Good evening, everyone. I'll start with some disclosures first, so please see the Morgan Stanley website, for more details on the disclosure, morganstanley.com/disclosures. But to introduce myself, I'm Erin Wright. I'm the lead Healthcare Services Analyst at Morgan Stanley. We're happy to have Henry Schein with us. I do cover them. They are the leading, dental and medical, distributor globally, and, we're happy to have with us Stanley Bergman, CEO of Henry Schein, as well as the CFO, Ron South. So thank you.
Thank you.
Thank you for coming to London. So, let's start with just a general question that we're getting from a lot of investors right now, is just the state of the dental market. Globally, if you can talk about kind of the different geographies as well, but North America versus other markets, but what you're seeing in terms of patient traffic trends and demand.
So, Erin, the dental market, I think, globally is relatively stable. You know, we went through a lot of activity between 2000 and 2019, and now with COVID, some backlogs we had to go through, and I think it's more or less stable. I think it's fair to say the market in general is ahead of where we were in 2019. Some dislocation. I mean, something like impression materials are down, scanners are up. Implants, perhaps the premium implants are not as popular today as some of the value implants. There's shifts. But generally, I would say the market in dentistry is stable. There are pockets of challenges. A couple of countries in Europe are not growing as fast as others. U.S. is relatively stable. Canada's relatively stable. We don't have a big business in China, but there've been some ups and downs there.
Japan is stable, and the market is good.
In terms of how you're thinking about it through the end of the year and into next year, I think, Ron, in the guidance, for instance, you tweaked for kind of the macro dynamics that are going on. Can you discuss a little bit about kind of what's embedded in your guidance for the balance of the year and how you think about what can continue into 2024?
Yeah, you know, so we did—you know, we had an initial adjustment to our guidance. It was really kind of guiding people to the bottom half of that original guidance, right? So we narrowed the range to the bottom half of the range. The midpoint came down about $0.05, which was about a 1% decline from the previous guidance. And that was really reflecting a little bit of softness we're seeing in end markets on premium implants, as well as some uncertainty. I wouldn't call it softness, but just some uncertainty we were seeing in patient traffic into dental offices in the U.S.
But I think we believe it's primarily attributable to a little bit of a tick up in COVID infection rates, actually, which is kind of an old theme, but one that kind of came back to us. And that's supported by also an increase in revenues we saw of COVID test kits, which tends to correspond with, you know, changes in that infection rate, which then ultimately leads to a small decline in patient traffic. So we'll have to y ou know, we're continuing to monitor that patient traffic, but that kind of led us to taking, you know, guiding people towards the bottom half of that original guidance. Yes.
Okay. I do have to ask about the cyber incident. And there was this second incident over Thanksgiving. Presumably, that would be less meaningful, given the timing of that. Where are you at now? Are you back to normal? Where are we at in terms of the impact of that? Has there been any other incidents? Hopefully not. But yeah.
So, Erin, I think what's important to understand in our particular situation is we had all of our systems in backup, in backup mode. So for us, what we had to do was rebuild each of our systems. But before we put them into commerce, we had to ensure that there were no sleepers, so we had to do a lot of forensic work. The biggest challenge was, of course, our website. We want to make absolutely sure that that was stable and that forensic work was done to ensure that there was no possibility of sleepers. We did have another incident, but we picked it up very quickly, and we had our systems up and running very quickly. It happened to be over the Thanksgiving weekend, so it didn't really impact our customers.
But from a customer point of view, we're more or less up and running across the world. There are some systems that relate to operations that are not fully functional yet, but generally and that's particularly in Europe. But generally, globally, our systems from a customer point of view are up and running, and they were, we were able to ship products on the second day after the incident. And there's some inefficiency still in the system that'll be ironed out in the months ahead.
Okay. And can you help us understand how you got to the $500 million in terms of the revenue hit in the fourth quarter, relative to the, or related to the cyber incident? And just in light of reconciling with the disclosure of other distributors as well in the industry, can you detail a little bit about how much of that is volume versus price or promotion-
Mm-hmm. [crosstalk]
activity, and how is, w ell, I'll stop there in terms of if you wanna break that down.
Certainly. So we did estimate that the EPS effect of the, of the business interruption impact in the fourth quarter would be $0.55-$0.75 a share, which is, equates to, you mentioned $500 million. That was kind of the high end of the range that we expected on the revenue piece, right? So it was kind of $350 million-$500 million in revenues. A lot of that is the lost volume in the first couple of weeks following the, the cyberattack. By week three, we were generating and fulfilling about 85%-90% of the order volume that we had in the weeks leading up to the cyberattack. So we felt like we were approaching normal.
The question was, how soon could we recover that 10%-15%, and to what extent we are expecting to provide some promotional discounts to recover that business? So the $350 million to $500 million takes into consideration what we think the impact on revenue would be relative to what our internal projections were for the quarter going into the cyberattack. You know, in terms of what our competitors and others in the industry have said that they have gained from this, that's a good question for them. I mean, I'm not sure how they went about generating that, those estimates. I just know that you know, we're continuing to monitor what we believe is the effect on us.
As we go forward and as we get better data, to the extent we need to adjust that, if we think we have a material difference from what we've originally estimated, we'll communicate that back out to the investment community.
Great.
I think what's important also, just to add on to what Ron said, is that 85%-90% was before our website was back. We have an element of our business where... which is related to customers that go shopping. They look to buy a case of gloves, and they may go to 5 or 6 websites, and of course, they couldn't come to our website, but we're pretty sure they'll come back. We may not get the business, but they will come shopping to Henry Schein again.
I recently saw Ron actually at Greater New York, and there was some promotional activity kind of going on with some of your corporate brands and also equipment financing.
Yeah.
How is the traction with that? Is it going as planned? Can you talk a little bit about kind of the promotions that you're doing?
Yeah. So really, there's two promotions going on. One, on the merchandise side, we are providing a 10% discount off of list on our branded merchandise and 20% off our private label merchandise. Now, I emphasize that's off of list. Some of our customers already have negotiated discounts, and so to the extent that their discounts may exceed that, they're not gonna get as much benefit, right? But for those, some of those so-called episodic customers we have who were simply going to the website on occasion that we think is part of that 10%-15% of order volume we weren't recovering, they're paying list. So we think that's that promotion will attract some of them back to the business.
We also had at Greater New York, we had announced a financing arrangement, 5.99% of financing on equipment. That is a promotion we are doing jointly with the manufacturers of that equipment as well. So, it's a, i t was very favorably received, and we're seeing a very good reaction to it.
Do you typically share some of that discount with the manufacturers on equipment?
We will do co-promotions of some sort with the manufacturers. They may take different forms, but this particular one, given the higher interest rates than has, you know, than what we've seen over the last several years, we felt like this was the appropriate promotion to do, you know, with them this time.
Are you seeing a competitive response?
I do believe there are others out there who are running or are likely have responded-
Right. [crosstalk]
with similar promotions, yes.
And last one on this. I'll move on, but just the DSO relationships, I think it's been pretty remarkable. You've been able to kind of service that client base, and can you talk a little bit about how those relationships kind of will evolve from here? It sounds like everything remains relatively status quo. Is that-
I would say our relationship with the top just 25 DSOs, I think 25 of the top 27 are pretty good customers of ours. I think it's pretty stable. I mean, our goal is, of course, to sell these customers much more in terms of consumables, our own brands, equipment, software, specialty products, and, basically, these relationships are pretty good. I mean, we have very good service for equipment with these DSOs, national capability, and not only in the U.S., by the way, but the DSOs here in the U.K. and in Europe, Australia, New Zealand.
Okay, great. Thanks. And then switching gears just to equipment, a little bit more, I guess, can you parse out what you're seeing in terms of traditional versus high-tech equipment in the market right now, the growth and demand trends and key drivers? And this is obviously an important quarter from an equipment perspective. How are you-
Yeah
... seeing things shape up?
Yeah, and you have to, I think you've split it up correctly. There's the traditional, and there's the digital. The traditional had problems in delivery in 2020, big part of 2021 because of the global supply chain dislocation for parts, for example, labor issues. It stabilized in 2022, stabilized in 2023, but I would caution that it's important to take a look at traditional equipment sales by us over a couple of quarters. We have a lot of DSO business. Maybe in one quarter, it's up, maybe in one quarter, it's down. But if you take two, three quarters, you take a year, I think you'll see that the traditional equipment is quite stable, mid-single-digit growth. There's not as much inflation as there was.
In fact, I think, there's been a bit of a reaction by the dentist to some of the manufacturers that took up their prices a little bit higher than others. So there's a little bit of compression on pricing. Doesn't mean our profits are being impacted. And then if you look at the digital side, this is growing very fast. Having said that, there's now significant competition for lower price scanners coming into the market, and many of them are doing well. But at the same time, the market is expanding. Mills in some parts of the world are not selling as well as they did. It could be because labs are becoming more efficient, or it could simply be dentists are waiting to see where the 3D printing is going. Our 3D printing products and materials are doing extremely well.
It's not covering the diminution in printers, but I would say the whole digital marketing area, the digital products area, is doing very well. We will provide you in our calls with further information on where that market is going, but definitely dentists are investing in this area, as well as in practice management and related services.
On specialty mix and just your overall business mix has evolved considerably over the years, and now a third of your EBIT is associated with some of those faster-growing businesses, and higher-margin businesses, whether it's tech or specialty. I guess, where does that mix go over time? I think you had some projections kind of at your Investor Day, but, how is that progressing relative to plan and,
Yeah.
Yeah.
So our strategy includes driving a higher percentage of our operating income related to specialty products and related services. I think in our last call, we spoke about 35%-37% of our operating income coming from, specialty products and consumable and related, software and services. And our goal is to take that up to about 40% in the next couple of years. We said that at our investor meeting. I think we're on track to do that. In addition, about 9%-10%, maybe a little bit more of our profits come from our own brands. So today, about half of our profits come from products that we really control the brand, and the goal is to take that up over time. It doesn't mean we will not work closer with our national brand manufacturers.
If a national brand manufacturer wants to work closely with us, we look... And it's a good product, and they have innovation behind their product, and we can make money, we will promote those products. And I think there's a clear understanding that the national brands have opportunity with us, but we do want to increase our percentage of profits, not necessarily sales, as they relate to products that are in the control of us relative to the ownership of the brand.
Can you describe a little bit more, and you mentioned this at the beginning, some of the recent dynamics around the implant business. Is this, you know, the recent trends that we've seen largely associated with the macro? And can you talk a little bit about, you know, with also your S.I.N. acquisition and the U.S. FDA approval there and your go-to-market strategy around the value offering as well?
Right. So yes, the macro trends are probably impacting the implant business to some extent, but I think implants are becoming much more standard of care, and so I think it is fair to say that some of the higher-priced implants are being traded down to lower-priced implants. Not in every country. For example, in Germany, our branded product, which does sell at a lower price than our competitors, is doing quite well. There is some government support for implant dentistry in Germany, but I would say also our discount brand is doing well. In the U.S., we do sell our branded products at a slightly lower price than the national brands. And, having said that, we realize that we do need an economy line specifically for the DSOs. That was the rationale for buying the S.I.N. business in Brazil.
They do have U.S. approval, and we will be, over time, I think, seeing more of the S.I.N. product in the Henry Schein DSO accounts. In our opinion, the implant business, if you look at it over a couple of quarters, although there may be some economic challenges, it's still an opportunity for us as our market share, although we think we're around the number three position, is still relatively small, and we think with the innovation we bring into market, the ability to pollinate, cross-pollinate acquisitions we've made, their products, Henry Schein's products, CAMLOG, BioHorizons products, into these newer acquisition businesses, all present opportunity to grow that business. And if you add to that our growth in the endodontic field, you will see we have a very good specialty business. Our aligner business is relatively small.
It's an opportunity to grow aligners in mostly our own DSO customers.
Got it. With combining implants, endo, and ortho across that specialty business, what is the long-term organic growth rate in your view?
You know, Erin, last year in the, in our Investor Day, we provided some, some market growth rates that we saw. And on the specialty, products, dental specialty products as a, as a subgroup, we expect the market to be able to grow, say, 5%-8% over the long term. Now, that may vary within those categories, between endo, between implants, ortho, et cetera, but we think the kind of the blended average can fall in 5%-8% on an annual basis. Some years might exceed, some years might be a little less than that, but we, we do think that would be the, the typical range going forward.
Okay. Then, switching to the technology value-added services segment, how should we think about the long-term growth there, more recent trends, as well as offerings, everything, so your AI offering, for instance, at Greater New York, anything new that you would like to highlight from a technology perspective?
Well, from a growth perspective, we see that market growing 8%-12%. And we're very bullish on the opportunity there in terms of some of the new product offerings that are coming out, some of the new services that are coming out within our technology and coming from Henry Schein One. You know, you mentioned Detect AI, which is a new tool that we can provide to the practitioner to help them, really, assist them with improving the accuracy of diagnoses and identifying certain, you know, caries, which are the is really the, the precursor to cavities, and helping them identify these things on a more timely basis and perhaps providing, you know, earlier care to the patient.
So we're seeing some early success with that. Some of our early adopters of this AI have-- we're seeing an increase in the number of restorative procedures they're doing, the number of periodontal procedures they're doing. So there is a return to the practitioner for subscribing to that service.
I think you can expect much more interest in this clinical type software from the DSOs, and they have the capabilities of internally assessing the investment relative to the return, incremental patients, identification of disease that maybe could not be picked up with the naked eye. I also, I think you could see that, and from there, Erin, I think you can expect a much more activity going on with the smaller practices who will follow the lead.
Switching gears a little bit to medical, I guess, can you remind us of your unique positioning in medical distribution and your key areas of focus there, the competitive landscape, and how you think, you know, you're gaining share in that market?
Yeah, on the medical distribution side, we focus on everything outside of the hospital and the drugstore and the long-term care. So a lot of that is in the physician office, but growingly moving to the ambulatory surgical center. Procedures are moving out of the hospital into the ASC. Day surgery is becoming important, and we do quite well in this market. I think that the fact that IDNs are now owning more group practices pays well for us because we do have systems that align very well with the IDN needs. A movement towards generic drugs, and particularly injectables and med-surg products, is something that's appreciated by the IDNs. Our ability to install systems for equipment is also appreciated, and so I think we do well in that area.
Our goal, though, is to follow the patient, and yes, the patient moved from the hospital to the physician practice and the ASCs. We have a big focus in the ASC area, but now we want to follow the patient to the home. We've been looking at this for a while. We acquired three companies in the last year and a half, and we pretty much have a wide variety of products at the moment for the home care consumable side. It's a pretty good margin. We have billing capabilities. We're not fully national yet with all the products, but our goal is to develop a national network. Our salespeople do have good relationships in general, our consultants with physicians, and I think there will be some synergies there-...
The Schein name is trusted in the physician offices, and I think we will get referrals in the long run from our customer base.
You've done some recent transactions in home health, which is kind of interesting, and is there more to come, presumably, on that front? How does the M&A pipeline generally look, but also within that home health category?
You're asking two questions. The pipeline for M&A has always been strong at Henry Schein. I think Ron can address capital allocation to you, but we invested about $1 billion this year, and we can talk. Ron can talk about the future. But as it relates to home care, yes, we've got three businesses now. One of the areas we wanted to focus on was continuous glucose monitoring. We have now that product offering, and we're able to bill for it. And we have businesses now on the West Coast and on the East Coast. Each one is focused more or less on a different product offering. Now, we need to take that product offering across the country, and there will be fill-in opportunities, of course, but we're very careful what we're going to be investing in.
And [crosstalk]
Ron, about the capital allocation.
Yeah, certainly, you know, in terms of the pipeline, yes, you know, as Stanley said, there are... We still have acquisitions in the pipeline. I, as I mentioned to you at Greater New York, I don't expect that we'll be investing $1 billion again in 2024. I mean, that's an unusually high year for us. Historically, we've been doing $300 million-$400 million a year, sometimes a little more, sometimes a little less. My expectations in 2024 is it'll be something more in line with that historical run rate. Having said that, we're opportunistic buyers.
When we see something that we think fits our strategy, and we have a willing seller, it would be something we would have to consider, you know, assuming that it meets all the parameters that we would set for it. You know, but right now, my expectation is that we'll be more in line with what we've done historically going forward.
Heading into 2024, as you think about more aligned with historical, would that be kind of the 200 basis points to top-line growth from acquisitions? And you gave that 6%-8% overall top-line growth, including M&A previously, and then 8%-11% EPS growth. Outside of sort of the cyber incident dynamics and promotional activity thereon, would there be any reason why you would kind of deviate from that?
Well, we haven't provided... We'll provide 2024 guidance when we provide our Q4 earnings release in February. So we'll be able to provide some details around that guidance at that point in time. Like we said in the prepared remarks to our third-quarter earnings release, right now we're seeing within dental, within general dental, as well as within specialty, probably the market trending more towards the lower end of some of those market growth rates, but all that will be taken into consideration when we start, when we provide our guidance, which will include you know, sales growth, components of that sales growth, as well as EPS, obviously.
Does the cyber incident have any impact, though, on deal activity for you?
That's something we're still assessing. We have to kind of see how the balance of the year plays out. We'll... You know, we're looking at, customer retention rates, customer recovery rates, and to the extent that there's a tail to this that runs into 2024, that we believe impacts the 2024 results or that we expect to impact the 2024 results, we'll communicate that as part of our guidance.
But I don't think it impacts acquisitions in the areas we are already focused on.
Yeah.
... which is the specialty products and the services. They were not impacted by the cyber incident.
In terms of a follow-up on the home health side, would you have, you know, corporate brand items within that?
Sure.
I mean, can you leverage that as well as the services component?
Oh, for sure.
Yeah.
I mean, these businesses don't have today, generic products, and our products will go into those businesses. For products that we don't really carry or that we carry most of them, we have our sourcing capabilities that are already sourcing for these businesses.
Then talking a little bit on going back to specialty, I didn't mention or didn't ask about Reveal clear aligner specifically. You briefly mentioned it, but how do you think the competitive landscape plays out in your view, and where does Henry Schein kind of play a role there?
Well, we have such a small market share. If we are able to go to our own customers and get a small percentage of them to move their products to Reveal and the Smilers brand we just acquired in France. But this is not our main focus. It'll happen. We have a separate management team that's focused on orthodontics. We have some traditional wires and brackets. It's a good business, but it's—we definitely are not gonna make that our focus. Implants is far more important to us and endodontists.
Great. Well, thanks so much. I appreciate the time today, and, yeah, we look forward to kind of what's next in 2024, so.
Great. Thank you, Erin.
Thank you.
Thank you.