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

Hi, everyone. Welcome, and thank you for joining us today. My name is Erin Wright. I'm Morgan Stanley's health care services and distribution analyst. I'm pleased to have Henry Schein's CEO, Stanley Bergman, with us in person today in his first in-person conference, I think, in -- since prepandemic. And then also Ron South joining us today, the CFO. Henry Schein is the leading distributor of dental and medical products globally. Before we get started, please note that this webcast is for Morgan Stanley's clients and appropriate Morgan Stanley employees only. The webcast is not for members of the press. If you are a member of the press, please disconnect and reach out separately. For important disclosures, please see Morgan Stanley Research Disclosure website. If you have any questions, please reach out to your Morgan Stanley sales representative. And with that, I'm going to hand it over to Ron for some more riveting disclosures, and then we'll open it up to you, Stanley. Thanks.

Yes. Pardon me for reading this, but I want to make sure I get it right or our attorneys will be very upset with me. As you know, risks and uncertainties involved in the company's business may affect the matters referred to in forward-looking statements. As a result, the company's performance may materially differ from those expressed in or indicated by such 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 and included in the Risk Factors section of those filings. In addition, all comments about the markets we serve, including end market growth rates and market share, are based upon the company's internal analysis and estimates. I believe that's it.

Okay. Great. Yes, thanks again for coming. And Stanley, if you want to start out with some introductory comments, that would be great.

Thank you for hosting us. I've been doing this for 28 years, going to these investor conferences, and this is, to me, the most exciting because I'm back after 2 years and 7 months. So it's really great to be here, speak to investors in person. There's nothing like talking in person. So Henry Schein, and I'll cover it very briefly, and then we're better to go in to have time for Q&A, is the largest provider of products and related services to office-based health care practitioners, dentists, but importantly, also physicians. Now the physician part of it, in particular, has crept out of the physician office into IDNs, for example, that own practices, renal centers, cancer centers, urgicenters. So it's really a broad portfolio of alternate care providers. And of course, procedures are moving from the acute care setting and much more activity is taking place in the ultimate care setting, including, for example, the ambulatory surgical centers, the ASC. Henry Schein has had a long track record of growing our sales, internal growth is what we focus on and driving operating margins, operating profits and providing our investors with a good rate of return, turning that rate of return into cash. On the dental side, we have the largest portfolio of products and related services, the biggest footprint. We are in most of the developing -- developed world, North America, Europe, Australia, New Zealand, Japan and also growing now in the developing world with a very good business in Brazil. It's a value-added service model. Of course, distribution of products is important, but it's the programs that we have to help practitioners operate a more efficient practice so that they can provide better clinical care that provide for the stickiness and ultimately, the consistent growth that we've experienced over the years. On the dental side, we, of course, are also an important provider of practice management software and related services. In that area, it's not only the electronic medical record, which serves as the center, but the interoperability with the plethora of devices in dentistry, including imaging, the old X-ray, which is now really software. And prosthetic devices, scanners, no need any longer for impression material, all connected to the electronic medical record, which today has a number of AI capabilities embedded in that, including revenue cycle management, different kinds of programs to help the practitioner operate a more efficient practice so that they can provide the better clinical care. We're also, on the dental side, an important provider of specialty products. We have leading brands in the oral surgery arena, where we provide implants and bone regeneration products and various products around the implants. We also are an important provider of endodontic products. These are vertically integrated businesses. And more recently, a provider of orthodontic products with our own aligner brand. On the medical side, we are a leading provider of products also and services to the office-based practitioner. Today, we are an important provider of these services to large groups, whether they are groups that are owned by IDNs or maybe independently managed. And got an hour or so, ask me questions.

Thanks so much Stanley. That was a great introduction. So first of all, I do want to talk about your expectations for the year. You're now targeting 3% to 6% top line growth. That is down slightly from what you were previously expecting. But can you speak to some of those factors that are embedded, whether it's FX, PPE dynamics, COVID-related products, but also the macro dynamic too, and what you're seeing there and how you're envisioning the durability of your end markets in a potentially more volatile macro environment.

Much too specific and factual for me. Okay. Ron can you help me.

Yes, you're right. We did -- we have estimated our revenue growth to be in the 3% to 6% range. And I think when you look at the buckets of what kind of creates headwinds versus tailwinds for us. Those headwinds are really in the form of -- let me start with the tailwinds -- we have a 53rd week this year. So that's just kind of math, but that week is the week between Christmas and New Year, so it tends to be a light week. So that's about 1 point of growth for us. We believe acquisitions can add about another 1.5 points of growth for us. And then just general price inflation across the whole portfolio, on average, we think creates about 2.5 points of growth for us. When you add those up, that's about 5 points of tailwind. Offsetting that, we have foreign exchange, which we think will be about a 2% headwind for us this year as well as PPE and COVID test kits. Those are -- PPE revenues are declining related primarily to pricing and COVID test kits there's also just lower demand for COVID test kits this year than they were in the prior year. That's about a 3-point drag on our revenues. So you got this aggregate 5 points of tailwinds, offset by those aggregate 5 points of headwinds there. That leaves us with about 3% to 6% that we attribute to market growth, additional market share, volume growth in general.

Okay. Great. And then just more broadly, how you think about the durability of your end markets in varying macro environments, what you saw during '08, '09, what -- how we should be thinking about that in the current state?

Right. On balance for the whole company, the company's sales are not that elastic as compared to the economy in general. There are pockets that are elastic and there are pockets that are totally unrelated to macroeconomic terms. But in general, the business is relatively stable from a growth point of view. On the dental side, clearly, there's an understanding of the direct correlation between good oral care and good health in general. We've seen that in the debate that has just unfolded over the last year or so in Congress there is a movement to cover dental care. People are understanding that correlation and putting aside the fact that there are COVID waves going through the world. You put that aside, the underlying fundamentals are pretty good. And on the medical side, obviously, there's a movement away from the acute care setting and much more activity taking place in the office space setting is a driver for positive growth. So in general, we are in markets that are positively -- that are growing in a positive way and generally are inelastic as we compare to the macroeconomic terms. But of course, there is some impact in parts of our business. But if you look at last quarter, I think, Graham, our internal growth, if you take out PP&E and tests was north of 6%, 6.7% globally. Globally. And I think we've been in that 5 percentage area. If you take out these unusual situation in the last year or 2 in these PPE and test swings of about 5%. So internal growth has been in that range for many, many years.

Great. And so let's break down dental a little bit in terms of U.S. versus what you're seeing internationally. And during the second quarter earnings call, you did mention dental staffing constraints, for instance. How much of that was COVID-related versus macro-related versus -- and how you should think that -- or you commented that it should normalize in the second half. Is that still the case? And how you're thinking about that dynamic?

Yes. I think it's just -- it's very hard to be precise. The data is not there. But clearly, there was a staffing issue in the United States in general, relative to dentists having contracted COVID, and in particular, hygienists, I wouldn't say only COVID -- contracting of COVID for hygienists, but several of them pulled out of the market. I expect that this will return, and we will be back with staffing at 2019 levels pretty soon. We were there about 9 months ago. But these new waves, although the latest wave appears to be very infectious, it's not as acute from a sickness point of view, certainly not from a [ death ] point of view, [ healthy ] point of view. So we just have to go through these waves. You can tell -- you can read yourself with where and when these waves occur, not only in the U.S. but in different parts of the world. I think we did comment in our last call. But for example, Germany had stabilized in July. And this wave goes through. But I do think that we'll be back to 2019 levels, at least from a patient visit point of view and growing in the next period of time, hard to pinpoint exactly. I wish I had a crystal ball, but the business is fundamentally sound and there's a demand for oral care and for these medical services in the ultimate care side.

Got it. And then on the equipment side in Dental, can you speak to the willingness for these practitioners to invest in their processes? And then also any sort of lingering supply chain headwinds that you're facing? And anything you can break down between core equipment versus high-tech equipment would be helpful.

A lot of questions in that one.

Sorry.

So on the equipment side, broadly speaking, there are 3 categories. There's the traditional equipment, the chairs, units and lights. Then there's been a desire to invest in practices, I would say, going back almost 3 years. Practitioners want to have their practice, look high-tech. They want to practice dentistry in a high-tech manner. And they want for that a good chair unit with light with some electronics included, but also an appearance that is good from a patient point of view. So that market has been strong. We did have a challenge in the U.S., the #2 manufacturer pulled out. We were particularly strong with that manufacturer. And -- but we're slowly getting the capacity we need, and it still takes a while now for us to deliver product from the time it's ordered because of these demand and some constraints on parts, not as bad in this area, but the demand has been very, very strong. And I think we're getting a good share of the output, and that business has been pretty strong. And I think we mentioned in the last call, that the backlog now for the past several quarters has been quite strong and that we expected that to continue. Then there is the -- and this is broadly speaking, the whole imaging area. This area is also relatively strong, but the pricing is not growing. It's pretty stable. And the price is stable, albeit that there is inflation in the manufacturing costs. So there's pricing pressure there. The units are relatively okay. It's a good business. And then the big opportunity is the third category, the digitalization of dentistry from a prosthetics point of view, both for dentists and for dental labs. Here, the demand is growing significantly and pricing is under pressure, but the demand is -- on the stand-alone, for example, scanners is significant. We have many manufacturers, lots of new features. So if you bought one of these things 3 years ago, you want a new one now because of the new features and the connection to our electronic medical records has added and fueled demand. So overall, we're very optimistic about the equipment area. International question, people are concerned about the interest rates, but they're still very low compared to where they've been historically from an equipment point of view and the practitioners can fund them. No problem. From a supply chain point of view, of course, there are issues. On the bottom line, there are very few products other than maybe pharmaceuticals where we don't have alternatives, where one manufacturer may have a problem, but we have products from another manufacturer. So we're pretty good. Our fill rates are slightly down. They're down because if you order x product and we have a y product -- but if you ordered x brand we have a y brand for the same product, that is reflected as a backorder, but we are able to switch the customer and our general fulfillment levels are pretty good. We have a diversity of supply and for sourcing capabilities. It's pretty good. So it's not a big issue for us. Of course, we'd rather satisfy the customer with every brand they want, but there are enough substitutes available for practically everything, except, of course, for branded pharmaceuticals where it's a different story.

And are there certain subcategories where you're more exposed to that sort of switching dynamic? And what is the fact you mentioned the building backlog? Is that giving you an incremental kind of 6 months of visibility would you say is the right time frame?

On equipment, the backlog has been pretty good, and it's consistently good, maybe building slightly. On the consumables, we don't have a backlog per se, if we don't have a product, then we'll explain to the customer that it's better to switch. And there've been a couple of products, even in our corporate brand where we couldn't source, but there has always been an alternative. So there's no real backlog. I mean there is always something a week or 2 or 3, but it's not like an equipment? This is not an issue for us at any new rate.

And then specialty continues to be an area of focus for you in terms of a key growth driver. Can you speak to the size of your specialty business today, the long-term growth rate you anticipate for the business in those the key drivers that are supporting that growth.

Our specialty businesses today, which are implant -- oral surgery implants, bone regeneration and some other products around there, our endodontic offering, orthodontic primarily, it's a small business in the Reveal aligner field. And in some -- small at this stage, medical that's vertically integrated specialty businesses. It's about $1 billion. And then on top of that, there's another $600 million or so of practice management type services and another [ $100 million ] or so in specialty services that we've categorized. We're about $1.7 billion, I believe, this now accounts for 35%, 36%, 37% of our operating income. It's grown as a percent quite nicely over the years. It's a small percent of our sales, $1.7 billion over to $1.3 billion, but -- over $13 billion in sales or so. But we expect this to grow, grow in profits and grow in proportion to our total operating income. We've indicated, I think, low single digits to low double digits and growth of specialty...

Kind of high single lows, low doubled digit.

That's not internal, that's in total. And although there's no guarantees, we're very optimistic that we'll be able to make some acquisitions in that field that should be supportive of that number or even take it a little bit higher.

And then I'll get to technology as well as medical in a second, but since we're talking about dental, I did want to ask about the Midway acquisition and that seemed logical, a logical tuck-in for you. How many of those are there out there for you to do given your size and scale where you are today, but that one seemed to make sense and what is the M&A pipeline like for you?

I can't tell you how many are out there because our competitors would love to know that. I mean it's not a street issue, but our competitors would like it. Look, our acquisition strategy has been a key part in our growth for the 28 years given that we've been a public company. We've continued to focus in this area. And I think we're pretty good at picking investments, integrating them, integrating the team that comes along -- and yes, tuck-ins are a part of it. Geographic expansion on the distribution side is a part of it. But a real very important part of this is in the specialty areas on the vertical integration side and on the specialty services. So I think we can expect that pipeline to continue to grow. But obviously, there's no deal until the ink is dry.

Great. Okay. And then alongside the M&A strategy, you have recently announced our preliminary announcement of restructuring. There's been a few details on that. But how is this restructuring program going to be different from your most recent restructuring program, which was actually relatively recently in 2020? What is it in terms of size and magnitude relative to what we've seen historically?

Yes. We'll be able to provide us more estimates around the restructuring process that we have in place now when we release our Q3 earnings. But I do think relative to past restructurings, this one is very focused on kind of our global footprint, right? I mean it's -- we did a lot of acquisitions in 2021 as we integrate some of those businesses as we look at our use of office space, what opportunities might we have to reduce the amount of office space we are using. So this is very much an approach from a global footprint review and where can we begin to kind of reduce workspace, whether it be operations or whether it be back office, as well as how can we just -- as we integrate the new businesses, do things more efficiently as well.

You anticipate you'll be giving guidance for 2023 during your third quarter conference call?

We expect to provide at least preliminary guidance at that point. A lot of this depends on the macroeconomic conditions that are happening. But yes, we would -- we do expect to provide preliminary guidance as part of our Q3 release.

And hopefully, an Investor Day in 2023, right?

Yes, we are projecting early 2023 for Investor Day as well.

Excellent. I do -- our clock turned off up here, but I think we still have time for some questions from my audience as well. So I want to make sure that we do give people an opportunity to ask a question if they want to. But in the meantime, can we talk a little bit about medical since we didn't touch on it. So can you talk about -- I mean it's still pretty strong growth even excluding kind of PPE and COVID testing. What -- how should we think about the long-term growth? What's driving this underlying growth? Is it market share gains? Is it something else that's a key driver there? And yes, how we should be thinking about it from a modeling perspective?

Yes. I think you can expect for this to be a strong part of Henry Schein's growth. I mentioned actually a couple of times today, the movement from the acute care setting to the alternate care setting and the increase in activity in that setting is driving activity, more activity leading to more suppliers. I think we continue to gain market share in that area. I would say that 15 years ago, even recently as 10 years ago, we were known as a very reliable provider of products to private sort of practitioners -- that's long gone. And the big IDMs today, many of them have tried to service their office space practitioners on their own. We've gone to the big med-surg suppliers or even the drug wholesalers, the service they need. I've realized that the kind of service we offer is very unique where we provide med-surg products, pharmaceuticals, various kinds of instruments, et cetera, all in one delivery, whether it's an actual one box or it's the virtual delivery of 6, 7 boxes arriving together, enabling the practice to be on a virtual -- on a stockless inventory method. That's paid off. And I think our brand in that market does very well. I would say that on most bids of any size, you'll find 2 serious contenders. We are one of them and we win a lot of these awards. The infrastructure we have is very good. We -- it's a profitable part of the business. We do very well with our corporate brands, but I also think that manufacturers understand the value of working with Henry Schein in advancing their brands and whether it's consumables or it's the testing -- I'm not talking about the COVID testing, the various kinds of testing activity, the lab testing that goes on in the office. We are known as a very reliable provider of services and goods. And of course, we're a very important provider of vaccines and other pharmaceuticals in that area. It's the extent to the offering and our credibility in the marketplace that has advanced our brand in this area. And we do quite well in this marketplace.

Great. And then on tech and value-added services, should we think about this as a double-digit growth segment for you longer term?

I can't tell you what I think I have to ask, Ron, what he has told [ TheStreet ].

No, yes. I mean it is a -- we believe we can continue to be right in that kind of low double-digit range. And that may include some acquisitions along the way in order to achieve that. But, no, that is a key focus of our growth is in that technology and value added service.

The extent of products that we offer, the value that the IDNs see in our software, there are many providers of software in our space that offer a piece. But the overall offering of everything, we are highly regarded because integration and interoperability are more and more important. It's not just a matter of the accounting services. There's a clinical integration. And I believe that we're highly respected in that area and the demand for those services from IDNs to smaller practices is growing.

Great. And then from a margin perspective, how should we be thinking about your normalized annual margin expansion type of target for you? And can you parse out the key drivers of that across both, I guess, distribution and technology?

We gave our guidance, and we affirmed this guidance as part of our Q2 release is that we were projecting growth of operating margin at 20 to 25 basis points, which of our non-GAAP number last year, operating margin was 7.06%. So 20 to 25 basis points off of that would get us to that 7.2%, 7.3% range this year. That is being largely driven by growth in our gross margin, which is, I think, as we accelerate growth in our higher growth, higher-margin businesses, such as technology value-added services and of our dental specialty products, those are contributing a greater gross margin, which allows us to kind of reinvest in the business a little bit below the line, but still achieve that operating margin expansion. So that's the churn that we're trying to continue to achieve going forward as well.

And just one last one on -- there's a question out there. One last one on just general utilization trends going back to dental, consumables growth. There were a lot of moving pieces in it in the second quarter. But how should we be thinking about the quarterly progression from here for the balance of the year? And any sort of dynamics we should be thinking about as we head into kind of 2023?

And by utilization, you're referencing patient traffic trends or...

Anything you can comment on patient traffic trends and also how that relates to kind of consumables growth for you?

Yes. I mean, obviously, we can't -- I don't want to comment on patient traffic trends beyond what we've said as part of the Q2 release, but there are some public data out there, that comes with the ADA and elsewhere in terms of what they're seeing. And I think -- I think we're seeing some stability in patient traffic. And it's like I told people the other day, the -- there were ebbs and flows in patient traffic prior to the pandemic. And I just think right now it's really under the microscope because we're all trying to figure out, our people back -- our people going back to the dentist. I think that the capacities and what we're seeing in terms of the fill of the appointment book with our customers tends to be fairly optimistic. So I think it's just an area that we have to continue to look at the patient traffic, but we can't necessarily look at it and say that's the only indicator of what we're going to see in utilization.

And it's so regional dependent. You can have a particular region in the U.S. that is down 1 month, up 1 month. The level of instability because of COVID is quite a range across the world.

Okay. That's fair.

I wish we could give you a precise number.

Thank you so much. I really appreciate the time. We're at time now, but I appreciate it. Thank you.

Thank you.

Thank you very much.