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

Good morning, everyone. My name is John Stansel. I'm a member of the health care services research team here at JPMorgan. I cover Henry Schein. Today, we have Stanley Bergman from Henry Schein, CEO; and then we have Ron South, CFO. Stan is going to kick us off with a presentation, then we'll go to about 20 minutes of Q&A. So Stan, the floor is yours.

Thank you, john.

You can go up there, or you can do it down here, if you wish.

Thank you. Ron, that's you.

Yes, the cautionary note. I could read this entire slide, but our presentation would be over, we'd run out of time. So I think everyone understands the safe harbor rules. So please be aware. Thank you.

So we were asked to put a deck together, John. We've done that, but we will fly through the deck very quickly. And I believe it's on our website. Right, Ron?

I believe so, yes.

Graham. So I'm not going into great detail, but there's a lot of information here. So Henry Schein is the largest provider of products and related services to office-based health care practitioners and alternate care sites. The data is on the screen here. In terms of size, over 1 million customers, about 1.5 million practitioners that we service. And again, this is all available on the website. On the distribution side of the business, we're the #1 distributor of dental products globally. We believe we're the #2 provider -- distributor provider of health care products to the alternate care sector of healthcare of primarily in the medical arena, but it includes physicians, includes ASCs, ambulatory surgical centers, urgicenters, renal centers, cancer centers, various government agencies that provide medical services, all outside of acute care sector and now, of course, into the home care products sector. Our estimated market shares are on the screen. It's essentially an offering of practically every product that our customers would need to run their practice, and our goal is to drive efficiency of costs, like all companies, and we have, of course, great supply chain systems and very, very good information systems for our customers. Now side-by-side with our distribution businesses are our specialty businesses. We are the #3 provider of oral surgery products, that's implants, bone regeneration type products; #2 in the endodontic space; and we're a relatively small player, but have quite a nice offering of traditional orthodontics, wires and brackets and aligners. These are all often under brands that Henry Schein owns. We do a significant amount of R&D in the space, and you can see all the information on the slide. So we have the distribution businesses. We have the dental specialty businesses as it relates to products. We will be entering into the medical specialty businesses with orthopedics. We've announced the transaction there, which we hope to close in the next few months. And then the third leg is the Technology and Value-Added Services. In this regard, the anchor to the mall, if you will, is our practice management software in dentistry, which is the largest provider of practice management software in the world, but more important, the electronic medical record and a whole series of products that operate off this electronic medical record system. In that connection, we've recently introduced an AI system that is quite effective in helping practitioners operate a more efficient practice, diagnosis and advancing obviously, quality of care. We have offerings for large practices, smaller practices, the largest provider of software to dental schools and traditional legacy systems and now gradually moving a significant amount of our business to the cloud. What I think is very, very important is we connect the electronic medical record, the practice management system, all the way to the dental lab through a clinical workflow. There is more information on this on our website. We provided a lot of information during our Investor Day in February, but these are all the steps that an efficient clinical practice could install. I think we have the most efficient system, the most extensive system in dentistry, all under one roof. Obviously, these components can be bought from different sources, but we have it all under one roof connected in an interoperable way and a way that embeds these various components into our practice management software. Our strategic plan for 2022 to 2024 ends this year, is built around 4 big concepts. One is to build our high-growth, high-margin specialty and software and other value-added services businesses, which I described earlier on, to operationalize our distribution businesses from an efficiency and customer satisfaction point of view. We're investing significantly in digital software in that area and leveraging our relationships. We have relationships with customers on the dental and medical side for many different businesses, but these customers may not necessarily buy from all of the Henry Schein businesses. So there's a huge opportunity, which we're capitalizing on to leverage relationships from one side of the house to the other and driving digital dentistry and digital medicine is a key area of focus. Of course, the +1 stands for our commitment to all 5 of our constituents, our suppliers, our customers, our team, our investors and society. We have been a socially responsible company for decades now before the concept of ESG actually was conceived. And I think this is one of the major reasons why we've had very good growth over the last 28 years since we've been a public company. Ron, do you want to go through the financial goals?

Certainly, the long-term financial goals for those of you who are familiar with the Investor Day we did last year, these are consistent with what we communicated then, but just to kind of reinforce them. We have long-term financial goals, total sales growth in the 6% to 8% range, that is as reported. So that would include some acquisitions in there. Non-GAAP operating margin expansion of a minimum 10 basis points a year. We do think that we could have some years where we could exceed that quite well, and non-GAAP diluted EPS growth of 8% to 11% going forward. There could be some years, for example, the last couple of years where we've had some headwinds with PPE market conditions around PPE pricing, COVID test kit. Market demand makes it a little more difficult to achieve that 8% to 11%. But we think over the long term, non-GAAP diluted EPS growth of 8% to 11% is an achievable goal for us. To the right-hand side, you can see non-GAAP operating income contribution from our -- what we consider to be a high-growth, high-margin businesses. That would be our specialty businesses in dental implants, endodontics, orthodontics plus our Technology and Value-Added Services. In 2019, those businesses contributed 32% of our operating income. We have a goal of those businesses contributing 40% of operating income by the end of next year, and we think we're well on the way to achieving that goal. That takes us to investment merits. Certainly -- so in terms of the investment merits, it's -- we have the core distribution business, where we think we can continue to provide some operating efficiencies. We always are looking for opportunities for some tuck-ins where we can leverage existing infrastructure or to expand our geographic footprint similar to the acquisition we did in Switzerland in 2022 and gave us some distribution in that part of Europe. We continue to have the long-term sustainable earnings growth, and that continues to be a focus for us going forward. I'll skip down here kind of to the last bullet, a deep and experienced management team. We're a very long-tenured team at Henry Schein. We understand the importance of delivering on the results and delivering on our promises. And that is something that is ingrained within the culture of Henry Schein. So with that, I believe we're there.

Okay. So I think that was a wonderful overview of kind of the longer-term trajectory of the company. Moving to the kind of the recent history. I think we're a few months on from the cybersecurity event that happened in October of 2023. As part of third quarter earnings, you called out a $0.55 to $0.75 headwind to adjusted EPS for the fourth quarter. Can you just remind investors how to think about that, the different components? And anything you've kind of learned as time has gone on as you've got a little bit of distance behind you?

Right. So I'll deal with the concepts, and Ron can cover the numbers. So John, we've recovered pretty quickly from a customer service point of view, the ability to service customers where were hit in middle of October. Within a few days, we were shipping products. But our website was not working for about a month. We want to be very careful about ensuring that we didn't infect our customers in any way. But essentially, we restored all of our systems through our backups, and most of our -- certainly all of our customer-related systems and all systems, enabling us to undertake business, whether its procurement or shipping, have been up and running for a while. So we're obviously cautious, like all companies should be, in the area of cybersecurity. Unfortunately, health care companies have been hit particularly bad in the last 1 year to 1.5. But we're back to undertaking business in a way that we were undertaking business pre the event. Ron, maybe on the math?

Yes. So certainly. So we have estimated a $0.55 to $0.75 per share impact from the cyber event. We have not provided any changes to that estimate at this point in time. The effect on the business was largely restricted to our distribution business, to our U.S. medical and dental distribution business as well as in Canada, and -- as well as in Europe. It did not impact distribution in Brazil, Australia, which are really kind of the 2 larger markets outside of North America and Europe for us. It had very little effect on our specialty business. The really only impact was in orthodontics, which is a small business of ours, as you're aware. So this is really restricted to distribution. So the recovery did involve some -- providing some promotions in an effort to regain that small group of customers who are more, what I'll say, transactional type of customers for us. They weren't necessarily those who we had very close strategic relationships, but those who were transactional would simply go to the website and buy product. And one day they went to the website and they couldn't buy product, so they went to somebody else's website. So we did have some promotions to regain a lot of that business. We feel pretty good about that recovery. We're still analyzing those results. Those promotions have not continued into '24, but we continue to analyze what the effects of this might be. When we disclose our Q4 earnings, we'll, of course, be updating this information. With that release, we will also be providing 2024 guidance. And to the extent that the cyber incident has any effect in 2024, we'll be sure to kind of call that out and talk to that as part of that guidance.

Great. And then I guess kind of following that up. Do you think you learned something about your sales force here? How they're able to manage through this? It sounds like you think your customer base is relatively intact.

Yes. So John, our sales force played a very important role during the period before our website was up. So customers could order from us using our teller services and our sales force who could pick up the orders. This was for a period of 3, 4 weeks. Of course, our larger customers were able to buy from us using various forms, electronic ordering. And so our sales force got very close to our customers, again, in a very different sense. And I think it was a good morale builder, and in the end, I think, a way in which we gained a significant amount of trust. Where we were challenged was with the episodic customers that would buy digitally that go and look at a price on our website and on a competitor's website and then come back to us if they like the price. Obviously, they couldn't go to the website for that month. But that's behind us now, and we've been providing website services now for a while.

Is there a way to think about that episodic group as a part of your customer base?

Yes, they're an important part of our customer base. We do have websites under different brands. Most of those were working, but the Henry Schein website was not working. And this impulse shopping, this notion of customers shopping, looking around for products and pricing, I think, is a key part of our strategy, and we are investing in that area through our global e-commerce platform. So it is an important part of our business. I think customers will just include us again now in their shopping spree when they go to look for products at different prices.

And you said you kind of completed promotions. Is there a chance that you -- after you've reviewed the data, closed the books fully that you would resume them in targeted ways? Or is there data that you look at in that area?

Well, we've always had targeted promotions. It's critical, whether it's through our e-commerce platform, whether it's through social media, through our sales force, through our telesales or simply even mailers today. We still have, believe it or not, mailers to customers. It's always been a key part, and we will be very careful to scrutinize our data. And if a customer hasn't come back, we'll, of course, offer promotions. But I don't think we'll have to offer the significant promotions that we offered in the fourth quarter, which were really geared towards customers coming back. But more important, to saying to our customers, you are loyal to us. Thank you. We want to share your pain and here's a deal.

I think moving to the other major topic in the dental space has been on the macro backdrop since October, and there's been a variety of commentary coming out of the third quarter about general pockets, where things would be stronger or weaker. Some publicly available surveys have been a bit more ambiguous since then. What is your view on kind of the state of the dental industry right now and demand trends broadly?

So I think one has to be, John, a little bit careful. At the end of the third quarter, there were a lot of cancellations that were related to flu. I don't know if it was COVID per se, but some COVID, but just general flu. So there was pull back and there was cancellations. And then from the data we've heard, it's public information, we've read, it seems like things got better in October, November, maybe December. So I'm not sure to what extent there's these macro concerns. There are some macro concerns. I think there's been a lot of dialogue about macro concerns in the implant field. Well, I think there were a lot of implant procedures undertaken in the post-COVID period, call it, end of '21, '22. Those were not run rates. Those were unusual situations. You saw it also in the orthopedic field, ambulatory surgical field. So I think a lot of that has been absorbed. There obviously is some pullback because of economic uncertainties, but I'm not sure the degree of pullback. I certainly don't think it's massive. It's small amounts, I think, at the edge and our equipment, you could say, we didn't have double-digit growth. But we also were working off a backlog in '21, '22. And now I think we've -- mid-single digits are more back to a normalized pattern, taking into account that traditional equipment is doing well. Digital equipment is doing well, but at a lower price per unit with many more units being sold. So there's a lot of puts and takes here, John, that are relative to the dental industry, but I would not correlate this with anything in a huge way relative to the economy. I mean there are countries where there are issues, but...

That gets me to our next question. How do you feel about -- I feel we sometimes myopically focus on the North American dental market. How are you viewing international growth?

I think Europe is a little bit more down. I don't think it's significantly down. We had a lot of negative comments about Europe. Look, in the dental world, specifically in equipment, but also in consumables, prices were taken up quite high in '22, at the end of '21, '22. And there was some resistance by customers who said, "You know what, there are alternatives to maybe some of these brands at a higher price, and I'm going to look at them, whether it's secondary brands or it's the Henry Schein corporate brand." So there has been, what some may call deflation, but it's not a deflationary concept in the normal way in which we talk about inflation. It's really a switching of brands. And so that resulted in some reduction in sales, perhaps, and not necessarily in units. So there have been some reduction in sales, but I don't think that's necessarily only the result of a concern with the economy, the macro concern. The units are still there, it appears on our side, but more a dampening on pricing of particular products.

Got it. So you mentioned implants earlier on. How are you thinking about the difference between, say, a high-end and a low-end or value implant? How you're positioned there? Obviously, the S.I.N. acquisition gives you a new value implant that can enter the U.S. market and have some DSO interest. How are you seeing -- to look forward, how the implant side of the business grows, where -- and where the pockets of the growth?

Right. So Henry Schein has always had the view that we -- our Camlog and BioHorizons implants are premium implants. Having said that, they sold -- have traditionally sold at a discount to maybe some of the global brands. So we've always viewed that we have a value premium brand. At the same time, we cultivated an economy area of implants, particularly doing well in Germany with Medentis, but we didn't have really an economy brand in the United States that could compete with our major competitors and implants. Each one of them had an economy stand-alone brand. So what the investment in S.I.N. has enabled to do -- enabled us to do is bring in a Brazilian implant, high quality and be in a position to sell it at a lower price than in the United States, the BioHorizons brand. And that has positioned us to compete with our competitors who, as I noted earlier on, did have such separate brand. And this is particularly important with DSOs, where we were at a disadvantage, in that we did not have an economy brand. Those products are approved in the U.S. They were approved shortly before the closing of the deal. And we believe we will be able to go into DSOs with an offering that we didn't have in the past on the economy side and do well. But I will say that the premium market, I don't think, is in trouble. What is growing is the economy as more patients are brought into the implant world, and implants are being viewed as standard of care.

Understood. You mentioned DSOs there. How are you thinking about the overall DSO cadence of expansion these days, given kind of changes in rates and expected changes in rates in '24? How do you view kind of de novo and acquisitions for the DSO space?

So the DSO world, in simplistic terms, could be divided into 2. Those DSOs that had good funding, yes, the cost went up, but they have funding and they can expand their DSOs. De novo, additional equipment, adding AI, software, investing in software. And then on the other side, you have the DSOs where they were the shoehorn funded. And those DSOs are struggling a bit now. I'm not aware if any of that really are not going to make it, but they're going to have to cut deals with their banks and whatever and get new equity, but there's still enough income to keep these DSOs in business. So there are parts of the DSO world that are not really investing as much as they were, but the well-run DSOs are investing.