Henry Schein, Inc. (NASDAQ:HSIC) Q1 2023 Earnings Call Transcript May 9, 2023

Henry Schein, Inc. misses on earnings expectations. Reported EPS is $1.21 EPS, expectations were $1.23.

Operator: Good morning, ladies and gentlemen, and welcome to Henry Schein’s First Quarter 2023 Earnings Conference Call. At this time, all participants are in a listen-only mode. Later we will conduct a question-and-answer session. [Operator Instructions]. As a reminder, this call is being recorded. And now, I would like to introduce you to your host for today’s call, Graham Stanley, Henry Schein’s Vice President of Investor Relations and Strategic Financial Project Officer. Thank you, Graham. Please go ahead.

Graham Stanley: Thank you, operator, and my thanks to you for joining us to discuss Henry Schein’s financial results for the first quarter of 2023. With me on the call today are Stanley Bergman, Chairman of the Board and Chief Executive Officer of Henry Schein; and Ron South, Senior Vice President and Chief Financial Officer. Before we begin, I’d like to state that certain comments made during this call will include information that is forward-looking. As you know, risks and uncertainties involved in the company’s business may affect the matters referred to in forward-looking statements. As a result, the company’s performance may materially differ from those expressed in or indicated by such statements. These forward-looking statements are qualified in their entirety by the cautionary statements contained in Henry Schein’s filings with the Securities and Exchange Commission, and included in the Risk Factors section of those filings.

In addition, all comments about the markets we serve, including end market growth rates and market share, are based upon the company’s internal analysis and estimates. Today’s remarks will include both GAAP and non-GAAP financial results. We believe that non-GAAP financial measures provide investors with useful supplemental information about the financial performance of our business, enable the comparison of financial results between periods where certain items may vary independently of business performance and allow for greater transparency with respect to key metrics used by management in operating our business. These non-GAAP financial measures are presented solely for informational and comparative purposes and should not be regarded as a replacement for corresponding GAAP measures.

Reconciliations between GAAP and non-GAAP measures are included in Exhibit B of today’s press release and can be found in the Financials & Filings section of our Investor Relations website under the Supplemental Information heading. For additional financial information, please refer to our quarterly earnings presentation also posted on our Investor Relations website. The content of this conference call contains time-sensitive information that secrete only as of the date of the live broadcast, May 9, 2023. Henry Schein undertakes no obligation to revise or update any forward-looking statements to reflect events or circumstances after the date of this call. Lastly, during the Q&A session, please limit yourself to a single question and a follow-up.

And with that, I’d like to turn the call over to Stanley Bergman.

Stanley Bergman: Thank you, Graham. Good morning, everyone. Thank you for joining us this morning. We are most pleased to report very good financial results for the first quarter of 2023 that are in line with expectations we provided at the beginning of the year, and reflect the good earnings momentum in our underlying core businesses. Market trends stayed consistent with those we discussed during the previous quarter’s conference call compared to the fourth quarter of last year, where we saw a high number of flu cases patient traffic to dental offices around the world has recovered and is at or nearing pre-pandemic levels. Patient traffic through the physician practices has also normalized. As we anticipated, our results continued to be impacted by decreasing sales of PPE products and COVID test kits.

Within the PPE credit category, the pricing focus was lower. Again, as we discussed, but pricing at this stage has stabilized on a sequential basis. COVID-19 test kits volume was lower. Excluding these product categories, we achieved strong internal growth companywide of 6.3% in local currencies. Our financial results were also adversely impacted by acquisition-related expenses as well as foreign exchange. With respect to acquisitions, our pipeline remains robust. In early April, we closed our acquisition of a majority stake in Biotech Dental a business with a market-leading portfolio of dental implants and clear aligners, and we also recently announced our plans to enter the large Brazilian implant market with the acquisition of S.I.N. Implant System, one of Brazil’s leading manufacturers of dental implants and a complement to our successful resilient general dental consumables and equipment business.

And we also announced the acquisition of Regional Healthcare Group entering the medical market in Australia and New Zealand and leveraging our dental infrastructure in the region very successful business we have today in the region. I’ll discuss these in more details in a moment. Today, we are updating our non-GAAP diluted EPS guidance, financial guidance for 2023 to include the impact of Biotech Dental, the acquisition of Biotech Dental. The outlook for the underlying business is consistent with prior estimates, including expectations for operating income growth in the high single to low double-digit percentage range when excluding the contribution from PPE products and COVID test kits and acquisition-related expenses. Let me now turn to a review of the highlights from each of our business units.

So let’s begin with dental, the dental distribution business. Overall, the underlying fundamentals of our dental end markets remain solid, fueled by an aging global population, low unemployment levels and global — and a growing global awareness of health care benefits of preventative care and oral hygiene. First quarter dental sales growth, excluding PPE products, reflect stable patient flow. Dental merchandise sales, when excluding PPE products, was very good, partially driven by lower prior year merchandise sales comparison that was impacted by the higher level of flu cases and some COVID — Omicron COVID-19. Our dental equipment sales were solid. Traditional equipment sales grew very well, while digital equipment sales comprising of 2D, 3D digital imaging, mills, intra-oral scanners continued to be lower than the previous year.

In North America, the traditional equipment growth included some price increases introduced in the second half of last year as well as good growth in our parts and service business. We’ve been focusing on this area for a while. This growth was offset by a decrease in sales of digital equipment. The market for intraoral scanners is healthy, as demonstrated by increased unit sales in the quarter. However, as we commented last quarter, our sales decrease reflects declining average selling price for intra-oral scanners, plus we also had a significant sale in the previous quarter — in the previous year of scanners to a DSO. Unit sales in other digital categories are lower, and we believe are now normalized compared to the last year. We also posted good sales growth in dental equipment in Europe.

International dental equipment price inflation has not been significant, and the growth was supported by the equipment backlog, which is reverting to a more normalized level in Europe and also, our parts and service business is doing quite well. The biennial IDS show in Cologne in March was once again a good event for Henry Schein. And from a sales perspective, the overall impact was consistent with previous IDS meetings. Our global equipment order book, which is mainly comprised of traditional equipment, remains robust and it’s up year-over-year. Let’s take a look in a bit more detail on our Global Dental Specialty business. Our Global Dental Specialty product sales growth increased from the fourth quarter. We continue to expect modest year-over-year growth to the first half of the year given the strong first half of 2022.

Implant sales growth was driven by meaningful growth in our premium Camlog product line in Germany, Austria and Switzerland, where we have our biggest strongest market share in the category, and we continue to achieve double-digit growth in our Medentis value price line. In North America, we are seeing an increase in dental specialty practices being acquired by larger DSOs. Importantly, we have excellent relationships with a growing number of DSO accounts and are committed to driving specialty product conversion at practices within those networks. We also continue to see growing adoption of specialty dental procedures amongst general dental practitioners and as demonstrated by enrollment in Henry Schein’s continuing education courses in these categories.

As mentioned earlier, recent highlights in our Global Dental Specialty business was the acquisition of a majority stake in Biotech Dental and an announcement of our entry into the Brazilian implant market with S.I.N. Implant System — through the acquisition of the S.I.N. Implant System business. Biotech Dental provides Henry Schein with a comprehensive integrated suite of planning and diagnostic software as well as a fast-growing portfolio of dental implants and Clear Aligners. Together, these products resulted in revenue of approximately $100 million in 2022. We are particularly excited about bringing the Biotech Dental software products to our customers, along with our existing portfolio of practice management software and clinical software we will offer a seamless digital workflow solution to a growing number of customers worldwide, very, very exciting.

Last week, we announced a definitive agreement to acquire S.I.N. Implant System, which is one of Brazil’s leading manufacturer of dental implants with revenues of approximately $60 million in 2022. This agreement marks our planned entry into the large Brazilian implant market. Brazil has been a very good growth market for Henry Schein, where we have brought good value to Brazilian dentists and dental laboratories over the last five or six years since we became active in that market. S.I.N. recently expanded distribution of the value price dental implants including United States and other geographies. We expect this transaction to close later this year, subject to, of course, regulatory approval. Both the S.I.N. Implant System and the Biotech Dental transactions represent progress we are making to advance our BOLD+1 strategy, which calls for us to focus internal growth and, of course, business development activities on the high-growth, high-margin opportunities and particularly with innovative products and services.

This quarter, our endodontic business continued to grow nicely, primarily through our [ Brasseler and Edge brands in North America. Our orthodontic business is quite small, but we’re pleased with the continued positive development of our Clear Aligner business, particularly with DSOs. So now let me turn to our Technology and Value-Added Services business, where the largest component, Henry Schein One, which had an excellent quarter. Investing in growing these businesses a key pillar of our BOLD+1 strategic plan and we believe our customers are recognizing the advantages in technological innovation that we bring to the marketplace. Growth in North America continues to be driven by Dentrix and Dentrix Ascend cloud-based solutions and customers upgraded from our Easy Dental product with the Easy Dental lifecycle ending later this year.

International growth was supported by the entirely cloud-based solutions for customers outside the United States, particularly in Australia and New Zealand, where it was recently launched. The number of customers on Dentrix Ascend and Dentally, these are our cloud-based solutions, has increased approximately 30% over the last year. We are very, very pleased and excited with our customers moving to our cloud-based solutions. We also saw growth with our revenue cycle management insurance claims product with growth driven by the number of e-claims reprocessed and enhanced functionality by electronic invoicing and reimbursement solutions. Sales of this product are a strong indicator of the underlying markets as evidenced by the higher number of e-claims we processed.

In short, our practice management solutions provide a competitive advantage to our dental business. Our highly integrated software is at the core of the operatory and supports clinical workflow while improving practice efficiency. Our practice management software also provides opportunities for us to sell products and solutions into the practice, including digital devices demand generation analytical software as well as our growing AI-enhanced product portfolio. Towards the end of the first quarter, we announced the full integration of Detect AI powered by Video Health and Bola AI into Dentrix Ascend. This software automatically analyzes digital images to identify and localized carriers allowing for faster evaluation of x-rays and effective treatment recommendation.

Products — this AI product offering has been well received. Additionally, our new voice technology feature improved speed and efficiency for dentists and hygienists when completing periodontal exams and clinical nodes. While it is still early in the launch, we have already seen good adoption of this new AI-driven solution, and we are excited to extend our reach and support dentists in providing the best possible patient care. So in our medical business, the distribution business, during the first quarter, our medical business achieved growth of 4%, excluding PPE products and COVID-19 test kits. As I mentioned last quarter, we expect the internal sales growth in our underlying medical business to continue to grow quite nicely, but at a somewhat slower pace this year than last year, given the prior year comparison resulting from significant growth we achieved last year.

We remain highly bullish also on our medical business. Unit sales for COVID tests were down significantly. And within the PPE category, drug pricing has stabilized, albeit at a lower price than last year. Looking at specific product categories, once again, pharmaceutical and equipment sales were strong, while sales of point-of-care diagnostic products decreased to some extent because of the high flu diagnosis last year this quarter. We were also pleased to announce our acquisition of Regional Healthcare Group in Australia and New Zealand both growing markets that have contributed to the growth of our dental business. Through this acquisition, we will be able to further leverage our Australian and New Zealand infrastructure and expand our global medical products footprint.

In summary, the underlying fundamentals of our core business remain solid, and we are executing well as anticipated with our BOLD+1 strategic plan. So we’re very comfortable with where we are. We’re bullish about the business and are excited as we advance our BOLD+1 strategy. With that in mind, I will turn the call over to Ron to discuss our first quarter financial results and our full-year guidance. Thank you very much, everyone.

Ron South: Thank you, Stanley, and good morning, everyone. As we begin, I’d like to point out that I will be discussing our results as reported on a GAAP basis and also on a non-GAAP basis. Our first quarter non-GAAP financial results for 2023 and 2022 exclude restructuring costs as well as amortization expense of acquired intangible assets. This is detailed in Exhibit B of today’s press release. With respect to sales growth, I will focus on LCI sales growth, which is internally generated sales in local currencies compared to the prior year and excludes acquisitions. First quarter global sales of $3.1 billion reflected an LCI sales decrease of 3.7%. However, when excluding sales of PPE products and COVID-19 test kits, our LCI sales grew 6.3%.

This sales growth benefited somewhat from the timing of our fiscal reporting calendar whereby the December 2021 holiday week was included in the first quarter of 2022, but Q1 2023 did not include a holiday week as it fell in the fourth quarter of 2022. In the first quarter of 2023, we sold $149 million in PPE products, a decline of approximately 35% year-over-year and $52 million in COVID-19 test kits, a decline of approximately 80% year-over-year. On a combined basis, PPE and COVID-19 test kits declined approximately 60%. As a reminder, our first quarter sales in both PPE and COVID-19 test kits were especially strong last year. Our GAAP operating margin for the first quarter of 2023 was 5.7%, a 196 basis point decline compared with the prior year GAAP operating margin.

Our non-GAAP operating margin for Q1 was 7.7%, a 102 basis point decline compared with the prior year non-GAAP operating margin. This decline was mainly a result of lower gross profit dollars from PPE and COVID-19 test kit sales, which helped to cover our fixed costs as well as higher acquisition-related costs, partially offset by gross margin rate improvement. First quarter 2023 GAAP net income was $121 million or $0.91 per diluted share. This compares with prior year GAAP net income of $181 million or $1.30 per diluted share. Our first quarter 2023 non-GAAP net income was $161 million or $1.21 per diluted share. This compares with prior year non-GAAP net income of $200 million or $1.44 per diluted share. Several factors adversely impacted our GAAP and non-GAAP results this quarter.

Specifically, the contribution from PPE products and COVID-19 test kit sales to diluted EPS decreased by an estimated $0.24 per diluted share relative to the prior year period. Acquisition-related costs impacted diluted EPS by $0.04 per diluted share this year compared with approximately $0.015 per diluted share last year. And note that these acquisition costs are operating expenses that we do not add back for non-GAAP reporting purposes. Additionally, foreign current exchange negatively impacted our first quarter diluted EPS by approximately $0.02 versus the first quarter last year. So turning to our first quarter sales results. Global Dental sales were $1.9 billion, and LCI sales increased by 4%. When excluding sales of PPE products, LCI sales growth was 7.4%.

Global Dental merchandise LCI sales increased by 4%, but increased by 8.4% when excluding PPE products. We expected strong merchandise sales growth as last year’s sales were impacted by the Omicron variant and timing of the reporting calendar, as I previously mentioned. North America dental merchandise sales increased 1.3% and by 6.6% when excluding sales of PPE products. International dental merchandise LCI sales increased by 8.1% or 11% when excluding sales of PPE products with strong sales growth in Central Europe, Australia as well as in Brazil. Global Dental equipment LCI growth was 3.9%. We had strong LCI sales growth for traditional equipment, and this was offset by a decrease in digital equipment LCI sales. Our North America dental equipment LCI sales increased 2.6%.

International equipment LCI sales increased by 5.8% and were bolstered by tax incentives in Italy and the UK, which ended this quarter, and in Australia, which are due to expire at the end of the second quarter. Dental Specialty products include implants, bone regeneration materials, orthodontic products and endodontic products. Sales of these products were approximately $233 million in the first quarter with LCI growth of 4.4%. Global technology and value-added services sales during Q1 were $191 million, with LCI growth of 6.5%. Sales were again negatively impacted by a government contract, which expired early in the third quarter of 2022. LCI sales growth was 12.4% when adjusting for this contract. In North America, sales growth was driven by our practice management and revenue cycle management businesses.

Growth internationally was driven by our Dentally cloud-based solution. Global Medical sales during the first quarter were $971 million, and LCI sales decreased 17.1% due to lower sales of PPE products and COVID-19 test kits. In North America, excluding sales of PPE products and COVID-19 test kits, LCI sales grew 4.2%, led by strong medical equipment and pharmaceutical sales offset by lower point of care diagnostics revenue. Keep in mind, this is against a difficult comparison as North American medical LCI sales growth, excluding PPE and COVID-19 test kits was approximately 15% in Q1 of 2022, driven by higher office visits related to the Omicron variant. Regarding stock repurchases, we repurchased approximately 1.2 million shares of common stock in the open market during the first quarter buying at an average price of $81.70 per share for a total of $100 million.

Turning to our balance sheet and cash flow. We continue to benefit from significant liquidity, providing our businesses with the financial flexibility and stability to execute on our organic growth initiatives and strategic acquisitions, while continuing to return capital to our stockholders. Operating cash flow for the first quarter was $27 million compared with $93 million last year, with the decrease primarily due to lower income from PPE and COVID-19 test kits as well as restructuring expenses incurred in the quarter. Those restructuring expenses in Q1 were $30 million or $0.16 per diluted share and were incurred as part of our previously disclosed restructuring initiative. These expenses mainly relate to severance benefits and costs related to the exit of facilities.

We expect to continue to record restructuring charges during the remainder of 2023. Let me conclude my remarks with our 2023 financial guidance. At this time, we are still unable to provide estimates for costs associated with integration and restructuring for 2023. Therefore, we are not providing GAAP guidance. We are updating our guidance for 2023 non-GAAP diluted EPS attributable to Henry Schein to a range of $5.18 to $5.35 per share, reflecting growth of negative 4% to negative 1% compared with our 2022 non-GAAP diluted EPS of $5.38. This guidance now includes $0.05 to $0.10 of estimated dilution for the Biotech Dental acquisition, primarily due to acquisition accounting adjustments for inventory and integration-related expenses. Our outlook for the remainder of the business remains consistent with our prior guidance.

Our guidance for 2023 assumes total sales growth of approximately 1% to 3% over 2022, with sales of COVID-19 test kits now expected to decline by approximately 65% to 70% from sales in 2022 as compared to our previous 2023 guidance of a decline of 35% to 40%. Additionally, PPE product sales are expected to decline about 20% to 25%, consistent with our original 2023 guidance. Note that our sales growth guidance reflects one less selling week in 2023 than in 2022. The impact on 2023 non-GAAP diluted EPS from lower sales of PPE products and COVID-19 test kits is still estimated to be $0.35 to $0.40. We expect the impact of the steeper-than-anticipated decrease decreases in COVID-19 test kit sales in 2023 to be offset by slightly higher-than-anticipated gross margins on PPE sales relative to our original guidance.

These headwinds are anticipated to be largely offset by earnings momentum in our underlying core businesses, and we expect non-GAAP operating income will grow in the high-single-digit to low double-digit range when excluding the contribution from PPE products and COVID-19 test kit sales and acquisition-related expenses. We expect lower non-GAAP operating margin of 10 to 15 basis points below the 2022 non-GAAP operating margin of 8.2% and this was largely a result of lower PPE products and COVID-19 test kit sales and profits. Our guidance reflects non-GAAP operating margin expansion when excluding income from PPE products and COVID-19 test kit sales and acquisition-related expenses. Our 2023 guidance includes higher interest expense that in 2022 as a result of higher interest rates and higher borrowings along with higher minority interest from our higher growth businesses such as Henry Schein One.

We also expect an effective tax rate in the 23% range, assuming no changes in tax legislation. Our guidance for 2023 diluted EPS is for current continuing operations as well as completed acquisitions and does not include the impact of future share repurchases, other announced or potential future acquisitions or integration and restructuring expenses. While the recently closed Biotech Dental acquisition is now reflected within our guidance, our recently announced acquisition of S.I.N. Implant System is not. Guidance also assumes that foreign currency exchange rates are generally consistent with current levels and that end markets remain consistent with current market conditions. To summarize, although we are updating our financial guidance for the year, we are maintaining expectations for the underlying business and continue to anticipate steady growth trends in both dental and medical markets.

And we do expect that the second quarter will continue to have some headwinds from PPE and COVID-19 test kits, but we do expect good income growth in the second half of the year as some of the year-over-year comparatives already covered on this call should normalize. With that, I’ll now turn the call back to Stanley.

Stanley Bergman: Thank you, Ron. Graham, if we can now open the call to questions. We’ll be happy to answer any questions investors may have.

Q&A Session

Operator: Thank you, sir. We will now be conducting a question-and-answer session. [Operator Instructions]. Thank you. Our first question comes from the line of Jason Bednar with Piper Sandler. Please proceed with your question.

Operator: And the next question comes from the line of Nathan Rich with Goldman Sachs. Please proceed with your question.

Operator: And the next question comes from the line of A.J. Rice with Credit Suisse. Please proceed with your question.

Operator: And the next question comes from the line of Jeff Johnson with Baird. Please proceed with your question.

Operator: And the next question comes from the line of Jon Block with Stifel. Please proceed with your question.

Operator: And the next question comes from the line of Elizabeth Anderson with Evercore ISI. Please proceed with your question.

Operator: And the next question comes from the line of Kevin Caliendo with UBS. Please proceed with your question.

Operator: And the next question comes from the line of Brandon Vazquez with William Blair. Please proceed with your question.

Operator: We have time for one last question coming from the line of Erin Wright with Morgan Stanley. Please proceed with your question.

Stanley Bergman: Okay. So thank you, everyone, for calling in. I realize there are a couple of complexities in this quarter. But if you peel out the PPE and the tests and you understand that the accounting regime for acquisitions on inventory step-up, takes those expenses relating to the step-up and runs them through the operating income against operating income, likewise, some M&A expenses are run through operating income. If you take all of that out, you’ll see our core business is doing quite well, good internal sales growth. Gross profit is doing quite well, moving it a bit higher, all on with our strategic plan. And I think you will see that the business is quite stable. We anticipate operating income to continue to grow as Ron outlined in our guidance and we’re happy with the business.

So of course, if you have questions, Graham and Ron are available. And we’re optimistic about the business. So I appreciate all the questions and look forward to our next call in a couple of months’ time. And I think we’re going to be at some conferences and happy to provide more color on the business. But overall, we’re very pleased with the performance of the business and nothing really unexpected at this time. So thank you very much.

Operator: This concludes today’s teleconference. You may disconnect your lines at this time. Thank you for your participation. And have a great day.