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

Hi, everybody. Good afternoon or good morning depending on where you are. My name is Elizabeth Anderson. I'm the health care technology and distribution analyst at Evercore, obviously also covering Dental, which is near and dear to my heart. I am very pleased this afternoon to be joined by Stanley Bergman, CEO of Henry Schein; Steven Paladino, CFO of Henry Schein; and the new guy Graham Stanley, who has just stepped into the role of IR a couple of months ago. Thanks so much for joining us today. One quick administrative note. I obviously have many questions for this team, which we can discuss over the next 45 minutes. If you people listening have questions as well, please feel free to put them in the chat. We can read them in. And on that note, I'll pass it over to Graham, who I think has some opening statements.

Thank you, Elizabeth, and thanks for hosting us this afternoon. I'd just like to start by just reminding everybody that certain comments made during this call will include information that's forward-looking. Risks and uncertainties involved in the company's business may affect the matters referred to in forward-looking statements. And as a result, the company's performance may materially differ from those expressed in or indicated by such forward-looking statements. These forward-looking statements are qualified in their entirety by the cautionary statements contained in Henry Schein's filings with the Securities and Exchange Commission, including in the Risk Factors section of those filings. So with that, I'd like to pass it over to Stanley, who will provide some opening comments.

Thank you, Graham. And Elizabeth, thank you for hosting us. Thank you all for calling in to this webinar. I'll be very brief, leaving more time for asking Steve and I questions. So in summary, Henry Schein is the largest provider of products, a wide variety of products, practically everything that an office-based practitioner may need. And so we are the largest provider of products and related services to office-based practitioners. And that includes dentists, physicians, and practically all of the various components of the alternate care setting, although we do not really service the long-term care facility and nor are we involved much in drug stores. But these practitioners buy consumables from us, pharmaceuticals, equipment, specialty products. For example, in dental, we're a leading provider of oral surgery products, that's implants, bone regeneration products, endodontic products, orthodontic wires and brackets, aligners and then related services with a key service that we offer being in the practice management software and related services arena. And in that context, we are the largest provider, largest installed base, if you will, of practice management software, both in the regular computerized systems that are desktop and in the SaaS model arena small practice, midsize practice, large practices, government and all the related services that are related to practice management software. We also are a large provider of equipment service, other kinds of services, including financial services, education, really any kind of activity that goes on in the practice, dental practice; we do offer some of the services on the medical side but in the dental world, pretty extensive array of services that we offer. The business has been around for 90 years. We've been public for 27 years -- 26.5 years actually. We've shown consistent growth. EPS has grown at about 12%. Compounded annual growth, some years a little higher, some years a little lower. Even during this pandemic, we did pretty well, and we managed our expenses appropriately. And generally, there's a long track record for growing the top line through acquisitions, internal growth and driving operating margin through leveraging our expense structure. And we supplement that with a pretty decent track record on acquisitions, which we continue to expect to go forward on a consistent basis. And our internal growth has been very good in addition to the acquisition growth. And then we supplement, we utilize our cash also for buyback of stock. I had very good results from the last quarter, you can -- I won't go through them now because you can see that on the internet, but I think it is safe to say the best way to view our success is to remove the PP&E and the tests from the sales calculation, although we believe that both tests and PP&E will be part of the equation going forward. We're a big player in point of care tests generally, but of course, COVID point of care tests as well. But if you just look at our sales internal growth, moving those PP&E and testing sales, which were good from the equation, you'll see that we've done pretty well on a consistent basis, really during COVID last quarter in particular as well. And I think, Elizabeth, I will leave it up to you to ask specific questions that's of Steven and I.

Great. Thank you for that introduction, Stanley. So maybe two shorter-term questions before we move into the core of the discussion. One is particularly unfair question given that no one knows what is going on. But it would be great to understand what your -- how you're thinking about Omicron right now and the potential -- current or potential impact of the new variant?

So Elizabeth on omicron. I think we -- this is a new variant, we're going to have probably other variants. And I think we are just going to have to continue to live as a society, as a world with infections, and we will get through this. I don't think we're going to have the panic that we had in the second quarter of 2020 when in the United States we closed down practices, dental practices, medical practices. I don't think that's going to happen again. I think people are going back to the dentists, going back to the physician's office, ambulatory surgical centers are up and running, they're seeing patients. And I expect that this will continue around the world. There are some unique situations unrelated to this new variant. In the U.K., there's some reimbursement challenges. But I would say other than that, we had a brief closing down or a reduction in visits to dentists in Sydney and Melbourne for about 6 weeks. I think we could expect things like that. But basically, I do not believe we'll have -- this variant or any future variants, at least from what we can tell on visits to the dentists and certainly also visits to the physicians.

That's helpful. Maybe on another sort of short-term basis, I'd be curious about how your feedback was on Greater New York this year. I know it was in-person again unlike last year, but it is sort of a slightly different format. How did you guys find that versus prior years?

Yes. So what's very interesting, Elizabeth, like with a lot of other activities, our business is not necessarily being conducted on the floor. The number of participants, I don't know, maybe it was 20% of what it was. I think some say it was as much as 30%. But we had all of our promotions in the hands of our sales organization, our customers 3-4 weeks before. And generally there's not much change in buying patterns from what we saw in the third quarter. I wish we could deliver every dental chair that a customer would want. There are some challenges there, although our sales of traditional equipment, as we noted in the last quarter, continue to be good but there's a significant demand and there's a hole in the supply chain because the manufacturer left the market. But other than that, I would say business generally has been very good, we confirmed that in our last call. And I think we also confirmed that we had a pretty good DS world. And I think it's similar and people are getting accustomed to not necessarily buying on the floor of the show. So our traffic was pretty good, compared to others, I would say.

Yes [indiscernible]

But we're not reliant on shows anymore for our business for kind of engines. Social media is playing a huge role as well.

Yes. That certainly makes sense. Okay. So maybe a little bit more broadly. I mean patient volumes have seemed largely stable as we've moved through the fall. How are you seeing this trend continue? And anything to call out in terms of this reactivity from what you guys are seeing?

Yes. I think it's pretty much where we left it off at our conference call at which -- we're not the only point of reference. The ADA statistics in the United States showed, I think, about 90% of patient visits compared to 2019 compared to prepandemic levels. It's about that. Having said that, we have data from our practice management billing service, which indicates we're probably at about 100% from a dollars and cents point of view of billing compared to where we were in 2019 this time, perhaps slightly positive to that. And in most countries, as I noted earlier on, I think we're sort of back to where we were, maybe slightly positive. I think the visits relative to more expensive procedures, particularly implants, is quite strong. Endodontic treatment is also pretty good. We're not the biggest player in the aligner world, but our orthodontic business is also quite strong, and has been. And these are all comments that I made in the last call. And I think basically, we are where we were when we had the call and I would say, on the physician side, there are pockets where maybe ambulatory surgical centers are not doing the amount of business they were doing. But there are other parts of the country where they're actually doing more than what they were doing in 2019. So it's basically where we were in our 2000 -- in our third quarter and we are -- it's a relatively stable market.

Makes sense. One area that I think people have been spending a little bit more time on is -- on the dentist side, is on implants, [ obviously sort of ] moving through the pandemic. Where are you seeing the most success with your implant portfolio right now? I mean it just as broadly that maybe the environment is getting a little bit more competitive. Is that true? And sort of how are you seeing that right now?

So we are a little bit different from most of the other public implant oral surgery companies in that our strength is in Germany and in the countries around Germany, in other words, Austria, Switzerland and the Netherlands. We have some business in Spain, and we have some business in Japan, and we're very strong in the United States and Canada. These are all stable and growing markets but are not growing necessarily as fast as the developing world. We have an implant business in China that's growing quite rapidly but off a small base. So if you take all of that into account, our specialty business as a whole grew by about 10%, just over 10% in the third quarter, and it was a little -- I think it was in the teens in the second quarter. I think we have very, very good brands and are gaining, we believe, quite a bit of market share, I would say, in the markets that I indicated to you. I don't think pricing is a big issue for us, of course, it always is. We are, I believe, of the important, what we call premium brands, perhaps one of the lower priced. So we already are -- we have a decent price. And so the issue there is more a debate on who gives the best service, who has the best software to support surgical guides, who has an integrated system with the practice management systems. I think we score well on those -- in those areas. So price is not for us an issue. Of course, when you're going into potentially a heavy bid, price is important. But generally, it's not the driving factor for us. For us, we're focused on R&D and software development.

Makes sense. So maybe given all these -- the pandemic dynamics that we've been seeing in 2021 as well as some of the installation delays, are you anticipating seeing the same kind of seasonality that we've seen in prior 4Qs [indiscernible] there?

Yes. And I assume you're talking about equipment.

Yes.

So generally, equipment business, as we noted in our Investor at the last call is quite good, and it's steady. Certainly, in the digital world, the CAD/CAM world, so shall we say the scanner world, not the CAD/CAM world, the scanner world is quite strong, and anything around that theme is quite strong. The full chairside scanner with mills is okay. It's not that great. But -- and as it relates to the imaging machines, there's a good demand for them, the digital machines, although pricing is generally quite competitive but our manufacturers understand that. So what I've described to you now is basically everything other than chairs, units and lights. Chairs, units and lights is also quite strong. And in the United States, we have a challenge. And it relates to the fact that a major manufacturer of chairs, units and lights, I think [ fair enough to say that ] that was the #2 player for which we had a significant market share because we used to own that manufacturers. We sold it, it was our original equipment company. And they exited the market and the other two major manufacturers just could not fill the void. So we have quite a bit of backlog on chairs, units and lights. However, I'll be quick to say that if somebody needs the chairs, units, or lights right away, we'll provide it immediately. But for larger installations that are more elective and planned out, It's going to be delayed probably into the second, third quarter next year. There are also, of course, some delays on the construction side, as construction raw materials is a bit of a challenge now. But as we reflected in our last call, the COVID business is overall quite strong. And all this -- these orders will be installed. I think the momentum for general equipment sales, general momentum, be it the digital side, the imaging side, the traditional chairs, units and lights side is doing quite well. And so I suppose it could be doing even better. But we have to spread it out. And I'm referring to the United States. This is not impacting Canada where the manufacturers were slightly different, the mix and certainly not impacting outside of North America. Equipment sales were close to 30% growth on an international basis last quarter.

Yes. No, thank you for clarifying that. That's helpful. I guess you mentioned as they were passing in your prior statement, but how would you characterize high-tech equipment sales right now. It's definitely been one of the surprises of the pandemic, broadly speaking. But so as we're sort of almost approaching year 2 of the pandemic, how are you sort of seeing things?

Well the DI, the scanner, there is no question, it's being viewed more and more as standard of care, and there's still a huge part of the market that doesn't have scanner and many of that have it, have an old fashion version. So this is a very, very hot market. And not only are we referring to the United States but to Europe as well, even china and Australia and New Zealand, it's hot. Brazil, our business is hot in that area. So this continues. There is obviously some competition amongst manufacturers. I think we carry a very good array of these products. And the opportunity for us is integration of those scanners into our practice management software and into our general digital platform. All of that presents opportunity. The full chairside, it's not terrible, but it's really not as hot as the scanners. And I expect that before long, the general public will not want to go to a dentist that has a manual impression capacity only, and we'll want one of these scanners. There's also a lot of interesting technology that's coming along in that area from a diagnostic point of view. So this is going to be a very good area for us. There are many manufacturers that are supporting us 1 or 2 that are key. But there's some interesting technology coming, and we're very excited about this area, including, by the way, the area of 3D printing.

Okay. That's -- okay. Lots to dig into on there. So I would just say that one thing which is, who is buying intraoral scanners right now? You sort of -- we've had a phase where you have some early adopters. We've heard about DSO interest, at least on the scanning side. So who is the incremental buyer now?

First of all, the DSOs were not owning these scanners until about a year or so ago -- 1 or 2 but I'm not sure who has announced, but if we have announced, then Steven can clarify. But I don't remember what we've announced? But we've had some pretty substantial deals with DSOs that are using these -- installing the scanner. The midsized DSOs are big buyers and the smaller 1, 2 and 3, were the very few one solo practitioners that are starting to realize that they've got to be investing in this area. So it's across the board. But I would say that there have been a couple of decent wins on the large size of this. I will say that it's not material to [indiscernible] but some good anecdotal information is we are selling our aligner system with scanners now and we're meeting a bit of success from bundling that. So that's a small and large DSOs.

So you're talking about aligners in the DSO space. Is that what you're referring to?

I'm referring to aligners and the scanners in the DSO space, but also with the smaller practices, yes.

Got it. Okay. That's helpful.

It's not only one brand of aligner. We are now connected with several brands -- not one brand of scanner. We are now connected from an aligner point of view with multiple scanners.

Okay. That's helpful. And what is that opportunity with connection to the practice management software, specifically for you guys?

If you're referring to aligners, the major...

Sorry, I mean between the intraoral scanners and the practice management software broadly?

Yes. So most of the -- certainly all the major brands of intraoral scanners that we sell are connected to the traditional Dentrix system and to the Ascend system. The degree of integration may be slightly different, but generally you can get a connect directly through to the practice management, the electronic medical record system. It's been a key way in which we have been able to sell these aligners with connectivity, the interoperability has been important for our customers.

That makes sense. And is there sort of like a revenue opportunity there? Or is it just kind of like a sort of feeds back in and maybe convinces people to move maybe in a cloud-based direction or something like that.

Well, I would say that the best salespeople for these DI -- these scanners is the patient, because if you've had a scan before, you're not going -- scan and you've had a traditional impression before, you're not going to go to a dentist that does not have a scanner. It's a different experience. So it's the public that is driving this. And I think we're -- it seems to me, although I don't have a crystal ball, we're at the beginning of an acceleration in these scanners because it's going to become expected to be standard of care. And COVID gave it a boost. People are now expecting far more digitalization over the last -- in our day-to-day lives -- in the last 18 months than before COVID.

Yes. No, that makes sense. And then obviously, yesterday, I believe you guys announced your new orthodontic software planning for Reveal Clear Aligners. Can you talk about what's notable in terms of the upgrades there? And then broadly speaking, where the traction is that you're seeing in the Reveal product.

Yes. We've never really provided specific information on sales of Reveal. It's a good product for us. It's likely to be a good product...

I was hoping you would now, Stanley.

You want to make history. But we want to be very careful. There's no one product that is going to move the needle so much at Henry Schein. And we would not want Henry Schein to become a story because of our aligners. Having said that, we have what we believe, and this is our belief and our KOL believe this, key opinion leaders believe this. We have an outstanding transparent Clear Aligner. Qualitatively, it's outstanding. And of course, conditions will decide that. We had two issues. One was being in a position to provide adequate supply. And we've just upgraded our manufacturing capabilities in Savannah. And hopefully, that will satisfy a lot of the demand, but it is possible that 1 or 2 larger contracts will take a lot of that and we'll work on that. So that's a little bit -- it's there. Of course, what we want to do is make sure that every aligner we sell works very well. So we're not going to sell more than we have the capacity to quality control. But the area we were really lagging behind was the software. And the ability for the practitioner to show the patient what the aligner -- post aligner image would look like. And the whole interoperability between the dentist, the clinician that is the operator, [indiscernible] , technical individual that is helping to chaperon the case and the factory and back again. The actual communication vehicle DDX, which we've had in place for a long time to move cases to labs, that was there. But the general software from a patient interface physician -- orthodontist point of view was not there. I believe that this software deals with a lot of that. And we're happy to show it to any analyst or any investor that would like to take a look. It's pretty slick software. We are rolling it out slowly because what's important here is in the end, customer satisfaction. So what we have is a good product, an outstanding product from an actual aligner point of view. The manufacturing, we have to make sure that we can service the needs and then the software, making it easier for the practitioner to work with us and, of course, making it a tool for the practitioner to discuss the outcome with the patient of all areas that are coming together nicely. And I believe that an average orthodontist or GP even will compete very well with the direct-to-consumer players in this field. And our job is to make sure that at the end of the day, aligners belong in the dental operatory, which is where they belong, not in a way where the practitioners bypass. And that's been a whole goal here.

Yes. No, that certainly makes sense. And then maybe circling back on the software side. Where are you seeing the strongest new product interest in software? And how do you see the transition, specifically in Dentrix to sort of Dentrix cloud playing out over the next 2 years?

Yes. It's very interesting. We had a 5-year challenge in close in killing DOS. We just couldn't kill it because our customers like the system, it worked and it's never broke. We never had a problem. And we moved to Windows and that was relatively -- at least that has been very successful, both at Dentrix and Easy Dental and in our Dentrix Enterprise and even some of the large DSOs, the military. And there was interest in Ascend, the cloud-based system. People knew we had it, younger, new dentists who opened a practice, bought it, has a little bit more operability -- interoperability in the clinical software and that was cool, and suddenly over the last 6 to 9 months, Ascend has spiked. Perhaps it's the technology wins from COVID but it's spiked. And we're selling a lot of these units. And both Ascend in the U.S., and we have a comparable product in Europe. And I think the movement to the cloud will be very, very quick and rapid, more rapid than in the past. Again, we have to make sure we can support all of this. I think we will be able to. Our Ascend product is a good one. It doesn't have everything that Dentrix has yet, but it has additional features. And from your point of view, from an analyst point of view, it's a different model, selling a piece of software versus a SaaS reoccurring revenue model, which in the end is a much more profitable model, but there is a conversion taking place today. But despite that, we did have a very good third quarter in Henry Schein One sales. So this movement to Ascend is kind of parallels the movement to the scanner. I think dentists are looking for much more friendly and more capable software.

That makes sense. What are you -- sorry, just maybe one follow-up on that one. What is the sort of incremental financial benefit for you guys if somebody switches from sort of software to the cloud-based system?

So I see Steven's getting ready to answer that one. And it's about time you ask him a question because you're working me too hard and he has all these answers. So Steven go for it.

So financially, it's a big long-term benefit for us because when people buy the cloud-based system, they're paying a monthly subscription fee, it really goes on as long as they utilize the software as opposed to buying a license for a onetime fee and then paying annual support that goes on as long as they want to stay on the system or be current on the system. So it does have some financial impacts because when we're transitioning, there will be lower sales because recording the whole sale upfront, you recorded over subscription period. It's also a benefit to customers because customers do not have to outlay a very large amount initially. It's really a pay-as-you-go for them. They don't have to worry about paying annual support because that's all included. They will be ensured of being on the most recent, the latest software for us. So really it is, I think, a win-win. And I think as you know, in most other areas of technology outside of dental, the move to the cloud has already substantially occurred. In dental, that's ahead of us. And that's a nice opportunity for us because we have the Dentrix Ascend business or platform. And really, many players that we compete with don't have a cloud-based system at all or if they do, it's not as advanced as ours is. So we feel we can really lead in this space over the next few years.

Got it. Makes sense. And I have another one...

So Elizabeth, interoperability is very important for the devices. And this has been a key focus, and it really becomes cool when it's in the cloud. And we have a great digital system for imaging, storage of imaging in the cloud. All of this goes together in a nice package.

Yes. No, that makes sense. And maybe, Steven, not to let you off the hook, just one question. What are you seeing in terms of typical price increases? Obviously, Dentsply announced that they raised prices broadly across their portfolio as of October 1. what are you seeing more broadly across the market from your manufacturing partners?

Sure. So I'll give you what our estimate is, because price increases are really coming in now and most of our price increases, we're being alerted now and they are effective January 1. There are all few manufacturers that have raised prices before that. We're expecting that price increases will be 2% to 3% higher than normal.

Can you remind everybody what normal is?

Sure. Normal was probably in the 1% to 2% range. So it's really like similar to really all areas of the economy that we're seeing significant inflation. For us and for the market, typically, price increases get passed through to the end user. It's unfortunate, but there's really no other way to deal with that. And we expect really, as in prior years, when we had even smaller price increases to pass the lion's share of price increases on to the end user. We never pass 100%. There's always some exceptions there, but it's a very high percentage that we pass through to the end user. And all those comments are dental, medical. Medical is a little bit more choppy because of some of the pharma components that we're not seeing as much price increases. But on the pure MedSurg products, it's probably very similar to dental in the U.S.

Okay. And there is a rumor flying around the dental investor [ role ]that DSOs do not accept price increases. Do you care to comment on that at all or provide any additional color on that topic?

So we pride ourselves as being as transparent as we can to investors. And I think those that know us for a long time would agree with that. On this particular issue, we're not really commenting. And it's not because I really care from an investor point of view. But from a competitive point of view, we really don't want to talk about specific contracts that we have or don't have with certain groups of companies. Because if we do that, I think that would be bad for us.

No, no, that's fair. So maybe turning to a different area. I mean if you think about -- do you make more growth -- broadly speaking, with these price increases that you're mostly passing through, do you make more gross profit dollars when you're passing through the price increases? Or are you sort of maintaining -- so does that give you opportunity to like grow those dollars? Are you sort of like maintaining the margin -- how should we think about that?

Yes. We're typically maintaining the margin. So there is slightly more gross profit dollars for that. But remember, we also have inflation with labor, with transportation and other things that we have to offset, though.

Yes. Okay. That's fair. So how should we think about perhaps -- I know we haven't really spent much time on medical so far. But how should we think about the COVID dynamics as we move through the late fall in medical? I mean are you sort of seeing testing following broadly national trend? Is there any other kind of dynamics to think about on that end?

Yes. So we're still very optimistic about the ability to continue to sell test kits. Unfortunately, I think this COVID is going to be around for some time. So it is difficult though to forecast. And just as an example, in Q3, we did $206 million of COVID test kits for the company; in Q2, we did $75 million. So very lumpy, very -- and the one thing that the Delta variant did, it looks like it accelerated the COVID test kit sales for us. It happened at the same time, so we attribute it to the Delta variant. But we, in our guidance for Q4 and for 2022, because that does have lumpiness to it, we try to be conservative on what we expect for COVID test kits in order to just be a little bit conservative given the difficulty in projecting.

No, that makes sense. Anything to call out for the fourth quarter in terms of PPE inventory levels or pricing and on that specifically on that category?

Well, on PPE, we did say on the third quarter conference call that we're still seeing some price reductions, which is good overall for the industry. But that will probably have a little bit lower sales impact because of the price reductions. But the margins are still holding. And the unit volume is still high, and we expect -- I think we said we used the term, it's the new normal for PPE on the Q3 conference call, and we do believe that, that the unit level will stay at existing levels, which is much higher than pre-pandemic levels. But we'll see some continued price declines in PPE. But remember, back in 2020, especially at the height of pandemic, where there were short supplies of PPE, pricing for manufacturers doubled, tripled, quadrupled. So the fact that they're coming back is good for everyone, and that's really because the supply chain has improved, and the availability of product is much better than it was several quarters ago.

Makes sense, and maybe one last one as we're running down on time. Can you talk about, as you say, right now, the biggest opportunity is for margin improvement at this point in time as you look out with your crystal ball?

Sure. So I would point to 3 things that are going to help us improve margins. And although we haven't given specifics on this yet as to how much operating margin we're expecting -- We have said long term, we do believe we can continue to get operating margin expand. And maybe we'll provide a little bit more color on that on the next conference call. But there were at least 3 things that I would point to. One is continued shift in faster-growing product categories at a higher margin. And we talked about the 2 big ones here. It's dental specialties and technology and value-added services. The second really is, we can still leverage our expense structure with incremental sales. So we still believe that, that's helpful to us. And lastly, we're continuing to look for ways to be more efficient where we are restructuring activities as well as this one distribution activity that we talked about that will help not only with improving customer satisfaction but also improving efficiency. So those, I would say, are the 3 big areas that will help us drive operating margin expansion.

Got it. Well, on that note, unfortunately, we are out of time. Sure, we can go 45 minutes again and still not cut through everything. But thank you very much, Stanley, Steve and Graham. It is a pleasure, as always, and really great to connect with you guys today.

Thank you.

Thank you.