst the best. I'm not going to say somebody other than us have a better system on an aspect or one aspect of it or another. I just don't now. But for the entire offering of intraoperability that a practitioner may need, we have pretty good systems and I think the market recognizes that. Of course, the other areas of interest are demand generation. And in that, we have quite an interesting suite of products, but it's also connected to the WebMD platform. Our partner owns WebMD. So that's a way in which people that go to WebMD to look for dental information can be connected to our customer. Of course, in the area of demand generation, we also own a business by the name of DentalPlans. This is a discount dental service with DTC, direct-to-consumer advertisers that generates demand for our customers in terms of dental services. And then -- and there is a lot of activity relating to demand generation. Then, of course, revenue cycle management, bill a dollar and collect as much as possible of what you as a dentist are entitled to receive. That's a whole area of important interest. And of course, the whole education area is very, very important in the Henry Schein One area. In other words, it's all about helping the practitioner operate a more efficient practice so they could provide better clinical care. The software is used by a number of DSOs. The U.S. military uses it. It's going into the VA right now. And of course, there are multiple versions of the software. There's an entry level, a leading entry-level system, Easy Dental. Then there's Dentrix, the leading system based on Windows. And then there is the Sense system, which is a cloud-based system. There's the Enterprise system. And there's the large DSO system and the system of Exan that goes into dental schools. I've just referred to a lot of U.S. brands. We have similar brands in Europe, in the U.K., in particular. We're very strong in a number of places, brands in Europe, in Austria. And in Australia, New Zealand, we are, by far, the strongest also. So we have a very good platform. We have what's needed by practitioners. We're investing significantly in more features, more benefits and, of course, taking this entirely to the web. What I have left out of this, are website opportunities with practitioners, reputation management. And yes, we don't talk about it a lot, but it's positive for the cybersecurity.

And along those lines, you mentioned the geographic strength you have in so many different areas. Are the different platforms leverageable into different markets, i.e., can you take some of that lead generation practice management tools that are ingrained in the U.S. and move them to Australia and move them to Europe? Or do you need different systems and different localized brands?

Yes. Well, we're not going to really affect -- change the brands other than our cloud-based system, Ascend, is a brand that is used around the world. We have platforms that operate in the different products in different countries. But we're moving to a global cloud-based platform noted -- as I noted, by the name of Ascend. So as we move to the cloud, there will be a global platform emerging. I can't do this that quickly. But a lot of the features that are in Ascend are also available in countries around the world that sell cloud and Henry Schein cloud business.

I know we're coming close to the end, but this -- in this quarter, we start to see some of what I would consider the traditional Schein playbook. You announced some M&A. You restarted your repurchase program. In particular, as you come post-COVID and you think about capital deployment, has anything changed about your either quantitative or qualitative hurdles for evaluating how you're spending capital?

I think it's the same footprint we've been using for since we've gone public. Certain amount to manage our working capital as the business grows, although we tend to become more efficient on working capital each year. There's stock repurchase, we use about 1/3 or so of our cash for that, maybe a little higher sometimes, stock with -- the price for us now to buy back. And then in M&A. We do $300 million or so a year, $300 million a year on a consistent basis for acquisitions to add to our platform. And then we, at the same time, periodically make a large [ acquisition ]. The pipeline is full. And bottom line is we can only announce a deal when it's done. But the pipeline, there's still, no guarantees, but it's full.

Got it. Well, I see the flashing 0, so we're out of time. But as always, thank you so much for updating us on the business, and best of luck with the rest of the conference.

Thank you, Mike.

Thank you, everybody.