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

My name is Jeff Johnson. I'm senior medical technology analyst at Baird. Our next presentation this morning is from Henry Schein, the largest distributor of health care products and surfaces -- services , I'm sorry, to office-based practitioners in North America and Europe. With us today from Schein, we're very happy to have CEO, Stanley Bergman; and Chief Financial Officer, Ron South. Stanley, I'll turn it over to you for a few minutes if you have some prepared remarks, and then we'll go into Q&A. Thanks for joining us.

Thank you, Jeff. Before we start, Ron, do you want to say something?

Yes. Just -- obviously, we're in a quiet period. So regarding any kind of forward-looking statements, I'd simply refer you to the safe harbor language in our SEC filings. So I'll leave it at that. That keeps our journey happy...

Thank you, Ron. Jeff, it looks like a pretty educated group here. I'm not going to go into the whole story of Henry Schein to give you and the audience time to ask questions. Essentially, Henry Schein is a lot -- as was pointed out, the largest provider of products and services to office based practitioners, dentists, health care practitioners, physicians, renal centers, cancer centers, [ OG ] centers, et cetera. There's a movement of procedures on the medical side from the acute care setting to the office setting and the various kinds of the alternate care settings. And clearly, there is a growing awareness of the importance of oral care in the continuum of care. These are trends that are baked into, I think, the future of dentistry and the alternate care physician, medical markets we serve. There have been some bumps in the road because of the wave of COVID going through the world, as it goes through a particular part of the world, periodically. Patients don't go to the dental offices and dentist stayed at home a little but take care of themselves. There's also been some [ occasional ] issues that have been more profound in certain parts of the world, particularly in Europe. But generally, these are good markets, full employment is good for dentistry. Lots of puts and takes. I think the key part of the Henry Schein story, Jeff, is that, yes, we are a key distributor of dental and medical products, but there's much more to the Henry Schein's story, which includes specialty products that we own brands, vertically integrated and specialty services from practice management software to electronic medical record and related interoperable services, all the way to specialty services. We expect that these businesses, high margin, high growth will grow as a percentage of our operating income over the years to come. We have a plan designed to achieve that. And Jeff, with that in mind, let's get into specifics.

Yes. No, that's great. So I want to come back and really focus on some of those specialty areas and the technology and the value-add side because I agree, I think that's where the future growth will come from. But let's just talk maybe a little bit shorter term just for a second. I've lived through a couple of these cycles. I think you'd probably lived through a few more these cycles. But how do we think about dental -- the outlook for dental consumption, dental demand, dental end markets; however, you want to think about it over the next few quarters in this macro economy? And maybe if you can compare kind of in contrast if there's a U.S. versus European different slant on that?

Yes. I wouldn't be able to give you a view on the next few quarters, I think that's something beyond, I think, any of our capabilities because there's so many variables. But generally, I think the trend is good. If you look at the equipment, which is a good indicator. I think there is a demand for this equipment, whether it's the traditional equipment. Yes, there's a backlog in installation because there's a shortage of capacity, but also a little bit because of the construction delays. But overall, I think the equipment market, traditional equipment is quite strong. Dentists are investing. There's a concern with interest rates, but these are relatively low rates compared to maybe 5, 6, 7, 8, 9, 10 years ago. And so I don't think the rates are going to impact it. There's a genuine demand for this equipment, traditional equipment. Imaging equipment is also quite strong. Having said that, the price is going down, talking about x-ray, what we used to refer to as x-ray. And the whole digital revolution from scanners to chairside mills to 3D printing to converting the dental lab from an auto zone environment to a digital lab production machine. All of these are good trends, and I think the equipment seems pretty positive, Jeff, in the United States, in Canada and in fact, Europe and globally. On the consumable side, there's so many variables. I think the demand for units likely will be okay even if we -- the economy goes down a little bit, but there's many variables in the pricing. There's a switching from one brand to the other. Some extent, there's a switching to private brand. So it's much more a nuanced response than the economy changes and therefore, the sales of consumables going in one direction or another.

Yes. Yes. And maybe on that consumables point, I guess, 2 follow-up questions. One, Ron, for you. Just where do you think the level of pricing is right now as far as kind of a year-over-year tailwind you're seeing kind of more broadly across the consumables portfolio? And where do you think that could go next year? Not asking you to speculate, but Stanley, I think for you, what's interesting, the most recent ADA survey, I think, really highlighted this. And it's rare that we get someone of your steam and the history here. So your view on -- the dental industry has been interesting over the past decade in that these dentists just have not seen their reimbursement go up a whole lot, and now they're seeing their practice expenses go up and maybe volumes be impacted by the macro. Is there something that has to change in the industry here for dentistry to be a good profession for it to be a good return for these kids going to school and coming out with $200,000 plus probably in debt? So one pricing, Ron, for you specifically, but Stanley, I'd love your view on this...

I'm going to respond to this, while Ron thinks of the price because his calculator has to work a lot more on this. It's a very specific question. Look, I want to be very careful because this is a hotly contested debate within the profession. So I don't want to take one side or the other. But it is clear that there's a growing demand for oral care and the capacity is not quite there yet. Capacity will have to be built up, and there will have to be some formula of adjustment to price versus volume as there has been an adjustment on the medical side for the past 20 years and specifically after health care reform when more services were provided and pricing got adjusted. My personal view is on Henry Schein's view is the demand is there. And if the profession doesn't adjust, the government will adjust because there is a demand for oral care. There's no question, whether there's a demand for the highest-priced implants or not, that's a different story. But for basic oral care, seeing a primary care dentist and getting basic oral care services, specialty services, the demand is there, there's been pressure from Congress to advance access to oral care. I'm talking about the U.S. now. And that will find -- there will be an answer, whether it's the profession that you adjust or the government that adjusts. What this means for us in the industry is it's going to mean more units used. Having said that, we'll have to become more efficient just like we are on the medical side. Our medical business does very well from a units point of view, from a pricing point of view and from a profit point of view. But that profession went through a lot of changes over the last 20 years, but specifically through the IDN movement in the last 10 years or so. And dentistry is heading in that direction. How it turns out? And who wins? I don't know, but I believe that younger dentists are prepared to see more patients using technology and will be okay with a bit lower reimbursement but this is going to have to play out. This is my personal view, not Henry Schein's view.

Yes. And I think what you're weaving in there in your discussions and tell me if I'm wrong, is the thoughts around potential Medicare expansion to seniors, maybe some increased Medicaid coverage, also the evolving trend towards DSOs. I think your answer was kind of weaving in all of that. And I think that all makes sense. From a commercial payer perspective, and I know, again, a hot topic, these commercial insurance companies have not raised an impact for many services have cut their reimbursement rates over the past decade. How does the average dentist who wants to just hang a shingle out in practice as a solo practitioner or a group practitioner, how do they survive when their costs are going up or flourish when their costs are going up and these payers are cutting reimbursement rates?

I don't want to be facetious, but the answer is see Henry Schein sales consultant literally because we have the tools. We have legitimate Medicaid practices. All they do is the Medicaid services, and they do okay financially. And they're 100% legitimate. They're not missing around with reimbursement. It's got to be efficiency. This is not a dental issue, Jeff. If you look at any of these -- yes, you're in the city now, go down and why you go up to Cornell, look at their medical practices, they become very, very efficient. Software methods of dealing with the electronic medical record, connectivity to devices. The tools are there, we can make a practice more efficient and provide better -- to give the tools to the practitioner to provide better clinical care, but the game has changed. It's not -- however, you want to practice your dentistry, you've got to practice high-quality dentistry using the best tools possible and digitalizing your practice. We have that -- those tools, and that's why we are so optimistic about dentistry because we believe the next generation of dentists is prepared to adjust, see more patients and use tools.

And that's a great segue into your tech and VA, but Ron, I'm going to go back to you on the pricing.

I'm not going to state the pricing, Ron.

So on the pricing, when you look -- like what we've talked about earlier in the year was that price inflation really is largely a factor in our consumable merchandise piece of the business in dental and to a certain extent in medical as well, obviously. And we have disclosed that we had -- we believe we have about a 3% to 3.5% kind of lift in pricing on the merchandise side when excluding PPE. And I'll talk about PPE a little separately, right? We really haven't gotten any indication yet from manufacturers in terms of what they believe their price increases will be next year. And as I've said before, we do our best to manage those price increases to the extent we have to pass those price increases on to our customers, we do, but we also are able to offer our customers a broad range of alternative products to the extent that pricing gets too high on the specific product that they have historically been buying. And that might mean shifting them to another national brand of a similar nature that is of a lower price or to our private label products if, in fact, it is something that is -- that suits their needs. So we feel like we have a portfolio that helps us address the -- any price increases, which may turn out to be burdensome to ultimately to our customer. We try to help them with that. Regarding PPE, and specifically gloves. It's no secret that glove pricing has been coming down from some peaks in kind of mid last year. If you look at our PPE revenues as a company, going back to prepandemic when it was a little north of $400 million in 2019 to last year, we disclosed that our total PPE and COVID-related revenues were about [ $1.7 ] billion, but about $500 million to $600 million, at about $600 million of that included COVID test kit. So PPE would be kind of $1.1 billion, $1.2 billion. That's largely price driven. There was obviously some volume increases over the course of the pandemic as well. As we see that pricing on gloves come down, our costs are coming down, but so are our prices. So that kind of is impacting top line. We've been able to protect those margins fairly well. Where that is going to find a landing spot, we're not sure yet. I think we're still going to see some ongoing price declines based on what others are seeing in the industry in gloves. And that's something we just continue to manage. But -- so it's -- that is a -- there's different dynamics there. You have parts of the merchandise where we're seeing price increases and then a large part of our consumable merchandise that being gloves, we continue to see price declines, but we also see cost declines. So we're protecting that margin fairly well.

Yes. And I want to follow up on that point, just conceptually how to think about how that rolls through into 2023, and I know you haven't guided '23, but maybe some high-level questions there in a second. But Stanley, I do want to go back to that technology and the value-add side. I think it's probably one of the more underappreciated growth potentials in your business. It's about 5% of your global revenue, but it is 10% of gross profit, 15% of operating dollars. How would you expect that business to hold in this kind of operating environment? What's your growth outlook over the next 3 to 5 years? I think a few years ago, Tech and VA may have been as high as 18% or 19% of operating profit, but obviously, you've switched over to some SaaS models, some cloud-based stuff and that has resized a little bit. Just how do you think about kind of the growth in that business over the next few years?

I don't know the numbers, right, it's 18%, I don't doubt your numbers, Ron, may recall that. But I will say that I think our sales in this business have consistently grown 10, 15 years. Having said that, there is a movement from a sale to SaaS model, which in the end, does provide very good, stable margins. And from the practice management system, from the electronic medical record, there are many services that we sell related and interoperably connected, including connecting to our various devices. This presents a huge opportunity. Specifically, the younger dentists want to interoperability, but second is going to be required to service the demand for dentistry at controlled reimbursement pricing.

Yes. where do you see uptake of those products the most? Is it the private and smaller group practices? Is that mid tier DSO or group that wants to become a bigger DSO? Is it the large DSOs? Who primarily looks to you for those kind of back-office support systems.

I think it's across the board. What we offer is a little bit different depending on the size of the practice. But the very large DSOs, I mean, I think it was an announcement of one of them bought a lot of scanners from us. We don't just sell a scanner in the absolute. There's a reason why scanners are bought from us beyond price. And that relates also to the interoperability to the software services we provide. So it's across the board in terms of where we provide these services is just the slightly different emphasis depending on the size of the practice.

Okay. And Ron, I guess, on that point, I think whether it was 18% or 19% a few years ago, it is 15%, I think, in the past 12 months or over the -- in '21, I forget where I pulled that number from. I mean, can that go to 20% of operating profits over the next 3 to 5 years? Can it outgrow the rest of the business by that kind of margin or by that rate?

I think it can outgrow the rest of the business. I think some of the shift you're seeing there is kind of a change in the mix of value-added services that we've been able to add to that segment, right? Most recently, a revenue cycle management investment we made in a company named DSO, which has been very popular with practitioners. And I think a lot of it is a lot of what you were talking about earlier, Jeff, in terms of the dentists to the extent they're not getting the increase in reimbursement from the insurance companies. They have to get a little smarter on running their business. And that's where these value-added services can really help them. The revenue cycle management to the extent it can improve their cash flow, very, very important to them. So it is -- while they are being -- they might be getting a little squeezed with increased expenses and not getting the reimbursement increases, we find a greater demand for some of these -- whether business analytic tools, revenue cycle management tools that we can offer them through that segment.

These are fast-growing businesses, Jeff. We invested in eAssist but year changing and the demand for those services are through the roof. And this is basically how do you make sure that you build the right way and you get the maximum reimbursement for what you're entitled to receive.

I mean there is no secret on the revenue cycle management side. A lot of the problems originate with errors in the original claim submission, right? So just working through that process so that they don't get a claim kind of hung up, and then it's just that much longer to get your cash. And this goes from the individual practitioner to the national DSOs. These products are of interest, I think, across the board regardless of size.

Yes. Okay. Okay. And maybe, Ron, help us think conceptually again about the setup as we move into next year and again, with all the disclosures of you haven't provided guidance at this point. One, I mean, would you expect on the third quarter call, historically, you have that changed a little bit during COVID, but historically, you've provided guidance -- forward year guidance on the 3Q call?

Yes. Last year, we provided some preliminary guidance in Q3 as part of the Q3 call that was really a range of growth we were targeting for -- off of the full year. And then when we did our Q4 release, we provided more details around that. That's why we provided specific range. I think that, that approach will be -- that we did last year could likely be similar this year.

Okay. And if I think kind of over the next several years, conceptually, I think would you push back at all if I think of you as a kind of 4% to 5% or 3% to 5% organic grower, obviously, some tuck-ins a little bit below the line, whether it's buyback or debt pay down or something and then kind of an upper single-digit EPS grower. Is that how we should think of your business?

Those probably aren't unreasonable assumptions. I think that we'll be able to provide greater color around that. We do plan to have an Investor Day in early '23. We're kind of targeting late February, early March, and we'll be able to provide some more details on longer-range growth at that point of time.

Okay. Okay. And then what I do want to push on a little bit is sofa. If my upper single-digit EPS, maybe it's even, let's call it, 8 to 10 or something like that, if that's a normal year, macro might mean next year isn't quite a normal year. You've got a little bit of currency headwind in there. To your point, PPE coming down. And I think there's one other thing that...

COVID testing.

COVID testing coming down, currency headwind, like I said, if I didn't say that. As I kind of put -- oh, you had an extra selling week this year.

This year, correct.

That you'll have to comp against next year. I mean conceptually should next year be less because the Street is kind of modeling you, I think right now in kind of that 6%, 7% EPS range, I struggle to get there. And over the -- I've covered dental for 20 years and maybe I'm $0.05 off the street or $0.08 off the street. I'm like $0.30, I think, below the Street on you guys next year. And I'm trying to figure out what the disconnect is between kind of how I'm viewing a few of those headwinds to your bottom line versus how it seems like everybody else on the sell side is.

Well, like I said, we're going to provide some preliminary guidance as part of our Q3 earnings release, but I do think that there are a lot of moving parts. I mean whether it be PPE pricing, whether it be just general macroeconomic conditions, what's happening in terms of the demand on dentistry. There are a lot of moving parts out there, but it's up to us to kind of manage our way through that and deliver the growth that we believe we can deliver.

Yes. And Stanley from where...

We have delivered mid-single growth -- internal growth, local currency for a long time. There may be one quarter that was 4%, another quarter -- like last quarter was 6.7%, if you leave out PP&E and testing. So it's been a consistent grower.

Yes. No, that's what I have appreciate...

That's how we manage the margins. We will give you ideas of where we're investing and...

Yes. And you do it, the restructuring program you announced last quarter that obviously could help in there, too, and maybe I need to take that into better account. I'd agree with that.

I'm not saying your numbers are right or wrong, though, you'll have to wait.

Yes. Understood. Understood. Well, let's -- I guess, Stanley, from where you sit today, talk to me about kind of your comfort on where the business is competitively where the industry is, kind of bigger picture, secularly, things like that? Are you as bullish as you've always been on kind of dental and Schein's ability to win in this market?

I'm as bullish as ever. I'm not giving guidance for next quarter. I may be better, maybe worse than what you're thinking. I'm as bullish. I think we have -- we're in great areas. Oral care is a great area and the movement of procedures from the acute care setting to the alternate care setting is a great place to be. We don't feel that the Animal Health strategy was part of this because we wanted to just focus on prevention and wellness. And those are great areas to be. And I think we've got an outstanding management team from where I'm sitting. All the major seats are filled, and we're very happy with the team. We got a great transition on the financial side, we have a great transition on the infrastructure side that took place 3 months ago. Great team, each of the business units are well stocked with management. So a great market, great team and we've always been able to transform the company, Jeff and deal with the issues in a moment. We're a consistent grower, and that's what investors are looking for. That's us.

No. Understood. Ron, I want to go back. You just announced a small deal a couple of weeks ago, the Midway deal. I think a nice tuck-in acquisition for you guys of decent size, but also just a company that had been out there and had been well known, I think, for going after some of your sales reps, some of the Patterson sales reps over the years, things like that, so nice to bring them in-house at this point. You did talk about that deal being slightly dilutive this year. Our understanding is Midway was reasonably decently profitable. So what's the disconnect there? Is that just amortization or something else in there?

Well, I think there are some integration costs that will be factored in. That is a fold-in. So there will be some activities in terms of whether be closing some distribution facilities or otherwise as well as while we're bringing a lot of their reps on to our sales force, we're not bringing all of them. So there is some onetime costs associated that's on a GAAP basis, it will be dilutive. But I do think that it becomes accretive really on a cash basis fairly quickly for us. And I love the transaction, quite frankly. It's a kind of transaction that's -- for us, it's complex operationally in that, we need to make sure that we transition the fold in efficiently, but it leverages our existing infrastructure. It allows us to really -- there's some outstanding kind of sales reps and some opportunities that we can learn from there. We're bringing on a couple of members of management, including the founder, who is very talented, and we think it's somebody who we can kind of learn from in terms of serving that mid-market a little better. So those are all things that we see as big positives for that. I've said before with the distribution businesses, we talk a lot about our capital allocation being skewed more and more towards the technology businesses and the dental specialty areas. But if we can do this type of transaction and distribution like we've done, I really like that as well as internationally, when we can expand our footprint. We recently invested in Switzerland. And we didn't really have a core distribution business in Switzerland. So it expanded our geographic footprint there. So those are good distribution investments for us to complement where a lot of the allocation of M&A is going to go in terms of technology and dental specialty products.

Yes. It feels like a 2005 transaction or something like in a day where...

It was a little retro.

Yes. All right. So last topic, just Stanley, I wanted -- and we've got 45 seconds. But -- it seems like the international DSO opportunity is starting to flourish and grow a little bit. Just any high-level second thoughts here on kind of your ability to compete and how that could help the business over the next few years.

Yes, I think, Jeff, it is growing back in several countries, and it's growing from a pan-European point of view, and we're starting to see some global DSO transactions. This is what we thrive on. There's no one that has the capabilities to advance the DSO space the way we have and infrastructure is great. And there's always somebody a competitor saying we're going to invest more in DSO. This, we're going to do that. We just move along and do a little bit of research and find out why DSO come to Henry Schein.

Yes. No. As the only pan-European distributor -- dental distributor, I would assume you should be in a good position there to take that lion's share of that market.

I believe so. Yes, we can't sit back and just assume it's going to come to us. We have to work hard. But it's also more than that. I mean it's global, one of our customers acquired a decent-sized DSO, U.S. customers in Canada, Australia, New Zealand DSOs are coming together, maybe even jump to a different part of the world too. So we work with these DSOs, and it's -- we bring them a lot of good knowledge, there's much more than shipping a cotton ball.

Yes. Understood. Well, great. Stanley and Ron, thanks for such a wonderful overview of Henry Schein here. And as a reminder, the next presentation is set to begin at 10:50 a.m. include Catalent in this room, AMN Healthcare Services in Ballroom A, Vor Biopharma in Ballroom B and Innovia in the Morgan Suite. Thank you.