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

Thank you, everyone, for joining us this morning. For those of you who don't know me, I'm Elizabeth Anderson, I'm the health care technology and distribution analyst here at Evercore. Very pleased to be joined by Henry Schein this morning. Ron South, as many of you know, CFO; Graham Stanley, VP of IR and Strategic Finance Project Officer. So thanks, guys, for coming down to Miami. I appreciate your being here.

So I guess maybe one of the unfortunate topics of the quarter, as we'll hit upon, as I'm sure you know I'm about to ask and I do that. It seems like -- can you just give us an update on sort of the site? I know you said almost everything was back up and running as of Monday. So maybe just sort of update us on what's going on there.

Yes. I mean, I'm happy to say that, as of this morning, all the European markets are -- the websites are up, running, taking orders, business as usual. U.S. was up -- back up again Monday morning for the business -- sort of business. Canada was up during the day, U.K. before the day started on Tuesday, and the rest of the European businesses have followed that. So we're back to normal.

Great. That's very good to hear. So as we think, it's obviously early days and sort of the customer retention and sort of follow-up to this, can you talk to us about sort of any early learnings from that in terms of how you're thinking about addressing that or things that have come across in sort of your conversations with customers?

Well, I will say the overriding theme in terms of the learnings is the importance of that strategic relationship with the customer, right? If you had a -- if you have a transactional relationship with your customer, they're just going to go complete the transaction someplace else. And we have a very small percentage of the customers who -- that is the type of relationship they have. They go to the website, they buy something, they don't have a rep, that's all they want. And in those situations, they went and bought from somebody else. That's a relatively small percentage of customers.

Probably not your most profitable customers.

Exactly. And so -- but those customers who use the rep and have a strategic relationship with that rep in order to help manage their practice more efficiently, more profitably, whether it be that individual practitioner who leans hard on their individual rep, or the national DSO with whom we have periodic and regularly scheduled strategic meetings with them, those are the customers that, yes, you tell us what you need us to do to make sure that it's easier for you to fulfill our orders and get product to us. And that's what we did. And so that -- the importance of that strategic relationship was -- really came to light through this whole process that we've gone through.

No, that makes sense. And I think when we spoke on Monday, you talked about maybe that the sort of promotional plan in terms of thank you to obviously some of your customers and sort of retention for some of the more transactional ones, was sort of 20% maybe on the Henry Schein brands and 10% on the national brands. Can you say, was that -- how did you sort of -- how did that sort of become the right rate? And sort of, are you -- how are you thinking in terms of the length of that potential promotion plan?

Well, I think in terms of why that percentage, I'll kind of defer to the...

The pricing gurus?

Yes. We -- I wish I could say there was -- that I know of the significant science behind it. But I think that at the end of the day, we felt like that was sending a message to our customers. And it's all customers, right? And it's for those who we inconvenienced through this whole cyber issue, it was a thank you for sticking with us, and it's also an attempt to kind of bring back like I said a small percentage of more transactional type of customers to come back as well. How long are we going to do it? That remains to be seen. We'll be able to kind of use this to gather data to see how many -- what our customer volumes are relative to, say, the first half of October. And then we'll be able to see if we need to extend it or not, but...

And it really just launched, what, last week, and it was Thanksgiving...

It was about 2 weeks a -- it was, yes, 2 weeks ago. And I think that, that was -- we got -- so we have some early data.

Right. It felt like [indiscernible] data from last week.

Absolutely Yes. So we're getting there.

Early days on that. Okay. That makes sense. So I think you talked about in the call sort of the -- to sort of disambiguate that $0.55 to $0.75, right? That was the impact of sort of like the manual [ pack and pig ] the lost sales, like that kind of portion of the business, not necessarily sort of the onetime items, which you talked about, which I think you're going to non-GAAP out. That's the right way to think about that in terms of...

Yes. And just to clarify that a little. So the $0.55 to $0.75 a share that we called out in terms of the estimated impact in Q4, kind of our early estimate, is really the business interruption impact, meaning what's the effect of the lost revenues, what's the margins, and then ultimately, the operating income associated with those lost revenues. It takes into account -- and we anticipated, okay, we may have to do some discounting, such as we're doing now. But it does not include kind of direct costs that we are incurring right now that are -- when I say direct costs, costs that are directly attributable to the cyber incident. A lot of these are in the form of professional fees, the IT experts, the third-party IT experts who are working with us, the legal costs we're incurring associated with this. So these are all costs that we'll likely call out as non-GAAP expenses because they are onetime and would not have been incurred if not for the cyber incident.

Yes. No, that makes sense. And then as it relates to sort of additional warehouse resources that you may have employed, is that something you can kind of turn on and turn off fairly quickly. So if you had -- you had to have extra [ football ] everybody except for Graham packing [indiscernible] and you and the organization, like that's something you can then like ramp down pretty quickly as we go back to sort of a more normalized cadence, right?

That's right. I mean in the U.S., we actually have like some temp agencies that we tap into for heavier times of the year anyway, and we literally went to a 3 shifts, 7 days a week approach because of the inefficiencies associated with the pack and pick. In some of our smaller international markets, it was literally, we had the office personnel out in the warehouse, helping with the picking and packing product for customers. So whatever it was that we needed to do to get the product out, we were doing it.

Got it. Okay. Maybe just sort of switching from, I'm sure, what's your least favorite topics to be speaking about these days. If we think about your core business, how do we think about sort of the macro environment and sort of patient traffic as we've kind of gone into the end of the year, maybe sort of October, November?

Yes. The -- and I'll -- I'll link this back to what we saw in the latter half of Q3 and what led us to -- when we reported our third quarter results, we did adjust our guidance. And obviously, we had to adjust our guidance for the cyber incident that we've experienced. But we did it in 2 steps. We also -- before we kind of layered in the effect of the cyber incident, we did, with reference to our original guidance, essentially bring it down. We went to the bottom half of what we had originally guided. So we had about a $0.16 range. We narrowed that to an $0.08 range. The $0.08 range was the bottom half of that $0.16. And that reflected -- it's really softness -- generally softness that we were seeing on premium implants, more so in North America than in Europe. And then just a little bit of trending softness that we saw just generally in our dental market that we began to see more in September than anything else. So we kind of figured, with that type of momentum or softening momentum going into Q4, that worked us to the bottom half of our guidance. We also said then that, in terms of 2024, we've always kind of worked off an assumption that dental markets are growing, the market itself is growing 2% to 4%. Given that kind of softening momentum, our expectations at that point in time going into '24 was that we would be closer -- the market would be something closer to the bottom end of that 2% to 4% range. We haven't provided '24 guidance yet, but when we do, we'll take all that into consideration.

Got it. And you'll provide that on the 4Q call as per normal. Okay. That makes sense. And then maybe on the equipment side, how do we think about sort of the demand trends there? I know you still talked about some more things in backlog across the portfolio. Can you kind of just maybe tease those plans out for us to sort of understand what's going on there?

Yes. I'll -- I think if you talk about equipment, you really got to look at it in the 2 subsegments, right? You got the one subsegment, which is what we call traditional equipment, in the dental industry, that being the chairs, units and lights, so that the -- typically, the chair of the patient is sitting in when being treated. We're still seeing very steady demand for traditional equipment. We've had double-digit growth in standard equipment in the early half of the year. Third quarter, we saw that growth work its way down more to kind of mid-single digits, but it was a -- what was still very encouraging, we actually saw an increase in the backlog. And Graham, you can count on this a little bit more, too, I think that's more -- that's not unusual for us to see an increase in the backlog in Q3 in anticipation of Q4 orders as Q4 tends to be a heavy equipment quarter for us, a lot of tax incentive buying happening by our customers. On the high-tech side, there's really a couple of things there that are impacting high-tech equipment revenues. One is kind of the ongoing lower average selling price of intraoral scanners. And that has continued, and we were thinking that might annualize a little more so Q3, Q4, but we now believe that's not going to annualize until probably the first quarter of next year. So that's causing some disruption. But we are seeing very good volume, very good demand for scanners. It's just that lower average selling price is kind of keeping that revenue pretty neutral or a little lower.

Got it. And that's just sort of -- so sort of that lower selling point is just kind of broadly expanded access, you're talking about sort of continuing penetration of that product, not like a further replacement cycle.

Absolutely. Absolutely. I think that the price point has become very attractive for a lot of practitioners who did not have scanners yet, or they've added on scanners. If they only had one scanner in their practice, perhaps they've added on scanners as well. So that's one thing that's disrupting a little bit on the high-tech equipment side. And the other thing that's being a bit of a disruptor on high-tech equipment is 3D printers. We're seeing, the New York Dental Show this week, started on Sunday, we sell at that New York Dental Show and our Head of Sales who was there, Dave Steck, you had a chance to meet as well, mentioned that, that was probably amongst the most popular things being sold, that and scanners, on Sunday. Sunday is a fairly busy day. That's a day dental practices are closed. A lot of the local dentists will come to the dental show and then they end up buying something. So we did see some good sales of 3D printers as well as scanners. But what that means is that there could be some dentists who are buying 3D printers in lieu of higher-priced, more technical, more complex equipment such as a chairside mill. And what we're starting to see more so is that our chairside mill sales tend to be replacement units. They tend to be when a practice wants to replace their chairside mill as opposed to an initial investment in chairside mill. I think more and more of those initial investments are happening on the 3D printer side. That is likely price point, right? You can kind of take a chance on a 3D printer for $15,000. You're not going to take a chance on the chairside mill for $60,000. So I think that's creating a little bit of disruption within the high-tech equipment market as well.

Got it. No, that makes sense. One of the things we sort of picked up, too, is that maybe some of the pace of office opening on the DSO front has sort of slowed a bit just because of higher debt financing costs, et cetera. Is that something that you guys have seen come through in some of the demand? Or is that sort of that DSO opening has been sort of fairly consistent for you guys?

I don't think we're seeing a significant effect from that. I think that some of our customers, DSO customers, grow through acquisition, others do it purely through de novo practices. And we're still seeing, I think, sufficient growth there. That hasn't been disruptive for us.

Got it. And all of sort of the changes in equipment manufacturing and things sort of COVID, are we sort of through that hangover? I know like people are talking about like a backlog in chairs and like things like that. Is that sort of normalized? Or do you still think that that's a somewhat disrupted situation that still needs to normalize a bit?

I think it's normalizing. I don't know if I would say it's completely normalized. Something we've talked about before was when you think about some of the end-market effects of the pandemic, there was kind of multiple things at play. There was some of your older dentists. We did see a higher retirement rate amongst dentists during the pandemic. Some of your older dentists just decided, okay, this is -- I'm out. You also saw a lot of patient movement, some patient turnover, people who were going to a dentist that was near the office they worked in, well, now if they were spending more time working at home, they were changing dentists. So this created some -- you think about that dynamic in the end-market and think about that dynamic with those dental practices, some are losing patients, some are gaining patients. And so you did see -- I think that led to a lot of this standard equipment investment that we've seen over the last couple of years. Partly the retirements -- I don't think the retirements have been completely backfilled personally. I think the demand for dentistry services exceeds the supply available out there right now. . So those practices who did pick up new patients, whether they're dentists retired or their patients had a switch because of their work location, they expanded their practices. They added chairs. They -- that created some good investment. I think a lot of that is starting to play out a little bit now. You also have situations of people who got out of the habit of going to the dentist. Their appointment was during the pandemic, early in the pandemic, that got canceled, and they just didn't rebook. That's why before you leave, they make sure you come back in 6 months, here's the appointment, right? And you're starting -- when you talk to our customers, they're starting to see more and more people coming back, and they're coming back for the first time since prior to the pandemic. So that's increasing some traffic, too. But I do think we have a little bit of a capacity constraint. I do think that there's there is a bit of a shortage out there, whether it be dentists or dental staff, the hygienist, the dental assistants or whatever. And I think that that's constraining the opportunity to grow beyond that market growth of 2% to 4% a little bit as well.

That makes sense. And then where are the sort of release valves to that supply shortage, right? Like we talked about it taking sort of, jokingly we say, like 2 years to grow a general hygienist, how do we think about sort of those numbers, and then obviously longer for a dentist or other clinical staff, how do we think about how that eases?

Well, it's really 2 things. One is the lapsing of time hopefully will help in terms of getting more hygienists out there. I do think there's also opportunity, and I was just at our Henry Schein one subsidiary last week, meeting with them. There's opportunities that make the offices administratively more efficient. So that takes some of the burden off that front desk staff, right? Right now, when you think about -- think about your typical trip to the dentist. There's literally about 2,000 dental plans out there in the U.S. right now. So what's your coverage? You walk -- your coverage is going to be different than the patient that just came in before you. Are you eligible -- you're going to meet some restoration treatment. Are you eligible for that? Staff spend a lot of time tracking down what's insurance, what's -- so -- and if you're sitting in the chair, and the dentist says, okay, here's what we can do, and you say, "Well, how much is that going to cost me?" They don't know.

They have no idea.

They have no idea. All of that takes time. It creates inefficiency in the practice. That requires them to add on administrative staff, which right now is difficult to find. If we can help them become more efficient at that type of administrative process, it takes some of that pressure off. So that is something we're -- that all kind of falls under the larger umbrella of revenue cycle management, and that's something that we're really going to put, I think, a greater focus on going forward. Henry Schein One, we have like Detect AI, which is our artificial intelligence tool that help dentists diagnose cavities more efficiently and more accurately, which is a great tool. But it's like I said to them, I go, that's sexy, but the fundamentals are, how do we get better at just that -- in this day of AI, how is it that we don't know almost immediately what your dental eligibility, what your benefits are when you walk in? So that's the type of thing that we can do with our customers to help their practices become more efficient, which in turn takes perhaps some of that burden of having to find that many staff to support them in the future.

I think some of the investments that we made in equipment also procedurally more efficient as well. Digital scan is a lot quicker than the sort of the traditional sort of impression material. If you can have 2 operatories working, you can be having someone prep on patient whilst you're treating another. So again, you can get better productivity out of the dentists in order to sort of like make sure that procedures are more efficient. And taking some of the points that Ron has been saying, taking some of the back-office work away from the dentists and putting it into the back office for someone else to do.

Yes. And that's -- I mean, that's really the only way that they can grow revenues, right? Because the dental reimbursement is still -- no.

Well, it's growing productivity, but it's also growing the range of procedures. Things like mouth guards or more dentists are getting into implants, more dentists are getting into orthodontic procedures, things like that.

No, that makes sense. And maybe to your point, that's a good segue into talking a little bit more about Henry Schein One. How do we think about sort of where people are focused in those investments? Is it, again, on the sort of revenue cycle side? And -- or is it sort of the transition from server-based [indiscernible] like cloud-based? How do we think about where that is and sort of the opportunity to sort of expand people's presence into the number of services that they subscribe to in that?

Well, we do believe there's continued opportunity in the revenue cycle management side. I mean when you -- I mean you've seen the dental -- the surveys, what are the biggest pain points for dentists? And it's really kind of 3 areas. It's staffing, it's reimbursement from the insurers, and it's dealing with last-minute cancellations. And Henry Schein One can provide solutions to all 3 of those, right? So that's something that we really need to work with our customers on to try to help them solve this with -- the model that our team has come up with that's working on the revenue cycle management improvements is help our customers get paid more, get paid faster, with 0 effort, not less effort, 0 effort, right? And that's how it should work if we can get this automated, right? So I think that -- well, like I said, well, we want to -- and we're getting very, very strong positive reaction to our AI tool, if we can make things easier at the front desk, at the entry point when the patient comes in, that efficiency works its way all the way through the practice. And so those are very important tools that we're -- that we need to do a better job of educating our customers in terms of what these tools can do for them. But we also got to make the tools better and more useful for them as well. And that's what the goal is right now.

And is that sort of because it's sort of that productivity, and to Graham, your point in terms of growing practice revenue, does that help with sort of maybe the cyclicality of that business too, to like be able to, okay, maybe my patient volumes are great and I'm a little worried about this macro, but like here are some things I can do to make my practice more -- that was one of -- I mean that was my biggest surprising take out of that COVID lockdown period was just like the investment that went in by dentists during -- that were shut down and had no revenue.

Yes. I mean we do sell tools that will allow them to prioritize. If for whatever reason there's a downturn and you realize you've got 5 or 6 open appointments coming up next week, we have tools that will help them identify patients who haven't come in that should be coming in. And when we get really good at it, it's like -- and don't worry, they are insured, these people are going to pay you too, or someone is going to pay you as a result. So how do you improve that process of drawing more traffic into the practice? And that's another area within Henry Schein One that we can we can increase that share of wallet with our existing customers, right?

That makes sense. And we've gotten 23 minutes without speaking about your medical business at all. So maybe we'll switch over to there. How do we think about the cyclicality of that business? Obviously, it has pretty different dynamics than the dental side.

Yes. I mean cyclicality, a lot of our medical, especially the subsegment of medical in which we operate, which is either just kind of starting with the ASCs, we don't -- as everyone knows, we don't necessarily serve the hospital itself. Our philosophy has been to follow the patient. And more and more patients are now being treated in ambulatory surgical centers or at physician office or now, more recently, at home, and that's where we've been making our investments. So that cyclicality tends to be driven quite frankly, by things such as what are flu infection rates, what are the -- but what also, what is the migration of procedures that's working its way from a hospital setting to an ASC setting? Stanley loves to tell people that -- about his knee replacement surgery he had earlier in the year, and he did it at an ASC. He didn't go to a hospital. He was home that night. And that's something that was unheard of just a couple of years ago. So more and more procedures working to the ASC, more volumes of patients going through the ASC. So I think that's more the cycle that we're looking for. That's more the what -- as the ASCs are building out and requiring more supplies, that's better for us. It's more -- as more procedures are being done in the physician setting, that's better for us. And then now more and more people are being treated at home, we've made these investments in some home health care providers. Mind you, we are not providing the home health care. We are providing supply to the home health care provider, right? But we see that as a great area of growth going forward.

How big is that home health care business as a percentage of your, I don't know, medical revenues or however you think about it?

We did disclose what the trailing 12-month revenues was for Shield.

The Home Health is about a $300 million.

Yes. It's about -- in aggregate. Now does that include Prism, Graham, [ you might be against it ]?

Yes.

So our medical business. So you could call it approaching 10% by the time we get to something right.

And how do we think about sort of that growth rate versus even like within the sort of doctor's office and ASCs that you've been talking about?

Our expectation is it can grow faster than what I'll call our legacy medical business.

Like high single digit...

Yes, we think it can grow faster, and it also gets slightly better margins than our legacy medical business as well.

Got it. Okay. And then I think you also talked about a little bit how you're sort of thinking about getting a little bit more into the orthopedics section ex hips and knees. Why is that sort of another attractive area for you guys to go into?

That's a couple of things. One is we just think there's going to be ongoing increase in demand for that type of product. But two, we think -- we expect ASCs to be taking on more and more of these procedures and...

Providing more of a one-stop shop.

Yes. and so we can be part of that.

Okay. And how do you sort of pick like what are the right areas for you guys versus somebody -- some of the national brands, et cetera, that we think about?

It's a -- at a -- it's a much more fragmented field than I realized, when we started looking at what different alternatives for us out there. So a lot of this comes down to what field do you -- where do you think there's demand for certain thing. Things like hips and knees, that's a very -- that's a very -- first of all, it's a very established market, but it's also much more complicated and something that we're probably not looking to pursue in the short term. But there are other areas, hand, wrist, ankle, foot type of surgery or orthopedic surgery that is quite common and where we think we can -- and more likely to be happening in the ASC environment, albeit Stanley had his knee done in an ASC. And so I think that's where we see greater opportunity for us.

Got it. And is that something you would look to sort of bolt on? Or is that something you could...

Yes.

Okay. Okay. Got it. That makes sense. And then I think at your Investor Day, you guys talked about maybe like 40% of your operating income coming from sort of dental specialty and tech in 2024. In light of the macro environment and what you said about sort of the expected growth rates, is that sort of still something that you think is sort of the right way to think about that business? Or do you think that's maybe pushed out because if the macro deteriorates?

Well, it's still our goal. It is still our goal. We're still going to be pushing to get to that 40%. We're expecting continued growth in Henry Schein One on the technology side. And while there is some implant softness, we've also successfully executed on 2 acquisitions in the implant space this year that will add to those -- that operating income. And then there's also on just the steady growth that we see in endo, with our endodontic products. That's been a very good performer for us. And so I think if you add all that up, we still have a very good opportunity of reaching that goal of 40% of our operating income coming from those product categories, that being dental specialty and technology and value-added services, before the end of '24.

Ron, I'd also highlight that maybe there's a little bit of softness in implants in the North America market, our European market, which is they're probably half of our implant business. That's still growing pretty well.

And you think that's just a function of sort of different consumer spending patterns? So what would you attribute that to?

Yes. I guess it's a trend in that market as well. Maybe the European market didn't grow as fast post COVID. So it's starting up at a more steady sort of like longer-term growth rate.

Yes. And do you feel like you have the right implant portfolio for -- at this point for sort of everything you need in terms of types of products, et cetera? Or do you still feel like that's a future investment area?

No, go ahead.

So I mean, there's products where we already have where we've got to spend money in order to launch them in those markets. So for example, SIN, making sure there's a successful launch in building that sort of brand and product line in the U.S. There's always bolt-on opportunities, different parts of the market, looking at different product lines. .

It doesn't sound like you're like dying for -- right, something like that. Okay. Maybe in the last couple, we have 30 seconds left, what do you feel like is the least understood thing about Henry Schein by investors?

I think people -- I think it's easy to undervalue the value of the diversification that Schein brings, right? I think we frequently get questions around, well, company X and company Y are talking -- they had to take their guidance down more than you did, or they're seeing much softer markets and you don't see -- it doesn't seem to be as soft. And I think a lot of the companies in the dental industry -- when people ask us about our competition, we have to clarify, well, do you mean in distribution? Do you mean in implant? Do you mean in technology? Do you mean our medical competition? Do you mean -- because there's nobody who does all of those, right? There's nobody who does all of those. And I think that's the thing, that we tend to get pigeonholed sometimes with those who are have a narrower scope of operations than we do. And sometimes the beauty of the broader portfolio allows us to weather some of the macroeconomic conditions better than others.

Great. Well, on that note, I think we're out of time. Thank you, Ron. Thank you, Graham.

Thank you.