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

Everyone, thanks for joining us on our last day here at the growth stock conference. My name is Brandon Vasquez. I'm a research analyst here at William Blair, who covers Henry Schein, and we're excited to have with us today, Ron South, SVP and CFO. Before he kind of dives in and gives a little corporate presentation for us all, I'm required to inform you that for a complete list of research disclosures or potential conflicts of interest, please visit our website at williamblair.com. Thank you very much.

Very good. Thank you, and thank you all for stopping by. I appreciate your interest. As mentioned, my name is Ron South. I'm Chief Financial Officer at Henry Schein. I've been the CFO for just over 1 year there now. I've been at Henry Schein for 15 years. And I succeeded Steve Paladino, who many of you may know, Steve was the CFO for 29 years at Schein since the company or since prior to the company going public in 1995. So a lot of this -- a lot of what we talk about here has his fingerprints on it as well as Stanley Bergman, who has been our CEO for 30 years plus and has been able to remain as CEO since the company went public in 1995 as well. I think that if you -- Henry Schein has been in business for 90 years. It was started as a -- really as a pharmacy by Henry Schein and his wife, Esther. And the company went public in 1995. We -- when the company went public, it had revenues of approximately $600 million and we will be at $12.6 billion, that was our fiscal year '22 sales. Now operating in 32 countries and serve over 1 million customers globally. I think when we talk about our market position, what are the kind of the 3 kind of key things we look at. One is, it is a very fragmented customer base. We're dealing with individual practitioners in many cases, on the dental side. On the physician side, we're dealing with individual practices. But we also deal with IDNs, DSOs in the dental space and as well as in some cases, governments, corporations, depending on the nature of the customer, but it is a very fragmented customer base. In the U.S., our average shipment is about a $700 shipment. It's a small box, could have anything from a box of gloves and some cotton balls and some pharmaceuticals included within -- all within the same shipment. So that's -- it's a high-volume pick-and-pack operation from a distribution standpoint. Our customers also come to us for technological solutions. We provide software products to our dental customers that help them manage their practices, whether it be across the billings, the appointment management, et cetera. Markets we serve, we are the #1 global dental distributor. We do have our own brands on the dental specialty side that we self-manufacture. Specialty products include implants and bone regeneration products as well as endodontic products and orthodontic products. On the physician side, our focus is really on the alternate care center. So we don't serve the hospitals per se, but it is more in the alternate care. It's in the physician office. It's in the ambulatory surgical centers, community health centers, et cetera. And we are starting to expand more into home health care. And we have made an initial investment a couple of years ago into a company that serves the home health care market. And lastly, I want to talk a little bit more about our global dental practice management solutions. It is the #1 in its market for practice management systems. So the macro trends that we find to be favorable to our business includes the aging population. As they say, Father Time is undefeated, right? We're all getting older. And as we see the population age, you begin to see a greater need for various different dental procedures and just that much more traffic into the physician office. In terms of health care developments, we're seeing more and more procedures move from an acute setting to -- more to the alternate sites. So whether it be the ambulatory surgical centers, whether it be in the physician offices, our CEO, Stanley Bergman likes to -- increasingly he's been sharing the anecdote that 6 weeks ago, he had a partial knee replacement, and he was not hospitalized. He went to an ASC, got his knee replacement and was home that night. And we're seeing more and more procedures of that sort occur outside of the hospital. So our philosophy in terms of health care development has been to follow the patient. And on the medical side, it has been, as more and more patients move to these alternate care sites and are now starting to get more and more care in the home, we're going to follow that patient into those various sites and try to be part of that supply chain, part of that value-added process that serves those patients. Also within health care developments, we think that there's clearly a growing awareness, and this has been happening for years now, but it continues to expand of the importance of oral care to the overall care of a patient. And as that expands, we're seeing kind of better procedures in the dental offices that ultimately have a better outcome for the overall health of the patient as well. And then lastly, I'll talk about, on the bottom of the screen, the increased adoption of digital technology. I think we're seeing more and more use, not just of digital technology in terms of managing the back office of the practitioner, but also in the technology they're using to serve the patient. There's -- now it's almost a standard that you expect your dentists to have an intraoral scanner when you go in as opposed to the impression material that was typically used. Having said that, there's still a lot of offices that aren't using intraoral scanners. So there's still a runway out there for technology to be adopted in practices. We're seeing greater use of our artificial intelligence now. There's some new tools out that will assist the dentist, not replace the dentist's diagnosis, but assist the dentists in making an accurate diagnosis of where there may be caries or cavities within the mouth. And it's a tool we recently launched called Detect AI, and we'll talk about a little bit more in the presentation. So our strategic plan that's currently in place, we developed this acronym BOLD+1 and what BOLD+1 really means the B stands for Build, meaning we'll continue to build some internal complementary software, various other specialty products to really continue to provide high growth for us. But the things that we can build ourselves, even though we are kind of viewed as a distribution company, there's a lot of products that we are now currently selling that we build ourselves. We develop our own software that we sell to our customers. We are also manufacturing all of our own dental specialty products. So there is a -- we will continue to build within that product portfolio. And then also the O is Operationalize. How do we use 1 distribution, operate as 1 company, to serve a customer's needs. Our customers don't want to deal with 1 party for their distribution needs, another party for their specialty product needs and another party for their software needs. So it's also how do we kind of operationalize as one Schein. And then Leveraging, leveraging our existing relationships with our customers. You have to have a value-added relationship with your customer, also become irrelevant to that customer. Several years ago, there was a lot of discussion around the threat, for example, of Amazon in the health care space. Why wouldn't a dentist just go to Amazon and buy what they need for their practice? And I think that really undervalued and underestimated the value that the -- our field sales consultants have with their customers. And so it is truly a relationship type of build that we have with our customers. They understand what are the emerging trends in dental practices, what are the emerging trends in physician care that we can help them grow their practice, make their practice more profitable. And then finally, Drive, the D in bold is for Drive, which is driving the digital transformation. I think if we try to visualize what a dental office will look like 5 years from now, it will have much more technology use to it, whether it be a 3D printer, whether it be a continued use of intraoral scanners but also how does it make it more efficient. How does it make it more importantly, a better experience for the patient? And I think as we drive that digital technology, it will make -- and as we improve patient experience this way, it also improves the profits for our customers and allows them to expand their practices. And then lastly, the Plus 1 is really creating value for our stockholders -- our stakeholders, and that includes our ESG priorities as well. We have -- from the beginning, Henry Schein has taken a view that they play a role in the communities in which we operate. And we've taken on a lot of kind of social responsibility as being part of really the fabric of the company. And so when ESG came along, we felt like we've been doing this now anyway, so we were able to kind of easily adopt into a lot of the ESG initiatives that are out there. So our approach, Henry Schein sort of is really a distribution company. But then as we -- as you kind of go left to right on this screen, so we have supply chain solutions for our customers, but then we were able to start introducing specialty products and services for our customers. A very important part of our business is service and support. We have a very robust equipment service team. If you're a practitioner and you have a problem with your chair that -- your patient's chair and if you have to wait a week for someone to fix that, that's lost revenue for you. So we have a very robust equipment team -- equipment service team that is able to provide very timely service to minimize the disruption to the practitioner. We have since adopted or built a lot of software value-added services. These include practice management systems, like I said before, that can manage appointments, but we also sell business analytic tools that our DSO customers especially like. It provides a dashboard of the profitability of the individual practices. And if you're a DSO with multiple practices, it allows you to kind of look at a snapshot of the various different offices you have where the outliers in terms of profitability or certain different financial metrics that you may want to put out there, and what can you do to address that to assure that you get consistent profitability across all your practices. And then lastly, the relationship. Like I said before, it's not -- this -- our relationship with our customers, whether they be individual practitioners or national DSOs, it's not a transactional relationship. It's a strategic relationship. It's what can we do to help you grow your practice, what can we do to help you improve your profitability. So these are things that we -- these are really the touch points across the spectrum that we really emphasize internally. So the supply chain excellence. I think that when you look at this, I don't need to read all the words to you on this, but 1 of the things that jumps out is 300,000 unique SKUs globally. So when -- we're getting a lot of questions last year during the high inflationary period, but what's going to happen if your costs go up on certain brands, and will your customers accept the higher cost. And 1 of the -- because we have such a broad offering of products, if the customer was unhappy with the price increase on a particular product, we typically had another SKU of another national brand or perhaps even a private label that we were able to point them towards that perhaps was at a better price point for them. So we didn't lose the sale. So this was always an important part of our business is that we have this broad spectrum of products available to our customers. So the dental market, as you can see here, market share in the various portions of the world in which we operate, with just over 60% of our business in North America, 26% in Europe and then the balance in the rest of the world. We do have a presence in -- a question I get frequently is, what's your exposure in China. I will say our revenues in China are less than $200 million of our $12.6 billion of revenue base. Having said that, we remain committed to China. We think that there's -- it's important to have a presence there, and we do think that there will continue to be growth opportunities. But as you can see here, most of our business is in North America and in Europe, probably our 2 largest markets outside of North America and Europe are Australia and Brazil, where we've had very good success, especially in Brazil. And most recently announced a transaction, that hasn't closed yet, of an implant manufacturer, the leading implant manufacturer in Brazil. Our long-term growth strategy in Dental. We have -- the success we've had with our distribution business and that gets us an entree into the customer. So it's really what else does that customer need and how do we increase the penetration with that customer. I mean everything you see in a dental office is something we sell to that customer, whether it be the chair you're waiting in the waiting room or the chair in which you are being serviced or any instrument being used by that dentist. So what else -- but what else does that dentist need, that practitioner need that we can -- that allows us to increase the penetration with them. Kind of moving down a little bit within this. We talk about continued focus on large group practices, the fourth 1 down. Several years ago when DSOs were really starting to gain traction and get a lot of publicity, it was viewed as a threat to Henry Schein that this was going to be -- DSOs were going to ruin our margins, dilute our business, et cetera. And what it's really turned into for us is the DSOs have turned into a great opportunity for us. Like I said before, our relationship with all of our customers, including the DSOs, is a strategic relationship, not a transactional relationship. We have a team of management who meet on a regular basis with our largest national DSO customers to talk about emerging trends in dentistry, what can they be doing to improve the profitability of their practices. And it's -- it makes that relationship very sticky with them. The scale that DSOs require is we are uniquely positioned to provide that scale, to provide them with the services they require, just -- not just the gloves and the cotton balls and the things they need, but also the technological products they use to run their practices. They want that common platform across all their practices, and we're able to provide that to them. And then more recently, we've been able to really get better penetration with them in the sales of our specialty products, our implants and our endodontic products and with a couple of DSOs specifically, some orthodontic products as well. The medical market. So like I said before, our medical market is really confined to primarily the alternate care space. And we are #2 in the market behind McKesson in that space right now. And then once you get -- after us, Medline is also a player in this space, but they tend to focus only on their branded products. After that, it's a highly fragmented market and that we feel like we have some opportunity to gain some market share there. We list some of the key acquisitions we've done in the, what I kind of call, peripheral space of medical in the last couple of years here. Two years -- back in 2019, we invested in North American Rescue. North American Rescue provides a lot of military based product to whether it be the U.S. government or other countries, and it's been quite successful for us. In 2021, we invested in Prism and Prism was the first investment we made in the home health care area. Prism provides wound care products to home health care providers. And it's given us a chance to kind of learn a little more about what are -- what the opportunities may be within home health care and where do we play in that supply chain, what can we do to add value to that supply chain. And as I said before, as more and more patients migrate into care in the home, we think that this is an area that we want to try to expand in. And you can see the circle on the right, it is largely a North American business. We do have a little bit of medical business outside of North America. We did recently make an investment, excuse me, in Australia in a medical distribution business. And that was really more of an opportunistic transaction for us because it allowed us to use our existing infrastructure in Australia that we use to distribute dental products to bring in these medical products. So it was a really nice fold-in for us into our Australian business, and we decided that we would kind of take the leap, so to speak, and start selling medical products in Australia as well, even though it's typically a U.S. business for us. So the specialty markets. This is an especially exciting area for us and 1 that is -- we are really placing a lot of priorities. We began in the specialty area with an investment in Camlog, shortly before I joined the company in 2008. I want to say it was around 2005, 2006. It wasn't really intended to just -- we're going to do this to compete with our suppliers because we get a lot of questions around your suppliers also provide implants and endodontic products, but it was the only way we could really get into these markets. Our suppliers wanted to go direct with their specialty products. And so for us to participate in the dental specialty arena, we had to do so through our own manufacturing, and we did that through acquisitions. So it started with Camlog and around 2011, we purchased BioHorizons in the United States. And as you know, we have recently acquired Biotech Dental, which was the largest implant manufacturer in France. And we closed on that transaction in the early part of April. And then we most recently announced the signing of a contract or a signing of an agreement to purchase S.I.N., an implant manufacturer in Brazil. And we expect that transaction to close sometime in the back half of 2023 in this year. We also have Medentis medical, which is a smaller, what we call, value implant manufacturer in Germany. And as -- what we're seeing is that the implant market is largely untapped. There's a significant number of people in the world who currently require an implant and don't have one. And there are going to be more people as the population ages, as we mentioned earlier, who will be requiring an implant going forward. And we think that investing in value implants with lower-cost implants will allow greater and greater revenues, especially in developing countries right now. So Medentis was an important transaction for us. Outside of implants, we continue to operate in endodontics. It's a very steady growth area for us. We've invested in both Edge and Brasseler and both have done very well in the market. I think our endodontic products had approximately 8% year-over-year growth in the first quarter of this past quarter. And then orthodontics, where we're not as large of a player, but we do have some good relationships with a couple of DSOs to sell aligners. It's a relatively small part of our business, but we do see some opportunities for scale there. And we think that we'll continue to make appropriate investments. On the technology side, I mentioned before, I want -- we talked a lot about the practice management solutions that we have already. In addition to Henry Schein One, where we provide practice management systems, we also have other financial services. We can help practitioner sell their practice. We can help practitioners on their revenue cycle management, a lot have -- we have a product or we invested in a company called eAssist and it allows the practitioner to essentially outsource the receivable function to eAssist. They make sure that the claims are processed accurately. They make sure the receivables are gotten, are received timely from the insurance companies and that the balances are then received primally from the patients, and it's been very well received by our customers. So within Henry Schein One, on the technology side, we do think that there's a great opportunity there. We think that right now, as you can see on the right-hand side, the typical office spend is kind of $300 to $320 a month on our Henry Schein One offerings. But we offer services and products that could get that up to $1,000 a month. So we really are trying to increase our focus on increased share of wallet with our existing customers to Henry Schein One. We think there's great opportunity there. We already have -- #1 in the market share there. So gaining new customers is getting more and more difficult. So it's really how do we expand the services that we can provide to our existing customers. I'll touch more briefly on financial performance. I do encourage you, if you haven't already, take a look at our -- on our website, we have our Investor Day slides. Some of these slides, you'll recognize from there. But you can see we've been able to sustain very good growth, a sales CAGR of 8% over that period of time, which was '19 -- 2019 to 2022. When you take out PPE and COVID test kits, that does drop down to 5.9%. We do see COVID test kit and PPE revenues continue to subsiding a little bit this year, but they are leveling off, and I think we'll be able to talk less and less about that going forward and talk more about the core business. And we are expecting kind of -- we kind of have this goal of long-term sales growth on an annual basis of 6% to 8%. You can see the earnings highlights, 4-year CAGR there and our EPS of 10.6%. And we do think that we've set a goal for ourselves that we think is achievable of having an 8% to 11% continuing EPS growth on a long-term basis. Operating cash flow, generally speaking, we -- our goal is to generate more operating cash to net income. And you can see in each of the last 4 years, we've been successful with that goal, and that will continue to be a goal for ours. In Q1, we did achieve internal sales growth of 6.3% when you take out the effects of PPE products and COVID test kits. We believe that we're getting much more stability in the end markets and the end dental markets. A lot of the kind of disruption that occurred from the pandemic has kind of played out now. People have resettled in. They're going back to the dentist. And we really feel like the end markets are stable now as they have been since prior to the pandemic. And our guidance, we're holding to our full year guidance on the core business. We did adjust our guidance a little bit for 2023 to reflect the dilutive effects of the Biotech transaction. There will be some costs associated with mark-to-market adjustments on inventory on Biotech as well as some integration costs that's going to contribute to that dilution. But we do believe that beginning in 2024, Biotech will be an accretive investment for us. These are the long-term financial goals as we communicated at our Investor Day. Like I mentioned before, 6% to 8% in terms of sales growth. 8% to 11% in terms of non-GAAP diluted EPS growth. We do think we can get at least 10 basis points or more each year in operating margin expansion going forward. So in terms of the investment merits, I think if you want to invest in dental space -- dental or the physician space, we do offer a unique investment opportunity in that we're not just a distributor. We're not just in specialty products. We're not just in dental software. We're not just in dental. We have a very robust and healthy medical business as well. So we provide good diversity across the band in terms of the dental space, and we can consider that to be 1 of the more important characteristics of the business. And I am out of time and out of slide.