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

Great. Good afternoon. My name is John Stansel. I'm a member of the Healthcare Services Equity research team here at JPMorgan. Today, we're joined by a full contingent of people from Henry Schein. We have Stanley Bergman, CFO; Ronald South, CFO; Andrea Albertini, CEO, International Distribution Group, and Tom Popeck, CEO, Healthcare Specialties Group. So they're going to go through a quick presentation, and then we're going to have hopefully 20 minutes of good Q&A. So I think Ron is going to run the controls here.

Very good. Thank you, John. First, if you could read this really quickly for -- and then just to read through that really quick, and then we'll get on with the rest of the presentation. Thank you very much. A cautionary note, I think it's we're all familiar with. Stanley, I'll allow you to provide us with the Henry Schein overview.

Sure. Thank you, Ron. I'd like to stand.

You could -- you can. As you wish.

Okay. Thank you all for being here. So Henry Schein is the largest provider of products and related services to office-based practitioners, that's dentists, dental laboratories, medical practitioners and related areas, including the dental lab. We know dialysis centers, cancer centers, the military, everything outside of the acute care setting, the long-term care setting and the retail pharmacy. The data is on the slide.

Oops, sorry. I knew I'd mess it up. Go ahead.

I just want to see if I -- did I miss anything yet?

No, go ahead. You want the next slide?

Right. No, leave that slide. That's what I...

Okay.

Okay. So our goal is to help practitioners operate a more efficient business to generate practice performance, integrate our proprietary products and services, and elevate clinical care in their offices. That's the data. There's plenty more on our website, but perhaps I'll go to the next slide. The demographics, you've got the aging population more interested in prevention than ever before. A big part of our business revolves around prevention. There's movement of procedures from the acute care setting to the physician environment, to the ambulatory surgical center, ASCs. These are areas that we service. The movement, of course, is good for our business. There's a growing awareness of the direct correlation between good clinical care and good medical care and the quality of life. So an understanding that oral care can, in fact, help with the quality of life with wellness, prevention. And that's, of course, upping the focus of oral care in the general spectrum of health care. There's the whole reimbursement area, not enough time to deal with it today. Wellness and prevention I spoke about. There's a growing demand for wellness and prevention, ideas in the office-based environment outside of the hospital. And of course, there's the consolidation of practices, dental and medical. This is a core competency of Henry Schein, and we do well in this area. And the area of digitalization of dentistry and digitalization in the practice of medicine are all important areas for us that we spend a lot of time and a lot of focus on, and I believe that dentists view us as a place to obtain solutions and ways in which they can turn to us to improve on the efficiency of their practice and the clinical care that they provide. And we are the largest in our -- in the markets that we serve. Broad customer base, great relationships with large customers. It's a pretty diversified portfolio. And a lot of what we do is integrated. Go ahead, Ron. The markets that we're in are stable in terms of units used. Some of the markets are growing. We can get into specifics a little later if there are questions. But we have seen a migration to more of the specialty products over time. There are dynamics within that. The higher-end implants, for example, are under challenge, but the value side and the premium side, that is available at a more reasonable price. It's a growing part of dentistry, and that's an area that we focus on. And the medical markets were a little bit volatile during the COVID period when there was a greater demand for tests. And during the COVID period, both the dental and medical side had a greater demand for PPE. We provided -- we provided this information in our quarterly calls. This is normalizing. We had a cyber incident in October of '23, had an impact on our e-commerce business on practitioners that bought product through our website. That is now improving, and we are slowly getting our market share back again. The dental market for equipment is a solid market. Of course, it's impacted by higher interest rates. The lower interest rates, the better that business is. But it is a steady grower. And I think we are doing well compared to our competition in a market where traditional equipment continues to be quite strong and the digital equipment, doing very well. We've had -- we spent about $1 billion on acquisitions in the last 2 years. They're all doing quite well. We have had a challenge with the recapturing of all of our distribution business as a result of the cyber incident, and we felt that it was important to rightsize our infrastructure and accordingly, we announced a $75 million to $100 million restructuring, and that's moving along quite well. We have a strong balance sheet. We use our cash flow to buy back stock, make some acquisitions, although we're not making them at the rate we made acquisitions last year and the year before and of course, to repay debt. And we have our BOLD+1 Strategic Plan, which we'll cover in a little bit more detail. So Tom, are you going to cover this?

Yes. Yes. Thanks, Dan. So BOLD+1. So this is our guiding principle, our strategy. It's build, operationalized leverage and digital. And it's really our guiding principles for everything we're doing. In particular, we've been very successful in executing on this to transform our business from being that pure-play distribution business to being more of an integrated vertical manufacturing business, leveraging all of the assets that we have. I think of important note is really on those 2 bottom bullets there, which is our high-growth, high-margin businesses. These are what we call Henry Schein products. My responsibility is for the Henry Schein Products Group. And today, that represents 25% of our overall revenue, but it represents 40% of our operating margin. And if you were to include our private label that we sell through our distribution business, it represents an additional 10%, so a total of 50% of our operational margin comes from Henry Schein products, products we own. How that relates specifically to our bold strategy. When you look at build, you look at a couple of specific specialty businesses that we're focused in. The first will be endodontics. We've done a couple of acquisitions over the years, built the business, putting that together. We are now the #2 player in global endodontics. Our implant business, again, Stan just mentioned, we've made some significant investments over the last 2 years. We view ourselves as the #3 -- excluding China, the #3 implant player in the market. And recently, we just made some investments in the niche segment of orthopedics, meaning hand, wrist and foot and ankle. Fast-growing extremely high-margin business, it's a business we didn't get into without a whole lot of thought. We've had an orthopedic business that we've had for quite some time. And when you look at the orthopedic business and you look at competencies that we have within our company today, dental implants and orthopedic implants are pretty similar, same materials, same manufacturing competencies, same biomaterial technologies, lots of really common space where we already had competency. And then the last piece of our investment in that -- in building out this orthopedic business is the synergy and the alignment with our ASC strategy in medical. Most of the extremity orthopedic businesses are focused in the outpatient ASC segment. And this is a real nice way to add a nice high-growth, really high-margin business into that segment and start to build that out. So we're doing really well on build. On operationalize, lots of different acquisitions. How do we start to integrate them, build centers of competency in our endodontic business. We're building a center of competency, even manufacturing and R&D in Switzerland. And we're looking to do that in each one of those specialty segments. On leverage, this is where really Henry Schein shines, no pun intended. But no one can touch a customer like Henry Schein can. When a customer wants to be touched through a distribution relationship, we could design products, put brands on them to fit that market. When a customer wants to be touched by a clinical specialist, we have that sales channel. We design products, put brands on them, put them in that channel. When a customer wants to be touched by e-commerce, digital, alternative channels, we build the product, design the product, put a brand on it to fit that market. That's unique in the industry. It's something where we really think is our opportunity to shine. And then last is digital. Within our implant world and our orthodontic world, we have our Nemotech software, a really great platform. It's a vision of -- for our future. It came along with our biotech acquisition that we did about 1.5 years ago, excited to have it. We think it's our future. Hand it over to Andrea.

Thank you, Tom. I stand up as well. Can you hear me? I go quickly through the same bold strategy for the distribution and technology business. And I'll just mentioned some of the highlights of what we achieved. And I start with something we are very proud of, that is we have the #1 software platform in the dental space. And we can say fast accelerating sales on the cloud and digital solutions. Still, I mean, it's more in distribution, but I like to think about this as a high-growth, high-market business. We have today 1 of the top 5 home care distribution company. And this is a fast-growing segment, high-margin, and it represents for us already more than $350 million in this segment. Of course, distribution, operationalize means also to be more efficient. As Tom mentioned, cost reduction program, we had to launch last year, especially coming out of the cyber with the market that was what it was. So we had to take out cost from the distribution business. And we believe this helped us to improve our efficiency significantly. We always knew -- I mean, again, as a distribution business, we are always to look at efficiency. But last year, we did more than what we normally do. But we continue to do it within mind, our customers. So making sure that we don't downgrade the customer experience. Tom mentioned the leverage and it's very important because more and more, as a distributor, we need to balance the work we do with our supplier partners with our own product. And this is what we call the blended distribution. It is a customer need. Customers are asking for these products, and we deliver this product, leveraging our own internal manufacturing, leveraging our own corporate brands. And in digital, I want to mention again, not only the software, but we launched our new global e-commerce platform. We started in a, let's say, small geography last year. We went live end of last year in U.K., and we are fine-tuning it, learning how to use this very powerful platform to do e-commerce to reach our customer that wants to deal with us digitally. It's not only order intake. It is a real e-commerce platform, and we will roll it out to U.S. this year, so that's an exciting step. Let me go quickly to the next slide where we talk about the strategy to generate growth, to generate the growth needed to sustain value. So the key strategy, both in dental and medical, and it sounds easy, is to grow our customer base. And we continuously have to find new customers. But we believe, because of all the values that we can deliver to our customers, we believe there is a lot of opportunities also in growing the market share inside the customer we are in. And we do it through our omnichannel approach. Tom mentioned it. We have multiple channels that allow us to meet our customers where they want to be met and allow us to deliver all the solution we have through our supplier partners or through our manufacturing -- internal manufacturing companies. So this will be a big part of the focus to grow again, our share and the number of our customers. We will continue to be focused on specialty business. And on the technology side, very important where we can deliver value is through digital solution to -- through cloud solution, through subscription bases. So we are moving from on-premise solution to a subscription cloud-based solution. And we will continue also to push our digital workflow. We call it [ 3-key ] dentistry. The idea is to help our customers navigate through the clinical workflow digitally, but in an easy way. And this will be a big driver of technology sales for the future. So these are the key focus we are on. And with this, I turn it to you, Ron.

Certainly. So just in terms of resiliency of the business, Henry Schein went public in 1995. And since then, we've got a track record of delivering double-digit earnings growth. We have a 13% non-GAAP EPS CAGR since doing that IPO back in '95. We have had some recent headwinds impacted our business. We know we've talked about cyberattack. We've had some volatility introduced to the business, both negative and positive related to the pandemic. But as we have continued to work through these things, we -- you've heard that word "transformation" a lot. We have really been able to evolve the business from that of a pure-play distributor to that who is also manufacturing dental specialty products, providing technology solutions for our customers and really focusing on the high-growth, higher-margin aspects of the company. You look at the non-GAAP operating income, you can see where some of this disruption comes from, whether it be in 2020 or again, in 2023 with the cyber incident. But the lines show that when -- especially when you look at the non-GAAP EPS, you can begin to see, there is a CAGR there going back to 2018, 8.7% on our EPS through the third quarter of last year, the significance of that is the cyberattack that we had was in October of last year. As we find ourselves kind of emerging from that, we're looking, really pushing so that we can get back to a consistent delivery of this 8.7% CAGR in EPS going forward. So to sum this up, we feel like we have a clear strategic plan. We are creating operating efficiencies. We're actually bringing an exceptional customer experience where they get a breadth of products they can't get elsewhere in the industry, whether it be their day-to-day consumable merchandise, their equipment, their specialty products, et cetera, all from a single supplier. The proven track record of sustainable earnings growth, leading position in attractive markets where in every significant market out there necessary for us to grow in both the dental and then in the U.S. in the medical space, a highly complementary set of products and services that complement each other. Like I said, we're able to go to the customer and provide a wide base of products and services. And then finally, a management team that is highly motivated to get back to the level of growth that the market has been used to seeing from us as we go forward and get through 2025 and into 2026. So thank you very much. John, back to you.

Great. Thank you very much. So I think probably, the easiest place to start here just on kind of the core dental consumables. And 2024 was a bit of a strange year given everything that had transpired and some of the market share changes and everything that we had to kind of look at as we exit '23 to '24. So I guess first question is really when we think about -- into consumables, both on kind of North America and maybe international, that'd be helpful to that perspective too, what do you see as the market growth level? And then, I think, you've talked for '25, you gave very kind of high-level preliminary commentary that indicated there would be, I think, modest improvement was the phrasing. What is the bridge that drives kind of where we were in '24 to '25 kind of modest?

So John, there are a couple of things. First of all, in the United States, in particular, procedures, the number of units of product used in practices are relatively stable, leaning towards positive. There are areas that are a little bit different. But, essentially, the basic products, the basic procedures undertaken, the products that we sell are used, are stable to leaning positive. We had challenges with pricing, namely that there was no real inflation from our major manufacturers. They increased prices quite significantly during the COVID period because of labor shortages, because of materials. Prices went up, they didn't stick. And midsize manufacturers, second-tier manufacturers came in and our own brand grew, so we had a bit of a compression of sales. Gross profit was okay, and that's 1 element. The second element is the recovery from cyber. It took a little longer than we thought, specifically with the smaller customers that were used to buying from us through our website, which, in the United States was down for a year -- for a month, and for 2 months in parts of Europe, for example. So we had a compression of sales. Yet our pricing -- our cost of doing business went up. So we had a bit of a squeeze, and we're addressing that through our restructuring. We think that the distribution of dental products will be more stable in '25. We haven't given guidance yet. And we believe that our expenses will come down. So we will be able to return to higher growth EPS but not all the way yet to what we've experienced in the previous 24 years, so we can peel the onion on that.

And I guess on the trade down point that you just made quickly there. Do you feel that, that's a sustained trend that we see kind of going forward, the sensitivity to maybe prefer to use a private label product. If someone switches to use private label product today and switch back, does -- if practice economics improve, they return to maybe a premium, higher-priced product, is -- was it durable?

Yes. I think what happened during the COVID period. This is not only in dental products, but in consumables and just all kinds of products and services, the consumer was far more prepared to go and do a little bit of research on whether one product versus another, products and features, quality, value, what's different compared to, say, a national brand. And so there's much more awareness of quality and value than necessarily brand. And I think that is part of the culture today in general, not only in the United States but globally. So I do think the movement towards value will continue unless there's innovation. So if you have innovation, obviously, the opposite applies. If you do not have innovation, there will be greater movement towards value for similar products. And so I think that is sort of a given. It's not terrible. It's pretty good for Henry Schein because we have a value offering for our dental and medical consumables. And we have a very good offering of equipment, not our own brands, but where we get support from national brands, manufacturers, but also manufacturers that are trying to get a greater market share, and we'll do that based on value.

I think that's actually a great dovetail into the implant side of the business. Because at times we talked about how Henry Schein is very well positioned on the what I'll call premium value and value elements of the kind of the hierarchy of implants. So I guess the same question applies there, maybe a little bit more specific. How do we think about the durability of the favorable trend towards value implants and premium value?

Yes. Well, in the past, we struggled a little bit there. But over the last 1.5 years, we made an acquisition of S.I.N., Brazil-based manufacturing company. And we've been really happy with the progress we've seen in that segment here in North America, small still, but making great progress.

And I think one of the things, when we talk about S.I.N. is that there is interest from DSOs, particularly.

Yes.

Is that something -- you've now had it for a little bit longer of time. You've gotten to know it better. You got to spend more time marketing it to practices. Has that enthusiasm persisted?

It is. We're still exploring. We're still learning, but those opportunities are coming up.

Okay. And then the big thing that happened kind of midway through '24 was to launch the Tapered Pro Conical. Can you just talk a little bit about how that complemented or fit within your overall portfolio strategy for the implant space.

Well, let's just start with, it's 50% of the market. So here in the U.S., we were only playing with half a deck of cards. So it's a great opportunity for us. We launched it in Q3. We're rolling it out slow, right? Slow is better, getting the sales force trained, getting the material out there, talking to our customers, doing the education. Early results are great. We're excited about what we're going to do in 2025. We also have a new healing abutment that complements that as well. So between the 2 new products, we're excited about '25.