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

Great pleasure to have Henry Schein with us at the conference this year. Joining us at the table for this conversation and who needs no introduction, Chairman and CEO, Stanley Bergman; as well as CFO, Ron South. Thank you both for being here.

Maybe to start off, Stanley, I would love to just get your state of the union on the dental market in the U.S. and Europe. Depending on who you talk to, I feel like we're sort of seeing a mixed read on the current market environment. You had a good first quarter, it seems like, in terms of demand. What's your current read of U.S. and Europe dental right now?

Brandon, thank you for hosting us. Thank you, everyone, for being here. Sorry, we were late. Henry Schein does not service these elevators. We would have been here quicker. So Brandon, the market is pretty stable. Look, there are aspects that are up, there are aspects that are down, but essentially visits to dentists in the United States have been relatively stable. We're about where we were in '19, perhaps a little bit higher. I would say in Europe, it's pretty stable, specifically in the countries where you have government support, a slight issue in France. I think you know that the country came to a halt for about a month or so. But generally, it's pretty stable, which means stable consumables. The dental equipment business is a business for us that has always been around, on average, take a few quarters, add them up, look for an average, it's about mid-single-digit growth. There have been challenges with delivery on the traditional equipment, which is about 2/3 of the equipment. I think that will stabilize, still a backlog, it will stabilize out. And the digital side, there was a lot of price competition on the scanners for a period of time. I think the pricing has stabilized. The units are going up. It's a good business. The mills, there were some challenges because for a couple of quarters, I think [ analyst ] was saying, maybe the 3D printing will replace it. I think that's sort of died down. The mills are being bought again, maybe not as rapidly as 2018, '17, but it's a good business. 3D printing is growing not so much necessarily for replacing crowns in the dental office yet, but for other ancillary products and of course, in the dental lab. The specialty businesses, on average, are doing okay. We're bigger players in the implant and bone regeneration business. I would say that, that business maybe in parts of the world, the very high-end premium is a bit down, but the more value seems to be doing okay. And I think you have to look at a few quarters. And the endodontic business is quite stable. I think we're gaining some market share in that space. And then the aligners, orthodontics in general, the -- why is the brackets very small for us? Aligners are also very small market share. It's growing for us with specific accounts, specifically DSOs. And -- but it's 10% of our $1 billion business in specialties. Software continues to be a great interest, specifically the AI software that we introduced. So overall, I would say the dental market is pretty stable. The medical market, the comps, of course, are a challenge because last year, we had COVID, suspect COVID, heavy flu season. Many people visit -- many people went to visit the practitioner. I would say it's more or less stable right now, a little bit -- the comps are still high. But overall, the business is relatively stable, Brandon.

Ron, you did 8% in terms of Global Dental consumables ex PPE in the first quarter. The comp wasn't exactly easy. I think it was a plus 5 or so. What are you assuming for kind of the balance of the year for consumables? And is there any cushion baked in for maybe a slower macro in the second half?

Yes. I think that consumables did benefit a little bit in the quarter from a -- in the prior year, dental consumables were adversely affected by the Omicron variant in -- that was pretty fairly prevalent in the first part of the quarter. So that gave us a little bit of a lift in the quarter. And then also the fiscal calendar or the timing of the fiscal calendar gave us a little bit of a lift. But nevertheless, we were very happy with that, with the growth, as you mentioned, being 8%. I think the run rate going into the year, I don't expect it to be quite that high. But I think we can still kind of do mid- to high single digits on dental consumables as we progress in the year.

How much of that was net pricing in the period? And is it consistent through the year as well?

Pricing probably gave us a couple of points of lift in the quarter, but I would say pricing has become a little more consistent with normal practice. I mean, last year, we talked a lot about pricing. There were a lot of interim price increases from suppliers that we were able to pass along. But I think we're seeing a little more stabilization in the increasing of prices now.

Flipping gears maybe over to equipment. Feel like you've carried a backlog in traditional equipment for some period of time. Is that starting to unwind at all? What's -- why does that continue to persist? And I guess what's your expectation? I think that grew kind of maybe low doubles, remind me if I'm wrong, in the first quarter, which is pretty strong for a category that's mostly replacement. Where is that level kind of growth coming from?

So standard equipment, and as Stanley kind of touched on this as well in his opening remarks, I think that in North America, standard equipment revenues versus last year were in the double digits in terms of growth. That was -- benefited a little bit from a decline in the backlog. The backlog got abnormally high in the last kind of year or 2 as there were some delays. In some cases, you had customers anticipating delays in getting equipment, so they were placing the orders fairly early. And in other cases, if they were building out a practice, adding capacity to their practice, they were experiencing some construction delays. So we're starting to see some of that work its way down, which is good for us. We want that backlog to get down to a more normal level so that our customers are getting their equipment on a more timely basis. It gives them greater capacity. It gives them -- ultimately, it expands the capacity of the industry. It gives us an opportunity to sell more merchandise. So we do think the backlog will work its way down over the course of this year to a more normal level. But right now, the backlog is still higher than it was a year ago and much higher than it was prior to the pandemic if you go back to 2019 backlog levels. So there's still some room to move that down.

So Brandon -- thank you, Ron. It's not all replacement. There is investing in dentistry. I think people are buying practices. They replace some equipment, yes, but these are new investments that may have had 1 or 2 [indiscernible] that go into 4 or 5. New practices are being opened. DSOs are investing. So it's not all replacement.

Would you kind of unpack what you're seeing in the digital side of equipment? Some other manufacturers have seen really weak trends. You seem to suggest that maybe pricing is more stable now. How is it different between IOS and more 2D, 3D imaging?

Well, pricing for IOS has stabilized. In the U.S., we had an entrant that has set the market a bit. But I think it's stable. Also, we had on the high end a manufacturer that introduced some new systems and software. Their availability of product was a bit of a challenge for us. But overall, it's stable. There's a good demand for the product. And the mills seem to have stabilized as well. As I said, there was all this concern that the mill will be replaced by 3D printing. I don't think that's the case right now. 3D printing is -- it's a very nice category. It's growing fast off a relatively small base. And it's mostly been -- a big chunk of it's going into the lab, although there is some going into dental office. But -- and I think we've seen a relative unfreezing of the mill market.

Ron, correct me if I'm wrong. I mean, I think digital equipment may be down low double digits in the first quarter?

Yes. So on a revenue basis, yes. I think we -- like Stanley said, we actually saw some volume increases in intraoral scanners but lower revenue because of the average selling price being lower than the prior year. And then lower demand on some of the 3D -- on the 2D, 3D imaging as well as some of the mills.

But based on your commentary, it sounds like maybe that ASP headwind moderates moving through the year?

In the back half of the year, we would expect that. It was that really last year in Q3 that we began to see a meaningful entry into the market of some of the lower-priced scanners coming in. And so some of that should begin to annualize as we get into the third quarter.

Okay. The DSO market, it's always been I feel like a hallmark of Schein's. Would you talk about your relative market share in that customer base? Is it higher than kind of your core, I guess, traditional business? And what are the, I guess, long-term implications of that cohort of customers being a bigger piece of the market in terms of your gross and operating margin profile?

So we have a disproportionate share of that market, both from a market point of view and also within Henry Schein. The business is growing a little bit more than the whole average. The margins maybe on some of the products are -- the national brands are a bit lower, although manufacturers do provide support. We do well with our corporate brand and our own brand and our software. So overall, it's a good market and contributes nicely to our -- in general, to our operating income, which the DSO business provides a very nice growth to our operating income.

At the operating line, at the operating margin line, Ron, is it comparable? It seems like gross margins may be a little lower. Is that offset at the operating line?

Well, you'd have to look at the whole relationship with Schein. On the distribution side, it may be lower. But if you add the specialty products and the software, it's a good business.

Yes. But also our cost to deliver is lower. So while the gross margin may be slightly lower on our DSO revenues, our cost to deliver is lower. So we do get fairly comparable operating margins on that business.

And of course, in that light, we don't provide commission to salespeople. We don't have marketing expenses.

Right.

Overall, it's a good business. Exactly how we get to our position is something we don't talk about because of competitive purposes. But for Henry Schein, it's a good business.

Got you.

Likewise on the medical side, the IDNs that are investing in office-based practitioners, it's a good business for us.

I do want to touch on the specialty business for a moment. Growth has moderated there over the last 2 or 3 quarters. But I think implants is 2/3 of that segment. What's your, I guess, assessment of the implant market right now? And how should we think about growth in specialty in the back half, particularly as you come up against maybe some easier comps?

Yes. I mean, we are in the middle of a quarter, so I'm not sure what we can say and what we can't. But it's a pretty stable market. I would say there is some moderation at the high end of the premium line. We don't really play in that. We play in the premium line. We have very good brands, but they're slightly lower priced than some of the major brands. There is a, in some markets, a movement towards value. We have value within our premium brands. We are at a slight disadvantage in the U.S. because we don't a fighter brand. That's one of the reasons we bought the company in Brazil. Our competitors all have fighter brands. But overall, the market is stable, and we have to look at some regions. Maybe we're growing very well in one region or another because the market is growing or because we're growing from a market share point of view. For example, Camlog has a very good market share or very good business in Germany. And we pointed out on the last call that Camlog did very well in Germany. Now is it because of the market? Or is it because we have a better brand or a better sales organization, better products? Hard to tell. But we're at the hundreds of basis point difference. The market is not down hundreds of basis points nor are we growing significantly more than 100 basis points in market share. It's a relatively stable business leaning towards growing.

Ron, in terms of the guide, one sort of, I guess, nuance after this last quarter that you can take a $0.07 charge for this Biotech acquisition in 2Q and 3Q. What's the impact going to be in gross margins? Is that all going to be in the COGS line? Or is there some in OpEx? How do we think about the impact of that?

There will be some in both, Brandon. I think that we have the mark-to-market, the inventory as part of that close is the so-called inventory step-up. And the effect of that mark-to-market adjustment will reduce gross margins a little bit as we work that acquired inventory out. And typically, an implant business is going to turn its inventory about twice a year. So it takes us about 6 months maybe to work that inventory out. And then after that, we'll go to more normal gross margins on that element of the business. There's also some integration costs associated with the transaction that will be flowing through OpEx as well. So there's a little bit in both, yes.

You've got another pending acquisition. I think it's S.I.N. Implant.

Yes.

Do you anticipate to have a similar magnitude of noncash charges once that closes?

It could be similar. I mean, we'll...

It's pretty unique. I mean, most companies would kind of non-GAAP those types of things out, but just trying to anticipate once that deal actually finalizes.

Yes. I mean, we'll -- depending on the timing of when that one actually closes at that point, be able to assess what impact it will have on the earnings in '23.

Okay.

But it is a similar type of business to Biotech, yes.

But, Brandon, you've seen from our press release, from our investor call, from our filings with the SEC, you can take those expenses and you can figure them out, the expenses and the inventory adjustment. If you take them out, you'll see that our numbers are pretty good.

Well, you started to make it easier on us when you took out amortization.

Yes, we were trying to...

But leaving the charges in. So...

We were trying to make it as simple as possible. We have a lot of accounts at Henry Schein, including myself. I wasn't a very good one.

One foot in GAAP, one foot out GAAP. The -- can you just talk about your visibility and confidence level that on PPE and COVID testing, which is the $0.35 to $0.40 EPS headwind to the year? Is that largely behind us now? Will we be able to not be talking about this when we roll into '24? Or is there still some lingering maybe drag next year maybe from lower ASPs?

I think we did disclose that we thought we had about -- we estimated about $0.24 hit in Q1, but we're holding to the $0.35 to $0.40 headwind on -- estimated on the full year. So -- and we did say when we gave guidance that the effect would be far more pronounced in the first half of the year than the second half of the year. So we're continuing to assess that. And to the extent if we need to adjust anything that we'll communicate it accordingly. But yes, we do think that as the year goes on, we're seeing some stabilization in PPE pricing that will begin to diminish the effect of this a little bit. COVID test kits is that's really more of a demand issue, right? It's just a market demand issue at this point. I think that we sold $52 million of COVID test kits in Q1 versus a couple of hundred million dollars of COVID test kits last year in the first quarter. So I think that COVID test kits is really just going to become a product category that we'll be selling like other products and will still be a beneficial product for us. But it won't create the same volatility probably be getting in '24 versus '23 as we have in '23 versus '22. PPE, we'll probably go into '24 at a -- math will just dictate that we'll probably be going in at a slightly lower price point than what we -- what the average will be for '23. But I don't think it will be nearly as pronounced as the effect was '23 versus '22. And we are seeing it stabilize at levels where our total PPE revenue is well north of what our PPE revenue was back in 2019. I think there may have been some concerns that would it go all the way down to that revenue base, which was around $430 million, $440 million. If you're looking at where we are in Q1, we did $149 million in Q1 of PPE. That's down from like $161 million in Q4, but one -- but Q4 had an extra week. It was a 14-week quarter for us. So you can start to see that there is some stabilization in where that PPE revenue is going to level off at.

But we'll give you the information. We can't tell exactly what the profit impact will be, but we've estimated it. So you have estimates for PPE. And gloves have pretty much, I think, reached the bottom. There's some masks, but it's not material. And the COVID test will give you that information. Who knows where that's going to go? But both of them -- both of the incremental business have been good for cash flow, great for customer service. But you can look at the core business absent the tests. And they will be a part of the test, that always remain part of the core business, very nice lab business will always -- part of that business will always include these COVID tests but not at the levels that we experienced. And we'll show that to you.

We've only got a minute left, Stanley. You've been around this industry a really long time. I'd be curious to get your view on what role generative AI tools are having in Schein, ways that you see them to apply to your business or -- and/or how disruptive they might be and where the biggest applications might be in dentistry.

I don't think that will be disruptive, Brandon. But we have a couple of very nice AI tools that really attach to our clinical workflow in the Henry Schein One business. And they sell for a couple of hundred dollars a month. And I think that within a period of time, it will become standard of use. And there's many, many more tools that will be available. But I don't think they're going to be disruptive in any sense. It will be incremental to us. We spent a lot of time looking at this stuff. We read every article that comes our way. But it's a good business. Henry Schein One with its clinical workflow and all the opportunities there is a great business. AI will play an important role but not disruptive.

What about as far as just like equipment demand or imaging demand to a degree like software can better detect caries that we can't see with the eye today. I mean...

Of course.

Any roles or applications like that, that stick out in your mind?

I would imagine that a dentist that graduates from dental school today will require this in their practice. And not only the applications that we're selling today, but many more. There's a lot of good stuff coming, and it's all incremental. Will it double the business or half the business? No, but it's incremental. And we sell this on a SaaS model, and our reoccurring revenue at Henry Schein One is doing well. Can't guarantee 12% growth every quarter. I think we'll have growth. I think over the course, it will be greater. But the nice thing about Henry Schein One is a lot of reoccurring revenue. They are as part of it.

Super. Cool. Unfortunately, we're out of time, so I have to leave it there. Stanley, Ron, thanks so much for being here.

Thank you, Brandon.

Okay.

Thank you. Thank you all.