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

All right. Why don't we get started. I'm Jason Bednar. I cover Med-Tech here at Piper. Our next fireside chat is with Henry Schein. Very happy to have with us today Schein's CEO, Stanley Bergman, and CFO, Ron South, and Graham Stanley from IR is in the audience here. So thanks a lot for being here, both of you, I really appreciate it. A lot to talk about right now with your business, Stan and Ron. So why don't we get right into the Q&A.

I want to spend some time in the dental market and really talk about some takeaways with the Greater New York Dental Meeting. But first, I think it would just be helpful for everyone here to cover -- we did have a little bit of a recurrence with the cyber attack. You took your website down last Wednesday. We had some updates here over the Thanksgiving holiday, the weekend, but you're back up as of yesterday. So maybe give us a little bit of update on what actually happened and what's the status as of this morning with your various e-commerce systems.

So we can't get, Jason, into the absolute specifics because there's obviously a criminal investigation. But we have pretty good experience now on managing through this kind of activity. And our website work to restore the system was undertaken pretty quickly in about a 3.5-day period of time. As you know, what we're doing, and we've mentioned this to the Street, is we have very good backups. So what we're doing is restoring each backup. We have to check to make sure there's no, what they call, sleepers in there. And then as we -- our IT people and our consultants and our forensic people become comfortable, we turn it on again. And so, we've gotten pretty good at this. And the system was up in the U.S. before business yesterday, Canada a little later in the day and the U.K. this morning. And in the rest of the world, we expect in the next day or so.

Okay. Is there a concern internally this is just -- right now a recurring issue because you have these attackers that are being relentless?

It's very hard to say, but I think something like 80% of these situations, there have been recurrences. We, at the moment, feel very comfortable, and have really since the beginning, that we do have our backups. And if you look at the history of other companies, companies don't usually have the kind of backups we have. So we are comfortable that we can go -- continue to go through this process, should we be attacked in this -- everybody's attacked thousands of times a day -- should there be a serious issue. But our outside consultants, and we have several world-class firms, feel that we're in pretty good shape. But you know, no company is immune from this. So at the moment, we feel pretty good that our recovery is going well.

Okay. All right. Perfect. Other topical item here from this week, so Greater New York Dental Meeting going on as we speak, really right in your backyard. This is a really important trade show for you. I was over there yesterday. It seemed like the feedback was we're almost back to pre-pandemic type activity at the trade shows, which is a little bit odd. It felt like, for a while, maybe we're going away from trade shows. But the -- what I heard was activity was pretty darn good on Sunday, especially, some really good equipment buying on high-tech equipment, iOS, the scanners, 3D printers. So I guess, does that all align with everything you saw out of the show, really, so far? And maybe the follow-up would be, how do you reconcile this good buying activity with what was maybe some more guarded commentary about equipment coming out of the third quarter reporting cycle?

Yes, Jason. Firstly, Sunday was active. I'm sure you heard that from others. Yesterday that was not great, but never is on the Monday. Actually, what has happened in the last quarter is activity starts with -- for us on the equipment side for the DS World, which was a little later in the quarter than in previous years, but it was pretty active. So we expect to have good conversion from the DS World, and where we had interest but were not able to convert, we feel that for Northeast customers this is a good place to close. It seems, and we mentioned this in our last call, that traditional equipment is steady. There's not the kind of inflation that we had in the previous 2 years. It's steady, but there is a significant interest in the scanning devices. Having said that, the prices have come down significantly. We've been asked, have we reached the bottom? Hard to tell, probably yes, but there is a growing demand by dentists for these devices. And it's not necessarily the most scientifically driven dentists that are buying now. It's very often people that say, I want one of these things. I just want it to work, do the basic work, and then get a good deal from a number of suppliers. Having said that, the very top end with one of our suppliers is doing quite well for the more sophisticated IO devices. And mills are not great. We've mentioned that before. I think that 3D printing is gaining momentum, but not enough to cover the challenges in the printing -- in the printers.

Do you think that's more of just a 2023 issue, as 3D printers have taken off and mills have taken a step back, and now when we go to '24, we're kind of at a better baseline, we've anniversaried through a lot of these issues and the pricing situation in IOS scanners, I think, knock on wood, doesn't get any worse? And then 3D printers continue to grow off of what was a good '23 and mills are kind of at a new status quo. That seems like a setup where equipment can actually have a decent year next year.

Your thesis in the categories is all pretty good, except I'm not sure about mills. Because what has happened is, believe it or not, the dental laboratories have become more efficient. They can now receive the scans and can manipulate, et cetera, and their turnaround times have improved. There's now been some consolidation. And so the more sophisticated labs are turning around high-quality products very quickly, very accurately. And I think for many dentists, this is not a bad alternative. So is that shift -- of course, we are a significant distributors in the lab space, so we pick it up there. And I think there should be some excitement on the lab side with respect to 3D printing as well in 2024. Again, from a $13 billion company, this is at the margin. But for that particular sector, there is, I think, a movement not only to the 3D printing in the operatory, but also, I think, back to the lab.

Yes. Okay. Ron, a lot of focus in the last few weeks on account recapture, promotional activity that might be going on. Has that commenced yet in order to go recapture some of the business that hasn't come back to Henry Schein? Have you started that -- that promotional activity, that target -- maybe targeted promotional activity with some of those accounts to try to win back that business?

Yes. When -- when the website was reactivated on, I want to say -- well we released earnings on the 13th and I think it was reactivated either that day or the following day, we got -- we did see -- I think there may have been a little bit of pent-up demand, but people have worked down stock a little bit. So we had some good week. It's a little volatile, which suggests that there may have been a little pent-up demand, but we feel like the volumes were approaching normal. We are offering some promotions to all our customers. We're not going after a subsegment of customers we felt like we lost. We also are very appreciative of those customers have kind of stuck with us during that kind of 4-week period that was very difficult. So we are offering some promotions to those customers. And we'll likely continue with those promotions for -- at least through the end of this quarter, would be my guess. What will be the effect in the '24 remains to be seen. A lot of it will depend on what kind of retention we see and what kind of recovery we see. We said -- on the 13th, we said that we will provide guidance when we release our Q4 earnings, which will be in February. And when we do that, we'll provide some flavor around what are our assumptions of any kind of lingering effect or what's the tail of this going into '24, so that people can kind of understand core business versus some of the noise that might still be out there.

When you say lingering effect, lingering effect of account -- of customers still coming back, or lingering effect of promotional activity continuing?

It could be some combination thereof, frankly.

I think, along those lines, just to add a little further clarity, our larger customers and midsized customers generally understood what was happening. They know, they've either had one of these attacks or they know that it's, unfortunately, part of commerce today. And I don't think we lose many of those. Having said that, we want to show appreciation to them. So we're offering some onetime discount opportunities. It's the smaller accounts that come episodically to our site, look for pricing, et cetera, that we have to have something that keeps them excited, brings them back. But we're going to provide these kinds of promotional or onetime discounts to the entire customer base.

Okay. let's maybe pivot over to some pricing dynamics in the industry. This has been a focus from folks like myself, investors as well. The general mood has been here you've got pricing that's probably moderating for consumables. We had been running probably plus 2%, plus 3%, maybe even plus 4% in some categories. But we now have an accelerating shift to private label consumables. It's probably making manufacturers a little more hesitant on pushing through bigger price increases, maybe some moderating demand as well, making them also a little less aggressive on pricing. So what happens? What do you think happens, when we look ahead at 2024 and think about the direction of pricing from manufacturers and then how that influences your business as we think about the top line?

Yes. I think -- you summarized it correctly. What we had was some significant price increases, particularly from the larger suppliers. And it didn't stick. Either they had to provide more chargebacks to the bigger customers or they lost market share with the smaller ones, midsized and smaller. So I think that is now being understood, and I wouldn't call it a list price reduction. But I think there is an understanding that if they want to -- if these bigger players want to maintain market share, they're going to have to cut some kind of a deal, through us of course, with the larger customers, or the smaller ones there's going to have to be promotional activity. Because if not, product moves the corporate brand and all the midsized distributors. There's no -- very few products in dentistry where the consumer or somebody can say, "Well, I have an antilock brake that no one else says has." It's not like in branded pharmaceuticals. So this is working its way through. I would be surprised if there's much inflation next year, either on the consumables side or the equipment side. From our point of view, of course, corporate brand carries a lower selling price, but the profit per unit is pretty good. And so we're relatively agnostic. We would, of course, be comfortable selling the brand if we can get a price that our customers appreciate.

Fair. So to go back to the comment you made, you're saying that you think inflation -- nonexistent, I can't remember the word you used, but probably won't see much price increase or price inflation next year, that's your expectation from the branded manufacturers?

I would expect that. I mean, there may be manufacturers that decide to -- like in the pharma world, there's generic. They take it up, and they figure out they will lose some market share, but they'll make more money. But if a manufacturer wants to keep market share, they're going to have to understand this dynamic.

But you haven't seen that yet, where manufacturers are -- have announced price increases that are similar to what we've seen in the last couple of years?

No. I mean there may be particular product categories, particular manufacturers [indiscernible].

But holistically?

I think manufacturers, those that are close to their customers close to the dentists, understand this. And this is not an issue on the medical side, where -- I mean, there's very little inflation on that side. Maybe as a new product or something, but...

Okay. So when we look out...

I wouldn't call it deflation, but I would say it's...

Sure. Yes, I mean, maybe to be clear, I mean, this is going back to where we were before we ran into a lot of inflation, it's kind of flat to slightly positive. Yes. Okay. So maybe taking a forward look view now, Ron or Stan, what's your level of visibility as we look across each of your business segments? You got Dental, Medical and Tech and Value-add. When we look at 2024, how comfortable or what's your level of visibility is from a demand perspective on each of those segments?

We've looked at the kind of historical trends in terms of market growth rates in the various subsegments in which we operate. As you recall, Jason, last February we did an investment day -- or Investor Day, excuse me, and we provided some assumptions kind of that supported our long-term goals, what would the market growth rate be in various operating segments. And for Dental, we had been assuming -- the trend had been kind of a 2% to 4% growth. We do think -- just based on the trend we saw in the latter half of Q3 going into Q4, as we said in our prepared remarks earlier this month, that we would expect the '24 market growth rate in Dental to be more towards the low end of that range of that 2% to 4% next year. I think when we look at dental specialty products, slightly different subsegment. And historically, those market growth rates have been 5% to 8%. But I think we're going to be towards the low end of that as well, as we see -- and that can vary. It can vary by a specialty product that can vary by geography, right? We're seeing greater softness in implants than we are, for example, in endodontic products. But within implants, that softness tends to be concentrated more on the premium implant versus the value implant. So we feel like we can address that, especially in North America. It's more so in North America than it is in Europe. So you have to kind of really kind of keep peeling that onion a little bit, right? One of the things we're going to try to do to address this in North America, you're familiar with the transaction we did, we bought S.I.N., an implant manufacturer in Brazil. We closed on that transaction in July of this year. And they do have a value implant that is already FDA approved, and we're going to be able to sell that through our BioHorizons subsidiary in the U.S. So it's an extension of their product portfolio that we think is very -- is much more so in demand than perhaps the premium implants that we're seeing in North America. So that 5% to 8%, I think we'd probably go towards the lower end of that 5% to 8% as well, but there's some opportunity there. We think there's some opportunity there as we kind of make some changes in our business, and we also have some new products that we'll be launching ourselves next year on the implant side that we think can also help us with our growth there a little bit. Medical, we have said historical trend was 4% to 7%. We're lagging that a little bit this year, but it's coming off very difficult comparisons from the prior year. When you exclude the kind of noise you get from PPE and COVID test kits, last year our Medical business was consistently providing 10% top line growth or higher each quarter. So the fact that we're down kind of low single digits with that -- in that subsegment this year doesn't concern us too much. A lot of that is last year was a very heavy flu season. We had significant sales in flu diagnostic kits. There was a lot of patient traffic into the physician offices. So the fact we're getting at least -- at least a little bit of growth, we're pretty happy with that. And we think that over a longer term, that CAGR can stay kind of in that 4% to 7% for us. And then lastly would be our Technology and Value-Added Services businesses, which we really see as kind of an 8% to 12% growth opportunity in the market, and we're experiencing -- we're very happy with the growth we're seeing there. And Stanley and I just met with the management team at Henry Schein One last week. Very excited about some of the -- the vision they have around kind of improving revenue cycle management for our customers, just expansion of our practice management systems that are available. So we think we can achieve those growth rates and possibly take some market share there as well.

Okay. That's really helpful. Going back maybe to medical, is that staying within -- can you stay within that 4% to 7% next year? Or do you think you end up at the low end, similar to dental and specialty?

I think for Medical, just given what the growth rate is coming into the year, we would probably say something that's a little lower, right? Having said that, we're making very important investments in the home health care space. We're not becoming home health care providers, but we are providing product to home health care providers. And that is a faster-growing segment or subsegment of that segment, I should say. And it also has slightly better margins than your legacy medical businesses out there. So we have some integration we want to do with those businesses, but we think that as we continue to bring those into the fold as part of our medical business, that will help with that growth.

Okay. I want to pose something to you because you brought up M&A a little bit. Tell me where I'm wrong here. So when I think about some of the effects of what M&A has done to your business this year versus next year, you've allocated a lot of money to M&A this year, I think over $1 billion. That also results in a lot of deal integration expenses, a lot of onetime costs, things that you did not exclude from earnings, [ that ] also led to probably a -- maybe if -- you'd think next year, you could probably have a reallocation of some of that capital maybe more to share repurchases. And then you also should have probably better year 2 financials from some of these deals that are layering into the model this year. So I think that's all right, but when I put all those together, that should have maybe a net positive effect on earnings next year. Is that -- do I have all that right? Or am I wrong in any of those assumptions?

Yes. you're right. We've committed over $1 billion in capital on M&A this year, which is a very high number for us. Typically, we were doing $300 million to $400 million a year. And I would expect us to probably return to something that's closer to that $300 million to $400 million next year as opposed to the $1 billion we're doing in '23. It does put a bit of a -- it's a little more of a burden on the balance sheet than what we've done historically. I'm still very happy with the leverage that we -- where we're at. but it does create a higher level of interest expense. The transactions we did this year will contribute to operating income growth for us next year. From an EPS standpoint, they're going to be much closer to neutral given that additional interest expense, but to the extent we can continue to generate good operating cash flow, you mentioned perhaps we increase share repurchases next year. But we'll have to look at that allocation and say: do we want to take some of that operating cash flow and increase share repurchases or do we want to reduce that debt? And that's the formula we'll have to look at so we can bring down that interest expense as well. So there's going to be kind of an ongoing -- as every company does -- an ongoing analysis of where do we think we actually get the better accretion to our earnings as we generate that positive cash flow going forward.

Sure. But to be fair, either of those, whether it's debt paydown or share repo, that reallocated M&A capital would go to helping EPS. Okay. So then on the move into home care. I guess -- I understand this is a big secular shift in health care, and it's probably a good question for you, Stan, but what's the value-add move for Henry Schein? Like why are you the right company to be distributing products into the home?

First, Jason, strategically, you got to follow the patient. The patient is moving out of the acute care setting. I had my knee replaced in April. I was out of the center the same day. So that's where the patients are going. So that's number one. But number two is we have very good relationships with the referral sources. So that's very good from that point of view. And then the bigger one is that our big IDNs, several of them wanted a consolidated bid for both the alternate care setting, ambulatory surge -- ASCs, ambulatory surgical centers and home care. We were supplying some of these products, but we just didn't have the ability to do the billing, which we now have through these 3 acquisitions we've made.

Okay. And then I know you've made comments in the past about potentially wanting to do something within orthopedics or some subspecialty of orthopedics, leverage your existing presence in ASCs. What could that look like? Because I think a lot of people in the room probably naturally think, oh, this means hips and knees. But I know that's not what you're intending to do, so maybe illuminate for us what that -- what you intend?

Well, can't say we'll never be into hips and knees, but that's -- those are huge markets. There are other markets in the orthopedic area that we actually brought management on board 4 years ago to work on this with us. They've been running other parts of the business, and this team is raring to go to advance our orthopedic business. We already have a very nice business in the saws and blades arena. And we hope to add some other orthopedic products in the not-too-distant future. But I don't think it will be in the knees and spine or hips and the big markets.

Okay. We have about 30 seconds left. Same question for each of you. I'll come back to maybe a little bit of a 2024 visibility question. Do you feel more comfortable with the top line outlook for next year or more comfortable with the margin outlook for next year?

I'd like to hear what Ron has to say, because...

Ron, you're going first.

Because he is finalizing the budget.

I hope I get it right. I think I probably -- choosing between the 2, I probably feel more comfortable with the margin outlook. I think the ongoing -- and it's not like it's a seismic shift every quarter, but we're seeing a little bit of a shift to lower-priced corporate brands or lower-priced national brands as well as our own corporate brands. That suppresses sales growth a little bit, but it gives us good margins. Also, I remain very bullish on our specialty products. They are higher-margin products. I think we can get growth there that will outpace the rest of the business ultimately. And that's going to give us better gross margins as well.

Yes. I mean directionally, that is correct. Unless there's a big shift with some of the major manufacturers, I think these manufacturers are going to see, on a lot of the commodity products, the technique-sensitive products in dentistry, a shift to brands that are trusted, but at a lower price. And these are good margin products. On the specialty side as well, whether it's endodontics or implants, the high priced -- higher priced and the lower price, they all work, otherwise the FDA wouldn't approve them.

All right. That's a great place to stop. Thanks for joining us today. Really appreciate it. Thank you very much.

Thank you very much.

Thank you.