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

Okay. Great. Thanks. Good morning, good afternoon, everyone. Jon Block with Stifel. Really happy to have Henry Schein with us, and to my right, Stanley Bergman, Chairman and CEO; Ron South, Senior Vice President and Chief Financial Officer; and Graham Stanley in the audience Vice President, Investor Relations and Strategic Finance Project Officer. I was just telling to the guys we've got 30 minutes to figure it all out. A lot to hit on and a lot going on.

I'm going to actually start with the quarter and the core business because, everyone was so focused on the website and cybersecurity, I think what got lost it was the third quarter that actually was a little bit stronger than people had anticipated. So let me go through a couple of metrics. You hit the 3Q '23 EPS consensus. It was $1.32. Other dental companies missed third quarter top and bottom line and your revision to the 2023 core EPS was modest. It's about a $0.05 and a lot less then again, your dental peers. So Stanley, maybe if you just want to talk about the margin preservation in the quarter seemed impressive, flattish EBIT margins year-over-year despite revenues falling off late in the quarter. How were you able to achieve that? And how are you able to keep the core number more intact for '23 relative to some of the other dental companies?

This sounds like a very mathematical question. Ron?

I get the math questions.

You want the concepts, I'll respond.

All good. We'll hit on both. Jon, I think that when you look at -- and I don't want to start off by talking about our peers. But when you look at the scope of their operations and what impacted them, it was some areas such as in some of the specialty areas such as implants, I believe, and high-tech equipment. And those are areas that perhaps have had a little more volatility recently, and we steered towards the lower end of our guidance before taking any effect of the cybersecurity incident, largely driven by some of those same things. But the breadth of our business is such -- is so much wider than some of the others. When you take into account just the absolute size of our distribution business, we have a technology business. We're not just a dental business. We have a very healthy medical distribution business as well that all of that really, I think, gives us -- that diversification helps us weather through when there is pockets of softness in areas that perhaps impact some of the others in the industry more so than us.

Okay. And I guess that plays a little bit into that sort of more defensive dental narrative that we called out in the recent upgrade in terms of -- because of your diversification and absolutely broad portfolio. I'll go one more math oriented, and then I'll zoom out a little bit. But I went back and you look at the high single digit to low double-digit operating income growth that's embedded in the long-term model. And I went back to your Analyst Day, and you talked about top line of 6% to 8%, which was really robust. It was a little less about 100 bps less than that when you strip out M&A. But here, you held the line on margins with only sort of 1% growth normalized for PPE COVID. So Ron, what do you need from a top line perspective to get that margin expansion that would allow you to march to what you've laid out in your long-term plan?

Likely, the most important part of that top line expansion would be the components of that growth. By that, what I mean is, to the extent that the specialty businesses and our technology businesses are that, that pace of growth exceeds that of distribution, it gives us just through -- we're talking about math, just through the math, really gives us that margin expansion that we're looking for. So as our specialty businesses grow and our technology business grow and take on a -- if you view that revenue circle and that pie, that piece of the pie that comes from them, we'll see that margin expansion continue that we're hoping for.

And that goes to the march of the 40% of EBIT that you've talked about having from those businesses?

Right. So the goal is to advance our high-growth, high-margin businesses, which will go of 40%. Then you also have our own corporate brands, which are about 9.5% of our sales, and you add that up and you're approaching just under 50% of our profits, they're in higher growth, high-margin areas.

Okay. And I'll stick with that particular talk track and then I'll work back to some other topics. But Stanley, it was a very big year for acquisitions for you guys and some of that was certainly focused on dental specialties and implants. I want to call them holes, but were those big step forward? And are there any other areas that you want to really address and bulk up? Or is it a little bit more augmenting a niche going forward?

Well, our goal is to expand our specialty businesses. The 2 acquisitions that we made, the 2 major ones and implants. One was to expand our presence in France. We had a very low market share, and we believe biotech is the largest provider of implants in that market, and we didn't really have an implant offering in Brazil. We're a very good distribution business, but very small implant sales. So we expanded into Brazil with the implants. But more important, we needed for the United States, a lower-priced implant, specifically for DSOs and the acquisition of the business in Brazil helped give us good presence in Brazil for implants, but also perhaps even more important, a low-priced, high-quality implant for the U.S. I think there are more of those opportunities, although we're not focused right now on acquiring more of those kinds of businesses, but we'd like to finish the integration here. The other area of enormous interest is to expand our presence in the home care products arena. We believe procedures are moving out of the hospital into the alternate care setting, the ASC area and the home care, and we want to follow the patients. And so we've spent quite a bit in the home care area and we've made some important investments there. And then there's all the other value-added services that we -- there's a lot of those that we feel we could add to. And then we want to enter into some specialty medical product areas. We've mentioned that before. We have a smallish sized orthopedic business, but quite profitable, and we want to add to that. So I'm not saying we're going to necessarily make big acquisitions now because we've a lot to integrate a billion dollar capital that we put to work, but there are opportunities.

And maybe let's stick with some of those recent acquisitions. I know they've only been fully in your umbrella for a short period of time. But how are they performing? I mean, if we sort of talk about some of the acquisitions over the past several months, how are they performing? And then Ron, to take it back over to you. I think at the time of the acquisition, I believe each of the 3 main deals that you did were expected to be accretive to 2024. Is that still the plan? And if you can detail even to maybe what extent?

Right. So the 2 implant businesses are performing well in their home markets, namely Brazil and France. The home care businesses we only closed recently on the big 1 for the period that we own the business has done quite well. We believe we have a very good management team in the home care area to advance the variety of products that we'll be offering. And I think those are doing well. And then the big service -- value added service business we bought, which is LPS focused on the large group practices. [indiscernible] doing okay.

Okay. And I would say, Jon, the operating income growth, we'll definitely get some operating income growth next year from these transactions. From an EPS standpoint, the additional interest expense will neutralize that somewhat, but I think we're still going to get some accretion. We still expect to get some accretion out of these transactions in '24, but especially on the operating income side. But the additional interest expense does put a little bit of pressure on that, but we do expect accretion in '24.

Specific to EPS, even with the higher interest expense.

That's right. That's right.

And that's probably a good segue to go over to capital deployment. So in '23, you did a lot of deals. You've got some higher interest expense, Ron, that we saw hit the P&L in the third quarter, we should probably all be thinking about what that means for numbers in '24. You're also buying back stock, you're buying back stock at [ 75 ] and then you had the unfortunate situation with cybersecurity. So you're sitting with a stock even with the recent move, it's sort of 10% below where you were buying it back. Stanley, there's still interesting deals to be done out there, right? And now there's some debt that arguably, maybe you could go ahead and try to pay down. It's a really interesting time for a solid free cash flow company such as yourselves, how do you sort of allocate and figure out where you want to go from a cap deployment perspective?

Well, leading into '23, a typical year for us from M&A is -- would have been $300 million to $400 million a year. We've always made it clear that $400 million didn't necessarily represent a cap for us, but that was just the historical run rate for us. We had a balance sheet that allowed us the wiggle room that we wanted to take advantage of some of the opportunities that we identified in 2023. And as a result, we did take on to more debt, and we did do -- we've now committed to approximately $1 billion in acquisitions for the full year. My assumption at this point is that -- and as Stanley mentioned earlier, we need to work on integrating some of these businesses a little bit. I think the management capacity to try to go out there and do another $1 billion next year might be a little limited. So my expectation is while we still want to be opportunistic with M&A, we'll likely return to something that's more in line with the historical trend coming into '23. In terms of share buybacks, share repurchases, we have continued those throughout 2023. We plan to continue those at a level that would be consistent with that historical trend as well, meaning typically, that has been also in the $300 million to $400 million range as well. And we do plan to continue with that going into 2024.

Okay. So let's talk about patient trends because you talked a lot about it on the earnings call. I thought some of it may have differed from some of the manufacturers. So dental was weak in the third quarter. More notably, it seems on the exit. But when you talked a little bit about it, you said, look, our PPE business did really well. I thought -- correct me if I'm wrong, you attributed some of that weakness to COVID, flu cancellations. I know some of the other dental peers were more structural in nature, right, in terms of what's going on. So can you put those 2? Is it more a function of COVID flu and things will subside? Or do you see more structural issues on the horizon?

Yes. It's hard to pinpoint this, Jon. We talk about hundreds of basis points. But it is clear that in September, patient traffic went down into October. Some of it traditional flu. But I think COVID picked up, we saw it in our COVID sales. So I think that put a dampen on cancellations of visits to dental offices. It's hard to see whether that's going to trend forward, but also clear that on some of the more expensive specialty products, dentists are trading down to lower-priced products. So implants in particular. So the implant is a nice business for us, but it doesn't carry as much weight as at some of the other public companies in the dental space.

But as we think about long term and that trade down, you feel with your enhanced dental implant portfolio that positions you well to maybe go ahead and capture some of that?

Yes. I mean we have branded implants at the top end, we sell that at a slightly lower price than maybe some of the other manufacturers in that space. So we are relatively well positioned. We also have a decent pipeline of new products on the premium end. And the economy side, we're very well positioned with Medentis. And now hopefully, the S.I.N. business we acquired in Brazil will help us in that area. And I would say, the French business we acquired also has a good price product. So I think our portfolio is very good. If you include some of the R&D that's going to be coming to market in '24. So we're quite happy with our portfolio.

To push a little bit, is it fair to say after hearing your comments that maybe you have a slightly more upbeat view of dental versus some of the dental manufacturers that, again, seem to be leaning into structural or we'll see the way that 4Q...

It's really hard to tell. Our equipment business seems to be okay. We had a bit of delays because of our incident in installation. It was working, but the systems are working to certainly take care of all calls with respect to repairs, maintenance. We may be delayed a little bit on the installation of equipment. I'm not sure if it's going to impact our December numbers, obviously. But I think our equipment business is in pretty good shape. The backlog looks good. We said it on the call. So if that's a bellwether, certainly traditional equipment, it's selling in the mid-single digits region, not a lot of inflation in there, inflation was the previous year. So that's pretty good. And we're selling a lot of digital equipment, although at a lower price. So practitioners are investing, and if you take a look at the software businesses, the AI systems are selling. So not as dentists are negative about their practices. But to calibrate within 100 -- a couple of hundred basis points that's not easy. .

Tough to do. Okay. I want to spend a little bit of time on the website, and then I'll sort of go into the numbers and geek around 2024, a little bit, Ron, and pull you in. On the website, on Monday's earnings call, you said the website would be back up and running the next day. We're doing what we can on our end. We believe the U.S. site went back up on Tuesday morning. I believe the U.K. went up this morning. But I think Germany and Spain are still down. Is that correct? Maybe let's just start there.

Yes. Firstly, the U.S. and Canada went up yesterday and the U.K. Canada seems to be -- they're all -- the website is working, it seems to be good. And Europe will come up probably most of it will come up this week. I'm not sure if the French website will go back, but we have an alternate website that works. But we're more or less, I would say, within a week or so away from the websites being up and running. And a huge part of our business goes to the website.

And just to be clear, I mean, you never said even on the earnings call that it would be a light switch and everything comes up on Tuesday, you were sort of saying, within a week, you thought it would broadly be up and expand to the controlled substances stuff that you going to be a little bit more careful about. Is that still the thought selling after that week, you're broadly up and running across the different...

Yes. I mean they may be isolated, I mentioned France. We have already a website that works. It's the old website. We brought it up. The new one will probably be another week or so. Controlled substances, we are able to ship, and we have hopefully the full functionality this week, but we're very, very cautious, obviously, in that area.

Okay. And let's talk a little bit about U.S. and Canada that's been up since, as you mentioned, Tuesday morning. I mean I know we're sitting here and it's not a ton of time is passed. But has everything gone according to plan, right? You got to put it up and then you got to go ahead and see the orders come through and everything has got to work.

I'm not going to say that a day makes a trend. I think even Wall Street would agree with that, although Wall Street can take a day and make a trend out of it. But yesterday, we had a very good production date. It seems to be working. We're quite confident we'll have our promotions back on the street very soon. We just wanted to wait a day or 2 to make sure everything is working. But as of an hour ago, things seem to be working very well, wherever the websites are.

Okay. And how about the level of confidence that it's very -- it's going to be very different ordering patterns on Henry Schein used to, right? And you're going to sort of have a bolus of orders hopefully, that come online over the next, I don't know, 7, 10, 14 days. So Stanley, just your comfort, conviction that the organization can pivot and handle the different order flow that likely comes through the website?

Yes. We have not had an issue with actually shipping product once we got the order into the system. That works very well. Our infrastructure is very, very good. Because we had a website and the website was down, we had to rely on our field representatives to enter the orders into the computer, and I'll tell our salespeople to do that. So there was a little bit of extra waiting time some days for telesales. Although I have to say that the COVID period, when we've got all these customers calling us for masks and gloves, that was very good.. Yes. So I'm happy with the way the team has performed. There may be a couple of countries that have had challenges smaller countries. But the bulk of Henry Schein handled the entire order processing pretty well. We had problems in a couple of countries bringing our procurement systems back, but we're able to get through that through manual systems. And basically, from a customer point of view, it's working, and it has been working really for a couple of weeks. We're kind of taking orders on the Monday after the incident.

And sort of that last point, I just want to level set for everyone. We did some checks and we did our own work. But it seems like a dental practice might order through the website, maybe roughly every 2 weeks, and you weren't down for even a month and how much inventory are they carrying at that practice? Like I'm just trying to figure out for people who think, "Oh, my gosh, I had a horrible experience and they're going to Benco or they're going to Patterson". The average practice probably only ran into this issue, what onetime, onetime and change in terms of how we're doing the ordering, can help us with that?

The bulk of our customers, this was not really a big issue. I mean some DSOs have specific ways in which they order and maybe for a week or so, we didn't have the work around or the manual system for them. But in health care, unfortunately, practically every one of our customers has either been impacted or know somebody. And so they were very, very supportive so were our suppliers. But there's a part of our business that involves kind of impulse shopping, if you want to call it. So we're not really marketing in that area. And now that the website is up, we'll have a lot more on this infill shopping and social media shopping and various kinds of promotions that will attract customers that are more spotty customers but buy something every month.

You can go ahead and bring back online.

We're not talking about months. I think this is in the next month or so, we should be getting closer to where we were at the moment that we took down our systems.

And that's probably a good segue, run. So let me go through some numbers and a little tough to do up here, but let's give it a shot. So for 2023, you lowered the top line from -- I'm going to do a midpoint 2% growth to a 2% decline, and you said the step down was primarily due to the cybersecurity incident, and these are my numbers. So if I say primarily, if I say, "Hey, look, 3 of the 400 bps of the lowering was due to cybersecurity", you sort of get about $380 million in lost sales impact from cybersecurity. Maybe I'll pause, is it fair?

No, it's definitely fair. I mean we've run multiple scenarios on this, right? I mean it's -- we're kind of working with a lot of assumptions, some soft information. We're going to get much harder information beginning today based on yesterday's orders coming to the website, right? So over the next couple of weeks, we'll really be able to see what's the recovery of revenue, what's the recovery of orders on the website? Who has come back that didn't maybe to your point, had not ordered anything during that 4-week period. Our range is in that kind of $350 million to $500 million range in terms of what the potential loss revenues could be, taking into account what kind of tail might come off of this of how long it might take to get some customers back, right. So it's really a $350 million to $500 million top line effect that we're working with right now.

So if I take that $350 million to $500 million, and I have to assign a decremental margin to land at your $0.55 to $0.75 hit for 4Q, I was getting like 20%, 25% on the decremental?

Yes. So on an operating income basis, it's about a $90 million to $130 million range that we're looking at most of that coming through gross margin because what we're going to see is we're going to have some discounting of prices for -- in certain customer categories. We also are assuming, like I said on the call, a little bit of a risk to our rebates. Most of our rebates are sell-through rebates. So we've had to assume some risk there. If we recover more sales, then that we'll also recover more of those rebates, right? So there's -- like I said, we're working with a lot of soft assumptions right now. And we'll be able -- if, in fact, as we get well into the quarter, and we feel more comfortable about what it is and it's materially different than what we have said, we'll obviously be required to disclose what we think those differences are.

Okay. But there's a great building block right there in terms of the revenue and then the EBIT impact and the decrementals seem to be in the same ZIP code or neighborhood we were at. So let's think about 2024. Because...

Sure. We have an insurance payment that will come. We can't recognize that until it actually arrives. But that will cushion the...

The below the $0.55 to $0.75.

Yes.

And then as we were sort of saying, I don't want to say no one cares about '23, but this is all about '24 and where that goes, and maybe the one thing Wall Street does do is predominantly look forward, maybe sometimes only a day. Let's think about the core business, [ 522 ] midpoint, and we're going to put some growth on that. And maybe it's not high single digits to low double digits because dental is a little bit softer. I don't know. I mean you do have some accretive acquisitions, but let's put a growth rate on the [ 522 ]? And then what, Ron, the right exercise would be figure out the lost sales, the tail into '24 and put the same decremental on it, definitely not higher because you're decremental in 4Q as some of the promotions. We put the same decremental on it. And I think my [ 522 ] plus 6%, that's my number, less the hit, and that's the Zip Code area where we're falling out for '24?

Yes. When we provide '24 guidance, which we plan to provide that when we release our Q4 earnings in mid-February, we'll include, to the extent that we believe there is some headwind in '24 associated with any kind of tail coming off of this cybersecurity incident. We will make sure that people are aware of what our assumption was when we do that. We'll also talk -- we get -- it's something we talked about a little bit during the Q&A session on the earnings call on Monday. We have been working with some assumed growth rates in the market that we communicated on our Investor Day last February. And one of those was that we've assumed that, for example, dental markets are growing annually 2% to 4%. Right now, I think if you ask us to commit where do we think that market growth rate is for next year, we would probably be more towards the lower end of that range. Those are things we will take into consideration when completing our '24 budget, which has been interrupted through this process and then also providing our '24 guidance. We start with those market growth rates. What do we think we can do off of those market growth. We'll probably be starting with numbers that are towards the lower end of that.

Okay. That was very helpful. Just maybe we tried to lay out fair construct, silly, nothing broken in there in terms of how I try to bifurcate it and...

It's a reasonable approach. It's a reasonable approach.

Nice try for reasonable. In the end, it's only a question of how long will the tail be? We're going to get the business back. we're going to get the business back. Yes. I mean our brands are pretty good. And I think we're noted in the dental industry and in the medical.

So let's hit our medical for a second. And Ron, it plays up on what you just said. But at your Analyst Day, you called out 2 to 4 for dental, maybe at the lower band of that now. You also gave some good medical numbers in mid-single digits, right? Now you've been fighting really tough comps. You'll work your way through that. I think it's in the first quarter of next year. But I also feel on the earnings calls, you've talked about some of this business moving more to generics, and there's a trade-off there, right? Less on the top line, but better margin profile. Should we recalibrate the medical numbers that you gave at the Analyst Day a little bit to take into account the generics?

I think that example is, at least in my personal opinion, why it's important to not only look at year-over-year, but kind of step back at this. And when we're talking about long-term growth rates, for example, in medical and in the medical subsegment in which we operate, we've said that, that growth rate is about a 4% to 7% market growth rate. That's really a long-term CAGR. So while there is some pressure on that number this year, especially given last year's comp, I think if you step back and look at the 3 years, we're consistent within that range in terms of the CAGR. And I think that's the best way to look at it going forward. Look more of a -- you're going to have a year like we're having this year of 2.5%, 3% growth in medical. Last year, we were approaching double digits consistently every quarter, again, excluding PPE and COVID test kits. But we do think over the long term, we can consistently grow this business.

If you add the 2 together last year and this year, it's roughly about 12% growth, half of that is 6%.

And you land right in that 4% to 7%?

Is it 5% to 7%. Is -- there's a variable in the 100 basis points or so for generics.

Okay. I want to spend the last 2 minutes, Stanley, just picking your brain on dental equipment and sort of where you see this evolving and where you see it going? And maybe just to rapid fire, can milling and printing coexists, can printing because of its lower cost, really broadly get on to dental and DSOs embrace it because of a different return on investment? Maybe let's start there.

Well, in the long run, printing is there. It's a matter of improving on the machinery but also the material and there's a huge amount of activity going. So will there be mills? There'll always be mills. Will they be laboratories? There'll always be laboratories. So how this all plays out is it's going to be gradual. We never had anything in dentistry that's been a while, I don't think it's changed. But clearly, scanners will come down in price and they'll be more sold. 3D printing is going to grow significantly. And in markets where we don't even in like a developing world today is a big opportunity. And the mills will be steady, probably a little bit going down each year.

And to push in the 3D printing, the materials will get better. The materials right now are the applications seem to be used for stuff that temporarily goes in the mouth, but not permanently. Do we get to a material standpoint where we are talking restorations, we are talking stuff that resides in the mouth and the durability is there?

I think so. Yes. There's a lot going on I think it's a bit more than temporary. I don't think the cosmetics are perfect, but for the back teeth, it's fine. And there's a lot going on in this area.

Okay. And the last one, just on the intra-oral scanners. So you talked about the units are good, you're experiencing some pricing pressure, but you expect to be on the back end of that entering '24s where the ASP comp sort of eases? Or is this a little bit of a, I would say, an ongoing spiral from a pricing perspective?

On our call, we said we can see the end maybe 1 or 2 quarters from now. But I think, actually, it's a good thing if the prices come down because we'll sell more of them. And this should be standard of use in the dentistry. I mean if you've had been a dentist that's used the scanner versus one that's using a still impression.

Find a different dentist, so they're still using...

I wouldn't go that far. But they're selling a lot of materials, impression materials. We don't want to kill that business. But it's going to be standard of care. When 2 years, 3, 4, it's going to be care.

Okay. Fair enough. I think we're going to have to conclude there. Ron and Stanley, thanks very much for your time. Appreciate it.

Thank you. Appreciate it.

Thank you.