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

All right. I think we are set. I didn't see the transition, but I'm assuming it happened. So good morning, good afternoon, everyone. Why don't we get started? My name is Jeff Johnson. I'm the senior medical technology at Baird. And our next presentation this morning is from Henry Schein, the largest distributor of health care products and services to office-based practitioners in North America and Europe. With us today from Schein, we're very happy to have Chief Executive Officer, Stanley Bergman; and CFO, Steve Paladino. Stanley, I'll turn it over -- or Steve, I'm sorry, I'll turn it over to you first. I think you have some disclosures you'd like to read. And then Stanley, if there's any opening comments you'd like to make, and then we'll go straight into Q&A. Steve, it's all yours.

Okay. Great. Thank you, Jeff. Before we begin, I just like to state 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 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 filings with the SEC. So with that, I'll turn it over to Stanley for some brief opening remarks.

Thank you, Steve. Jeff, thank you for hosting us. I'll be very, very brief, and then we can really turn it over to Q&A, which I think is probably going to be more interesting. So Henry Schein is the largest provider of products and related services to office-based health care practitioners, that's dentists, physicians that practice outside of the acute care setting in the alternate care space. We provide products and services to a number of other alternate care settings, such as ambulatory surgical centers, community centers, urgi centers, renal centers, cancer centers, et cetera. We provide all the products and services that a practitioner may need from the consumables to the pharmaceuticals to the equipment to a whole series of value-added services that help the practitioner operate a more efficient practice so the practitioner can focus on clinical care. The components of the business are, from a dollars and cents point of view, sales, dental and medical distribution, that's the bulk of the business. But from a profits point of view, a significant amount of the profits not only come from the dental and medical distribution, but also today from practice management software, the specialty products, dental, some medical and specialty products area, orthodontics, endodontics and oral surgery, bone generation and implant products and a number of other specialty products. The goal is to drive internal growth, supplement that with acquisitions, drive up operating margin and so increase operating income. We do -- we use our capital to buy back stock, invest a bit in the business, but the business generates a lot of cash and also to make acquisitions and so increase EPS. We've been public for 26 years and have had relatively consistent growth. With that in mind, Jeff, let's go.

Stanley, I think 2.5 minutes, that could be a new record for your introductory comments. I like it.

Yes. Steven made me rehearse that now for days, Jeff. You won't believe it.

I'm glad you've been preparing. Thank you.

All right. Well, let me start just with some short-term questions, which I know you probably don't like, but I'm going to ask anyway. In the second quarter, when I look at your consumables revenue growth, on a 2-year basis, it was about 5% or so in North America. That was excluding PPE. We have seen some delta concerns growing though. Obviously, over the last couple of months, it's been a little bit of a rough summer, especially in the south and some of the Midwest. Is there any reason to think that the risks have grown over the last few months to where kind of that low to mid-single digit 2-year growth? I know you don't guide revenue. But has anything changed materially? And how we should be thinking about your 2-year growth in the back half of this year?

Yes. Getting into specifics, I would leave that up to Steven. But conceptually, not much has changed. Look, we had a significant change in the second quarter last year when the dental practices and many of the medical practices just closed down. We're not in that kind of environment any longer. Yes, there's a COVID precautionary environment. Dentists, physicians, staff are taking precautions. Patients walking to the practice are taking precautions. But our customers essentially throughout the world are up and running, and there's a demand for dental services as demand for physician and related services.

Steve, anything there?

Yes, I would add a couple of quick things. One, the latest resurgence of COVID with the Delta variant, we really haven't seen that impact patient traffic at this time. So we can't obviously predict if that will change. But I think it's unlikely to change because patients seem to be comfortable going to their dentists and doctor. And the protocols that the practitioner are using work and make it to be able to track dentistry or medicine safely. But the thing I would say that did change with the Delta variant is in our medical business, where we've seen a resurgence of COVID test kits was slowing down in Q2 and Q1 for us. We reported those numbers. I think it was $180 million of COVID test kits in Q1 and $75 million in Q2. And we said at the end, as we were entering the third quarter on the second quarter conference call that we saw a resurgence, and that's continuing. So given what's going on with a lot of employers and the government, which is either mandating the vaccine or requiring people to be tested, that could stay at these levels for some time now, but it's very difficult to predict more than the short term on what's happening with that.

And I'm not going to let you distract me from the dental questions I want to ask with those medical comments. So -- but I do want to follow up with a couple of questions on the medical side here, and then we'll go back to dental. Then just since you brought it up on the COVID testing, you also mentioned in the last day or 2 at another conference, Stanley, I think it was your comment that you think the government may want to get out of COVID vaccine distribution soon. Is there something pending? Is there something looming? Have you had discussions on that front? And Steve, just remind us on the COVID testing and if you would get into vaccine distribution, are those margin dilutive, margin neutral at the operating line? How to think about what the flow-through is on those kind of products?

Yes, Jeff, I'm not sure when the government is going to exit being in the procurement and distribution of COVID vaccines. What I can say is whether you speak to people in the government, whether you speak to people in elected officials, everyone agrees that we need to find a way so that the office space practitioner can access these vaccines in a relatively simple way. It is very difficult for them to access today. Yes, if you're a big clinic or you're owned by a hospital or you happen to have a clinic within a drugstore, none issue. But there is a complex system today if you're in dental or medical practice and in certain states, dentists are allowed to administer vaccines and people or the groups I just mentioned are clear that it makes sense for the government not to be in the distribution business. When that decision is made, I don't know, but it's sitting within the government today, within the federal government.

Yes.

And on margins, Jeff, the existing COVID test kits that we're selling, the margins are comparable to the margins that we're experiencing in the medical business. So there's nothing unusual there. I really can't even guess what the margins would be on the vaccine because we don't have -- we don't know what our cost would be. We don't know what selling price will be. We don't know when we'll get access to it. So it will be pure speculation now. It's just too premature to talk about that.

All right. Fair enough. Well, let me -- we'll come back to medical then maybe later on. But as I look back to dental and some of my early dental questions here, so it sounds like in the hierarchy of where patients are willing to go for care, the dental offices still stayed pretty high there, which kind of surprised me a year, 1.5 years ago when we started to see the rebound, but we've kind of come to expect that now and that's good to hear. But as we move into 2022, is there anything you're seeing, Steve or Stanley, either one? Should we be back to now just looking at kind of normal year-over-year growth rates, whether that was 3%, 4%, 5%? Are we kind of back as we start thinking about '22 to where we can just think of normal organic year-over-year growth and that's how the business should trend other than understanding that COVID testing on the medical side may be a wildcard there?

I mean, I can -- maybe Steven has a mathematical answer to that. The business is pretty normal now. I mean you mentioned these exemptions. And not to blow this out of proportion, but there is an issue in the U.S. equipment business, but it's limited to dental equipment, chairs, units, lights. They switch from one manufacturer to another simultaneously with us increasing our sales in that area. The demand has been good. So it's being hit twice. One is moving from one manufacturer to the other, and the other is the increase in sales. You take those together and is an impact to the supply chain, not that this is going to last forever. And if a customer really needs a chair, unit, light of a certain color, they'll get it from us. No problem.

Yes. And on that point, Stanley, I guess, we know that Pelton & Crane obviously exited the market last year or was that earlier this year, whenever -- last year, right? And the rumor has been or not the rumor I think it's been pretty easily confirmed that A-dec had some supply issues initially, maybe that was staffing issues, some COVID shutdown issues initially, things like that. Where are we at in that process? Are those manufacturers, the 2 main manufacturers in the U.S.? Are you seeing any kind of supply improvement at all? Is it something that was temporary? Or should we just think for the rest of this year, you're probably going to kind of have to scratch and claw to get some of that?

Well, first of all, I think those 2 manufacturers are doing a very good job. This whole issue was magnified a little bit for us because Pelton & Crane was originally a company that we brought to -- we brought those products to the market. It was bought by an entrepreneur who sold it to, as you know, to Danaher. And we had a disproportionate share of that business. Meanwhile, that same entrepreneur started up a game, and he's been in business for 2 or 3 years now and is doing a great job. The product is great. The supply is good. I don't think he has such a big issue securing spare parts, components, but our demand has grown. And his business has grown with us, not only in the U.S., by the way, we are now getting some contracts for that business and for A-dec in other parts of the world. So our business generally with these 2 manufacturers has grown, but they're supporting us very well. And I think we'll be out of -- this is a quarter's issue. This is not a permanent structural issue, and we're not going to lose any business as a result of that. In fact, the opposite is happening. We're gaining business.

Okay. Helpful. And then when I think about that 5% North American dental consumables growth number from 2Q, and again, that was a 2-year growth rate relative to the second quarter of '19. Obviously, some of the COVID uncertainties were the weight on that growth. The positives are you did have above 5% growth in the specialties business. You obviously had some early contributions from the Heartland recapture of that account, and you sat at 5%. And Stanley, you're not going to like this question, but your closest competitor was at about 7.5%, and they have lost the Heartland contract and they don't have the specialty business. So just help me understand kind of what's going on dynamics between you and your largest competitor where it seems like their growth has picked up here in the last 6 or 8 quarters or so in a decent way?

So Jeff, you're right. I don't like that question. Maybe 10 years ago, I would have answered it. The -- we can't answer those questions. There are so many puts and takes. There are cutoffs. There are numerous changes in dynamics. Put it this way. Our business is doing well. We've put a new commission program in place for our salespeople. It's been very well received. We're not losing people because of that. Our telesales business is really doing well. Our e-commerce is doing exceptionally well. We've got a number of social media type demand generation activities that are all doing well. I don't think we're losing too much market share to anyone.

Yes. And that's what I was going to come back to. I mean, do you feel like when you look at overall market regardless of what your number is versus anyone else's? Your gut feel and maybe some numbers, Steve, can back up without giving us those numbers. Do you feel like you've been holding share, if not gaining share in the North American dental distribution market the last year or 2?

There's so many puts and takes here. Generally, I would say that is correct. I don't know what information Steven is ready to disclose here today because I think we have to be careful. But generally, that is the case. You have to take PP&E out of this because that was extraordinary situation, and we were only selling FDA-approved or EUA-approved product. And there was a lot of product being sold in the marketplace. And I still think today this product being sold that is not regulatorily approved. So we took a rather conservative approach. But taking that out, Steven, are there any specifics you're ready to provide?

Yes. It's -- we don't think that we are losing market share. We think we have a stable to gaining. The thing that makes it difficult to answer with precision is the PPE comment because, look, we had to ration PPE back in 2020 because we wanted to make sure that few customers that buy out most of the inventory and we had it for the majority of our customers. And I think we did a good job of that. But at that point, I think customers who are looking to buy more than what we were allotted when someplace else to buy PPE. And they may have added some -- a few items to that order of other items. And now that we have availability of PPE, I think all that business came back to us. So again, I don't have specifics, but I think we're either at or growing our market share in North America.

Okay. And Steve, on PPE, as you brought it up or as we talk about it here, has demand stayed relatively consistent the last few months or a couple of quarters that you're seeing? I used to wear a mask and a face shield and a smack and this and that. Now I'm going back down a little bit. Or is that -- is the usage rate kind of similar and pricing did come down a little bit, maybe close to the start of this year, we sit more stable here as we get into the middle of the latter part of the year?

Yes. Unit volume has been relatively stable from what we see. But you're 100% right. Pricing has continued to come down on what we pay for product, and obviously, that means our price to customers comes down also. We think there's still a little bit more room for the pricing to come down on primarily exam gloves, but the bulk of it has already been achieved. So it shouldn't be too much of a headwind going forward.

There's just one area where things have changed, and that is in 2020 and maybe even the beginning of '21, although I'm not sure, then it's thought that N95s were the way to go. That switched to the L3s, the regular masks. So there's been a movement within that category. But other than that, the units are relatively stable. And given the new standard of care, I expect not much to change. I think where we are now is going to continue with perhaps a little increase in units as volume increases in the practice.

Yes. That's helpful. All right. So a couple of other questions within dental. Henry Schein One, I think the last 3 to 5 years has been a big focus, probably even longer than that, but I know the last 3 to 5 years, a very big focus. For a couple of years going into COVID, we saw kind of your software and services business or the technology and value-add service, I'm sorry, side of your business kind of growing in line with Dental wasn't really growing above. The last couple of quarters, though, it seems like we're back to kind of double-digit growth, at least on a 2-year basis. I know some of the dentists I talked to. It feels like some of those private practitioners finally realize like, hey, I've got to compete against DSOs. COVID kind of knocked my practice down. It feels like maybe there's a little bit of awareness going on at some of these private practices that they need to understand patient recall. They need to understand some of the stuff you can help with. Are we at the early stages of that Henry Schein One business starting to accelerate to what maybe a few years ago, we thought it was possible it could do?

I think the business is getting, of course, greater awareness amongst dentists. Having said that, there are issues here. Dentists are very concerned with security. So that part of the business is growing. The whole idea of recalls, but more important, using the Internet to [ trove ] for new patients, those revenue attraction systems are all very important. Revenue cycle management, all of this is important. At the same time, the actual sale of the software, what's happened is the cloud-based system is picking up significantly in terms of units. Long run, that's good, but you trade down from 100% of the sale upfront to a monthly retention. And that monthly retention is very, very good for us because as customers tend to stay on the system. So this -- but -- within the overall scheme, this is a growing business and not only is it growing in terms of new products we're bringing to market, but this -- as you said, this growing awareness and the DSOs are really investing in this space.

Yes. Good. And Steve, when I hear about a transition to a SaaS model or the recurring revenue stream model, I tend to think of that's very helpful from a margin perspective longer term. I think the margins in that business had been like kind of mid- to low 20s kind of slipped down to about 20% in the last year, 1.5 years. Are we kind of stable in that low 20% margin for tech and VA? Does it go up from here? How do you think about the margin profile there?

Yes. I think the reasons why it went down, especially during 2020, is a lot of the high-margin services based on patient traffic and patient activity. And when that slowed down, obviously, those products slowed down also. But I think from here on, we should see margins either stable to improving in technology and value add.

Okay. And then, Stanley, another initiative just over the last year or 2, at least that you focused on more so than in the past on the e-commerce side, and I know you've always sold online through formulary portals, things like that. You went live with the TDSC powered by Henry Schein back in October. Just what's the updates there? How has that been received by customers? Are some customers buying a little bit there and most of the stuff through their standard Henry Schein account or you're seeing a lot of customers move a lot of business, all the TDSC? Just how to think about kind of the rollout of that now that we're almost a year into it?

First of all, let me just -- that's a good question, Jeff. First of all, let me just say TDSC is small. I think, I don't know, $30 million, $20 million, an $11 billion business. Having said that, TDSC as a stand-alone has been quite successful. You have to exit out the PP&E because they were selling a lot of PP&E in 2020. But if you take that out, the business is growing, and the goal now is to see if we can get those customers to eventually buy the equipment from Henry Schein and some of the exclusive products we are moving our private brand in there, but it's a very, very small business. But as a stand-alone acquisition, it's been quite successful.

Okay. And you did mention the sales commission changes that went in. I think that was July 1 when that changed. Just remind me what we've been saying in notes, and I think we're right on this, but if you can confirm, the formula kind of changed to a growth initiative within that commission pot? How has that driven maybe mindset change at your sales rep level? Do you think -- is it pushing these guys to work harder? Is it getting some of the old guys who have been kind of stable but not growing? Is it kicking them in the butt a little bit? Just what's going on with that commission change?

Well, some of the words you used make me scared because whatever -- however I answer, I'm going to get into trouble with at least 1 rep who don't appreciate me. So the bottom line, it has been successful, and the goal is to advance products, sales of products that a particular customer who may not be buying from us. And if somebody is buying just getting the equipment service from us get them to buy the consumables. If they're buying the consumables, get them to buy their specialty products. If they're buying specialty products from us, maybe even get them to take one of our loans through Henry Schein Financial Services. So it's all driven towards that. But this is being ramped up in terms of the number of products we are offering through these sales -- through the sales channel. We just have too much to offer, and we got to do it slowly. But for those products that the sales organization has access to, we've done well in attracting additional business from customers that were buying a particular group of products from us.

Okay. Great. And then I think we're -- I've got just a couple of medical questions left after the PPE and COVID testing questions. But one, are there adjacencies that you could consider within medical? I think over the last few years, you've built that into a few different areas. But I've always thought like ophthalmology and some others. I know you have to find kind of outside of the acute care setting, but are there adjacencies, number one? And then two, Steve, any sense that this is going to be a normalized flu vaccine year? Or how should we think about flu vaccine, which I think was pretty depressed last year when we were all sitting at home and social distancing and what have you?

So on the adjacencies, we're always adding greater depth to the specialties. We cover all the specialties, but you take ophthalmology, yes, we want to add more products there, and we want to add equipment, for example. But all the specialties, we're in them, but we're not necessarily in them with a full array of products. So that's something that we want to focus on. As to new areas, we've focused on the ASC about 3 or 4 years ago. That's doing well. And we focused on selling medical products to oral surgeons, for example, pharmaceutical stuff. That's working well. But Other than these, which are incremental and they drive sales, the big one is home care, and that's an area we are driving and we will advance in because our customers want, plus it's a growing area.

Okay. And then, Steve, the flu vaccine?

Let me just talk about what happened last year. So it wasn't our flu vaccine sales that were negatively impacted. That was a little bit, but pretty much when we were selling the flu vaccine in advance of the season, the influenza season, and there's only minor return rates that customers have for that product. But really what impacted us was we do rapid test for influenza. We also get that patient visit when someone comes in with flu like symptoms. We didn't get any of that last year because people really didn't get influenza because of face masks and social distancing and other things. I think right now, we're expecting more of a normal flu season. It's still hard to predict, but more of a normal flu season because people are back even though people are vaccinated, our people are pretty much out versus last year. So we're hopeful that will be the case. But it wasn't only vaccine itself. It was on the flu test and the patients.

On the vaccines, Jeff, we buy just enough for our own customers and a lot of that's already been shipped. The big area that's the question mark is, as Steven said, the rapid test for the traditional flu.

Okay. No, that's helpful. And then I'm just looking at my model here just to see where I'm at. So I think Steve, you talked about in the last day or 2, gross margins maybe have a little upward bias to them over the next couple of quarters. Just remind us what's the driver there? And then on the operating margin side, I think even I'm sitting -- I'm looking, I'm about $0.50 above your floor guidance. And even there, I've got your operating margin stepping down 70 basis points versus the first half or so. So I think I've captured kind of your operating margin comments from the last couple of days, too. So maybe just help us understand what's the upward bias on gross margins? When T&E goes back up, how much gross operating margins come down versus the first half? Those would be the 2, I guess, to help us understand.

Yes. On gross margins, it's a combination of not having any significant amount of inventory adjustments like we had. We had smaller adjustments in the first half, but we really expect to have virtually nothing or something -- if we have something to be very immaterial as well as mix shift. We do believe that we'll continue to get favorable mix shift to higher margin products. On the operating margin, we haven't given any guidance on the second half operating margin. So it's hard to give at this point. But I will say that make sure when you look at our guidance, you understand it's a floor that we expect to be above that floor. We just haven't said how much above. And if you assume we're just going to hit the floor, that's the wrong way of looking at it. That's not how we're approaching it. But we were reluctant to give a traditional range because of a lot of the uncertainties going on. But we certainly believe we'll be above that floor for the second half.

Well, I don't think I'm that far outside of consensus. Let me look real quick here just I'm saying this, I should have looked this up before. But it looks like to me, I know I'm just over $4.30, and the Street's at $4.30. So The Street's already, what is that $0.55, if I do the math real quick in my head, $0.55 ahead of your floor. So is the Street just crazy on thinking the floor means a real low floor? Or does anything in that $4.30 number tell you we need to sharpen our pencils.

Yes, given that we haven't given any comments, it's really difficult, Jeff. I can't...

Yes. I'm trying.

I know you're trying And you're doing -- but I really shouldn't give any further detailed information on this call since we haven't given it publicly.

Yes. Fair enough. And then I guess, let me just finish with this, Steve. As I think about your operating margins, and again, I'm just going back to my model, you were at about 7.3% in 2019. And -- is that kind of the base number you think by the time we get to next year? I know you don't guide operating margin, but the push and the pull of the model, kind of somewhere there. And then going forward, you get a little bit of expansion each year. You feel comfortable with that little bit of expansion each year kind of part of the story?

Yes. Let me answer it this way. We absolutely feel comfortable that we can continue to get operating margin expansion. But what we haven't done just yet, Jeff, is we haven't said is that going to be 10 basis points, 30 basis points or any other number. But we do believe that it's critical to our story, and we think we'll get there through 3 initiatives. One is continuing to shift the mix towards higher-margin products; two is continuing to leverage expenses on the core distribution business; and three is continuing to take cost out through restructuring efforts. But -- so we definitely feel that we can get margin expansion on a long-term basis, but we haven't quantified it just yet.

All right. Fair enough. Well, I think though with that, our time is up. So Stanley, Steve, thank you again. I think this is the 18th year in a row I've hosted you guys or close to it. So it's great to see you as always. As a reminder, next presentation is set to begin at 1:25 Eastern Time include AdaptHealth, Vocera Communications, Applied Therapeutics and AMN Healthcare Services. Thanks, guys.

Thank you.