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

Good morning, and thank you all for joining us today. My name is Michael Minchak, and I'm a member of the health care services equity research team here at JPMorgan. We're very pleased to welcome Henry Schein back to the Healthcare Conference this year. For those that may not be familiar, the company is one of the leading distributors of dental and medical products to office-based practitioners in the U.S. and globally. So with us today, we have CEO, Stanley Bergman; as well as Graham Stanley, who heads up Investor Relations. And during the Q&A session, we'll also have CFO, Steve Paladino; and incoming CFO, Ronald South, joining us as well. So thank you all for joining us today. Before we begin, I'm going to pass it over to Graham for the forward-looking statement, and then we'll move into the introductory remarks.

Thanks, Mike, and thanks for inviting us this morning. Before we begin, I'd just like to remind everybody that certain comments made during this presentation include forward-looking statements. As you know, risks and uncertainties involved in the company's business may affect matters referred to in forward-looking statements. 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'll hand over the presentation to Stanley.

Thank you very much, Graham, for the introduction there, those remarks. And Mike, thank you very much for hosting us. I'll flip through the 2 slides very quickly. The slides are available after the presentation, if you wish to have them through our Investor Relations team. But in broad terms, Henry Schein is the largest provider of products and related services to office-based practitioners, that's dentists and physicians and allied services. We had sales last full year reported sales of $10 billion in 2020. Obviously, a year that was -- where sales were suppressed because dentists to a large extent, physicians, were not operating in the segment -- mostly not operating in the second quarter of 2020. The split of our business is on the screen. We're a global business, 1 million customers, about 1.5 million practitioners around the world, 21,000 Team Schein members spread out throughout the globe. We've been on the Fortune Most Admired list for over 20 years. Ethicon lists us as one of their ethical companies, the S&P500 and Forbes Best Employer and highly rated by the LGBTQ ratings service. So let's go to the next page. Yes, there's been a lot written about Henry Schein's management recently. And I wanted to provide some clarity on how we're organized. Essentially, we're organized in pursuit of 2 big strategies. One is on the distribution side, where Brad Connett a quarter century veteran at Henry Schein on the distribution side, leads our North American distribution group, that's a dental and the medical group. Andrea Albertini leads our global, our international distribution group, that's a global business outside of North America. David Brous leads our strategic business group, which includes specialties such as endodontics, orthodontics and specialty distribution businesses. René Willi leads our global oral reconstruction group, which is the implants and bone generation group, but also a group that focuses on dental laboratories. And Mike Baird Henry Schein One which is our joint venture, we own a 75% interest in a business that focuses on practice management software and other practice management digital tools. So it's the to major distribution groups and then the -- what we internally call our high-growth, high-margin specialty software, specialty products and specialty services businesses, led by David, René and Mike. And these are all Brad and Andrea and David and René are all seasoned Henry Schein veterans. Mike joined a couple of years ago with a significant track record in software in various arenas. So let's move on to the next slide. We announced that Steve Paladino, who's been with the company for 35 years, last 30-or-so years as CFO, was the CFO of the company when we went public in 1995, will be retiring in April -- at the end of April of 2020. We implemented our succession plan on the finance side. Ron South assumed the role of Chief Financial Officer. Ron's has been with the company for around 13 years. Ron brought on board 6 months-or-so ago, Olga Timoshkina and Olga is a veteran partner from Ernst & Young, EY, many years in the accounting area in particular, and she will assume the role of Chief Accounting Officer. And to complement the team, we ask Graham to head up Investor Relations. Graham has been with the company for almost 20 years, been a financial leader, CFO for practically every one of our groups in the business and really understands the business very well. So you can see that Steve stepping down. However, Steve stays on the Board and will remain an adviser to the company, hopefully, for many years to come. So that's the team on the financial side that you will be working with. So let's move to the next slide. Just a couple of points on our position in the marketplace. We've had a very good track record, certainly disclosed since we've been public. If you look at our sales, we've had compounded an growth EPS similar number, we turn our profits into cash, pretty good consistent track records that to be public and even before that. Our customer base is fragmented. Our competitors about half the market is served by relatively small providers on the distribution side and even on the specialty side, I would say. There's a small number of large national competitors in each market that we serve. But there's no global player in the markets that we serve, we're the #1 dental distributor globally. We're -- I believe we're #2 when it comes to physicians and alternate care sites, including and surgical centers, oncology, renal centers, OG centers, et cetera. And we have the largest position on the practice management solution side through Henry Schein One. This is all complemented with our own brands of specialty products, surgical -- dental surgical products, its implants, different kinds of other products, including bone regeneration products, orthodontics and endodontics, which are all sold under our own brands and relatively vertically integrated. Let's move to the next page, please. So positive market trends, which we can discuss in the Q&A. Obviously, the population is aging. There's a need for more office-base practitioners. There's a growing awareness of the importance of prevention care in general. Large outgrowth of health care reform in the U.S., and this is a global phenomenon. There's a direct connection that's becoming more and more widely understood, direct connection between good oral care and good health care in general. Significant movement in procedures to the physician offices and to the alternate care sites, the ASCs, et cetera. Significant amount of consolidation, both on the medical side, which is a little bit more advanced than the dental side, but also on the dental side, IDNs, large group practices on the medical side. On the dental side, DSOs and group practices, national practices is even now a global practice and small regional practices. Henry Schein has been well positioned to service these kinds of customers for a long time now. In fact, I think we're the first to service dentists in this market. Is improving access to care in the U.S., we have the healthcare reform legislation. All of this leads to positive developments for our customers in general. And technological advancement, very important when it comes to software to run the practice, electronic medical record, et cetera, the interface, the interoperability between digital prosthetics and imaging is very important in dentistry, and there's a lot of activity going on digitally with respect to patient communication. We can move to the next slide, please. I think it's very, very important to realize that Henry Schein is a high-touch player. Of course, we do have some businesses that only focus on digital sales, e-commerce. But generally speaking, we're a high-touch, high value-added provider of products and services. It's called our profession, full service provider of supplies, equipment and services. This is what's needed by dentists. Of course, in the supply chain we have, in my view, the best supply chain solutions. There's no one that really offers as a wider variety of dental and medical products as we do. It's supplemented by our own brands of specialty products. We have quite an extensive array of services, including, for example, in-office installation and repair services for equipment, but also arranging all the way to financial services, educational services, revenue cycle management services. Our software and value-added services platform is highly valued. And we have these deep relationships. We have almost 4,000 representatives in the field called this field sales consultants focused in specific areas and many are generalists who manage the overall relationship with the customer and are there to help the practitioner deal with any of the challenges they may experience. So the bottom line is this full service, high-touch model that we have is something that we believe is most appreciated by practitioners, and it's one of the reasons why, if not the main business reason why we have grown so nicely and consistently since we've been public. So if we can go to the next page, thank you. Our financial information in the third quarter is public, of course, but it's good to note that we did well from an EPS point of view. Our sales that well, even if you take out the inflated sales from PPE and COVID-related products, testing, et cetera. But we think the levels of PP&E from a usage point of view, that we've been experiencing are what we call the new norm. Other observation, patient traffic generally similar in the third quarter to previous quarters. I noted the new normal on PP&E COVID-related products. The PP&E sales continued from a unit point of view at the elevated levels. Of course, the test kits, extremely volatile. We are experiencing inflation for merchandise and equipment products; transportation, labor, a little bit higher than usual, quite a bit higher, I would say. It's the supply chain disruption impacting North America equipment? Let me just clarify, there are delays in delivery of a traditional dental chairs, units and lights. The delay a direct result of the key manufacturer leaving the 2 major manufacturers and 3-or-so smaller manufacturers having a challenge in filling those orders in a market where actually has been elevated demand for chairs, units and lights. We believe we'll be through this in the second half of 2022, which is what our manufacturers are telling us. But if somebody really needs a product, we'll make it available, of course. And so far, we've not experienced significant disruptions on merchandise products. We may not have every brand in unlimited quantity. But generally, we have a substitute for practically every product that's needed other than maybe some branded pharmaceuticals, where there is a unique product and if there's a problem with that, there's no one in the marketplace it has an alternative. So with that in mind, Mike, we're ready to answer any questions that you or the audience may have.

Great. Well, thank you, Stanley. That was very informative. I'll just kick off the questions. [Operator Instructions] So just to start off with, in the past, you've commented that we're back to 100% of pre-pandemic levels in terms of patient volumes in the North American dental business. Have you seen any impact on visit trends over the past few months as COVID incidence rates have ticked up due to the Omicron variant? And then I guess just taking a step back, how should we think about end market demand and growth in the consumables business going forward, especially as we start to lap some of the easier comps from 2020 when dental offices were still in the process of reopening? If I think back to sort of the pre-pandemic period, underlying growth was generally in the low single-digit range. I guess just what are your thoughts in terms of the outlook going forward?

Mike, on visits, the last time we formally commented was in October during our investor call. Obviously, as we noted -- as Graham noted, we are in our quiet period. And at that time, we noted that visits were on 1 index, the EDI index, and I'm talking about dental in the U.S. at 90% of 2019 levels, but that survey measurement methodology may not be 100% accurate or reflective of the market condition. And then some other data which showed that we were close to where we were in 2019. And that was, what, 8 weeks ago. And we can't really comment on the last few weeks, firstly, we have the holiday period in between. But those are the comments we made back in October. As it relates to demand, as we indicated back in October in our call, we're pretty optimistic about demand for dental products, procedures, whether it's through simple drill and fill or the specialty procedures, specifically related to implants with odontics, endodontics. So in October, we were quite optimistic and that was less than approximately 8 weeks ago. So I don't think we want to comment beyond that. There's plenty available literature. But my personal view is, this current variant doesn't seem to be as bad as the previous variants. And I think that's the case, not only in the U.S. but globally. It seems like people recover within 5 days, a week. So you put 1 and 1 together without me making comments on the fourth quarter, it doesn't seem to be too risky.

Got it. And then maybe just moving to dental equipment. So you commented about traditional equipment being impacted by manufacturing delays and office construction delays. I guess just as a follow-up, 2 things. Number one, I think you typically see some seasonality in your equipment business in the fourth quarter due to year-end tax incentives. Have you seen that typical seasonality play out in this year as we have in previous years, minus what we've discussed with traditional equipment? And then secondly, I guess, just can you talk about sort of backlog in dental equipment, both on the basic and high-tech sides? What are you sort of seeing in terms of trends there?

Yes. So again, taking it back to the October call, we indicated that the backlog was quite good. Demand for dental equipment, pretty good. Challenged in fulfilling all the orders because of the elevated demand and also because of the exit of a manufacturer in the chairs, units and lights. I think we've also said for a long time that the digitalization of dentistry is something that's appreciated by dentists. I mean the fact is you've been to a dentist that has used manual impression tray on you and then you can't have the same dentist to use a scanner. I don't think you'll go back unless the dentist uses the scanner all the time. So I think it's quite clear that scanning is of interest, to the public will drive dentistry, I think the investment in digital products has been good. But I would also say that we -- the market is by no means saturated in these areas, and there's still a big part of dentistry that is not acquired all these digital products. So bottom, bottom line is, I think we can be optimistic about the equipment market without giving you specifics on the last couple of months of sales.

And so just sticking with equipment, not -- and not sort of looking at the last few months, but just sort of outside of the quarterly volatility that you see in terms of lumpiness related to new product launches or promotions or tax incentives, where do you see that long-term normalized growth rate of dental equipment going forward sort of once we do sort of normalize for some of those factors? And is sort of there any way to sort of break down that further into traditional equipment versus high-tech?

Yes. Obviously, you and I have the same crystal ball, but Mike, I'm quite optimistic about digital dentistry on the prosthetic side. Imaging, although imaging did come down in price, I think there's a demand for imaging equipment -- digital imaging equipment. The old X-ray is now a computer, a digital computer. There are things like the different kinds of devices to multi -- whether it's a printer or 3D printing or different kinds of molds. These are all huge opportunities, I think we're going to see pretty good development emerging in the next couple of years, both in terms of devices and materials. It's all exciting. And I think dentists realize that -- not only in this country but globally that they want a modern chair necessarily the most expensive chair, but a nice chair, units, lights, et cetera. And so that has been a process that has unfolded over the last couple of years, and dentists are investing in their practice, not just here, but globally. So I think the overall equipment business looks pretty good. How does that translate into a precise number? It's very difficult to tell. But we did tell you back in October for the last -- that our backlog was very good. But we've also mentioned that in several calls going back. So it seems like a good time to be in the dental equipment business.

Great. Maybe shifting to dental specialties. Obviously, an important tailwind to margins. In the past quarter, I think you talked about $900 million of sales growing at a double-digit pace. Just given your product mix, is that double-digit growth rate sustainable? And sort of what do you see as the biggest opportunities within the dental specialties category? And I guess maybe is -- can you talk about sort of North America versus international is one of a bigger opportunity than the other?

Yes. We're quite optimistic about our specialty business. If you just see that we've grown double digit for a while now. We're annualizing over $1 billion business at relatively high margins. So we're optimistic if you break it down by business type product categories. The oral surgery business has been good for Henry Schein for quite a while. We started off with a very small base. We've done well. The markets are good, but I think Henry Schein has been gaining market share in the U.S. under BioHorizons brand, which has done very well. We've put some Camlog products into that offering and we've kept the brand BioHorizons. And outside of the United States, in Europe, for example, the Camlog line does very well. I think in terms of units, we sell more units of implants in the leading market in Germany than anyone else. So that's doing quite well. We've taken some BioHorizons' products and put them into the Camlog line in Germany and Austria, markets in Europe. So we're very optimistic about the growth in the United States, Canada and Germany. These are the markets that were quite strong. Having said that, we're also very excited about some of the markets that we do not have a big position in Asia. We're investing in China. We have a decent position in Japan. We're optimistic we could grow that. And in the developing world -- or the lower income markets, we're feeling pretty good about growth as well as parts of Europe. So there's a lot of digitalization going on there, surgical guides, again, 3D printing, these kinds of things are all going to be important in this area, and we're very, very optimistic. That group also is responsible for our dental lab business, and we feel there's opportunity there for us as well. Our endodontic business, we carry most of the national brands outside of the U.S., carry some of the national brands in the U.S., but we have our own brands that we remain very excited about including some unique endodontic equipment that we've just launched. So we're very, very excited about the endodontic space. The orthodontic business is relatively small. We have a very good traditional wires and brackets business, which we -- it's been a consistent grower, some good products in there. And we're doing okay with our aligner. We have a very, very good product, transparent aligner. The product is good. But where we were challenged was with our software from a dental -- dentist point of view in supporting the aligner. We just launched our 4.0 version of our software in December. And I think that pretty much levels the playing field in most areas in software arena for aligners. And we were limited with production, and we've expanded our production capabilities in the U.S. and our facility in Savannah, Georgia. So we're quite optimistic about the aligner business. We're doing okay with some DSOs. And in aggregate this is a very good business. If you take the specialty businesses, products, the specialty services businesses and the Henry Schein One, these 3 high-growth high-margin businesses, and you aggregate them, Steven can give you data, but it's already starting to be quite meaningful in terms of profits. Sales are relatively small as a percentage of total sales. But Steven, you may want to provide thoughts on our overall profit contribution to the company from these high-growth, high-margin businesses.

Sure. So we gave some detail on either the Q3 or Q2 conference call. On Q3, we said -- for Q3, we said that the Specialty Products business was about $225 million of sales for the quarter. We also have the technology and value-added services segment, the entire segment. And if you combine those 2 on a profitability basis, it represents almost 35% of the combined Henry Schein operating income. So it is a much higher percentage of profitability than sales for obvious reasons because margins are high. It's also growing at very good growth rates. The dental specialty businesses has been growing in double-digit land, and the technology business has also recently accelerated, and we're looking for acceleration there also.

Got it. It's very helpful, and appreciate Steve. Maybe just if you could talk a little bit about private label. I think you've talked in the past 10% of global sales. Where can that ultimately get to? And I guess with what we're seeing in terms of elevated levels of inflation, has that been a catalyst or could it be a catalyst in terms of driving incremental private label penetration over time?

Yes, Mike. It's a careful balance. We support our national brands and where pricing becomes an issue with the customer and it's becoming growingly important, we -- the customer knows we offer our corporate brand. We do not offer a corporate brand in equipment. We do not offer a corporate brand in pharmaceuticals. We carry generic drugs from multiple and the multiple labels. But if you look at the available markets for our corporate brand, it is growing. And it's particularly important to some DSOs who can tell the quality of the product through their advisory boards. But in many instances, branded manufacturers are highly competitive, and that's fine with us. Our job is to make sure that our customers receive high-quality products, at as best of price as we can, and that's what we advocate for. But just the plain facts are that customers are looking for better pricing, and we have an offering and the private brand of high-quality products at a competitive price.

Got it. And then, I guess, just sticking on the topic of inflation, in the past, I think you've talked about the ability to pass through price increases to your customers, are you fully able to pass that through 1 for 1? And I guess, does that happen on a real-time basis or is there a potential lag in terms of how quickly you can pass through those increases?

That's Steven, who spent a lot of time on is going to address that issue.

Sure. Thanks, Stan. Yes, on product cost inflation, what we've said primarily on the third quarter conference call is we are expecting price increases to be approximately 2% to 3% higher than a typical year. Typically, year maybe is it a 1% or 1% to 2% range. We do expect to pass through those price increases or the lion's share of them to the end user. This is a practice that we've done consistently for a long period of time. It's also an industry practice. So we think the whole industry will do the same thing for that. So we feel pretty confident we'll be able to achieve that. We never passed through 100%, is always an exception here or there, but we do pass through generally the lion's share. And I'll remind you, Mike, that when we pass through a price increase, we pass it through with our margin. So there is some incremental GP dollars. From price changes, yes, most recently, our price changes have been closer to real-time. Historically, when price increases were much less and very infrequent, we sometimes didn't do that. But at this time, we really have to because some of the price increases are really pretty significant.

Right, that [indiscernible]. And then I guess just on -- sticking with sort of topical issues. As we think about the labor side, just wondering if you could sort of talk about it in terms of 2 dimensions. So first, at your customers. Are you seeing any issues with -- are they seeing any issues with their ability to sort of hire and retain people in their offices that's impacting their ability to treat patients? And then I guess just second, within your own internal business, have you had any issues with hiring or retaining employees? Are you seeing wage pressure? And if so, is that sort of incorporated into the outlook for 2022?

Mike, there's no definitive data on what's happening in dentist offices, there's anecdotal information. But there's always been challenges in parts of the country. It's been okay possible to get [ investor ] an appointment to see a dentist generally on average, but there have been shortages in certain parts, underserved markets. Maybe there are markets that are slightly accentuated now because of labor shortages as it relates to hygienists and perhaps dental assistance. But it's my understanding that there's no real challenge in getting an appointment for the dentist. Dentists are actually quite busy. As it relates to Henry Schein, obviously, we're not immune from the macro trends. But we've been able to keep our head above water, the last couple of weeks have been a little bit challenging because of Omicron. But we're getting through that. Our orders are getting out. We've had to increase price labor compensation in some of our distribution centers, not related to anything today, but I would say over the last 2 or 3 years. We have, I think, 2 benefits compared to many companies. One is we are a company that has a great culture, great values, great culture, and we tend to have lower turnover. And second, we've always focused on benefits. So if somebody is looking for the -- somebody in the distribution center, for example, is looking for the highest per hour rate, that's not us. But if you're looking for a benefit program and a decent salary, that's us. So I would say our turnover has been less, but we are challenged in the last week or so, 10 days with people that are ill, but it seems like they come back within a week. So we're getting to work out. So a lot of work, especially the supply chain issues, it's not that we don't have the products, but manufacturers are not shipping. If we order 100 items, complete purchase orders as they were many of the manufacturers as they were, say, 2 years ago, they're shipping in multiple shipments. So that has caused extra work. So we have those kinds of things. But overall, we're -- I believe, we're satisfying our customers' needs guess when the history books are written, probably better than most.

Got it. And then as it relates to PPE and infection control products, can you talk about what you're seeing there in terms of the pricing environment? Obviously, at the early part of the pandemic, we had seen pretty significant price increases where does pricing stand today versus those pre-pandemic levels as we've seen manufacturers add capacity over the last 2 years? And within that, maybe you could talk about separately if there's any sort of difference in terms of what's going on with exam gloves versus sort of other infection control products?

Yes. I think the demand levels, elevated levels, it's pretty stable in the last months or so. Pricing, there is some volatility, but we covered this also in October, not much volatility. Things have stabilized. Gloves was particularly volatile, I think it's stabilized now. I mean the one area where there's a lot of volatility in terms of demand is tests, and we've always been an important provider of rapid point-of-care test for physician offices. Actually, we're now providing COVID testing to dentists. So there's some spiking in that area. But I think more or less from our manufacturers supplying to us and are passing on prices to our customers, it's relatively in line with inflation, but no one has taken advantage of. And our supply chain of shortages or potential shortages of certain brands, there is the volatility in demand. And right now, of course, COVID tests are in demand. But I think the prices are, at least from our point of view, are relatively stable or certainly in line with price increases passed on to us by the manufacturers.

And then maybe just one before we wrap here as we're sort of getting towards the end of our time. You mentioned COVID test kits. Obviously, there's been a huge amount of volatility in terms of what you've been seeing on a quarterly basis. And obviously, there's been a ramp in terms of testing broadly. I guess just can you comment in terms of what's sort of factored into your fiscal '22 guidance from that standpoint? And then I guess as we think about margin contribution from COVID test kits, has that been a tailwind to gross margins over the past few quarters? Or is that -- I guess, just trying to understand where that sort of fits.

Yes, Mike, maybe Steven can on the margin relative to test kits.

Sure. So on the first part of your question, Mike, because of the volatility of test kits, we're trying to be conservative on what's in our guidance. We haven't given the data points, but I can tell you that it is conservative because of the volatility, which it should be conservative. Hopefully, that will pan out fine. With respect to margins, what we have historically -- what we have said just recently is that the margins for COVID test kits are comparable to the overall medical operating margins and gross margins. So it's really not a headwind or a tailwind, it's really very comparable to our current margins at this time.

Got it. Well, that's all very helpful. We're coming to the end of our time here. So I just wanted to thank you all for participating and the great insights that you provided over the last 40 minutes, and wish everyone good luck with the rest of their conference this week. Have a great day.

Thank you, Mike. Thanks for seeing us.

Thank you.