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

Good morning. Thanks for joining us for the Nasdaq and Association with Morgan Stanley Conference. This is Cecilia Furlong. I'm an analyst here. It's my pleasure to have Henry Schein, CFO, Ron South with us. Ron, thank you for being here.

Absolutely. Thank you.

And just to start off, I wanted to give you a chance to kind of give a high-level overview of the business. But then just if you could talk to across your different segments, underlying market, business trends and really how you're thinking about growth, you had some impact from PPE positive impact. So just stripping out that impact, how you think about growth going forward?

Certainly. So I'm not sure how familiar everyone is with Henry Schein, so I'll just provide a quick overview. We really operate as the -- right now, we're the #1 distributor of dental products in the world to the dental practitioner. In addition, in the U.S., we have a very robust medical business that sells to the ASCs, to the physician offices as well as other kind of medical -- alternative medical sites. The dental market would largely consists of kind of core merchandise, a lot of the other things we typically would see in a dental office in addition to equipment. So the chair that the patient sits in, the high-tech equipment, the scanners, et cetera, that are used in the office. And our medical products tend to be more on the consumable merchandise side, but we would also sell examination tables, other things that you would see in a medical setting. In addition, we have a technology business, a practice management software business on the dental side that does everything from providing some demand management on behalf of the dental practitioner, the practice management system that will manage appointments, we'll file the insurance claims, manage the receivables as well as then providing kind of a reminder type of notification to the patient for their return. So it's a complete kind of patient relationship system. In terms of our dental practice, we also have a dental specialty portfolio that includes dental implants. It includes endodontic products and orthodontic products. All those products are self-manufactured. Most products, we are purely the distributor. But on the dental specialty side, we self-manufacture that product, and that's about $1 billion of revenue out of our total revenue of approximately $13 billion. That's the overview. I mean I'm not sure if there's specific things you like taking from there.

I'd love to just ask you to go through also the benefit you saw from PPE during the last 2 years during COVID? And then how you're really thinking about underlying business trends in your business going forward ex-PPE?

Yes, very good. So PPE was an essential part of our business prior to the pandemic, but during the pandemic, obviously, became a very large part of our business. So if you go back to 2019, the last full year prior to the pandemic, we had PPE revenues of approximately $450 million. In 2020, that spiked to approximately $1.2 billion. And then in 2021, when you also include COVID test kits that we began to sell that reached about $1.75 billion. A lot of that was fueled, obviously, but there was an increase in demand but a lot of that was fueled by increased pricing. As the costs went up significantly for the cost of gloves primarily, the pricing had to go up with that. Margin stayed fairly consistent with that, but as the cost went up, so do the pricing. That pricing peaked out around mid-2021 and has begun to decline fairly significantly since then. So what we're seeing this year is about a 30% decline in PPE revenues and also about a 30% decline in COVID test kit revenues. So we think that on -- we're projecting this year that combined, those revenues will be in the neighborhood of about $1.2 billion versus the $1.75 billion we had last year. We do expect that the glove pricing will continue to decline not as sharply but will continue to decline somewhat into 2023. But we do think the revenues for these will kind of level off at something north of the $450 million that we did in 2019.

And then just last question, sticking with high level, and I'd love to get into business segments. But can you talk about your strategic plan, just the components? And just walk us through broad vision as well?

Yes, certainly. So our strategic plan is really -- I'll spare you kind of going through a lot of the details of it. But I think that the general direction we'd like to go in is finding a way to accelerate the growth of our dental specialty products as well as our technology offerings as those have kind of a greater growth and a higher margin for us. And we think that that's where we really want to try to emphasize the growth in the business going forward. Having said that, we're still looking for opportunities to grow our core distribution business. This past year, we did a couple of acquisitions on the distribution side. One in the U.S. was an acquisition of Midway Dental, which we were able to fully integrate into our business in the U.S. and another was a transaction that we completed in the middle of the year in Switzerland that gave us a core distribution business in Switzerland, which previously we did not have. We did have an implant presence in Switzerland, but not a core distribution presence. So it allowed us to expand the footprint in Europe. So our strategy, while we've done those distribution transactions, our strategy will be to grow the other aspects of the business where we think we get a little bigger bang for our buck in terms of margins on the dental specialty side as well as in technology. We do see a greater emphasis on the digitalization of dentistry. And so a lot of our investment and a lot of our effort is to really become a bigger part of that as dentistry kind of embraces this kind of digital environment, and we think we're well placed to do that.

Great. And I wanted to turn to Dental segment. Capital equipment has stood up. But I think you talked to manufacturers. You hear maybe a worsening environment. Just talk through what you've seen in the field and really where the strength that you've seen is coming from geographic products? Any color you want to provide?

Yes, we have seen very good growth in our dental equipment sales. And that actually -- we feel like that bodes very well in terms of -- as an indicator of the optimism of the dental practitioners. They're investing in their practices. Our equipment sales tend to be about 2/3 what we call standard equipment and about 1/3 high-tech equipment. So the standard equipment is the chairs, units and lights, that you're sitting in when you're at a dental office. What we're seeing there is we're seeing a lot of practices that are expanding their practice. They're adding 1 or 2 chairs or more to their practice. On the high-tech side, that revenue is not growing as quickly as it is on the standard equipment, but it is -- we are seeing better volumes, but you do have a little bit of price pressure in some of that high-tech equipment such as specifically scanners as that intraoral scanner that is used by the dentist, we're seeing that there are some -- as happens with tech products. Others are able to make the product similar features as they get scale, they're able to come in at a lower price. So we're seeing some lower-priced scanners come into the market, putting a little bit of price pressure there. But as a result, it's a more attractive price point for a lot of dentists. So we're seeing an increase in volumes there as they are adding more scanners to their practice. I think in terms of the geographics, our third quarter equipment sales grew 12.8% on a local internal basis in the third quarter. In Europe, the growth was less than that, but we still feel very optimistic about it. In terms of trying to reconcile that back to what some of the manufacturers have said, all I can really tell you is that we do have a backlog of equipment sales that -- at the beginning of the quarter, actually -- or during the third quarter grew to the end of the quarter versus the beginning of the quarter. So we're not eating into that backlog just yet. So we're seeing good demand for equipment. We see it as really as an optimistic indicator as a positive indicator of the health of the practice right now.

Looking forward to how are you thinking about just interest rates and how you're thinking about demand for equipment?

We haven't really seen a pullback in demand that I would link to interest rates at this point. I think that while interest rates are higher than they were a year ago, on a historical basis and you go back and look, I don't -- I still don't think interest rates have hit that tipping point yet, the dentists aren't willing to invest in the practice. So as they can add new chairs, it means they can add more patients which is a return for them. And as they add high tech equipment, it usually can increase their efficiency, also improves the patient experience for a lot of these products with the dentists and that can also provides a return to them. So I think that right now, we haven't reached that tipping point where interest rates have actually required the dentist to pull back on their investments.

And if you could speak a little bit more to digitalization of dentistry as well as just consolidation we're seeing across the field, but how are those two factors separately together contributing to equipment demand?

Well, I think that things like intraoral scanners make for a much better patient experience than if you have a dentist that is still using impression material. I think we've all had to bite into that, that cement or whatever you want to call it, it's not exactly. You can relate, right? And it's not a very pleasant experience, right? And so it's an improved customer experience when -- and it's also, quite frankly, a more accurate reading of what the ultimate purpose of the procedure is. So I think that as the intraoral scanners and that -- as that it continues to develop, what you're now seeing is the opportunity to directly feed that information into the patient's records. So there's not a requirement to manually enter the results of that as well as a direct feed to the laboratory who is going to produce the crowd or whatever the purpose of the scan was. So you're going to see more and more applications of that sort coming out. Kind of linking that to DSOs, DSOs provide some scale for the dentist. I think most DSOs are now kind of seeing slightly larger practices, those larger practices as they get scale, we'll be able to invest more and more in that type of high-tech product.

Okay. And also just some of the specialty products within your portfolio. Can you speak to your exposure there, but then what you've seen recently as we think about the economic backdrop, recessionary spend, how you're thinking about that segment of your portfolio?

Yes. So in terms of specialty products, we're really talking about kind of three different areas. And I'll kind of take them and for us kind of order of emphasis or order of importance. So like I said, we do run rate of approximately $1 billion in revenues in specialty products. Say about, say, 50% to 60% of that is an implant. And about 30% is in endodontic products and about 10% in orthodontic products. So implants, I did see a recent survey where they asked people to kind of rank what procedures in the dental office would be least vulnerable to most vulnerable in terms of a recession or a reduction in discretionary spend. And the most vulnerable was kind of identified to be implants. Having said that, I do think that implants are no longer viewed upon as an aesthetic process as much as it is a standard of care. Most dentists will tell you that the implant is one that will help promote better oral health and or better oral health in turn will does promote better overall health. So I do think that while there could be some pressure as a result of -- quite frankly, it's really more the reimbursement system. A lot of implants, at least in the U.S., there's a pretty large out-of-pocket cost for the patient. So you could see some pressure there. But I do think the standard of care aspect of it will keep some decent momentum with implants. Endodontic products, are typically the files that are used in a root canal process. Endodontics were identified in that same survey as being outside of the standard maintenance of going in and getting your kind of 6-month cleaning with the dentists as being the least vulnerable and that's typically because if you require a root canals because you're experiencing pain and you're still going to get that process. So we do think the endodontics products, we actually saw very good growth in endodontics in the third quarter, and we think that will continue. And then the last item was orthodontics. And for us, orthodontics is a pretty small part of our business. Like I said, it's about $100 million of annual revenue for us. We'd like that to get bigger. It is a mix between kind of standard wire and brackets as well as clear aligners. We have a Reveal brand Clear Aligner. We're seeing some good growth in that Reveal brand, some of that through some success we've had selling into the DSOs but albeit that growth is coming off a pretty low base. But in the event of a pullback in the economy, some say wires and brackets will continue to do okay because that tends to be what teens are given and the parents will continue to provide that type of product for their children. A lot of the clear aligners are attractive to the adult population who wants to get an alignment. And the thinking is possibly some of those will pull back. We haven't seen that yet, but I will say that we're probably not highly representative of the market because we're pretty small sample size of that market.

Okay. Last question on Dental, I want to get to medical too. But 3D printing, how do you think about just the role in dentistry going forward and your role in helping drive that as well?

Yes, 3D printing can be -- is potentially a fairly revolutionary process in the dental market. Currently, 3D printers are primarily used for night guards as well as for like a surgical map to assure that the -- that process is going to be very precise so that they're able to get a good molding of that. But I think that what we're seeing is that there's -- the future potential of being able to develop crowns and 3D printing would be fairly revolutionary. The challenge with that is coming up with the material that could be used and right now, most crowns are either porcelain or ceramic or metal. So what could be done from a material standpoint that would be highly functional for a crown and meet all the FDA requirements, et cetera. So -- but we do think that 3D printers are relatively small. The ease of use, there's a lot of different applications that could come through, that could really be very meaningful to the dental industry. Our role right now is we do provide a -- not just 1 3D printer, like we try to be -- we want to be able to provide just like all our other products, a broad portfolio. And so we are providing multiple different kinds of 3D printers that can be used by the dentist. And -- we intend to continue to work with our supplier partners to assure that there'll be ample availability as they become more popular.

Okay. Switching to medical, talk through just the strength you saw in 3Q and what is really the underlying growth rate of this business as you think about just trends and would love to get your take too on the shift in site of care and the impact that you expect that to have on your business?

Certainly. So -- yes. I mean we're obviously very happy with the growth in our medical business this year. I mean speaking of -- when I speak of the growth in our medical business, I look at it excluding PPE and COVID test kits, because of the -- some of the volatility in demand and pricing there. When you strip that out, in the first half of the year, each quarter, our medical business experienced in excess of 10% growth. And in the third quarter, it was just shy of 10% growth. A lot of that growth is being driven by just increased penetration with the IDN, our IDN customers in the U.S. expanding the market a little bit with the independent physicians. We're seeing -- from a product standpoint, we're seeing significant increases in demand for point-of-care diagnostic kits. So it's a -- the business is really generating some very good profits for us at this point in time. I think it would be difficult for them to continue to achieve kind of that double-digit growth going forward. But I do think given the ongoing shift of procedures from the hospital to the ambulatory surgical centers, which is really where our -- a big part of our business, as you continue to see growth in procedures in that environment, we think we can continue to get kind of mid- to high single-digit growth in that business.

And near term to just with the flu season and what we've seen to date and expectations around just the severity. How are you thinking about the impact, both vaccine as well as the diagnostics front?

Yes, certainly. So I'll be the first to acknowledge it's kind of perverse to say it that flu is very good for us, right? So as we see more and more -- and if you look at the CDC website, you can see that there has been what the flu statistics are right now. So yes, we do sell flu vaccines. That tends to be highly a Q3 activity for us. Flu vaccines that we sell are usually -- when we place the order with the manufacturer, it is based on preorders we've received from our customers. We will buy some excess that we'll sell into the spot market usually over the course of the fourth quarter. As you then kind of get into -- more into flu season, you begin to see an increase in sales of flu diagnostic kits. People start not to feel well, they go to their physician. The flu diagnostic kit is applied. We also sell multi-assay kits that will test for both COVID and flu simultaneously. So we have seen a pretty good demand for flu diagnostic kits. And then that increased foot traffic to the physician is also good for us in terms of just the churn of consumable merchandise. They're going to go through that many more gloves, that many more cotton balls, that many more tons to presents, et cetera.

And then lastly on medical, but just can you talk through your positioning across medical distribution margin as we think to 2023, what should investors be focused on there as well?

Yes. So I think that we don't -- like I said, we don't serve the hospital customer. We kind of start with the ambulatory surgical center in that space where in the U.S. -- and our medical business is a U.S. business, 98% of our revenues in medical are in the U.S. So I'm really just talking in U.S. terms right now. So we -- the largest supplier in that market is McKesson with about, I think, about a 30% market share, than we -- 30% to 35% perhaps and then we are second to them with a 25% market share. After that, you have Medline, it was a private company that typically only will distribute the products that they self-manufacture. So then you have a whole lot of local and regional players there. The growth that we've been able to get is really through our existing customers and IDNs. I think that what's happening is that you're just seeing an increase in demand of procedures in that environment, more and more procedures are being done at the ASCs or in the physician office. We've also recently made our first investment in a company that will -- that is distributing to home health care providers. So as we -- our philosophy has been to follow the patient. And as more and more patients are being treated at the ASCs, then also in the physician office and now more and more are being treated at home, we find our kind of our role in that supply chain and continue to follow that.

Okay. Tuck-in value-added services, strong 3Q. But can you speak through or speak to just the drivers of that business specifically? And also just wanted to ask you to comment on Detect AI that development as well.

Okay. Very good. I'll start just with our Henry Schein One subsidiary. So Henry Schein One is the subsidiary that makes that the practice management system that I was referring to earlier. So some customers will only use that kind of appointment system. The growth opportunity for us is to get more of those customers on to demand management or other aspects of the -- that are available to them. We also sell modules such as business analytics that gives the dentist a snapshot of how is our practice doing as a business, what are some of the key financial metrics that they should be analyzing. I think that our part of the -- or the evolution of this -- of our software product right now is taking it from an on-prem product. So we would sell Dentrix, it would be kind of a single point-of-sale of installing that particular software on-prem. And then there would be -- there is a kind of a maintenance amount of revenue that we would get after that. We are now -- we've developed a product called Ascend, which is similar to Dentrix. It's a SaaS product, so it's a cloud product that is more of a -- so it's a subscription base. And as we continue to make developments with Ascend, we're able to draw in some new customers to that product. The conversion can be a little slow of existing customers who are on Dentrix to Ascend, they're happy with Dentrix. But at some point, as Ascend becomes attractive, we think we can increase that conversion rate going forward. What was the second part of your question?

Detect AI.

Detect AI. Thank you. So last Monday at the New York Dental Show, we were able to provide a demo of a new kind of system called Detect AI or a new product, perhaps, that is a -- I'm trying to make sure I described this accurately. With Detect AI, we can take an X-ray of the mouth, run it against a whole series of other x-rays and determine on an early basis if there is a -- where is there a high risk of a cavity. And in other words, how do you kind of -- can you pre-detect what is called the carry, which ultimately results in a cavity and treat it in a simpler way and in a less painful way for the patient. There was something similar that came out last week that I saw in the news that talked about how if you take a series of chest X-rays that can now identify going through chest X-rays who is at higher risk of a heart attack. And it's a similar concept. It's something that maybe -- may not be completely detectable to the human eye when you look at the X-ray. But when you go through the whole -- a very, very large population of X-rays, you can start to detect which of these particular X-rays had teeth that resulted in cavities or other dental procedures. So it is a service that we will be able to provide to dentists. We're just now kind of starting rolling out the pilots, but it's something we're pretty excited about. And we think ultimately provides a better care for the patient, which is really the priority. If we can emphasize better care for the patient that we know ultimately, it's better for us as well.

Okay. I know we're almost out of time, but last few questions, capital allocation, M&A, how you're thinking about the pipeline? And then the last part is, you've talked about hosting an Investor Day in '23. Can you just talk to rationale, timing and should we expect in [ NLRP ]?

So the -- in terms of capital allocation, we've typically done $300 million to $400 million a year in M&A and about the same $300 million to $400 million a year in share repurchases. And we've been able to fund that largely through free cash flow. From an M&A standpoint, we're fairly opportunistic. So if we see something that would take us beyond that $300 million to $400 million, we're able to do that. Our debt ratio is about 0.7. So we have a lot of flexibility with the balance sheet. If we saw an opportunity to invest more than that $300 million to $400 million, we're able to do so. And we could do so without sacrificing the share repurchases, right? We would be able to continue with the $300 million to $400 million of share repurchases. In terms of the Investor Day, yes, we're looking to do an Investor Day in late February. The rationale really was as we -- as more and more of the business is shifting towards our dental specialty products towards technology, we want to make sure people understand that aspect of the business. It's easy to understand companies who put stuff in a box and ship it, that's relatively easy. But we're much more than that. And we want to make sure that we get -- we can paint a very clear picture for investors as to some of these other things we're doing. It also provides us with an opportunity to kind of allow people to meet other members of management. Stanley Bergman, our CEO, just signed a new 3-year contract, which we're very, very excited about. But Stanley does -- Stanley has been the CEO of the company since 1995. And he does worry that, that perhaps other members of management aren't getting the exposure to investors that he'd like for them to get. So it does give us -- that affords us that opportunity. In terms of [ NLRP ], we will be able to at least talk to in detail of '23, and we'll kind of talk to what our expected run rates are going beyond '23.

Great. With that, I think we'll close and Ron, thank you for spending the time with us.

Absolutely. Thank you.

Thanks.