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

Hi, everyone. This is Rachel Vatnsdal from the life science tools and diagnostics team. I'm joined by Stanley Bergman and Ronald South, CEO and CFO of Henry Schein. So today, this session is going to be 40 minutes. It's really going to be more of a fireside chat style. So it's going to be Q&A the entire time. For those of you listening online via the webcast, feel free to submit a question via the Q&A function. And then for those of you that are in person, feel free to raise your hand. We have mic runners throughout the room, so they will hand you a mic to ask a question.

So for that, Stanley, if you could just kind of walk us through the story for those of us new to this, I spent a few minutes talking about the business. How 2022 has gone so far, and how Henry Schein has come out of the Pandemic a stronger company?

Thank you, Rachel. It's good to be back here live. We're doing this for almost 30 years, and to see live people again is terrific. So Henry Schein, we are the largest provider of products and related services to office-based health care practitioners. That's dentists, health care practitioners outside of the acute care setting, although today, many hospitals own or IDNs, own our customers, but essentially, we're focused on the ultimate care market. We provide practically every product that a practitioner may need from consumables to equipment to pharmaceutical to med-surg products, equipment, dental, medical, huge part of the medical is diagnostics and various kinds of services. We're the largest provider of dental practice management services in the world, I believe. Of course, the practice management system is important, but really it's the electronic medical record, which is very much customized to the needs of dentists and the integration in an interoperable way between our software and devices and other related services. Of course, services such as management our billing, revenue cycle management, as it's called, demand generation tools, website management and in recent years, cybersecurity services are all services that we provide. We're today quite a significant manufacturer of general specialty products where we have our own brands. We do quite a bit of R&D in that space. We have a rapidly growing oral surgery business, which is the implants and the bone regeneration products, and we have, today, a rapidly growing, and I believe significant endodontic business, brands, generics, and a small but rapidly growing orthodontic and aligner business, that's wires and brackets and aligners. Our strategy, of course, is to help practitioners operate a more efficient practice so that our customers can provide better clinical care. That's what we do. For the smaller practitioners, we have field sales consultants that work with these practitioners in helping to optimize the practice from a profit point of view, efficiency point of view, but also from a clinical point of view. And that goes all the way up to we work with the largest DSOs in the United States and abroad, where we help these DSOs with the inventory management and other expense control procedures and management tools. Equipment service, by the way, is a key service that we offer. I believe today, we are the largest provider of dental equipment in the world, but more important, the service we have, I believe, an outstanding clinical workflow, helping practitioners connect the clinical aspects of their practice to the practice management system. Rachel, I can go on and on talking, but you asked within your question, out of 2022 go? So it's been a very good year for us. And what is very important in understanding Henry Schein's numbers is to take out the noise from PP&E and test kits. We had significant sales in these products in 2020, '21 and '22. We provided specifics in our quarterly calls on the amount of sales related to these products. If you take these out, and of course, we're in our quiet period now. But if you look at our numbers through the end of the third quarter, you will see pretty good growth in our business, excluding PP&E and test kits. The strategy is to advance each of our businesses, our distribution, dental medical and our Medical, by the way, is a rapidly growing business as well as our dental in many parts of the world. And to make these businesses more efficient and much more user-friendly from a digital point of view, where we're investing significantly in digital capabilities to connect with our customers. So our goal is to advance our distribution businesses, our specialty businesses from a product point of view and our services businesses, while at the same time, driving sales increase share of wallet between these businesses. We're able to provide customers that are buying from one side of the business with a very good deal on products that are coming out of another part of the business. And so this helps drive up our sales and our margin. I don't want to monopolize the time because we have our CFO here, and Ron, perhaps there's something we'd like to add.

No, I do -- I think you touched on a lot of the major points there, Stanley. I think that in 2022, we did face some headwinds with decreasing PPE revenues, decreasing COVID test kit revenues, but the core business really grew well and helped keep us in a growth mode. I think that we haven't provided guidance on 2023, yet. We'll do that next month when we release our Q4 earnings. But we did indicate in past communication that we do expect some of those headwinds to continue into 2023. There are some pricing headwinds with gloves, which is our primary product. We talk about PPE, where the primary product there is gloves. And there continues to be kind of some market conditions that are driving down the prices of gloves, and we do expect that to continue for a while. Having said that, we were very happy with the growth that we're experiencing in our specialty products. We're really excited about the opportunities and the growth we're seeing with some of the software products that we're offering up in our -- from our technology business. And so we go into '23 with some optimism.

Great. Maybe just following up on that comment regarding 2022. So during 3Q, you revised your guidance down to 1.5% to 2.5% sales growth from that 3% to 6% prior to reflect the strengthening of the U.S. dollar and then lower PP&E sales. So can you walk through how much of that difference came from the PP&E versus the FX? And then can you walk us through what you're seeing on PP&E that led you to that lower side of the expectations?

Yes. So I think for in terms of FX, and that's kind of the easier ones, that's the math, right? I think that our expectations then were that we would have about a 2.5 point to 3-point headwind from FX, if I recall. And the kind of -- the combined effect of PPE and COVID test kits would also be in that kind of 2 to 3-point range in terms of a headwind for us on revenue. So that was being offset by some pricing favorability we got in the inflationary environment as well as a little bit of volume growth -- and we also had the benefit of -- 2022 was a 53-week year for us, about every 6 or 7 years. We have that 53rd week. 2022 was a 53rd week, and we estimate that, that provides about one point of growth. So we got a little bit of a tailwind there as well as from the acquisitions -- We actually -- Our acquisitions, we probably got ended up with about 1.5 points of acquisition growth. So when you those headwinds and tailwinds kind of largely offset and you end up with this little bit of incremental growth that comes from volumes and a little bit of market share.

Helpful. You mentioned driving down the price of gloves. Could you just walk through, was that some certain competitor? Was it an online retailer like Amazon? Or what really triggered some of that glove price decline? And how do you think about that pricing moving forward for the PP&E?

R No, it's largely commodity based, right? So what happened was if you go back to 2019, which seems like centuries ago now, right? But 2019, we had PPE revenues of about $450 million, that's a round number, but about $450 million. And obviously, we had no COVID test kit revenues in 2019. Glove pricing then was probably in the neighborhood of, call it, $0.065 per unit. What we -- what happened with the pandemic was that there was a significant increase because of the demand, there were significant increases in costs of the gloves, which were largely imported. A lot of the gloves come from China, Vietnam, Malaysia, and those costs approach $0.16, $0.17, $0.18 in some cases as we went. So pricing went up with those costs. Things more or less peaked, call it, summer of '21. And we've seen declines in net pricing since then. So our pricing has come down with that. So our margins have stayed relatively consistent during that period of time. But just order of magnitude, and these are disclosed numbers. Like I said, we did about $450 million in PPE revenues in 2019. In 2020, PPE plus COVID test kits combined we did about $1.2 billion, yes, $1.2 billion, $1.25 billion. In 2022, that number was over $1.7 billion. And now this year, we've -- our latest guidance indicated we expect about a 30% decline in that number from 2021 to 2022. So we've kind of have reached that peak and now we're starting to come back down. I think the landing point will be something that as a run rate will continue to be well north of the $450 million we did in 2019. But obviously, we're going to come off those levels that we had in 2020 and 2021.

Helpful. And then maybe just since you flagged the margin. So on a total co basis for margins, you expect 2022 operating margin expansion of 20 to 25 bps over prior year. So what are the key margin drivers there? And then looking into 2023, what's your framework for driving margin expansion?

Yes. So 2022, we've benefited somewhat from a little bit of a change in mix in our revenue, right? So as we have seen some -- as our distribution revenue becomes a smaller piece of the pie because of the decline in COVID test kits and PPE, we see a greater part of that mix coming from the specialty business, which have grown quite well in 2022, and those are higher-margin businesses for us. So those are providing us with some gross margin expansion, which is a lot of which is falling to the bottom line for us. For us to continue to grow margins to that extent, we would have to continue to follow that formula. At the same time, we want to be sure that we continue to invest in the business. I think you're aware of our global e-commerce platform, which will be launching a pilot event in the U.K. in the early part of this year and then in the U.S. in the later part of this year in '23. So I do think that we want to be able to continue to invest in the business. So that type of investment can put some pressure on margins, but we feel very good about the long-term operating margin expansion opportunities that we have.

Helpful. I think we had a question here.

Yes, I was going to ask, What is the changing relationships...

Sir, one second, can you just wait for the microphone?

I was going to ask what the changing relationships with dental buyers groups, and in particular roll, private equity roll-ups of dental practices?

Do you want to start with that?

Dental roll-ups of private equity practices?

The private equity roll-ups of dental practice. Well, we've seen private equity roll-ups of dental practices that are trying to negotiate in a part of the gestalt of the putting 500 or 1,000 dental practices together is that they can leverage against you. So I want to understand how that relationship is panning out now?

So yes, there has been quite a bit of consolidation. At the upper end, these are very large DSOs in the United States. Abroad, I think maybe I heard from Australia, Australia and New Zealand, there's a very -- there are a couple of very large ones. We do business with most of these, maybe there's 1 or 2 that we do this. One maybe or 2 that we don't do business with at the top end. These businesses generate very good income for us, but also we provide tremendous services to them, and they buy a lot of our own brands. They can be more clear with the -- so they can be more clear with their practitioners to focus on our own brands and our own manufactured specifically specialty products and a lot of them are customers of our software business. So when you take everything into account, these are quite profitable accounts. We don't obviously pay the commission, et cetera. The pricing may be lower. But at the end of the day, the profit isn't bad. It's quite good. It adds relative to our investment. And these orders are generally taken totally digitally. So the orders come right from the customer right into our warehouse. So the cost of doing business with these accounts is quite low. Of course, this is not only the case in dentistry, but the same with the IDNs in medicine on the human medical side. And these are a big part of today's Henry Schein business. And at the end of the day, is quite profitable.

Because they have software, et cetera, I understand your cost to serve would be considerably lower straight through order et cetera?

It's that we don't pay commission.

Right and the flip side is how much do they save? How much lower is their pricing? And I'm thinking of it from the perspective of the private equity group rather than from your perspective?

It's different for every customer. It depends entirely on the mix of products they buy from us with the -- whether we can work with a specific manufacturer who wishes to provide a particular charge back for that customer. It's very, very customized. But at the end, I believe we provide the best supply chain alternative for any of these large customers, dental or medical. We've been at this business for about 25 years. First one of these dental customers was in '92 and on the medical side, even before that. We're the largest player in this combined business. We provide, I think, outstanding service to our customers and provide very good pricing. I can't give you the specifics. I don't think we have a specific average discount.

No. But I do that, can I understand the purpose of your question, but I think often, when we get questions about DSOs, they're kind of -- they're framed in a sense that the DSOs are a threat to us. And actually, we see the DSOs as an opportunity. Our relationship isn't, as Stanley said, it's not just transactional. It's not who can sell cotton balls cheaper than somebody else. It is very much a strategic relationship. What can we do to help the DSOs grow their practices faster than the market. And that's I think it's a very healthy relationship that we have with them. Yes, they do get better pricing and they're going to get better gross margins. But as Stanley said, it opens up a lot of opportunities for us with our specialty products, with our software. And having that common platform, having that practice management system, which is common across the practices is a very attractive proposition for the DSOs, and it's one that we can offer, we think, better than anybody else.

Just to add to what Ron said, it's not only about the price of the cotton ball nor is it simply about the practice management accounting system. The value we bring to these DSOs is enormous when it comes to practice management. We have, I think, the most advanced AI capabilities when it comes to managing a practice. And they're able to adopt these AI capabilities much better than the smaller practice because they have professionals that are in the IT space, for example, that can connect with us. So it's practice management and clinical management and quality of care that I think we can bring a lot to these practices.

Helpful. Maybe shifting over to a few questions on dental here. So could you spend a few minutes speaking about dental instruments and what really drove the strength this year? Do you think this was simply a catch-up from not reinvesting over the course of COVID? Or do you think this was an underlying market shift?

When you say instruments, are you referring to equipment?

Yes, equipment, apologies.

I wouldn't say it was a catch-up per se. There has been a very strong demand for traditional equipment, dentist, have some pressure to modernize their practice. And it's in that connection that our traditional business has been quite strong. In fact, the demand outstrip the capacity of the manufacturers. That's starting to get better now. At the same time, there's a strong demand for digitalization and products relating to digitalization of the practice. I would say the demand is strong. It has been strong. We've mentioned this on our calls, but there has been quite a bit of price deflation in that area, not with any digital product or service, and that balances out. But I would say the demand for modernizing the practice, combined with the desire to digitalize the practice and the prosthetic application, in particular, not only in the dental practice, but communicating that impression to the lab and the digitalization of the manufacturing, the crown and bridge Chairside, but in the lab, have all been drivers. And today, we are, you may notice. I think you probably do the largest provider of dental laboratory products as well, where there's been a significant movement towards digitalization.

Perfect. And then just since you commented on pricing pressure there. You noted recently at a conference that there's been some intraoral scanner pricing pressure. You talked about seeing some prices coming in from players now at the $12,000 range versus $20,000 to $25,000 historically. So how are these prices bringing the average or getting to the average market price? And then what do you think will happen with volumes given this price change?

Well, I think we're moving towards an environment driven by COVID, I think, and the desire of an increase in -- by the public and customer satisfaction to move away from the manual impression to the digital impression. So the demand is very, very strong. And I think we have moved, we're moving or if we haven't gotten there yet, we're going to be soon to a standard of care where the scanner is going to be assumed to be the standard of care. The price between the different products that we offer has come down significantly, and the features have gone up. I wouldn't want to talk about a specific price because there's no average price given the fact that there's such a wide variety of devices available and lots of different software. So the price has come down, though, generally per unit. And I think we can expect that to continue, whereas the offerings from different manufacturers have increased and at the same time, a significant increase in demand.