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

Good morning, everyone. I'll start with some disclosures first. So please see the Morgan Stanley website for more details on the disclosure at morganstanley.com/disclosures. But to introduce myself, I'm Erin Wright. I'm the lead health care services analyst at Morgan Stanley. We are happy to have Henry Schein with us. I do cover them. They are the leading dental and medical distributor globally. And we're happy to have with us Stanley Bergman, CEO of Henry Schein; as well as the CFO, Ron South. So thank you. Thank you for coming to London.

So let's start with just a general question that we're getting from a lot of investors right now is just the state of the dental market. Globally, if you can talk about kind of the different geographies as well but North America versus other markets. But what you're seeing in terms of patient traffic trends and demand?

So Erin, the dental market, I think, globally is relatively stable. We went through a lot of activity between 2019 and now at COVID, some backlogs, we had to go through. And I think it's more or less stable. I think it's fair to say the market in general is ahead of where we were in 2019, some dislocation I mean something like impression materials are down, scanners are up, implants, perhaps the premium implants are not as popular today as some of the value implants, the shifts. But generally, I would say the market in dentistry is stable. There are pockets of challenges, a couple of countries in Europe are not growing as fast as others. U.S. is relatively stable. Canada is relatively stable. We don't have a big business in China, but there've been some ups and downs there. Japan is stable. And the market is good.

And in terms of how you're thinking about it through the end of the year and into next year, I think Ron, in the guidance, for instance, you tweaked for kind of the macro dynamics that are going on. Can you discuss a little bit about kind of what's embedded in your guidance for the balance of the year and how you think about what can continue into 2024?

Yes. So we did -- we had an initial adjustment to our guidance. It was really kind of guiding people to the bottom half of that original guidance, right? So, we narrowed the range to the bottom half of the range, the midpoint came down about $0.05, which was about a 1% decline from the previous guidance. And that was really reflecting a little bit of softness we're seeing in end markets on premium implants as well as some uncertainty -- I wouldn't call it softness, but just some uncertainty we were seeing in dental -- in patient traffic into dental offices in the U.S. I think we believe it's primarily attributable to a little bit of a tick up in COVID infection rates actually, which is kind of an old theme, but one that kind of came back to us. And that's supported by also an increase in revenues we saw of COVID test kits, which tends to correspond with changes in that infection rate, which then ultimately leads to a small decline in patient traffic. So we'll have to -- we're continuing to monitor that patient traffic, but that kind of led us to taking -- guiding people towards the bottom half of that original guidance, yes.

Okay. And then I do have to ask about the cyber incident, and there was the second incident over Thanksgiving, presumably that would be less meaningful given the timing of that. Where are you at now? Are you back to normal. Where are we at in terms of the impact of that? Has there been any other incidents, hopefully not? So yes.

Erin, I think what's important to understand in our particular situation is we had all of our systems in backup mode. So for us, what we had to do was rebuild each of our systems. But before we put them into commerce, we had to ensure that there were no sleepers. So we had to do a lot of forensic work. The biggest challenge was, of course, our website. We wanted to make absolutely sure that, that was stable and that there were -- forensic work was done to ensure that there was no possibility of sleepers. We did have another incident, but we picked it up very quickly, and we had our systems up and running very quickly. It happened to be over the Thanksgiving weekend, so it didn't really impact our customers. But from a customer point of view, we're more or less up and running across the world. There are some systems that relate to operations that are not fully functional yet. But generally -- and that's particularly in Europe. But generally, globally, our systems from a customer point of view are up and running. And we were able to ship products on the second day after the incident. And there's some inefficiency still in the system that will be ironed out in the months ahead.

Okay. And can you help us understand how -- or how you got to the $500 million in terms of the revenue hit in the fourth quarter relative to the -- or related to the cyber incident and just in light of reconciling with the disclosure of other distributors as well in the industry, can you detail a little bit about how much of that is volume versus price or promotion activity? And how is, well I'll stop there in terms of if you want to break that down?

Certainly. So we did estimate that the EPS effect of the business interruption impact in the fourth quarter would be $0.55 to $0.75 a share, which equates to -- you mentioned $500 million, that was kind of the high end of the range that we expected on the revenue piece, right? So it was kind of $350 million to $500 million in revenues. A lot of that is the lost volume in the first couple of weeks following the cyberattack. By week 3, we were generating and fulfilling about 85% to 90% of the order volume that we had in the weeks leading up to the cyberattack. So we felt like we were approaching normal. The question was how soon could we recover that 10% to 15%? And to what extent we would -- are expecting to provide some promotional discounts to recover that business? So the $350 million to $500 million takes into consideration what we think the impact on revenue would be relative to what our internal projections were for the quarter going into the cyberattack. In terms of what our competitors and others in the industry have said that they have gained from this, that's a good question for them. I mean I'm not sure how they went about generating that -- those estimates. I just know that we're continuing to monitor what we believe is the effect on us. And as we go forward and as we get better data, to the extent we need to adjust that, if we think we have a material difference from what we have originally estimated, we'll communicate that back out to the investment community.

I think what's important also just to add on to what Ron said is the 85% to 90% was before our website was back. We have an element of our business, which is related to customers that go shopping, they look to buy a case of gloves and they may go to 5 or 6 websites. And of course, they couldn't come to our website, but we are pretty sure they will come back. We may not get the business, but they will come shopping to Henry Schein again.

And I recently saw Ron actually at Greater New York. And there was some promotional activity kind of going on with some of your corporate brands and also equipment financing. How was the traction with that? Is it going as planned? And can you talk a little bit about kind of the promotions that you're doing?

Yes. So really, there's two promotions going on. One, on the merchandise side, we are providing a 10% discount off of list on our branded merchandise and 20% off our private label merchandise. I emphasize that's off of list. Some of our customers already have negotiated discounts. And so to the extent that their discounts may exceed that, they're not going to get as much benefit, right? But for those -- some of those so-called episodic customers we have who were simply going to the website on occasion that we think is part of that 10% to 15% of order volume, we weren't recovering. They're paying less. So we think that promotion will attract some of them back to the business. We also had -- at Greater New York, we had announced a financing arrangement of 5.99% of financing on equipment that is a promotion we're doing jointly with the manufacturers of that equipment as well. So -- it's a -- it was very favorably received, and we're seeing a very good reaction to it.

Do you typically share some of that discount with the manufacturers on equipment?

We will do co-promotions of some sort with the manufacturers. They may take different forms. But this particular one, given the higher interest rates than what we've seen over the last several years, we felt like this was the appropriate promotion to do with them this time.

And are you seeing a competitive response?

I do believe there are others out there who are running -- are likely have responded with similar promotions, yes.

And last one on this, I'll move on, but just the DSO relationships, I think it's been pretty remarkable. You've been able to kind of service that client base. And can you talk a little bit about how those relationships kind of will evolve from here. It sounds like everything remains relatively status quo. Is that...

I would say our relationship with the top 25 DSOs -- 25 of the top 27 are pretty good customers of ours. I think it's pretty stable. I mean, our goal is, of course, to sell these customers much more in terms of consumables, our own brands, equipment, software, specialty products and basically, these relationships are pretty good. I mean we have very good service for equipment with these DSOs, national capability, and not only in the U.S. by the way, but the DSOs here in the U.K. and in Europe, Australia and New Zealand.

Okay. And then switching gears just to equipment a little bit more. I guess can you parse out what you're seeing in terms of traditional versus high-tech equipment in the market right now, the growth and demand trends and key drivers, and this is obviously an important quarter from an equipment perspective. How are you seeing things shape up?

Erin, I think you've split it up correctly, there's the traditional and there's the digital. The traditional had problems in delivery in 2020, a big part of '21 because of the global supply chain dislocation for parts, for example, labor issues. It stabilized in '22, stabilized in '23, but I would caution that it's important to take a look at traditional equipment sales by us over a couple of quarters. We have a lot of DSO business, maybe in one quarter, it's up; maybe one quarter, it's down. But if you take 2, 3 quarters you take a year. I think you'll see that the traditional equipment is quite stable, mid-single-digit growth. There's not as much inflation as there was. In fact, I think there's been a bit of a reaction by the dentists to some of the manufacturers that took up the prices a little bit higher than others. So there's a little bit of compression on pricing. It doesn't mean our profits are being impacted. And then if you look at the digital side, this is growing very fast. Having said that, there's now a significant competition for lower-priced scanners coming into the market, and many of them are doing well. But at the same time, the market is expanding. Mills in some parts of the world are not selling as well as they did. It could be because labs are becoming more efficient or it could simply be dentists are waiting to see where the 3D printing is going. Our 3D printing products and materials are doing extremely well. It's not covering the diminution in printers, but I would say the whole digital marketing area, digital products area is doing very well. And we will provide you in our calls with further information on where that market is going. But definitely, dentists are investing in this area as well as in practice management and related services.

And on specialty mix and just your overall business mix has evolved considerably over the years and now 1/3 of your EBITDA is associated with some of those faster-growing businesses and higher-margin businesses, whether it's tech or specialty. I guess where does that mix go over time. I think you had some projections kind of at your Investor Day, but how is that progressing relative to plan and -- yes.

So our strategy includes driving a higher percentage of our operating income related to specialty products and related services. I think in our last call, we spoke about 35%, 36%, 37% of our operating income coming from specialty products and consume -- and related software and services. And our goal is to take that up to about 40% in the next couple of years. We've said that in our investor meeting. I think we're on track to do that. In addition, about 9%, 10%, maybe a little bit more of our profits come from our own brands. So today, about half of our profits come from products that we really control the brand. And the goal is to take that up over time. It doesn't mean we will not work closer with our national brand manufacturers. If a national brand manufacturer wants to work closely with us, and it's a good product, and they have innovation behind that product and we can make money, we will promote those products. And I think there's a clear understanding that the national brands have opportunity with us, but we do want to increase our percentage of profits, not necessarily sales as they relate to products that are in the control of us relative to the ownership of the brand.

And can you describe a little bit more, and you mentioned this at the beginning, some of the recent dynamics around the implant business. Is this the recent trends that we've seen largely associated with the macro and can you talk a little bit about with also your S.I.N. acquisition and the U.S. FDA approval there and your go-to-market strategy around the value offering as well?

Right. So -- yes, the macro trends are probably impacting the implant business to some extent. But I think implants are becoming much more standard of care. And so I think it is fair to say that some of the higher-priced implants are being traded down to lower-priced implants, not in every country. For example, in Germany, our branded product, which does sell at a lower price than our competitors is doing quite well. There is some government support for implant dentistry in Germany. But I would say also our discount brand is doing well. In the U.S., we do sell our branded products at a slightly lower price than the national brands. And having said that, we realize that we do need an economy line, specifically for the DSOs. That was the rationale for buying the S.I.N. business in Brazil. They do have U.S. approval. And we will be, over time, I think, seeing more of the S.I.N. product in the Henry Schein DSO accounts. So in our opinion, the implant business, if you look at it over a couple of quarters, although there may be some economic challenges, it's still an opportunity for us as our market share, although we think we're around the #3 position, is still relatively small. And we think with the innovation we're bringing to market, the ability to pollinate, cross-pollinate, acquisitions we've made, their products, Henry Schein's products Camlog BioHorizons products into these newer acquisition, businesses or present opportunity to grow that business. And if you add to that, our growth in the endodontic field, you will see we have a very good specialty business. Our aligner business is relatively small. It's an opportunity to grow aligners in mostly our own DSO customers.

Got it. And with combining implants, endo and ortho across that specialty business, what is the long-term organic growth rate in your view?

Erin, last year in the -- in our Investor Day, we provided some market growth rates that we saw in some of the specialty products -- dental specialty products as a subgroup. We expect the market to be able to grow, say, 5% to 8% over the long term. Now that may vary within those categories between endo between implants, ortho, et cetera, but we think the kind of the blended average can fall in 5% to 8% on an annual basis. Some years might exceed. Some years might be a little less than that, but we do think that would be the typical range going forward.

Okay. And then switching to the Technology and Value-Added Services segment. How should we think about the long-term growth there, more recent trends as well as offerings. Ever since I saw your AI offering, for instance, at Greater New York, anything new that you would like to highlight from a technology perspective?

Well, from a growth perspective, we see that market growing 8% to 12%. And we're very bullish on the opportunity there in terms of some of the new product offering that are coming out, some of the new services that are coming out within our technology and within -- coming from Henry Schein One. You mentioned Detect AI, which is a new tool that we can provide to the practitioner to help them really assist them with improving the accuracy of diagnosis and identifying certain caries, which are the -- is really the precursor to cavities and helping them identify these things on a more timely basis and perhaps providing earlier care to the patients. So we're seeing some early success with that. Some of our early adopters of this AI have -- we're seeing an increase in the number of restorative procedures they are doing, the number of periodontal procedures they are doing. So there is a return to the practitioner for subscribing to that service.

I think you can expect much more interest in this clinical-type software from the DSOs. And they have the capabilities of internally assessing the investment relative to the return, incremental patients identification of disease that maybe could not be picked up with the naked eyes. I think you could see that and from there, Erin, I think you can expect a much more activity going on with the smaller practices who will follow the lead.

Switching gears a little bit to Medical. I guess can you remind us of your unique positioning in Medical distribution and your key areas of focus there, the competitive landscape and how you think you're gaining share in that market?

On Medical distribution side, we focus on everything outside of the hospital and the drugstore on the long-term care. So a lot of that is in the physician office, but growingly moving to the ambulatory surgical center -- procedures are moving out of the hospital into the ASC. Day surgery is becoming important. And we do quite well in this market. I think that the fact that IDNs are now owning more group practices pays well for us because we do have systems that align very well with the IDN needs. A movement towards generic drugs and particularly injectables and med-surg products is something that's appreciated by the IDNs. Our ability to install systems for equipment is also appreciated. And so I think we do well in that area. Our goal though is to follow the patient. And yes, the patient move from the hospital to the physician practice and the ASCs, we have a big focus in the ASC area. But now we want to follow the patient to the home. We've been looking at this for a while. We acquired 3 companies in the last 1.5 years. And we pretty much have a wide variety of products at the moment for the home care consumable side. It's a pretty good margin. We have billing capabilities. We're not fully national yet with all the products, but our goal is to develop a national network. Our salespeople do have good relationships in general, our consultants with physicians. And I think there will be some synergies there. The Schein name is trusted in the physician offices, and I think we will get referrals in the long run from our customer base.

And you've done some recent transactions in home health, which is kind of interesting. And is there more to come presumably on that front? How does the M&A pipeline generally look but also within that home health category?

You're asking 2 questions. The pipeline for M&A has always been strong at Henry Schein. I think Ron can address capital allocation to you, but we invested about $1 billion this year, and we can talk -- Ron can talk about the future. But as it relates to home care, yes, we've got 3 businesses now. One of the areas we wanted to focus on was continuous glucose monitoring. We have now that product offering, and we're able to build for it. And we have businesses now on the West Coast and on the East Coast. Each one is focused more or less on a different product offering. Now we need to take that product offering across the country. And there will be fill-in opportunities, of course. But we're very careful what we're going to be investing in. And Ron about the capital allocation?

Yes, certainly. In terms of the pipeline, yes, as Stanley said, there are -- we still have acquisitions in the pipeline. As I mentioned to you at Greater New York, I don't expect to that we'll be investing $1 billion again in 2024. I mean that's an unusually high year for us. Historically, we've been doing $300 million to $400 million a year, sometimes a little more, sometimes a little less. My expectations in '24, it will be something more in line with that historical run rate. Having said that, we're opportunistic buyers. When we see something that we think fits our strategy, and we have a willing seller, it would be something we would have to consider assuming that it meets all the parameters that we would set for it. So -- but right now, my expectation is that we'll be more in line with what we've done historically going forward.

And heading into 2024, as you think about more aligned with historical, would that be kind of the 200 basis points to top line growth from acquisitions and you gave that 6% to 8% overall top line growth, including M&A previously and then 8% to 11% EPS growth outside of sort of the cyber incident dynamics and promotional activity thereon, would there be any reason why you would kind of deviate from that?

Well, we haven't provided -- we'll provide '24 guidance when we provide our Q4 earnings release in February. So we'll be able to provide some details around that guidance at that point in time. Like we said in the prepared remarks to our third quarter earnings release, right now, we're seeing within dental, within general dental as well as within specialty, probably the market trending more towards the lower end of some of those market growth rates. But all of that will be taken into consideration when we start -- when we provide our guidance, which will include sales growth, components of that sales growth as well as EPS obviously.

And does this cyber incident have any impact, though, on deal activity for you?

That's something we're still assessing. We have to kind of see how the balance of the year plays out. We're looking at customer retention rates, customer recovery rates. And to the extent that there's a tail to this that runs into '24 that we believe impacts the '24 results or that we expect to impact the '24 results, we'll communicate that as part of our guidance.

But I don't think it impacts acquisitions and the areas we are already focused on, which is the specialty products and the services, they were not impacted by the cyber incident.

In terms of follow-up on the home health side, would you have corporate brand items within that? I mean do you leverage that as well as the services component?

Sure. These businesses don't have today generic products, and our products will go into those businesses. And for products that we don't really carry, although we carry most of them, we have our sourcing capabilities that are already sourcing for these businesses.

And then talking a little bit on -- going back to specialty, I didn't mention or didn't ask about Reveal Clear Aligner specifically. You briefly mentioned it, but how do you think the competitive landscape plays out in your view? And where does Henry Schein kind of play a role there?

We have such a small market share, if we are able to go to our own customers and get a small percentage of them to move their products to Reveal and the Smilers brand we just acquired in France. But this is not our main focus. It will happen. We have a separate management team that's focused on orthodontics. We have some traditional wires and brackets. It's a good business, but we definitely are not going to make that our focus. Implants is far more important to us than the [indiscernible].

Great. Well, thanks so much. I appreciate the time today. And yes, we look forward to kind of what's next in 2024.

Thank you, Erin.

We'll let you know.