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

Right. Good morning, everybody. Thanks for joining us today. I'm Jason Bednar. I cover med tech here at Piper. Next fireside chat is with Henry Schein. Very happy to have with us today Henry Schein's CEO, Stanley Bergman; and CFO, Ron South. Thanks a lot for being here, both of you really appreciate it.

Maybe why don't we get right into Q&A, Stan. I always love your perspective on the dental market. And don't worry, we'll talk about the medical business. I don't want to -- we're not going to ignore it. But let's start with dental. It really seems like the theme emerging over the past few months from your commentary and the commentary from others is stability. It's not just the U.S., but other geographic markets really sound stable as well. I got that impression from checking in with several companies at the Greater New York Meeting yesterday. Maybe talk about what you're seeing around your major dental markets as it relates to dental patient flow? And any concerning signs as this year comes to a close and we start contemplating how to think about 2023?

That's a good question. So we're in our quiet period, obviously, and December is not finished, and we can't comment on November, and we commented on October. Essentially, the markets are stable. That's what we were viewing in October. If you go to the dental show, you'll see less people, but you'll see people buying. I don't know if that's an indication of mood or not. People not going to dental shows just to look around, and they can do that on the Internet. Now they can do the webinars, they can go and see and talk to their friends digitally, get information. The people that are going to the shows are buying, and there was a lot of that kind of traffic to see it. You need to look at Henry Schein books to see it, you could see it. So I think if you look at 2019 visits, we commented on that in our call that the ADA, we think, was a little bit too far down. I'm not going to say the study is inaccurate, but a little bit further down than we were -- the data we reported on was a little bit higher. But as we noted in our last call, the market is -- the dental market is stable. It's so hard to tell. If you look at the more expensive procedures, are people trading down, is it to do with locations, is it to do with people really wanting less expensive implants. And I'm -- I think it's not material to the whole of Henry Schein, so I can mention it. I was with our German people the other day. And that's where we have a pretty good market share in both the premium implants at lower price. And lower prices are doing very well. Now is it because more people are going for implants or not, because the general premium implants are stable. So we're in a trading range of hundreds of basis points, but it's not as if the market's fallen out, and it's not as if the market is on fire. I don't know if that's good enough or not.

Yes, it seems like you agree with the kind of the general theme of stability.

We spoke about stability. The dental market is pretty stable. When you have unemployment rates at these kinds of numbers, it's stable. If the employment rate goes down significantly, which we haven't really seen, I guess, since perhaps 2008, '09, even then, it was pretty good. This was not only -- it's a boring industry that just grows over time.

Yes. I used the line that boring is great.

You need a boring stuff, good cash flow and good growth, that's us. Working for massive innovation with top line sales and maybe not such great profits, that's not us.

Yes. We'll come back to just maybe some more exciting pieces in the story because I think there are some faster-growing pieces and -- but maybe staying on dental for a moment and talking about -- let's talk about equipment. Because this is the piece that's probably surprised. I know it surprised me. I think it surprised others as well, just how durable the order book has been and how, I'd say, positive [ tone ] has been around the outlook for equipment. Because we like it or not, rates are rising. I'd have to assume that everybody I talk to and what I hear out there in the channel is that office budgets are getting squeezed. So there's just -- there's fewer dollars to go around to things like replacing equipment or buying new equipment. So -- but in spite of all that, your equipment demand in your order book is still really, really good. So maybe what's the reconciling factor here? Is it just like the traditional equipment is still so strong. There's such good demand on the traditional equipment side or digital, that the uptake -- the penetration is so low and the uptake is -- still has such a long way to go. I mean what are the factors here that are keeping that demand so strong?

When you've got the 2 sectors, correct, of course. One is the traditional, and it's been steady. Graham reminded me, he used to be our Treasurer, and he said, well, the interest rates may be higher compared to where they were maybe a year ago. But if you look where they were 4, 5 years ago, it's not so bad. And quite frankly, we don't sell equipment on an interest rate basis. I mean, yes, we disclosed the interest rate to the customer. We sell it on payment per month. And if somebody feels that they want to refresh their office and have a more modern chair, they're going to buy if the interest rates are significantly higher, that may be an issue. And from time-to-time, we use tax credits to say, by this year versus next year. It's not really a material issue at this moment in time. So the traditional business is -- it has been strong for a long time, for years. There's this bubble that we need to get through. But I mean at the end of that tunnel, it doesn't look like people are going to stop buying chairs. Now the digital side, it's hard to get the penetration rate. Is it 30%? Is it 40%? It's not 90% and it's not 10%. So it's somewhere around there. And quite frankly, it's not that important because what is important is that the scanner is being viewed as standard of care. My dentist didn't have one, and I had an emergency procedure during COVID [indiscernible] and I said, I'm not coming back to you. I mean I was very nice about it unless you get a scanner. And it's pretty -- if you've been scanned, you will not go back to a dentist to this stuff that is [ picking ] your mouth. So by the way, we're surprised that our impression material sales are still pretty good. It's like the film. It took years for the film to appear that we do through cell phone. So it's a hot market. It is not on fire, but it's a hot market. People need these things. And we have a very good selection of scanners. And we've introduced some lower-end scanners. They all work, more expensive and have more features like perhaps a catalog on Mercedes more features versus a smaller car, less expensive car, but it's pretty good. And I would say also the mills are not dead, they're there. And for us, we're in the laboratory field as well. We are helping labs move digitally. The consumables are going down as we move to digital, and of course, the consumables for digital materials is going up, but there is this movement and it's a strong -- relatively strong market, and it's been that way for a while. And we don't bundle much in terms of the scanner like maybe 1 or 2 of the other companies, public companies do. We'll give a discount if you buy more from us, but we expect this is a cost of the scanner and this is the cost of your aligners. We explain to the customer what the difference is. So that's pretty good. And then with the imaging. The imaging market has been pretty good in terms of units similar to traditional. The price has stabilized, although it's been tending to go down because there's availability. There's different manufacturers. And so overall, the market is stable to positive. But I don't think you can -- I don't know what our sales were last quarter. What -- Was it 10% up or something?

On the equipment?

Yes.

Yes, about 12% -- in North America was over 12%.

I mean, It's on the lower numbers. It's not going to grow 12% forever. But in the middle -- and I'm not giving guidance for this quarter because I don't think this quarter is relevant from your question point of view, I think mid single digits without inflation is not a terrible number for the dental market perhaps others say similar to...

Okay. And I'll come back to -- I'll come back to the mid-single-digit inflation.

Sorry, these are long answers, but these are very relevant questions.

No, I guiess and I was like you have great perspective, and you've been in this industry for as long as you have. The -- maybe real quick on medical. So I do want to do justice because that doesn't get enough attention. I know we always talk about that. But the growth has been impressive, upper single, low double-digit growth in medical. What's driving that growth? And because it's been a pretty long string here of quarters that you've put up here? Can it continue at that pace?

Well, I can't predict the future. I don't have a crystal ball, people mentioned during the budget process a few years ago. But look, the demographics are simple. Healthcare cannot continue to be operated as sick care, it's got to be, from a public health point of view, viewed as prevention and wellness. Where does that take place? It takes place outside the hospital. In addition, we have procedures moving from the office to the ambulatory surgical center, where procedures that may have taken 2, 3 days of stay in the hospital, [indiscernible] the same day. I can't tell you when this is going to happen, but I had an accident to my knee and I have to have a knee replacement after ski season. And I don't think it's -- I asked the doctor, I don't think it's exactly the same day. But what he said to me, a pretty good guy, who runs sports medicine here. And he said to me, expect this to happen a year from -- a year or 2 or 3 from now, where your knee is going to be same day. And I think that's what's driving this demand. So the market for alternate care sites, namely ambulatory surgical centers, the physician side, the areas of renal and cancer oncology treatments. These are moving out of the hospital. And this is the area we focus on. I think we do this, service these customers better than anyone else. So our big customers are big IDNs, they may even have soft distribution for the hospital, but they know to get 6 little items in a box, including an injectable and a tongue depressor. And if you place the order by 7, 8:00 at night, depending on where in the country you are, you'll get it the next day with a 99% fill rate. This usually is because of injectables [indiscernible] got a challenge. Some -- it works and [indiscernible] of dealing with what's called chargebacks. This all sounds easy, but to make this all work and to make sure that you can approve a physician for -- to receive a prescription drug or controlled drug in the right quantities, deal with all the sales tax, all done in a very efficient way. It gives us an opportunity to do very well in a growing market.

Yes. No, well said in that. Maybe I want to bring Ron into the conversation here. I can move to a topic that caught a lot of attention on the third quarter call. No forward to your guidance, which all acknowledge, having covered your stock now for 14 years, this was a bit of a departure from the norm. So I get that there's elements here that are unpredictable. But I guess to be fair, I'd argue there is potentially more unpredictability a year ago at this time. So I guess, is this a change in philosophy towards providing guidance as early as you do? Is this an element of one to get maybe a little bit closer to the Investor Day where we're going to be maybe having near-term and intermediate or long-term guidance that you might provide? Or is there some other factor that's kind of weighing in on the decision to wait on giving that forward your guidance?

Yes. I think, Jason, as we looked at 2023, and we're still looking at 2023. We had some very kind of business/market specific things that we felt like created some uncertainty, specifically around glove pricing and the ultimate effect on PPE revenues in '23 and as well as demand for COVID test kits in 2023, and the effect that would have on volume and a little bit of pricing concerns on the COVID test kits as well. We're not quite sure how that's going to play out as we go out to '23. We kind of felt like when you lump that in with some of the macro uncertainties that are out there, as we kind of went through our range of outcomes, that range was pretty broad. And we just felt like it was too broad for us to go to the street and provide meaningful guidance on 2023. To your point, perhaps it is convenient that we have -- we're planning to have an Investor Day shortly after when we release Q4 earnings that will allow us to kind of go into our 2023 guidance in a fair amount of detail, we can address some of the individual assumptions that we have there. Is this a precedent? I'm not prepared to say it's a precedent. I think we'll have to take it on a year-to-year basis, depending on the economic conditions at the time.

Okay -- go ahead.

It is again just an indicative story. It's not necessarily applicable from a macro point of view, but it's indicative to me. Yesterday, I met with one of our businesses that is in the, what we call, the second channel, which is not the full service. And they were presenting the '23 budget, and we're pretty sure about the core business and then had a big [indiscernible] on glove pricing, and glove pricing is important. The margin is not that relevant, because it whether goes up or down, we make approximately the same margin. And we don't buy product that's in a down market and not adjust the price, we bring it down right away and we bring it up right away depending on the price. And so we will continue to disclose the impact of gloves and great cash flow, good profits. But what's important to understand is the core business. And I think Ron and team are still settling in on these 2 big variables.

Okay. Okay. Yes. Understood. And then maybe since we're kind of on the topic of the Investor Day. I think right now, I don't think we have a formal date yet, but it sounds like it's first quarter of next year from the last update I had. This -- you haven't hosted many of these -- just one that I can recall in my career, it was almost a decade ago. So I guess what's influencing the desire standard to host an Investor Day? What are the -- if you can share anything -- maybe give us a little bit of a preview. What are the priorities of the event? And what should investors be prepared to hear from Henry Schein that day?

Yes. Jason, we did an investor survey. And the results came back that were a little bit surprising to me. They said, essentially credible management team, perhaps one of the most credible in health care, if you look at the longevity and -- we traded out CFOs, 1 retired, somebody came in, been around with the company for 13 years or so. And this was a pretty stable organization, and that was recognized. So people said we don't understand your story enough. And as you know, the story is not $13 billion of distribution. So it's not like traditional drug wholesaler, where you can -- or med-surg where you can figure out more or less exactly how the business operates and what the plans are. But it's a combination of 3 businesses, all around the same theme, a distribution business; [indiscernible] dental/medical, a specialty business, mostly dental, some medical; and services businesses, primarily software. And the 3 -- the impression was from the street that we're not giving enough information on that. So that was one. And number two, the investors said, "Well, we know Steve and you. We'd like to meet more." So investors now know Ron, they know Graham. They know the decision was made as a result of the study to put somebody into investor relations that really knows the business that could project where we're heading. And Graham has been practically every part of Henry Schein's business as the CFO in the past. So essentially, the idea was to explain more -- is to explain more about our business and expose Wall Street, and the analyst community to our management team.

Okay. All right. Perfect. Any -- assume that we will have some kind of longer-term financial plan as well. It's not something that I don't think that Schein has ever really spoken to on, again having like a 3- or 5-year view or whatever LRP you want to put out there. But is that something we should expect?

I think, Jason, we'll be able to talk to what we kind of see run rate trends that would be credible as assumptions going forward beyond '23. There's a lot of uncertainty out there, but I think that we'll -- we will try to address what our expected growth rates are in various segments of the business.

Yes. Okay. All right. Fair enough. Fair enough.

Well, we have provided a general concept on growth, a couple of hundred basis points more than the market and margin direction and turning our profits into cash flow. That's the same -- 28 years have been public.

Okay. Maybe on that margin topic, how much room is there on gross and operating margin to continue to expand from here? I mean, it sure seems like we're going to have a good -- kind of a good finish to the year just based on the guidance, a good operating margin finished for the year. You're talking 20, 25 basis points of expansion in 2022. Is that still a reasonable view if we're looking long term, like there is still good -- not holding it to a number, but there's still margin expansion to be had and there's still -- and that margin expansion can come via both gross margin expansion and also OpEx leverage?

Yes. I mean I do think there is opportunity for us to continue to grow operating margin. I think the formula this year has largely been driven by greater growth in our higher-margin businesses, such as our software business and our dental specialty business. The growth in those businesses has outpaced the growth of our core distribution. And as a result, we've been able to expand gross margins and then take some of that expansion and reinvest it back in the business and OpEx, but still achieve that operating margin expansion. To the extent we -- that's kind of the formula. And to the extent, we can continue with that, it should allow us to continue to expand operating margin. And when we provide guidance on '23, we'll likely try to provide a range of growth that we think we can achieve in '23 as well.

Okay. All right. Maybe touching on specialty dental here. Stan, you brought up -- you have about $1 billion specialty business, definitely not, I don't think, well understood, well appreciated, so therefore, justifying the -- part of the rationale here to do the Investor Day. But this $1 billion business definitely tilts more towards implants versus endo or ortho or medical. Is that -- is this an area the implant piece is that you'd still like to grow as a percentage of the business? Or do you have other initiatives or opportunities you see as more important than implants as you do try to grow that $1 billion specialty franchise?

Well, it's implants and just below that endo and ortho is very small. The endo is a very good business. I think we are the #2 in the world and a good #2 when it comes to units. Our pricing is lower. I think the dentists appreciate that. The quality is good. And we will continue to grow that part of the business. On the implants, there's a lot of opportunities. We have a good business in Germany, Austria and [indiscernible] the lake, the ripples, the further you go, the less it is. We have something in Japan, okay, it's not great. And China is relatively new. So the opportunity is to expand in all of these markets. We continue to invest in new technologies in the business. So I think we continue to grow our market share in Germany and in the U.S., but there's opportunity in a lot of other areas of geography and the opportunity to add more digitalization to that offering. And we expect to invest quite heavily in all 3 of these areas. But dealing with the profession, we're not interested necessarily in going to the consumer to advertise aligners, for example. That's not where we're heading.

Got it. Maybe in the last 30 seconds here, I was going to ask you today about management succession and just your plans there, but you preempted the question with your -- with the announcement yesterday with the 3-year contract here that you have. So first, congrats on really looking forward to working with you for more years to come. But I guess the question I have is, is there something kind of like one thing you're looking to is still accomplish here before handing the reins on to somebody else, something you're really looking to position that business for make Henry Schein great for another 10, 15, 20 years?

Yes. Well, we like Henry Schein to remain an independent company, growing strongly. We have a very good bench. I mean you saw how this transition occurred, the fellow that was running all of our infrastructure for the 30 years retired, and it was a smooth transition. So we have, of course, transition plans. But if you really want to understand where we're heading in our priorities, it's in our strategic plan, our bold initiative, there is no time to go through that now, but you'll hear plenty of that at the Investor Day.

All right. Perfect. Yes. We're out of time. But looking forward to the Investor Day. Thanks so much for joining us, Stan and Ron. Really appreciate it. Thank you, everybody.