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

All right. Good afternoon, everyone. Thanks for joining us. Welcome to the Jefferies 2021 Virtual Global Healthcare Conference. I'm Brandon Couillard. I cover the dental space here at the firm. It is my great pleasure to have Henry Schein with us at the conference again this year. Joining us from the company, 2 gentlemen who need no introduction, but Chairman and CEO, Stanley Bergman; as well as CFO, Steven Paladino. For those of you in the audience, I believe there is an option. If you have a question, please submit it, feel free to submit it in the online portal. We'll do our best to work it into the conversation. And I'll turn it over to Steven to make some opening disclosures and a word from Stanley, then we'll jump into Q&A. Steven?

Okay. Thank you, Brandon. I'd just like to note that certain comments made during this call may include information that is forward-looking as you know, risks, uncertainties involved in the company's business 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 video over to Stanley, who will make some brief opening remarks.

Thank you, Steven. Brandon, thank you for hosting us. I will be very, very brief so that we can allow as much time as possible for Q&A. Henry Schein, of course, is the largest provider of products and services to office-based practitioners. We have a dental business that's relatively global. We sell consumables, equipment, pharmaceuticals, any product essentially that a practitioner may want on the dental side for the office-based practitioner. In addition to our products, we also have a range of value-added services, including our joint venture, Henry Schein One, which is the largest provider of practice management software and related services. We also have a business that is quite active in these specialty areas, endodontic, orthodontics and implant dentistry. In the U.S., the business is coming back closer to 2019 visits. During our investor call, we did refer to the 87% that is being reported by the American Dental Association in the U.S., but there's also a lot of data showing right now public information that the number is closer to the 100% of 2019 numbers and essentially, there's no hard numbers, but it's getting pretty close to that on the dental side. On the medical side, it's getting closer on visits in general. However, it's still somewhat of a backlog or people haven't necessarily gone in for all of their vaccines. There's still a bit of a slowdown on that. Not much, an ambulatory surgical center for elective surgery is still not back to where it was, although it's much better than it was in the first quarter. Our business internationally also rebounded quite nicely. Couple of strong countries like France, Netherlands, Belgium, Italy, a little bit less in Germany. The U.K. was a bit of a challenge, but it's opened up in a significant way. Since our investor call, we did announce the award of the strategic national stockpile contract for PP&E. And we've also announced an acquisition in the technology space. So essentially, the business is, as was in our investor call, we're optimistic about the future. We believe that our strategies are the right strategies to continue to grow the business, drive up sales, operating income and EPS and turn our EPS into cash. We have a strong balance sheet to make -- continue to make acquisitions. We opened up the spigot for acquisitions in the fourth quarter of last year, made a few already. Expect to continue to do that, although -- and the pipeline is quite strong, although can't confirm an acquisition until it's signed. And we started buying back stock. We use our cash for 3 purposes. One is to invest in the business. We do generate a lot of cash. And the second is to make acquisitions to add to our platform. And the third, of course, is to buy back stock. So with that in mind, Brandon, fire away.

I appreciate those introductory remarks. Just to clarify, Stanley. So if we look at the U.S. dental market, right, ADA data might suggest we're maybe 10% off of the sort of previous highs. Is it your view that maybe we're a little bit closer actually to 100% in the U.S.? And then can you put some numbers around sort of where that is as far as Europe goes?

Yes, Brandon, it's very hard to get a firm number. I think we're closer to the 100% than to the 87% today. I think the more acute stuff continues to be doing quite well. And the preventive work, the hygienist, they're coming back, although the dollar amount per procedure for hygienists was not that great compared to the rest. But we're moving very close to what we were in '19. That's our estimate. And of course, there's no hard data. We do have anecdotal stuff. And of course, we have our claims processing that we look at.

Got you. Okay. I'd like to touch on just the PPE and COVID-related revenues for a minute. First quarter, you did about $460 million sort of combined between dental and medical, including $180 million of rapid COVID test. And I think you've been pretty clear that you expect that, at least as far as PPE, to be here for a while. But just how should we think about your volume and particularly ASP expectations for that group of revenues over the balance of the year?

I'll have Steven be more precise. But on general PP&E, we've said that we expect there to be an increase in units from where it was in '19, but the prices coming down compared to '20, but will be in excess of '19. And I think that's already more or less settled in on everything handling gloves. But our pricing is coming back to closer to '19, it will not go back to '19. But essentially, that's the case. As it relates to the other components of our COVID-related products. We've got PP&E, and then we've got the a rapid test. We are a large provider of office-based practitioners and related work sites of rapid point-of-care test. And I would say that in that area, the number of tests has come down a bit compared to the peak, of course, but the price has come down a lot. And we do anticipate a continuous use at least for the foreseeable future of a rapid point-of-care test, but I think the price will -- as more and more is available, the price will continue to come down, but the quantity will be there. And both PP&E and tests will continue. Steven, I don't know if there's anything else you want to add?

Yes. Maybe the only thing -- I think you covered it really well. The only thing I would add is given that the CDC has come out with new guidelines for the general public saying that if you're vaccinated, you don't need to wear masks, people have been asking, well, how does that impact the PPE. Don't think it really has any impact to our PPE because we're not selling to the retail market. We're selling really to the health care provider. And I think masks and gloves and all of the protocols in the health care arena will stay for quite some time, will probably become standard of care. I know I was recently at my dentist, and he was wearing 2 masks and I asked him about it and he said, look, I'm already vaccinated, but I think precautionarily, why not wear a mask? And he said it also gives patients a lot of comfort. So for patient confidence, I think it will continue. Yes. So the only other thing I'll point out is Abbott has talked about recently, they put an announcement out saying that test kits will be declining going forward. Really not new news for us, something we indicated on the Q1 conference call, we guided to that. So it doesn't really impact what our thinking was on the Q1 conference call because we were contemplating that anyway.

Would that be a good sort of proxy. I mean, I think Abbott basically implied that their 2Q rapid volumes will be down something like 40% in the second quarter sequentially. And that the back half would be down maybe something like 70% compared to the first half. Is that sort of a good benchmark to think about as far as your related revenues in that category?

Yes. I'm not sure it is because we're selling a number of different test kits, and we'll also be selling the new lower price ones where I'm not sure. I'm not that familiar with Abbott's product offering, if they're coming out with newer test kits also. But I think for us, it may not be that dramatic.

All right. Maybe switching gears a little bit, Steven, just on margins. It's been kind of a choppy period over the last sort of 4 quarters for a number of reasons. At least on the gross margin line, it does feel like a number of the dynamics that were at play in the second half of last year may be cleaned up at this point as far as the inventory noise. So just to be clear, you do view the 1Q gross margins is kind of a new sort of stable level. How should we think about operating margins over the balance of the year? And you still feel comfortable with kind of that 20 to 30 basis points of operating margin expansion on an annual basis going forward?

Yes. So just to recap, we did say on the Q1 conference call that we think the Q1 gross margin should remain fairly consistent going forward that the noise that you talked about, the inventory adjustments substantially behind us. Supplier rebates are higher than they were last year, although still not at 100%. On the other hand, operating margin, we didn't give guidance on operating margin, although we did say don't expect 8.4%, which is what we achieved in Q1. And part of the reason is we do expect expenses to grow in the second half of the year. Things like travel will come back we're making investments in the e-commerce platform and the Ascend software that we want to continue to make those investments. We also have some stranded costs. So once the operating margin normalizes out, we still feel that we have margin expansion capabilities. We haven't quoted a new number. Pre-COVID, we were talking about at least 20 basis points per year, but we haven't come with a new number yet. But we do think there's margin opportunity. It will come from continuing to leverage expenses. It will come from shift into higher-margin products and services. And it will also -- as we get more sales growth, obviously, that will be positive for the margin. I would point out that Q1 was also benefit from the margin because when you have -- when we have very strong equipment sales, it's important to note that the equipment business has a higher-than-average fixed cost component. And I'll name 2 of the key fixed costs that really don't change even with higher sales volume. One is our footprint for equipment centers throughout the country and throughout the world. That stays static whether we have higher or lower sales, and separately, service technicians in a range stays relatively static. And because we had such strong equipment revenues, that also helped our margin in Q1.

Got you. Maybe sticking with dental equipment. Clearly, that was a bright spot in the first quarter. And revenues already back above pre pandemic levels. Can you just talk about appetite for equipment spending, where you're seeing the bolus of demand, be it a high-tech or basic? And degree to which this is more replacement or new capacity builds?

I would say it's a bit of both on -- there's obviously a nice demand for digital prosthetic equipment, that's the scanners, the chair side, same-day surgery type equipment that's in demand around the world. And the traditional equipment is still in demand. There's been some price pressure on imaging, the traditional imaging. I'm not sure if it's settled yet, but there has been some price pressure there over the last year or 2. But generally, as we indicated in our call -- our last call, the backlog was quite decent at the end of April. Although there is -- a manufacturer did leave the industry for chairs, units, lights. So the industry is struggling to keep up with the demand. Not only was capacity taken up, but the demand is pretty strong. But other than that, we are really where we've been for a while, strong demand for equipment. There was anomaly in the fourth quarter related to tax planning primarily and also a manufacturer that had a real problem getting enough equipment out to us, 2 manufacturers actually. So it's the same tone, more or less, as we had in the last call, although the percentages, obviously, as we pointed out, can't be the same growth rate as we had in the first quarter.

Steven, if we at least look at just the North American dental equipment business, the first quarter is typically the lowest volume quarter of the year for dental equipment. Do you expect to see the same seasonal pattern as we look out 2Q, 3Q this year? Or is there some reason that may not necessarily play out the same way as it has historically?

Yes. I think there'll be a little bit of difference this year in the seasonality. And I'll just remind you that we talked about in Q4 and Q1, the fact that there were 2 issues that delayed equipment sales out of Q4 into Q1. One was a manufacturer stopped selling certain product lines and the other manufacturers in Q4 could not ramp up production quick enough, but that's now behind us and those sales happened in Q1. And the second one, we can't really quantify exactly. We do believe that people -- typically, in Q4, we get higher sales of equipment in part because of Section 179 tax deduction that customers could take advantage of. And I think a number of customers because, a, they didn't have high taxable income in 2020 because of COVID; and b, because everyone was expecting or is expecting tax rates to go up in 2021. I think people may have delayed some equipment purchasing to try to take advantage of a more favorable tax deduction on a higher tax rate. So Q1 is a little bit inflated because of that. And therefore, that affects the seasonality a little bit for 2021.