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

Guys, we're going to get going and jump right into things. Fortunate to have Henry Schein with us, the biggest global distributor in the world. Stanley Bergman, CEO; Ron South, CFO and Senior Vice President. Let's hit on a lot of different topics. Let's get right into things.

And really what jumped off for me so far this year throughout the 3 quarters was the very solid growth, we call it LCI growth, ex PPE and COVID, mid-single digit, mid-single digit-plus. Stanley, maybe that's a good starting point. What have you seen with the end markets? What's volume versus price? And what do you see on the horizon?

Right. Well, that's a lot, that's a whole lot of questions. So I mean, the markets are relatively stable. If you look at our overall sales growth exiting out PPE and the local currency, it's 6% or so. But we've been in that 4% to 6% a little bit higher range for a long time. And yes, I think some markets goes down a little bit. Other goes up, but the markets are relatively stable. Each market has some challenges. But I think for the portfolio we have, it's relatively stable. In the United States and Europe, of course, the FX is an issue. But [indiscernible] busy, there's a clear understanding that there's a direct correlation between good health care, good oral care. And of course, the dynamics in the medical business are quite good in that there are procedures growing -- a great number of procedures moving from the acute care setting to the ASC to the physician office now to the home. And so I think the overall dynamics are pretty good.

And when we think about the LCI growth of 6% to 8% and to your point, maybe it had been 4% to 6% in the past, it seems like price is playing a little bit of a bigger role. Ron, what's price been year-to-date, maybe 3% to 5%, 4% to 5%? Maybe that's question one. And then just to stick with my multipart questions, how about 2023? And how do you see that evolving? Are we going to see a similar amount of price in '23 as we have in '22?

I'll answer the '22 piece first. I mean, yes, I mean, I think that there are different segments of the business that are seeing price increases and especially on the merchandise side, whether it be in dental merchandise or on the medical business. We haven't really seen a lot of price increases yet in equipment because of the lag of when that equipment gets delivered -- ordered and delivered, right? And we'll begin to see the effect of some of that on the equipment side as we get into 2023, I do believe. There's parts of the business where we've seen deflation, gloves being the biggest -- I don't want to call it a culprit, but the biggest example of that. Certain high-tech equipment has seen price decreases around scanners and a few other things. So net-net, yes, we do believe maybe we're getting -- when all is said and done, across the board, about a 3% bump from price, but it can be a little higher in merchandise ex PPE, a little lower in other parts of the business.

And so leaning into that a little bit for 2023, is it something where -- when you said 3% more on merch -- on dental merch, does that come down a little bit in '23? And does the price around equipment go up because of that lag dynamic that you just alluded to?

Yes. I mean that's one of the variables we're trying to get our arms around a little better, right? I mean we're kind of working with the manufacturers now. This is when we can start talking a little more about what do we think prices are going to do next year. Historically, this has been -- you kind of had your price increase at the beginning of the year and you got on with it. Now this year, we've seen some interim price increases during the year from different suppliers. So those discussions regarding next year are kind of in process as we speak.

Okay. And your basic concept is right. It's the number, Ron is working on with the team. Yes. But the trend is right.

Okay. And certainly, you guys are in such a unique position where you're the biggest global distributor. You also have a massive specialty portfolio, we'll get into that, almost $1 billion run rate. If the manufacturer, some of your partners are taking aggressive price increases, you have the ability to also go in with your own portfolio. Talk to us about that dynamic. And is it really an interesting opportunity for you to capitalize on your specialty portfolio because you can give the dentist more options?

There are 2 separate portfolios. One is the distribution where we distribute branded manufacturing -- manufactured products with the components of private brand. And then there's our specialty products. In those, we're an innovator, and we're selling based on brand. In each one of those businesses, we've got a pretty good market share. So orthodontics is not so good. We're growing. The liners are growing, but it's very small. But in each one of those areas, on the specialty side, we're selling based on our own brand identity, and those areas, we're growing and we happen to be at good price points. On the distribution side, it's a careful balance because at the end of the day, yes, we can't pass on the price increases to our customers that we receive from the manufacturers. Having said that, we have to also advocate for our customers. And when particular manufacturers go a little too high, we do provide our customers with alternative brands, and we do offer our private brand where appropriate. But still a significant percent of our sales are from national brands, and we never want to be perceived as pushing our own brand over the national brands. So we're very careful. It's a careful fiduciary balance between our manufacturers and our customers.

And maybe one last one down this road and then I'll move on. From a pricing perspective, are you seeing those price increases from the manufacturers start to subside? On Dentsply's call the other day, we heard they took in October, but they usually take in October. I think Envista alluded to price playing a bigger role in 2H than 1H. Is it still the same trajectory? Has it gotten even steeper on price? Are you starting to see some of the price increases beginning to mellow out a bit?

It's hard to give you a generalization, but I think manufacturers, many of them, and you'd have to ask them individually are starting to realize that they may increase the price but doesn't necessarily stick.

Okay. So maybe we're sort of a peak there and that whole price versus...

It could be. It could be. And I think it's in line with the general consumer trends, However, I think a couple of the manufacturers may have gone a little bit too far in 2021, early part of '22. And they're realizing it.

And one of the thing that I wanted to discuss with you guys and you started off the conversation, Stanley, by asking how long I've been following you guys, and I said 14 years. I've never been a little bit more confused in dental on capital equipment trends, right? So when you look across -- and I've got some notes here, but there's just all these conflicting data points. Our lines systems and services business was down, the scanner business was even down more. Envista had a tough imaging quarter. X-rays' E&I results were arguably good. Straumann had good scanner sales. You guys put up 12.8% North American dental capital equipment? What's going on? Why are we seeing all these conflicting data points? And maybe more importantly, what you're really seeing on the ground day in and day out.

I split it into 2 but we -- at least the way we think of it, what we call traditional equipment. We coined that phrase about 15 years ago. Some manufacturers use that; others, don't. Some analysts use it, other don't. That's chairs, units, light. That's a good business in this country, abroad, it can be lumpy, but it's grown constantly for us. We believe the brand selections we have play a big role in that. The customers we have, I think we work well with the midsized practices, the smaller ones. And the DSOs, they are investing and they have invested with us. So that's a solid business with some issues with manufacturing. We were able to get product. May be some of the brands were a little slow. But right now, we can get product. The biggest challenge there, of course, is that in a number of parts of the world, I would say, particularly in the U.S., there's some construction delay. So it's not gotten really much better, but it is an issue. It's quite a bit of an issue. It's gotten maybe a little better but not much better. And then the confusion is the digital. And so the -- today, imaging equipment is not a big piece of iron. It's software and it's largely digital. That market has -- the growth has been reasonable, but there is some deflation because there's quite a few manufacturers out there. So we give numbers generally in our calls on that part of the market. And the units are okay and -- but there's a lot of manufacturers. So if one manufacturer is having a bad quarter, probably they lost the market share to someone else. It's not a troubled market per se. Price, a little bit down. And then you've got the digitalized prosthetics, the scanners. And there, the market has not always been driven by sale. It's been -- there's been all sorts of bundling activities. And I would say, I don't want to talk about any specific manufacturer, but when you find some of the specialty products, manufacturers having some challenges, they give them away and more of the stuff. So that may result in units being okay but the sale's coming down. That's never been an issue for us. We sell. But I will say that there is good competition today in this field. There are many manufacturers, and our customers can get a good deal. And our units have been pretty good, although our pricing has been somewhat down. And the mills have been relatively static. And then the lab field can also be a little bit lumpy. We are the largest provider of dental laboratory products. And some quarters, we do some big sales in laboratory equipment. And other quarters, we don't.

And maybe just, Ron, to take Stanley's comments over and try to think about the P&L, when we think about your North American dental equipment, is there a rough weighting, call it, traditional versus high-tech? And then are there even some growth rates to maybe put some framework around that?

Yes, the weighting is -- it's roughly about a 2:1 ratio traditional to high tech, right? And I think that you were probably seeing a little better growth in traditional than high-tech because of some of the pricing pressure in the high tech. And we're getting good volume growth, I think, in high-tech, but the pricing pressure is keeping it where the growth is not as extensive. But I said, like with the high-tech equipment, there's often a return on that, right? I mean it's -- and as that price point is coming down a little bit, the practitioner can see that it becomes a more attractive price point. There is a return on ROI, I think, as they invest in some of that high-tech equipment. If it allows them to see -- even if it allows them to see a few more patients over the course of a week, it may -- there's a return for them. So that price point, I think, is helping keep the volumes to be fairly stable.

So the consumer is now asking for it.

Yes.

If you've been -- had an image -- an impression created as a result of a scan, you will never go back to a dentist that's giving you...

I've been there with the old PDS impressions in the digital. I've been there.

Although I must tell you, basic and professional materials are not going down, but we saw that with Kodak from years ago, took a while to kill it.

And there's still plenty of penetration left, I think...

Plenty, plenty, plenty.

And maybe just how about the timing of DS World, it was mid-September this year. I think you guys mentioned it was a very strong event. How quickly do you fill those orders? Is that sort of a -- that was part of the 3Q and the 13% growth here in North American dental or I should say even globally? Or is that more of a 4Q phenomenon in terms of filling the DS World?

I think some of the plug-and-play is the fourth quarter, but there's also equipment that is dependent on the build out of the practice. So there will be some, I would imagine, that would spill into the first quarter.

So some's 4Q, and then to your point, some is even longer tail than that, dependent on the construction and that's sort of thing.

Right. Right. Yes. And Dentsply Sirona have a lot of plug and play but also a significant amount of imaging.

Okay. And last question on equipment. So in your commentary about traditional doing very well, the high-tech volume's good, some pricing pressure, do we just -- was that a global comment? Or is that more specific to North America? Is there anything to really call out in your international dental equipment book versus that of North America?

I have to think about that.

It's hard to paint international with a broadbrush, right? You really have to look at it market to market. It's even hard to paint in Europe with a broadbrush because it can vary depending on the markets within Europe. I do think that, generally speaking, what we're seeing, some of the trends we're seeing and the mix we're seeing in equipment sales domestically are relatively consistent with what we're seeing internationally as well. The growth has not been quite as extensive outside the U.S. But last year, we had significant growth in equipment in the third quarter. So it was a little tougher comp for them year-over-year. But generally speaking, the conditions, it's a very general comment but are very similar.

Okay. Very helpful. I want to make sure I touch on PPE and COVID. I mean, obviously, that became a bigger part of the portfolio just because of the sheer numbers. So I've got some metrics in front of me. Global PPE sales were around $1 billion in 2021. Now Ron, I think they're run rating closer to $800 million. Where do we go? Do we make our way back to pre-COVID levels, which were about $450 million? Based on your glove commentary and some of the deflationary metrics, do we go south of the $450 million because the volume's there, but the price fell out? Just let's start there with some high-level thoughts.

Well, I mean that's the riddle, right? And that's one reason why we didn't provide 2023 guidance because that's the riddle we're trying to solve. Glove pricing has continued to decline over the course of 2022, but that -- those prices continue to be higher than they were in 2019. So yes, 2019, very rough numbers. Our PPE global revenues were in the neighborhood of $450 million. Yes, we did about $1 billion last year. That number would be kind of in that $700 million to $800 million this year, we think. When we talk about PPE, 75% to 80% of our PPE revenues are gloves, and that's where we're experiencing the price declines. We expect price declines to continue into '23. We think that the decline will not be as steep as what we've recently experienced, but it will continue to decline through most of 2023 is what our current forecasts are telling us, right? Will they go? Will those prices go below that of 2019? I personally would be surprised. That's my personal opinion. I think a lot of people feel the same way. Volumes continue to be pretty good. And changes in protocols and the practitioners office have, I think, bumped up those volumes a little bit, both on the medical and on the dental side. So there's some protection on the volume side. Is it a substantial increase in volumes versus 2019? Probably not substantial, but I think we have some protection there. I'd be surprised if those prices go below 2019, but that's my personal opinion.

And this might -- I mean I'll just throw it out there to try to get a little bit more granular. But you mentioned that global PP&E business, $450 million to $500 million pre COVID, now $700 million to $800 million. So I mean, just broadbrush, maybe 50% higher. Is there a way to think about what of that is price versus volume? You mentioned prices are higher. Is that broken down roughly 50-50? I'm just trying to gauge how much higher prices currently are versus the pre-COVID levels?

I'm going a little off the top of my head, but I would say over 50% of that increase is price versus volume, but there are -- there is some volume increase.

Okay. That's great. It's very helpful.

I think the volumes are relatively stable.

Just a different world in terms of what people are doing and how they're treating patients.

Yes. I think people are a bit more careful for gloves. For masks, we were selling a lot of the...

KN95s.

It's not the sites in the N95s, but you can follow the big manufacturers. They're talking about the stuff and you can get more precise information.

Okay. Okay. And maybe just, Ron, one follow-up on the PPE COVID. I spent a lot of time. I think there's a lot of confusion of -- so for that bucket, let's put them together, is it south of corporate gross margins but north of, call it, EBIT margins? Because you're south of corporate GMs because of what they are, but then the drop-through is pretty significant. So it's still, call it, OM-accretive for those products?

I think that what we can say is, at least on the gross margin side, PPE -- the margins on PPE have been consistent with the respective margins we get in our dental and our medical business, right? Medical margins tend to be slightly lower than our dental margins. So they do sell within a very reasonable range of what those average margins are. Same with COVID test kits. COVID test kits might be selling a little lower than what the medical margins have been. But for the most part, those -- at a gross margin level, they are very consistent with our medical -- our global medical or global dental and our U.S. medical margins, right? When you try to boil it all the way back down to operating margin, it gets a little dicey because we'll be allocating fixed costs. What are we doing, right? So I think that -- but at a gross margin level, they are contributing a consistent amount with other products, other merchandise products that we sell within the 2 operating segments.

Very helpful. Guys, if you have any questions, please go ahead and just throw up your hand or shout them out. Stanley, for you, I'd love to get your pulse on here we are in November, we're going to turn the corner and go into 2023, just the trends you see, the health of the market, what gets you excited going into '23? I don't know, but from an innovation standpoint, what gives you some pause or consternation as we think about what's around the corner? And you can take that one at a time, Dental and the Medical.

Well, easier to tell you what's exciting.

Go ahead.

I mean the business is stable. Look, we're a boring story from a day-to-day point of view, and it's been that way for decades.

Nothing's wrong with boring, free cash flow and good returns.

All of that's good. But what's exciting really is the whole area of the digitalization of dentistry. We've been talking about it for years, and it's advanced. And I think you can expect some very good work coming out, particularly from us in the next year or so. Digital platforms, really connecting the various devices in an interoperable way with the practice solutions business at the center of all of that. So that's -- it's the digital clinical workstation. We've been talking about it for years. We've added to it each year. But I think we're going to see a lot more. And I think are we investing in that area. I believe we've got excellent management. It ties in very nicely with the work we're doing on the oral surgery side, on the ortho side of that, we're very small there. So I think that's very, very exciting. The work we're doing in the specialty areas and specialty services areas are all very, very exciting. We plan to launch our GEP, which is our new e-commerce platform in the U.K. sometime around the middle of next year. It's a 3-year project. I don't think -- perhaps we'll be able to show at IDS, but probably not, but we'll show it to the Street. I think that's very, very exciting. So it's the whole digitalization of dentistry and in medicine and then the continued movement our procedures to the alternate care side.

Okay. Ron, maybe just to follow that theme, I'm going to throw out some headwinds and tailwinds when I think about '22, '23. So for headwinds, I have likely another year of down PPE and COVID, maybe less than a drag of '22. The extra week comes out, FX continues to be somewhat of a problem. For tailwinds, the LCI ex PPE is doing well. Maybe you get some margin benefit from the restructuring. Maybe I'll flip it to you. What am I missing? And maybe take those one at a time, the headwinds into '23 and the tailwinds into '23 when we think about the P&L.

No, I think you touched on some of the headwinds that are -- that will be a challenge for us, whether it be FX, whether it be the glove pricing, as we mentioned before, COVID-19 test kit volumes. There's some uncertainty there. Those provide headwinds for us. I do think we have good momentum and some good opportunities. I think we're going to continue to see some market expansion. I think in the U.S., when I look at that equipment growth, to me, it's a barometer of the confidence in the practitioners in the growth of their practices. It's anecdotal, but there are dentists who are still talking about how they are still getting patients coming in for the first time since the pandemic, right? So people are still working their way back to their dentists. So I think that's a -- I think that provides a bit of a tailwind. I think we're going to see a little bit of market expansion there. And I think that's indicated by that equipment growth that we've been experiencing. On the medical side, we've seen great momentum. As the business continues to grow, I think that our segments -- our customer segments that we're working in, the ASCs have seen some pent-up demand, but I think that's going to continue for us into the next year. And I think we can continue with that momentum and that kind of growth. They're going to have some tough comps next year. I mean they're coming off -- when you strip out COVID test kits and you strip out PPE, first 2 quarters, they did double-digit growth. This past quarter was over 9% growth. So it's a great run rate. They're going to have some tough comps next year, but I still think we're going to get some good growth in that segment.

And maybe in the minute that we have left, that's probably a good segue way into sort of how I want to conclude that. I look at my model, and we have pretty modest '23 revenue growth. Now to be clear, that's reported, that's sort of being a victim of [indiscernible] success. Reported FX that I alluded to, the extra week, the PPE COVID, but Ron, is this a leverageable P&L off of a flat reported revenue number if we're in the right zip code there?

I think it is. We are going through some restructuring activities now. A lot of that is around global footprint. We did recently announce within the last few weeks, we are going to consolidate our global headquarters, for example, in Melville. But we are taking a look at other properties, and we're trying to find ways of kind of just reducing some of those occupancy costs. Separate from that, we just did the Midway dental transaction, which allows us to -- we did a complete fold-in with that. We're leveraging existing infrastructure. So I think it's -- a lot of this is how do we leverage that cost base that we have to grow the revenues faster than we're -- obviously, than we're growing costs.

So you really got to sort of peel back the onion, so to say, in terms of what's weighing on the reported 0% to 1% that we might all be arriving at and there's still margin opportunities even within that reported number?

Yes, I believe so. I mean it's not easy. There's -- the cost of doing business is going up for everybody. There's increased regulatory costs. There's -- I think if you pulled all the companies that are here and ask them how much more are you spending in cybersecurity versus what you did 5 years ago, it's going to be multiples, right? So there's areas you have to kind of redirect your costs and your investment to be sure that you're protecting your assets appropriately. But I think that we have to kind of manage costs accordingly. And you have to make sure you invest according to your priorities.

Okay. Any last minute questions? Great. Stanley, Ron, thanks very much.

Appreciate it.

Great to catch up.

Thank you. Thanks a lot.