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

Good afternoon, everybody. Thanks for joining us for day 2, the UBS Healthcare Conference. We are very proud today to have management from Henry Schein. With us is Ron South, new CFO; and Graham Stanley. That's an easy one to remember. And Graham Stanley, who's Head of IR. Thank you so much, gentlemen. Thanks for attending today.

Ron, I want to start off. This is, I believe, your first official conference, right, meeting investors sort of this kind of venue. And you've been in the role now for a few months. Take us through sort of the process, how is it going? Is it everything you always dreamed it would be?

Well, I think some of you may have met at some point in time, Steve Paladino. Steve was my predecessor. For those of you who don't know much about Henry Schein, Steve was CFO since the company went public in 1995, which is a pretty unusual track record. And just to make it that much more unusual, our existing CEO, Stan Bergman, has also been CEO since the company went public in 1995. So we -- I don't know -- I can't actually point to any research on this, but I'm willing to make a bet that they were the longest running tandem CEO, CFO of a public company out there. So it was a culture shock perhaps to the organization when Steve announced his retirement because he's always been there. He's always been the face of finance, I will say. I joined Henry Schein in 2008 and have worked for Steve since arriving in 2008. And so I've had a chance to learn a lot from him in that process. And so a lot of people have asked me. So are we going to see significant changes with you as CFO. And I think that while there are some going to be some changes, I think they'll be fairly subtle as opposed to significant, but I think that one thing that Steve did that I'm very grateful for is that he left me with a very strong bench of a finance team, both in our corporate functions, including Graham here, who's now in the IR seat. Graham formerly was a Treasurer, was also CFO of our Global Dental business. So having someone with that knowledge of the business working with me now on the IR side is very helpful. So it's not like I have to come in and make a lot of changes to personnel. We're able to just kind of keep turning with the business and see what we can do going forward. So conferences like this. We've done a lot of stuff on Zoom, Teams, name your video, right? But it's kind of nice actually being able to do one in person finally, and we are grateful to have the opportunity. So I appreciate it.

I'm going to ask you that again after you've done 10 of these in 12 months.

You appreciate the in-person small hotel room jammed in meetings.

I want to ask this first before we get into the dynamics. But when I initiated Henry Schein a few years ago, I initiated with an underweight rating. And my concern was margins. As DSOs started to take more and more share, it was going to pressure the business. I've been wrong. The stock has done relatively well in that period of time, and COVID was a benefit, but you guys have managed through it to a certain extent. I think if there is a concern right now in Henry Schein, it is the outlook for margins. Like how can margins continue to grow? I know you've put out, I think, 25 basis points this year of margin expansion. If we think about long term, though, let's just -- I'm not asking for guidance, but if we think about long-term margins, can they continue to expand over time, assuming COVID comes out of the model? Is it a mix thing that drives that or potentially drives it? Can you just talk sort of broadly?

No, it's a good question, and I think it's a common theme of some of the questions we get from investors and potential investors, right? So I think that -- I'll first talk about a little bit about the DSOs. And I think some of the initial reaction to the growing emergence of DSOs was that, oh, this is really going to put a squeeze on margins on companies like Henry Schein. And infrequently when we're asked about DSOs, it's in the -- the question is framed in the context of a risk, right, or a threat. But in fact, we really see the DSOs as providing us with very good opportunities. They provide a very good scale. And we've -- because of our specialty dental products, because of our technology products, which are higher-margin products, there's a lot of interest by -- especially by the national DSOs of having access to those products. And so while we might get a lower margin on some consumable merchandise, it does open up a very good avenue for us to sell kind of dental speciality products and technology products to them. Our relationship with DSOs is not transactional. It is strategic. And our -- we have members of our management team who will meet on a regular basis, by regular, I mean, sometimes twice a month with DSOs and work -- help them with their strategy. What are the some of the things they can be thinking about strategy wise and how can we partner with them to help them with that. So we -- like I said, we see the DSOs as a very good opportunity. In terms of the margins, and how do we achieve margins going forward, I mentioned our dental specialty products. I mentioned our technology offerings. These are our higher-margin products. And that's where we are pushing -- really emphasizing the growth going forward. That's where we're prioritizing investment, whether it be external investment in M&A or internal investment in terms of just generating growth there. And if we can generate that growth, we do believe that we can continue to expand operating margins accordingly.

Okay. That's helpful. Let's talk about the specialty business then first. Where do you -- where do you feel you're strongest? Is it in implants? Is it aligners, is it something else? Where do you think you need to add? I mean the market is -- if we just look at those 2 categories, new players coming to the market all the time globally. Implant pricing has the difference between value and not as narrowed dramatically. How do you maintain or be competitive in that market?

So when we reference dental specialty products, we're really talking about 3 principal product categories, the implants, the endodontist products and the orthodontic products, right? Of those 3, the most significant is our implant business. something that's unique about these particular products versus other areas of our business is that they are primarily self-manufactured. And so our implant business has both a Swiss business Camlog as well as a U.S. business on Birmingham, Alabama called BioHorizons. And it's the most significant of those 3. It's also the one that's growing the fastest of those 3, gets very good margins. And what we're seeing is that the implant business has become really a standard of care. I think implants went from being kind of an aesthetic process to being more of a health issue. Implants will provide for improved oral health and people, which in turn provides just for an overall better health profile. So what we're seeing is that you're getting more dentists who are getting the appropriate kind of education around implantology as they come out of dental school, and there are more and more dentists who are performing implant procedures now. We're able to kind of leverage our status in the marketplace with dentists to introduce our implant products to them, and that's actually been a great engine of growth for us. So it's really the implants of those 3 areas that's growing the most. Having said that, the endodontic products are also doing well. And I think the area that we would like to get a little more traction and get some greater growth is on the orthodontic side.

I want to start with the implants. Are your products primarily competing at the value segment or in the premium segment?

I refer to it as kind of the sub premium because you really have the Straumann products, which are premium. And we're able to come in at a price point, which is slightly less than theirs, but we feel like really competes for quality. And so that's really kind of our entry into the market. We also have some kind of generic style products that do quite well primarily in Europe. We have -- we bought a small business in Germany about 3 years ago, and that business is able to import -- or I'm sorry, export their products to Eastern Europe and elsewhere as well as within Germany and elsewhere in Europe. But that's more at a lower price point.

If you want to -- you talked about the orthodontic business, you want to maybe -- maybe that's an area for investment. Where are you lacking do you think or where do you think you can enhance your business? And are there targets out there, or is this something that you think you would want to develop internally?

I think we're open to all alternatives on that. I think right now, what we're seeing though is that some of the valuations that we're seeing on the orthodontic side, I think, feel a little inflated, quite frankly. So we haven't done an aggressive acquisition there, and we are trying to get better development internally through -- really through that organic investment with our existing clear aligner product. I think that we have made some changes to -- like to the software. I mean, often, the software around these things is one of the most important parts. We feel like we made some good enhancements to the software on the clear product and that's going to give us a little more traction. Having said that, believe it or not, people still buy brackets and wires. And that's a nice business for us. This isn't a real significant part of our top line revenue right now.

Have you seen any change in demand between aligners and brackets and wires in the last couple of months?

Well, you're going to get more -- the obvious statement there is you're going to see greater growth on the clear side, but than you will on the wire. But in terms of the last couple of months, it's kind of hard to say if there's been any like meaningful change in the market.

We're all -- we can only really track the public companies, right, which we've seen a pretty meaningful slowdown from the DTC players and the public clear aligner manufacturer.

Yes. I mean, I do think that, inherently, it is -- if one wanted to assume that orthodontic products might be a more vulnerable than, say, other dental products in a soft market, that's probably a pretty fair statement.

So it sounds like ideally organic, the software updates that you've done. Is there -- is the opportunity there into the GP market for you or into the orthodontic -- orthodontist market?

It's really both. You do get some GPs who want to expand into orthodontics, right? And we actually offer CPE and other things for them to get there and training and whatnot. But it's a little bit of both. There's some of both.

Okay. I'd be remiss if I didn't ask about trends. I know you don't want to talk about inter-quarter trends, but I do have to ask these questions. First, I'll start with maybe something that's not necessarily on volumes, but on price increases. I think X-ray said publicly, they took an earlier-than-expected price increase across their portfolio. Other companies taking larger price increases. Take us through how you view that? It's already played out. Do you expect it to continue based on your conversations with the manufacturers? And just take us through the economics of how that impacts you?

So I mean, the -- in a typical year, we would get an annual increase from our suppliers, and we would increase prices accordingly. And that would typically happen once a year, and we all move on. this is different. This is different conditions, and we're all kind of working our way through it. But you're right, some of the manufacturers have already announced price increases or signaled there will be price increases on an interim basis in addition to the annual increases that they've already done. We have kind of viewed this as to the extent we can pass along those price increases to our customers, we will. We also want to be cognizant of the pressure that puts on our customers. And if we believe a supplier is increasing prices to a point where it's going to be very difficult for us to pass it on, we want to make sure that supplier is aware. We do offer a pretty broad scope of products of different corporate brands as well as our own private label in many areas. So if we -- if one particular product gets to a point where we feel like we need to direct them to a different corporate brand, we can do that or we can direct them to our private label. We're balancing, advocating for our customers with the relationship we have with our suppliers. And we have to kind of walk that very carefully. But we -- I think we have to make sure that if a supplier is increasing price, and we believe that's going to be difficult to pass on, we need to let that supplier know where we're going to be in a position that we're probably going to have to offer up some alternatives to the customers.

Are we at that point, yes, that's happening?

I don't know if we're added on a large scale yet. We disclosed that in the first quarter, we estimated about a 3% lift in merchandise revenues associated with price increases. And by merchandise revenues, we're talking about both our Dental business and our Medical business, excluding PPE. PPE actually has a little bit of deflation on gloves and things like that, right? So when you kind of -- when you carve all that out, you had about a 3% increase. I don't think 3% was the tipping point to get people to say, forget it, I'm moving over, right? I'm moving over to these other brands or I'm not buying or whatever it might be. I don't think any of us know where that tipping point is, but it's out there somewhere, right? And if we keep getting price increases, we might start finding it at least for some customers.

And you expect these price increases are going to continue at a higher?

All indications are, yes. It's hard to say no to that, right?

Sure. So economically, when you get a price lift that -- I mean, they happen every year. So that's part. But it sounds like there was an added, I don't know if it's 3% was the actual delta from what you normally would say? Or that was just the absolute number? What does that do to your economics in terms of your gross profit or your operating profit? How much of that just drops down?

Yes. We're trying to get the same margin percentage, which translates to incremental dollars, right? So there's the margin on the increase, so to speak.

So you're keeping the margins the same?

Yes.

Is there any inventory benefit, meaning if you have $100 million of inventory do you get to 3%?

You could get a little bit, but in very broad terms, I mean we turn inventories about 5 times a year. So you're not going to get the opportunity there, maybe SKU by SKU, you're going to find opportunities. But I think in general, it's not going to be that significant to us.

Okay. Fair enough. So let me ask the awful volume question that we all have to ask, which is when you updated -- you gave us an update in April, have you seen -- has there been -- maybe I should ask it this way as opposed to just asking how volumes are. Are you seeing any impact in terms of demand from macroeconomic factors like inflation or the economy, consumer discretionary spending. Are you seeing in any categories or any kind of procedures or even overall demand?

When you say am I seeing it when?

Since you last gave us an update.

I have to go to the standard language. We can't provide any insight beyond May 3, which was when we released earnings. I think what we talked about when we released earnings on May 3 was that there was clearly -- it was no surprise to people that January, we saw some disruption to patient traffic related to COVID. We saw that begin to get better February and March and stabilized in April, and I think we finally said that April is really very comparable -- patient traffic wise was very comparable to December of '21. So we kind of felt like we were back to a normal thing. I know the ADA is getting data out around patient traffic so that there is public information available. I think part of the problem is, I think, for all of you is that by the time you get that data, is it already out of date because the conditions -- the market conditions are changing so fast. So that's kind of the best indicator I can give you right now. But it's -- this isn't unique to us. This is something all of us in the industry have to manage. And those of us who manage it better will benefit from it. It's that simple.

Historically, granted you haven't been with the company since 1995. But historically, when there has been an increase in inflation or some kind of impact on consumer discretionary spend. Has that impacted dental volumes or any particular type of procedure in your -- in your estimation, just historically?

Yes. I mean I think that -- while there have been kind of recessionary periods, I think the one period that a lot of people want to point to is like 2008, was a long time ago. 2008 is the year, I joined Henry Schein. And like 2 months later, Lehman Brothers collapsed, so it was -- some interesting times, right? But I think that we were just really starting to get into the specialty side of the business than it was at the end of 2008 that we bought our Ortho business. It was in 2010 that we bought heavily into the orthodontic business. I think one is like, I want to say it was 2011 that we bought BioHorizons on the implant side. So we haven't seen, at least on an extreme measure what the impact would be in some of those businesses. Having said that, I do think that the -- I think that the end patient is in a different position now. I think there's probably a higher level of higher number of insured dental patients out there now versus 2008, which helps. And I will say, in 2008, while we did see declines in growth, we still had growth. Not a lot of companies had growth, depending on what industry they were in. So we do feel fairly confident that we have kind of a recession-resistant type of business, I won't call it recession proof. I don't know if anybody is completely recession-proof. But I will say we do -- we feel fairly comfortable that we have -- we're going to -- we could see a downturn in a recession. I mean we could probably see a downturn in certain products. But I just think that for the most part, maybe it will kind of flatten out growth a little bit, but it won't create a big downturn for us.

I don't think I've ever asked this question before, but what do you actually think the growth rates are of your businesses, medical, dental, if you were to break it down technology like how do you -- when you think about the growth algorithm for Henry Schein across your businesses, if you were to break it down, all else being equal, a normal economic cycle, COVID is not part of the equation, this is what our business would grow. If we are taking normal going to come?

I think we've kind of guided in the past that our kind of core business is kind of a mid-single-digit growth business. I think our specialty dental businesses are kind of high single digits, same with technology, perhaps creeping into the low double digits along the way. I think those are probably the best benchmarks to start with, there's always going to be exceptions to that depending on certain market conditions and within the product lines themselves. But I think that's probably the benchmark to start with.

Okay. And when we talk about inflation and the impact suppliers are raising their cost because their costs are higher. How does inflation impact your costs, meaning whether it's fuel or if it's labor or take us through how we should think about that impact on your operating expenses?

Yes. I'll start with the 2 specific things you mentioned, one being fuel. And we have added a small -- we've actually bumped up a small fuel surcharge on products. And that kind of varies market-to-market. In some markets, you're not allowed to do it. So you actually have to build it into your price.

Geographic markets?

Yes, geographic markets, yes. But for the most part, like, for example, in the U.S., Keep in mind, it's small, and it's small because a lot of -- our typical order in the U.S. is small. Our typical order in the U.S. is going to be, say, under $500. And it's 10 things going into a box and off it goes. So I think, Graham, remind me, the fuel surcharge is now...

About $3.99.

Yes. So we're talking about a $4, right?

On a $500 order.

On a $500 order, multiply that by the hundreds of thousands of orders that we're processing, it's a meaningful amount of money to us, but hopefully, it doesn't like curtail orders too much, right? And we're trying to be transparent about that. It is a fuel surcharge. If we see decreases in fuel, we will pull it back a little bit, right? On the labor side, we're vulnerable to the war on talent like anybody else, right? I do think we have a very strong culture as a company that helps us with retention. We have a lot of long tenured individuals, who are team Schein members as we call them. And I think that's helped us. Having said that, we had to be perhaps a tad more aggressive with salary increases this year than we normally would be. But it's not -- it sounds like we had to go out and provide double-digit raises to people in order to retain them. We feel like we have a good culture. People are -- especially in Long Island, people who work for Henry Schein on Long Island, it's a known business out there. There's a lot of pride in working for them. I think I'll be honest with you, people like working from home, and our offices are now open and available for people to work in as they wish to. And we find that most people are working from home, and it's great, it's not disruptive to the business, it's working fine. And I think it's actually helping us with our retention.

I think you should tell that to all the Wall Street firms. So mandate and everybody go back to work lately. In terms of -- one thing that we're hearing from a lot of health care companies is it's costing more but also, they have a lot of openings and job availability and it's negatively impacted. We certainly hear it on the provider side where they can't -- there isn't necessarily enough providers to actually meet demand that's negatively impacted on. Are you seeing any of that, that's in any way negatively impacting your ability to service customers or anything?

I don't think so. We had -- we did go through a period of time and really kind of in 2020, where we had fairly high COVID-infection rates in some of our warehouses. And that really puts some pressure on the existing workers to get orders out. So that was something we had to be very careful of. But beyond that, we're -- I think not the absenteeism, but the openings we're dealing with in terms of empty positions, like I said before, we haven't had a real difficult retention problems. So that hasn't been a problem for us. I think in some cases, and I think we saw this more kind of in the early part of Q1, I think it was kind of well documented, at least anecdotally, that there were some shortages of dental hygienists and that was creating some capacity issues for dentists, which in turn could have an impact on our -- the volume of sales we have with them. But I think we're seeing some improvement there as well.

Okay. I'm going to do some sort of one-off questions. And if anybody in the audience has a question, you please use the little device, and I'll make sure we get it asked. The question we get a lot is trying to understand how much COVID benefit is sort of in guidance for this year. How much of it do you think will continue into 2023? I think a lot of investors are sick of trying to back out COVID benefit or even thinking that maybe there won't be much COVID benefit or negative impact, depending on the type of company next year. How should we think about it from Henry Schein's perspective?

It's a -- it is -- it's difficult to project that, right? We -- our initial guidance was that we expected and by COVID, I'm talking about COVID test kits in this point, right, that we expected our revenues on COVID test kits to be approximately 10% less than what we did in 2021. We did $250 million in revenues in COVID test kits in Q1. Our projection -- I think our initial projection was probably in the mid-5s, right?

For the year?

For the year. In spite of the fact that we did $250 million in Q1, the run rate coming out of Q1 was getting very low. And so we did bring that projection down. We're saying now that we think those COVID test kit revenues will be down about 15% to 25% versus the prior year. I think all we can really do there is we will continue to disclose like when we release Q2 results, we will disclose what our COVID test kit revenues were. And if we believe we need to change that our projection on those sales, we will or we will affirm that at that point in time. It's a, obviously, if we're struggling with understanding what 2022 is going to be, I really -- I don't know what to tell you about 2023.

Just remind us the margin of the COVID test kits are higher than corporate gross margins are higher than corporate?

They're consistent with what our medical margins, our medical gross margins.

Yes. Fair enough. The -- we always are focused here in the United States. I know China is not a big part of your business. It doesn't seem to be getting a lot better there, but can you provide any sort of update? Like how important is China for you? Just give us a reminder? And have you seen any loosening up of demand there in the recent weeks or months?

China is -- I think the number we've disclosed historically on China is that maybe around the 1% of our revenues, right, of our businesses that we have in China. Having said that, it's an important part of our business, and we hope that it becomes a more significant part of our business going forward. The other aspect of China is that it's also where a lot of our product that we sell and supply. And so I think more of being luck or otherwise, we haven't seen a lot of disruption to supply just based on the geographies of where some of these suppliers are -- so we haven't had disruption. I mean, Graham, I know that there's been some things you were looking at there. But anything else to add to that? I mean.

No, I think there's -- I mean it takes a little bit longer to get product from the manufacturing facility to the port. But apart from that, we're seeing slight normal continuous supply of product out of China.

And that timing hasn't changed. I mean I know we've had delays. We've had delays now for months and months. Has that been relatively stable in your...?

Yes, it's a stable situation at the moment.

That's a positive.

And we increased our safety stock, I think, towards the back end of last year, anticipating that maybe there were going to be some supply chain issues. So we wanted to make sure that we have product available for customers.

What do you bring in from China? Like what -- is it PPE related stuff?

There's a lot of PPE that comes from China. A lot of merchandise.

The price of PPE has come down. You mentioned it before. You've had to take a write-down in the past on the inventory. And I think almost every company has to do that at 1 point or another. Do you -- if the price keeps coming down, are you okay at this point in terms of your inventory and your price to?

Yes, I don't -- I think any -- if we have to take any inventory charges now, they would not be significant. They'd be real kind of ordinary course of business type of adjustments, right? So yes, I think we're comfortable with that.

The -- when the price comes down at PPE though, like, is it still -- where is the demand? Is that just because demand has slowed? Or is that just because supply has increased? What's actually driving the cost down?

I think the cost coming from the supplier is going down, right? And so the market is just reacting to that by bringing prices down with that. So you had the situation where prices went up, costs went up significantly, like literally like 4x in some cases, right? And so the prices went with that. And now those costs are starting to come back to where they were and the prices are simply falling back now.

We have like 5 minutes left. And I want -- there's some M&A questions I want to ask, and I also have a couple of questions from investors here. Let me read those. Have you seen a shift of general dentists ordering more specialized products like implants, how does that affect your business? Are they doing more specialty in the GP office?

Yes. I mean like I said before, I think more and more dentists are trained in implantology. And so I think that that does benefit us. Having the implant products available to them. And given the breadth of customers we have, that's been a benefit to that business.

Okay. This one's a little longer. So can you talk about the continued growth of digital dentistry and how that's impacting your business? Have general practitioners been completing more complex cases, again, implants, et cetera, because of -- is it being driven by digital dentistry scanners and the like. Do you land and expand with PMS and upsell iOS and CAD and CAM designs, just like that?

So I think firstly, in terms of digital sort of intra-oral scanning, it's a much better experience for the customer, for the patient. And so that's what's driving sort of that part of that, also better clinical outcomes in terms of just the accuracy of the final product that goes in the mouth. Also, I think the number of dentists are looking for additional revenue streams, whether it be mouth guards or other products like that. So you need an intraoral scanner in order to be able to access those types of products. So a combination of the dentist stacking as a good business manager looking for opportunity to expand the range of services and the better clinical and patient outcomes. I think that's what's driving a lot of the market demand in those products.

The -- in terms of the scanner market, you guys don't necessarily have your own scanner, right? And a lot of the scanners are sold directly. How do you participate in that market? Is that something you'd be interested in acquiring potentially? We just saw Envista buy one. They paid a decent multiple for that, but they obviously have their own clear aligner, is that something in the orthodontic side that you think you need?

We had our unit at one point. Remember, we had the [indiscernible] was partly owned by Henry Schein. We are divesting that business prolly about 4 years ago. Something that -- so certainly, our strategy in terms of owning manufacturing businesses is typically -- we want to provide a full range of products to the customers, where we can't get access to a product. So a number of years ago, we couldn't get access to the -- what was the Sirona product would typically invest in manufacturing in order to gain access to that product.

There's a bunch of OEM scanner manufacturers globally, right? That's why I was just wondering if that was an option for you guys to white label a scanner if you're not doing a lot of direct yourself?

Yes. I mean, I don't see it as an immediate option. I mean, I like having the ability to -- for us to have an array of scanners available for the customer and buying one could restrict us on that.

Got it. Fair enough. The M&A opportunity. Your balance sheet is great. You don't have any buybacks really built into your estimates. Take us through what's the capital deployment plan? How much Henry Schein is, I don't call you a serial acquirer, but over the years, you've done hundreds of transactions, large and small. We haven't seen a ton of activity unless the next Q comes out and we find out there's a handful that you did. Take us through where are you looking right now?

Yes. So last year, we did $570 million in transactions, which is high for us. And that -- I think that illustrated what was really the result of a bit of a backlog from 2020, right? So we kind of caught that up a little bit. We did very little in Q1, very little close in Q1, that doesn't mean we don't have a lot of due diligence going on right now. But I think that we also need to integrate some of those businesses a little bit. There's -- there was a high volume of activity and it puts a lot of pressure on management to really begin to deliver on the integration process on those.

So is it harder to integrate during this period like through COVID or even plus COVID?

I don't think -- I would say no. A lot of what we acquire are stand-alones. We do buy some things that we fold in, but a lot of what require a stand-alone. So it's really -- by integration, you're really kind of just getting them up to speed on Schein policy. Do they have the right people in place? What other changes do we need to make, but I -- so that process is going on right now. We have a lot in the pipeline that we're looking at. M&A remains a very important part of our growth. And we are looking at multiple opportunities for this year. I will say we're trying to emphasize, as I said kind of earlier on, we are emphasizing growth in the technology side on the -- with our specialty products. And that means we're also -- that's kind of getting the priority on the M&A side as well.

In buybacks this year?

Yes, we will do buybacks. I know in the first quarter, we hadn't done any. It was really kind of the terms of our 10-5b plan, but I think we're going to -- we have already implemented a new plant, and we are buying back shares, as I speak.

Well, gentlemen, we are out of time. This has been great. Thank you so much, and thanks, everybody, for joining us today.

Thank you.