Henry Schein, Inc. (NASDAQ:HSIC) Q3 2023 Earnings Call Transcript

Henry Schein, Inc. (NASDAQ:HSIC) Q3 2023 Earnings Call Transcript November 13, 2023

Henry Schein, Inc. misses on earnings expectations. Reported EPS is $1.32 EPS, expectations were $1.33.

Operator: Good morning, ladies and gentlemen, and welcome to Henry Schein’s Third 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 I would now like to introduce your host for today’s call, Graham Stanley, Henry Schein’s Vice President of Investor Relations and Strategic Financial Project Officer. Thank you. Please go ahead, Graham.

Graham Stanley: Thank you, operator, and my thanks to each of you for joining us to discuss Henry Schein’s financial results for the third quarter 2023. With me on today’s call 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 on the company’s internal analysis and estimates. Today’s remarks will include both GAAP and non-GAAP financial results. We believe the 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 and 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 is accurate only as of the date of the live broadcast, November 13, 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 today’s Q&A session, please limit yourself to 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, and thank you for joining us. Before reviewing our third quarter performance, I’d like to update investors on the cybersecurity incident that were discovered on Saturday, October 14, primarily affecting some of our distribution businesses. That morning, we initiated our business continuity plan when we promptly took precautionary actions, including taking certain systems off-line and other steps intended to contain the incident, which led to temporary disruption of some of our operations. The following week, our distribution centers were processing orders with temporary interim processes and were generally delivering orders to customers within one to two business days.

In accordance with our business continuity plan, we activated a previously identified team of leading cybersecurity experts to assist in the investigation and recovery of the systems and to advise us through the recovery process. Over the past weeks, we have worked to create a clean network in a controlled manner from the backup data we maintained. Our distribution businesses are now operational and we are initiating our e-commerce platform early this week, and we’re indeed hopeful that the website will come up tomorrow morning. We’ve also made significant progress resuming the high levels of service our customers expect from us. Over the last week, orders from our distribution businesses were approximately 85% to 90% of what they were pre-incident.

We expect orders to increase with the reactivation of our e-commerce platform. Of course, our field sales consultants and telesales representatives have deep relationships with our customers, and our complementary software and other value-added services bring value that we believe continues to make us the best choice for our customers in the areas of services we provide. As a reminder, this incident mostly affected the operations of our North American and European dental and medical distribution businesses. Our distribution operations in Australia, New Zealand, Asia and Brazil were generally not affected. Henry Schein One, our practice management software, revenue cycle management and patient relationship management business was not affected.

And our manufacturing businesses and our equipment sales and service operations were mostly unaffected. We are now aware that a significant amount of information was obtained by an unauthorized third party in the cybersecurity incident. Bank account information for a limited number of suppliers was misused, and we have already separately addressed this with those impacted. More details have been posted on our Investor Relations website. We are continuing our investigation of the cybersecurity incident. In a moment, Ron will speak about the financial impact of the cybersecurity incident, which will affect our fourth quarter financial results. I would like to extend a heartful thanks to our customers as well as our suppliers and team members for their patience and the incredible support we’ve received from all of our constituents during this period.

Our customers, our suppliers and our team understand that a cyber incident could occur to any business and has been particularly prevalent in the health care arena over the last six months. Turning now to the third quarter. We’re reporting solid financial results for the third quarter. We achieved good total sales growth and non-GAAP diluted EPS growth despite continued lower sales of PPE and COVID-19 tests. Our internal sales growth slowed in the third quarter due to some market softness in September as a result of general macroeconomic weakness as well as lower sales of PPE products at COVID tests. However, we believe that the dental and medical markets that we serve are relatively recession-resilient. Sales of PPE products and COVID-19 test kits continue to decline but at lower rate compared to the earlier year.

Increased customer demand for lower-priced corporate brand, merchandise and generic products, along with growth of equipment technical service revenue, also has helped our profitability this quarter. Profitability for the quarter benefited from our technology, value-added services and dental specialty products as we continue towards our goal of achieving 40% of operating income from sales of high-growth, high-margin products. We are now more than halfway through our three-year gold BOLD+1 strategic plan. Despite current macroeconomic conditions and the cybersecurity incident, we have confidence in the stability of the dental and medical markets and remain committed to our strategic priorities and long-term financial model, which includes high-single digit to low double-digit growth in operating income.

Year-to-date, we have closed several strategic investments, and just last month, we were pleased to announce the closing of the acquisition of Shield Healthcare, a business that distributes medical products to patients in the home including continuous glucose monitoring. Overall, these acquired businesses are performing well. So let me turn to a review of our quarterly highlights from each of our business units, beginning with dental distribution. In North America, dental offices generally remain busy. However, dental patient traffic somewhat slowed in September. This seemed to be the result of an increase in patient cancellations, which we believe were partially due to the seasonal uptick of flu cases and COVID-19. And our overall consumable merchandise sales, excluding PPE products reflected this.

Looking at our international dental business, overall volumes of consumable merchandise held steady across the regions. Sales of traditional dental equipment in North America have largely reverted to pre-pandemic levels with growth in it mid-single digits. Dental equipment sales continued to be impacted by lower average selling prices, and we expect this to normalize in the first quarter of 2024. The equipment backlog was sequentially slightly higher and included strong orders taken at DS World Show held in September — actually at the end of September of 2023. This increase reflects typical seasonality as we head into the fourth quarter. International dental equipment sales reflect a slowdown in sales in large equipment, and this is in parts of the world outside of North America, not everywhere.

Our equipment sales vary quarter-to-quarter, of course, partially as a result of purchasing dynamics of large DSOs. But over the long term, we continue to expect equipment sales growth in the range of low to mid-single digits. Dentistry is undergoing a significant transition to integrate high-tech digital workflow systems in the dental practice. Henry Schein is well positioned to be the brand of choice for our customers who are seeking an integrated digital clinical workflow, and we remain confident in the long-term outlook for dental equipment in general. Turning now to the dental specialties. Overall, we believe we continued to gain global market share during this quarter. Our global implant business grew 40%, predominantly through acquisitions.

BioHorizons Camlog to continue to perform — outperform the market, growing sales in the mid-single digits. Our acquisitions of Biotech Dental in France and S.I.N., S-I-N, in Brazil are showing strong growth in implants and related products in the local markets. Our value brand, The Dentist, is also growing well. This is offset by somewhat slower — in fact, a slowing market in North America. The performance of our endodontic business continued to be strong, and the clear aligner segment of our orthodontic business grew by double digits, albeit on a small base. So we’re optimistic about the long-term growth prospects for the specialty markets as we continue to see adoption of specialty procedures among general practitioners the growing adoption by DSOs of specialty procedures and, of course, due to the macro trends of demographics.

We’re also optimistic about the dental specialty products in 2024 as we have a robust new product line with upcoming launches in various geographies. So we are really optimistic about our specialty businesses in 2024 driven by the macro demographic trends and our robust new product pipeline. Let’s now turn to our technology and value-added services businesses. We had excellent sales growth in our technology and value-added service businesses, driven by the Henry Schein One practice management software sales and by Large Practice Sales, the practice brokerage business we acquired at the close of this quarter. Henry Schein One’s growth continues to be driven by practice management software solutions and, of course, particularly by Dentrix Ascend and Dentally, our cloud-based solutions, which provides the opportunity for their practices to integrate clinical workflow, and it’s very important throughout the dental office.

Once again, the customer base of cloud solutions increased by about 40% this quarter compared to prior year. DSO accounts in particular are seeking integrated platforms along with the tools that are enhanced by artificial intelligence. In this connection, we recently formed a DSO Strategic Advisory Council, which is strategically focused on growing practice revenues and solving operational issues for large group practices. We of course, have similar programs for midsized practices and for the smaller practices, where this advisory kind of service is provided by our field sales consultants. During the third quarter, we introduced new features and upgrades, including the launch of Lighthouse 360. This new platform facilitates integrated patient communications, reputation management and overall practice success.

This feature rich product includes online patient scheduling, digital customized forms for patient intake and payment reminders and more. Henry Schein One’s goal is to continue to grow our practice management customer base and to increase the breadth of solutions offered to our existing customers. Our priorities regarding software integration are critical to achieving this goal, and we are well on our way towards an integrated clinical offering for the clinical aspects of the practice with a focus on specialty procedures as well. Turning to our medical business. Third quarter growth was in the low single-digit, excluding sales of PPE and COVID-19 test, similar to recent quarters. This growth reflects high prior year comparison sales growth and higher sales on lower-priced products, including generics and corporate brands, albeit with higher margins.

Of note, we are now distributing COVID-19 vaccines, although we do not expect this low margin product category to have a significant impact on sales or profits. In September, we saw an uptick of sales COVID-19 test kits, which we expect to continue into the fourth quarter. So in summary, the underlying fundamentals of our core business remain solid. We are executing ahead of schedule with our 2022-2024 BOLD+1 strategic plan. So with that in mind, let me ask Ron to discuss the quarterly financial results and our full year guidance. Ron, please?

Ron South : Very good. Thank you, Stanley, and good morning, everyone. As you may have seen on November 2, we filed a notification with the SEC advising that we will not be filing our Q3 Form 10-Q until later in November. This delay is related to our recent cybersecurity incident. We were able to complete our consolidated income statement prior to deactivating our systems. However, we have been delayed in completing our consolidated balance sheet and statement of cash flows, which we normally include as attachments to our earnings release. These statements will be available when our Q3 Form 10-Q is completed. The third quarter non-GAAP financial results for 2023 and 2022 exclude integration and restructuring costs and amortization expense of acquired intangible assets.

This is detailed in Exhibit B of today’s press release. Note that there are no effects of the cybersecurity incident on our Q3 results as the incident occurred in October. With respect to sales growth in the quarter, I will focus primarily on LCI sales growth, which is internally generated sales in local currencies compared with the prior year and excludes acquisitions. Third quarter global sales of $3.2 billion reflected an LCI sales decrease of 1.2%. However, when excluding sales of PPE products and COVID-19 test kits, our LCI sales grew 1.1%. We sold $131 million of PPE products in the third quarter of this year, a decrease of approximately 19% year-over-year. And we sold $44 million in COVID-19 test kits, a decrease of approximately 46% year-over-year.

Our GAAP operating margin for the third quarter of 2023 was 6.3%, a 52-basis point decline compared to the prior year GAAP operating margin. On a non-GAAP basis, operating margin for Q3 was 8.1%, a 12-basis point decline compared to the prior year non-GAAP operating margin with higher gross profit margins offset by higher operating expenses, primarily acquisition related expenses. Third quarter 2023 GAAP net income was $137 million or $1.05 per diluted share. This compares with prior year GAAP net income of $150 million or $1.09 per diluted share. Our third quarter 2023 non-GAAP net income was $173 million or $1.32 per diluted share. This compares with prior year non-GAAP net income of $177 million or $1.29 per diluted share. Details of acquisition expense and acquisition-related adjustments for the quarter and year-to-date are included in Exhibit C to our press release.

The foreign currency exchange impact on our third quarter EPS was immaterial. Now turning to our third quarter sales results. Global Dental sales were $1.9 billion and LCI sales decreased by 0.2%. Excluding sales of PPE products, LCI sales growth for Global Dental was 0.3%. Global Dental merchandise LCI sales increased by 0.3% or 1.1% when excluding PPE products. North American dental merchandise LCI sales decreased 1.2% compared to the prior year and decreased 0.1% when excluding sales of PPE products. International dental merchandise LCI sales increased by 2.9% and by 3.2% when excluding sales of PPE products. Global Dental equipment LCI sales decreased 2.0% with mid-single-digit growth in traditional equipment, offset by lower digital equipment sales, reflecting lower intraoral scanner prices as a result of new products introduced late last year.

Our North America dental equipment LCI sales increased 0.2%. This was against a difficult comparison as North America dental equipment LCI growth was 12.8% in the third quarter of 2022. International equipment LCI sales decreased 5.9% compared to the prior year as a result of some macroeconomic uncertainty in Europe, which primarily impacted digital equipment sales. Dental specialty products include implants, bone regeneration materials, orthodontic products and endodontics products. Sales of these products were approximately $268 million in the third quarter with reported growth of 25% driven by acquisitions. Global Technology and value-added services sales during the third quarter were $210 million with LCI growth of 9.6%. In North America, sales growth was driven primarily by our Dentrix Ascend practice management business.

Growth internationally was driven by our Dentally cloud-based solution. Our technology and value-added services and specialty products represented about 35% of total operating income in the third quarter. Global Medical sales during the third quarter were $1.1 billion and LCI sales decreased 4.6% 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 1%. This was against a typical comparison as LCI growth, excluding PPE products and COVID-19 test kits grew 9.7% in Q3 of 2022. Regarding stock repurchases, we repurchased approximately 660,000 shares of common stock in the open market during the third quarter, buying at an average price of $75.79 per share for a total of $50 million.

At quarter end, we had approximately $215 million authorized and available for future stock repurchases. We continue to benefit from significant liquidity, providing our businesses with the financial flexibility and stability to execute on organic growth initiatives and strategic acquisitions while continuing to return capital to our stockholders. As we stated last quarter, we have committed over $1 billion to the acquisitions we have announced so far this year, with $417 million invested in business acquisitions that closed in the third quarter and $668 million invested year-to-date. Restructuring expenses in the third quarter were $11 million or $0.06 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 exiting facilities. We still expect restructuring activities to extend through 2024. 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 and expenses directly associated with the cybersecurity incident. Therefore, we are not providing GAAP guidance. We are updating guidance for 2023 — our non-GAAP guidance to $4.43 a share to $4.71 a share, reflecting a narrowing of the range of our guidance for 2023 non-GAAP diluted EPS for the underlying business to $5.18 to $5.26 from $5.18 to $5.35 that was previously communicated, reflecting softening macroeconomic conditions and estimated $0.55 to $0.75 per share impact is due to business interruption from the recent cybersecurity incident.

As Stan mentioned, we believe that our teams have contained the cybersecurity incident, and we have mostly restored our operations. Although we believe a significant portion of sales had been disrupted while certain systems were offline were deferred, we estimate the percentage of sales growth for the full year will be negatively impacted in the low to mid-single digits. Our estimated fourth quarter impact of $0.55 to $0.75 per share does not include certain expenses directly associated with the cybersecurity incident as we expect to report these as non-GAAP expenses in the fourth quarter. The financial impact does not include any future insurance claim recovery. We expect to file an insurance claim arising from this incident under our cyber insurance policy, although final resolution is subject to insurer approval.

This policy has a $60 million after-tax claim limit after a $5 million retention, and any claim recovery will likely not be recognized until late 2024. Our 2023 net sales are now expected to be 1% to 3% lower than 2022 net sales, which is an update from prior guidance of 1% to 3% sales growth. This change in guidance primarily reflects lower sales as a result of the cybersecurity incident which, as previously mentioned, is expected to lower full year 2023 percentage sales growth in the low to mid-single digit range. As a reminder, our guidance also reflects one less selling week to 2023 and 2022. Our 2023 guidance includes higher interest expense than in 2022 as a result of higher interest rates and higher borrowing levels. We also expect an effective tax rate for the year in the 23% range, assuming no changes in tax legislation.

Our guidance is for continuing — for current continuing operations as well as acquisitions that have been announced and does not include the impact of future share repurchases and potential future acquisitions as well as certain expenses directly associated with the cybersecurity incident. Guidance also assumes that foreign currency exchange rates are generally consistent with current levels and that end markets remain consistent with current market conditions. We intend to introduce 2024 financial guidance when reporting Q4 and full year financial results. With that, I’ll now turn the call back to Stanley.

Stanley Bergman : Thank you, Ron. I appreciate that. Operator, we are ready to take any questions that investors may have.

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Q&A Session

Operator: Thank you, sir. We will now be conducting a question-and-answer session. [Operator Instructions] And the first question comes from the line of Jon Block with Stifel. Please proceed with your question.

Jon Block : Hey, guys. Good morning. Thanks for taking questions. Maybe the first one, just high level. Stan, what are you guys hearing from the customers? The ordering frequency from a practice might be, I don’t know, maybe roughly every two to three weeks. So some customers might have encountered the issues pretty minimal number of times, maybe one time, possibly twice at most. What have you guys heard regarding, call it, customer retention? Or do you think you don’t have a better feel for that until the actual website is back up and running, which seems, to your prior point, tomorrow morning? And then I’ll just ask a follow-up.

Stanley Bergman : Yes. So Jon, that of course is a very important question. We believe we are at this 85% to 90% floor. The larger customers that are more sophisticated from an IT point of view are buying — using either the e-commerce systems that we offer or workarounds. I would say that is even with the smaller customers — the midsized customers. The smaller customers are relying on visits from the field sales consultants to collect the orders, or they were until recently, and from the telesales reps. So the funnel for doing that is not as wide as of course, digital ordering. So I think we will start seeing much more business from the smaller customers, which are a key part of our business as the website returns. But we have very good relationships with our customers, the field sales consultants, tremendous telesales connectivity and, of course, the value-added services.

Generally, we’ve not heard of customers leaving us. Have customers made alternative decisions? Yeah, of course. Some of the buyers of pharmaceuticals couldn’t wait, for example, for controlled drugs. We expect our controlled drug system to be up relatively soon. So I would say, generally, we are heartened by the support we’ve received from our customers. Jon, as you know, unfortunately, cyber issues in health care have been quite prevalent. In fact, the first six months of this year, there were over 300 incidents in health care alone. So the customer base is quite attuned to this. And obviously, it’s going to be a lot of work on behalf of our field sales representatives and our telesales people as well as our e-commerce team to bring all the customers back.

There will be some trailing, I would imagine. But overall, we remain quite enthusiastic about the level of support we receive. And by the way, not only from our customers, but the entire industry has been very, very supportive of us.

Jon Block : That’s great color. Thanks, Stanley for that. And maybe I’ll pivot, Ron, to you for the second question. Any really high-level thoughts around 2024? And not a specific number, but just maybe just the construct. Should we think about it as sort of growth on the core underlying EPS of $5.22, the revised midpoint, and then offset by, call it, the lag hit on the cybersecurity incident? And on that second point, I just want to make sure, the $0.55 to $0.75 4Q ’23 cyber hit, that’s all, call it, decremental low sales? I think you said no expenses in there. That would be excluded from non-GAAP. Is there any promotional stuff in there? Sorry, and last sort of question, tack-on, how do we think about the exit impact for December?

Because you talked about the top-line impact for the quarter, but obviously December would likely be much lower than what you’ve experienced in October. So any color on the cadence for the trailing throughout the fourth quarter. Thanks, guys.

Ron South : Yeah. Thanks, Jon. Yes, you’re correct in that the $0.55 to $0.75 that we’ve called out as Q4 impact is attributable to business interruption impact. It does not include the onetime cost that we are incurring that are directly attributable to reactivating the systems. And right now, it’s our intent that when we report the Q4 results, we’ll be calling out those particular costs as part of our non-GAAP reconciliation. In terms of run-rate into ’24, that will be something that really is largely contingent on the level of business that we see with One web being back up. That is a very important turning point for us. It’s something we’re very excited about in the organization this week. And I think that we’ll have greater intelligence in terms of what’s happening with customer retention with One web back up.

I do anticipate we will likely have some, whatever you want to call them, customer retention programs or promotions in the quarter that may put a little bit of pressure on I4 margins. I wouldn’t expect it to be real significant. But having said that, we do want to show some appreciation to our customers, and we do want to ensure that we go into 2024 with a solid of a base of businesses that we can possibly have.

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

Elizabeth Anderson : Hi, guys. Thanks so much for the question. So as we think about the cybersecurity, you said the website’s back up tomorrow, that’s great to hear. Now if we think about just sort of like the broader operations that support that, is that something that you feel like is also kind of in a similar place? And obviously, you probably wouldn’t put the website up if you’re having a ton of internal issues. So I just want to make sure how you feel about sort of the rest of the systems that are supporting that ordering process. And then sort of as we think about 2024, you obviously have the BOLD initiative. I just wanted to see if given the cybersecurity situation or the current demand environment, how do you sort of think about that conceptually, whether there are places there you can accelerate cost cuts. Any color there would be helpful. Thank you.