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

[Audio Gap] Senior Vice President and CFO; Graham Stanley, good to see you, Graham, VP, Investor Relations and Strategic Finance Project Officer. As I've been saying, guys, feel free to fire away with any questions. I'll try to keep us on time and have a good talk track with you guys.

And your questions will take priority. I'm just going to go ahead and jump into things. And maybe, Ron, for Dental, on the recent earnings call, you talked about North American consumable merchandise recovering in the second part of the first quarter, right? You had the COVID phenomenon, so January was pressured due to COVID. Then you mentioned trends getting progressively stronger in February and March. Maybe just bring us up to date on how we think about things. Is that the true real run rate that we saw in February and March and January was specific to COVID, and we're able to extrapolate those February and March findings going forward?

Yes. I mean I think, clearly, January we know was affected by the Omicron variant and the infection rates that were in the market at that point in time. And because it was -- as we saw that infection rate drop, we saw patient traffic increase in both February and March and into April. I think we did the release on May 3, so the most recent information we had was through April. There's a lot of things that are affecting things out there besides the infection rate. You have interest rates. You have inflation. You have geopolitical concerns. So it's kind of hard to say what is our normal run rate. But we did feel like we kind of emerged from the quarter approaching something that was closer to what we saw, say, going back to the latter part of 2021. So it did level off at that point.

Okay. So to your point, it was -- the Feb, March, April trends were recapturing that '21 time period.

Yes.

And for all intents and purposes, that might be the best one to extrapolate going forward. You mentioned other challenges. What are those challenges? Are they a bit more supply related than demand related?

Supply related. We haven't really had the supply disruption that we perhaps experienced earlier. We still have some backlog in equipment, but the backlog kind of going into the first quarter was fairly consistent with the backlog in the back end of the quarter. So our equipment activity in the quarter was very, I think, illustrative of 3 months of demand, right? So that's -- as long as those backlogs stay consistent, we don't really feel the pinch from that. So some of those backlogs are coming due to some disruption in the supply chain, a little bit on the electronic component side for some of the high-tech equipment. On the traditional equipment side, it's more related to, say, construction backlog, construction delays, where our customers, the practitioners are expanding their practices and experiencing some delays in that construction. So they've ordered the chair. We're holding the chair for them. We're ready to install that chair, but we don't install it until they're ready. And we don't record that revenue until we do that.

So you actually have a receipt of that equipment already.

Yes.

It's more of a timing thing, if you would.

Yes.

Okay. Okay. And that backlog of in and around 3 months, one is -- maybe just talk to us what's normal backlog. Does that look at like 1 or 2 months and now it's 3 months? And then when you run in your crystal ball, are you able to say, hey, we think that backlog will come down and be more in line with historical norms?

I'm not trying to be difficult, but your guess is as good as mine on that one. I think that what is normal now is, I think, is the challenge we're all trying to figure out on not just on backlogs but a lot of other things, too, right? Right now, normal is about probably about a 3-month backlog. I mean it's -- I mean, Graham, I mean you've monitored the backlog probably closer than I have over the years. I don't know when it will get back to something less than that. I don't know if it will actually get worse than that. So we are kind of treating that dynamic as normal operating.

That's the new normal, that 3-months backlog, give or take?

Until it isn't, right? And unfortunately, that's kind of the environment we have to operate in.

Yes. I think, Jon, what we said is I think we're seeing the backlog being relatively stable, right? So it's not -- the sort of the delays in installing or the delays in equipment, it's not getting worse. We fully expect that it will get a little bit better, but effectively, I think the timing has really shifted back a quarter effectively in terms of the unwinding of that backlog is going to happen.

And actually, it's that stability that it makes -- it actually makes it easier for us. As long as you have that kind of consistent...

The [ 1 6 2 5 ].

You're able to -- yes, you're able to operate a little more -- with a little more consistency.

And I know it's a $12 billion-plus top line business, but I got to ask like, Ron, was that embedded in the guide in terms of that backlog staying in and around 3 months? Is that the expectation in the 5% to 8% top line goalpost that you put up?

Yes. I mean I just think that it's hard for us to predict what the backlog will be. So as a baseline assumption, we would include that whatever backlog we went into the year with is what we're going to come out of the year with.

Okay. Fair enough. And maybe just to pivot over to international, so we talked a little bit about like North America dental merge. We talked about the equipment side of things. You guys are so big. You're global. What are you seeing in the international markets? Is it still very market dependent? Or is there any way to sort of say with a broader brush, hey, some of these -- our international footprint is getting stronger going into 2Q as some of these markets normalize?

I mean I would say it's more market dependent. I mean you're seeing a lot of dynamics that are -- I won't call it unique but are specific to certain markets. And that really kind of goes back to what we kind of started off talking about, and that is the effect of COVID and the effect of COVID on patient traffic. And so that is going to vary market to market. You're going to have different infection rates market to market. You're going to have different government reaction or government regulations around that market to market. The most extreme that we've -- everyone talked about is what China is doing to try to moderate that. China is a relative -- is a very small market for us, so that doesn't really hurt us too bad. But nevertheless, it's something that we have to monitor and understand what's going on. Australia, the same way, there was a little more volatility in Australia. In Europe, you have the effect of infection rates varying country to country and, again, how those countries want to react to it. And then you also have the -- on top of that, the geopolitical risk that come from the proximity of the Russia-Ukraine conflict. So those are all things that -- it's up to us to manage that. It's up to us to kind of manage through that. But I would say that it's hard to kind of paint international with a broad brush and say these are the conditions internationally. It's a very, very kind of market-specific environment.

Okay. Okay. Guys, feel free to go ahead and chat on any questions. I'm going to sort of change topics a little bit. I want to go to inflation. Believe it or not, that's top of mind in a lot of people's thoughts. You mentioned on the 1Q '22 earnings call that you've seen about 3% price inflation in total so far. I think Stanley mentioned that was across maybe the entire portfolio. But is there a way to sort of break that out between Dental and Medical? And then I think within Dental, it seems more specific to the consumable side. Maybe we can talk through some of those.

Yes. So just to kind of clarify your statement, we -- I think what we communicated was that we saw about a 3% effect of inflation on our consumable merchandise.

That was specific to the consumable merchandise?

Consumable merchandise business excluding PPE, right? So -- and that goes over both our merchandise business in Dental as well as the merchandise business in our Medical business. So I think that -- so it was primarily confined to that. And when you then took that and extrapolate that over what we think is going to happen over the course of the year to the top line, I think we said it would be about a 2% lift, right? On the equipment side, because of this lag of when we actually get price increases from a supplier versus when a customer places an order, we take possession of the equipment and then have to -- and then ultimately install that equipment, we honor that ordered price, obviously. And so on the equipment side, we won't start seeing what I'll call the benefit of those price increases until we get into the back half of the year.

Okay. Okay. And maybe just to go down to that 3%, so 3% price inflation on the merge across both Dental and Medical is a 2% lift to overall [ rev ]. As I sort of walk that back to your 5% to 8%, we'll get into this a little bit in a moment in terms of the moving parts. But price right now is a 200 basis point contributor to the 5% to 8% that you gave overall?

It could, yes. Now keep in mind we're also kind of monitoring some price decreases in gloves over the course of the year, so we have to kind of start working that into our assumption a little bit as well. So that 2% could get diminished or could get watered down a little bit by that effect on gloves.

And you didn't just stop here earlier. They talked about maybe, I don't know, the possibility of more price increases as we work our way throughout '22. Have you seen that price inflation start to subside or no? I mean as we sit here today, that 3% in consumable merch might be 4% or 5% by the end of the year.

Yes. Well, it's more erratic. So historically, the business has always been you get your annual price increase from your supplier and then pass on that price increase.

And maybe buy a little bit ahead in time.

Yes. I mean but that wasn't -- I don't think -- we don't -- we turn merchandise fairly quickly, right? So you're not going to -- I don't know if the economics always work out to do -- for us to do that. But I will say that there was a -- you get your price increase from your supplier, you pass on your annual price increase to your customer. Historically, you didn't really have those interim price increases. Now we're starting to see, in some cases, we actually have received interim price increases. In other cases, we've been -- we've gotten the signal that they're coming. So it's still -- we're still trying to pass those price increases on to our customers, and we still expect to. I think the dynamic we have to manage carefully is we want to make sure that we just -- we don't want to be kind of haphazard or nonchalant about assuming that, yes, we can just pass this on to our customers, right? We want to make sure that we're working with our suppliers. And if we believe we're getting price increases that are going to be -- we might get an adverse reaction from our customer base, we need to let our suppliers know that. We need to advocate on behalf of our customers while maintaining a relationship with those suppliers that when we think price increases are going to be difficult for us to pass on.

Have you been able to pass through the 3% to date on consumable merch?

Yes.

All of it you have?

Yes. Yes, I mean I'd say yes. Is everything 100% in life? Probably not. But it's -- yes, I mean generally speaking, we are passing on those price increases, right? But keep in mind, we haven't -- I don't think we've hit that tipping point yet of saying okay, the customer is clearly now moving on to another product. I mean we feel like we're well positioned with the range of corporate brands that we can offer to someone as well as our private label on some products that if they begin to bulk at a particular product, we can say, okay, well, look, here's an alternative, another brand or here's an alternative that's our private label.

So you're sticking with the current one right now, and maybe you're going to have a couple hundred bps come through, that's where they might start to say I want an alternative of a lower-cost solution?

Yes. I mean I think it's hard to say that they're all sticking. We don't have evidence of that seismic shift, right? And when you really look at it top-down, and this is very top-down, roughly about 9% of our revenues on a total global consolidated basis are of private label product. That mix is consistent. That's still 9%. So if there has been a shift down to private label, we're not seeing it yet. And that doesn't surprise me. I don't think a 3% price increase is going to be that tipping point. But if we continue to have these price increases, I think that tipping point gets here sooner rather than later.

It's very helpful. And let me just use is as sort of a decent segue over to your Dental Specialties business. So I still think it's a really sort of a solid hidden gem. It's a $940 million business; on a TTM, roughly $1 billion.

Yes.

I think the growth was high single digits year-over-year in 1Q '22. Maybe just to level set with everyone, when I think about that $1 billion Dental Specialties business, do I think 60% to 65% implant; endo, at 20% to 25%; and ortho, around 15% in the sort of the grand scope?

Yes, we haven't provided those specific percentages, but I will say that you have the order right. You do have the order...

With the magnitude, correct order.

Yes. And you have that order right. I mean it is -- the implant business is the largest product offering we have within the specialty products, yes.

And I had this question. You just sort of went there and touched on it. But for Henry Schein, is this inflationary environment sort of a really solid backdrop to try to push your own proprietary bag of specialty products. I know you said, Ron, hey, the breaking point isn't there yet, but costs are going up for the dentists. They're passing it through for now. Maybe they get to a point where they have less conviction and they can pass through. And hey, I'm now more receptive. Tell me about that implant product. Tell me about that endo file that may have not previously existed in a different sort of backdrop.

Well, on the specialty side, that was kind of where we were anyway, right? We self-manufacture our implants. We self-manufacture a lot of our endo products. We self-manufacture our ortho products. So those are -- that's the priority. That's the priority. I think where it might be a little different is on the private label. We might not go out there and push the private label first until we start to see that. And private label, that's not in specialty. That's in -- that's just in normal merch, yes. That's where we -- rather than lose the customer, we're going to go, well, how about an alternative, this private level.

But are you seeing the receptivity within -- sorry, with Dental Specialties, just to be clear, are you seeing -- to your point, that division had a lot of traction. High-quality, lower-cost solutions were resonating, right? With the customer base, is it even resonating more now because of this inflationary environment where they might be more receptive to try out these products? Your thoughts on that?

I think that, I mean, certainly, we're getting a lot more interest in our specialty products from the national DSOs. So we're at a lower price point than maybe some of the other branded products, so that's an attractive feature. I think if you're a general practitioner, yes, there are a number of hurdles in order to switch brand, right, because whether it's education or familiarity with the product, the technique of putting an implant in or other products in. So there are certain challenges in switching a customer from one brand to another. But it's like where there's a new customer that's entering into that space that hasn't necessarily done implantology before is now starting to do implantology or as national DSOs are sort of expanding their products and services that they're offering to customers. I think those are the easier entrants into those marketplaces.

So some of those market share gains that we've seen collectively across your Dental Specialty business, Graham, to your point, some of that is resonating the most in some of these DSO customers, they're, pardon me, I don't want to say more sophisticated but maybe a little more open to trying these products out.

That's right. And we are planning the growth with our DSO customers on the specialty side.

On the specialty side of things. And I would assume there's a long potential runway there, right? Like you still got low share to begin with, and the market's consolidating behind it, so that means the runway or the opportunity there was just extended.

That's very much so. Remember, I mean, it's not just selling the product, it's selling the support around the product as well. So we have to be able to provide potentially clinical solutions where if the customer has got a difficult implant case, we'll provide some sort of support in terms of how to plan for that implant. So it's really not just selling a product. It's selling the services and the package around it as well.

And Ron, help us out with the margin profile. I hope -- I think I've got these numbers correctly, but maybe the margin for the Dental Specialty business, mid-teens in 2020, 20% in 2021. How do we think about the margin progression in Dental Specialties? Should that continue to be the beneficiary of volume and that number could even move higher over time?

Potentially, yes. I think I've said this before. I think the biggest benefit that we get or the thing that can drive our operating margin the best is growth in sales, right? And that because there's a certain element of fixed cost, whether it be the occupancy or depreciation, amortization, et cetera, so as we can grow those sales better, I would hope that we could also increase those margins better. Having said that, for these businesses to grow, we need to invest in them. We need to invest internally at them, and we're not going to be afraid to invest in them. So we need to invest to drive some of that growth. I think that might create a little bit of lumpiness in those margins, but I really think that over the long-term trend, we do expect to see improvements in those margins.

Should that get investors comfortable that for Henry Schein 20 to 25 bps of OM expansion per annum, hey, look, I got a lot of levers to pull here? I've got a Dental Specialty business. It's $1 billion. It's growing high single digits. It has an OM at 3x my corporate. I got a TVAS business that might be growing high single digits with an OM 3x my corporate, that I could actually have some compression on the underlying supply business and still get to those margin goals because of Specialties and TVAS?

Yes. I mean I hesitate to accept compression in our base business, right? I want to at least maintain those margins. And we can do that through, I think, smart investment, leveraging our existing infrastructure, expanding into the international footprint into territories where we don't have a presence right now. I think there's -- those are all things that can give us an opportunity to continue to also grow that margin in our core business. Henry Schein became what it is because it was really good at that core distribution. It's now generating greater growth. We're now generating that growth through specialty products, through technology, but you still got to be really good at that core distribution in order to maintain those customers, in order to generate some of the cash you need to continue to grow the business. So we're not going to take our eye off the ball at the quarters.

And it's the customer relationship, to your point, that opens up the door for them to use the specialty products.

Absolutely, yes.

I'm going to throw some numbers at you. It's our model, so you don't have to sign off on it. But I just want to spend some time on PPE and COVID because where those product lines were in 2019, where they went and like the peak of at some point of time in 2021 and then where they can sort of end up going forward. So I'll start with Dental. In 2019, for PPE, 2019, and you guys have a lot of great disclosures in your Qs, quite honestly, I think those products were south of $300 million, maybe around $285 million. In 2021, we estimated those products were $680 million. Just help us on where do you see that in '22. But maybe more importantly, where do you see that longer term? There's that debate in dentistry, which is we know PPE is going to be higher than pre-COVID but still probably like well off peak. Do you accept that? Can you talk through some of those variables, Ron?

Yes. I mean there's a lot of ground to cover there, right? And I think that a lot of ground to cover there and a lot of uncertainty associated with it. I think that you have this -- you have kind of a dynamic of volatility in pricing. You have -- also have even volatility in demand. The what I'll call the usage, not demand but the usage by the practitioner has changed from the peak demand for PPE, we think that our customers are using less PPE per day just because they might not be changing out gloves and masks as frequently as they were, right? So -- and you have -- so you have the volatility in demand, some volatility in pricing. So to me, the default conclusion is, yes, at some point, you get to a level that is going to be consistent with pre-pandemic. But at what price, we don't -- we're not quite sure. And will there be -- will that usage be a little different than what it was pre-pandemic, it's to increase the volumes a little bit. So we're continuing to monitor it, but it's a difficult market to really predict and difficult to predict for the balance of '22, let alone going into '23.

Okay. I mean just a similar amount of questions that I have for Medical. I mean, actually, where it was and where it went is much bigger, right? In 2019, these products, and now I'm going to group together, PPE and COVID, $135 million in 2021. We estimate that the products totaled $1 billion. Maybe just talk to us, you updated the guidance for what, PPE, the COVID part, I mean COVID.

Yes, for COVID test kits.

That specific is going to be down in and around 20%, I think 15% to 25%.

Yes.

I mean how do we think about those 2 big revenue items? $135 million in 2019 going to $1 billion, where does that ultimately normalize and shake out?

I think it's going to be the same dynamic as what we saw in Dental. But I think that COVID test kits, like I said, we brought it down. We said we would probably be down about 15% to 25% versus the prior year. We'll continue with each quarterly release providing that revenue number. And if we have a new projection for the balance of the year, we'll provide that as well. I think that there's puts and takes in Medical because what we're also seeing in the Medical side is a really good growth in demand for other point-of-care diagnostic kits. So set aside the COVID test kits, we're seeing very good demand, very good growth for things like flu diagnostic kits, for strep diagnostic kits. These are all things that people -- when we're all wearing mask and staying 6 feet apart, we weren't giving each other strep or flu or whatnot. And we saw a decline in demand on those. Well, now we're starting to see them come back to -- I think, to a level that even exceeds pre-pandemic because I think people are more aware of like I got a little something going on here, I'm going to go see my doctor and get a test, right? So we're seeing very good growth there. So there are some puts and takes that I think that are creating kind of a net benefit, and that's what's driving some of that growth in our Medical business.

Okay. I'm going to shift to guidance a little bit. I want to try to deconstruct the revenue. It was up 6% to 8%. Now it's a 5% to 8%. It seems like price per the comments that we had could be up 3%, maybe closer to 4%. The extra week is plus 1% in change. Acquisitions and FX offset each other. I guess what I'm trying to go with this, Ron, is like is underlying volume still flat? You almost get to the 5% build on price and extra week of acquisitions and FX offset each other. I know there's some dynamic on the COVID tests, as we just speak of it. Of the 5% to 8% revenue growth, what's the underlying assumption in volumes? And is that actually closer to 0 to 2%?

Yes, I think the price number, I wouldn't put the price number as high as where you had it.

3% to 4%?

Yes, I would put it down closer to 2%. I would say 2% to 3% because -- and that has taken into consideration the effect of what's happening in the market with glove prices, right? So -- and COVID test kit pricing is actually coming down some as well. So when you factor those in, net-net, I think we're looking at something closer to 2% to 3% on that -- on the pricing effect, all in, everybody in, right?

Across all showing?

Yes. Yes. You mentioned the 1 point for the extra week. We've simply guided to about 1 point of acquisition growth, and then the balance would be volumes, gaining market share, et cetera.

Okay. And the last one I just want to get out after the 1Q number beat handily, the 1Q number view annualizes north of $5. Your guidance is $4.75 to $4.91. Your 1Q EPS in 2022 would be about 27% of full year EPS using your midpoint. And I ran the numbers pre-COVID, and 1Q was like clockwork, it was 23% of full year EPS. So maybe just talk us through like, Ron, is that conservatism in the number? Or is it just, look, Jon, whatever happened pre-COVID in your math for those 3 years is just completely obsolete and throw it out the window with today's world?

I think there's 2 things to take into consideration. I'll start with the last thing you said first. And that is I do think that the seasonality of kind of looking at Q1 and then -- because typically, Q1 was, you said, 23%. I'll -- I haven't done that research, so I'm going to buy into yours, right, this 23%. Then we would see a little growth in Q2, maybe a little flat in Q3 because you had the effect of the European summer vacations, et cetera. And then we usually got good growth in Q4, and then we would go back. I think those days are kind of I don't want to say over, but it's not as predictable. And I just think it's just the macroeconomic situation that we're all operating in, whether it be the timing of price increases, wage inflation. There are so many other things, geopolitical risks, and then we already mentioned COVID on that list, right, so then the effect of new variants, the effect of higher infection rates. So I think it's more difficult to go quarter-to-quarter. I think there's going to be an increase in lumpiness there. I do think that this particular first quarter, we can ignore the fact that we did $250 million in revenues on COVID test kits in the quarter. And we're just not going to repeat that. We're not going to have, I don't think, another quarter like that with COVID test kits in the balance of this year. And that's a contributor to that, part of that 27%.

And the conservatism?

No, I would say no. I mean...

For those reasons that you just mentioned.

Yes. I just think that I will say the range that we provided of EPS guidance is $0.16. It's -- we want $4.75 to $4.91. Typically, we had done our range to be -- pre-pandemic, we would typically provide a range that was $0.10. And I think that, that extra $0.06 really is -- really kind of illustrates some of the uncertainties that we're trying to manage in the macro conditions.

Okay. Perfect. Fair enough. Guys, thanks very much for your time. Great conversation.

Thank you.

Thanks, guys.