Henry Schein's Management Presents at Barclays Global Healthcare Conference (Transcript)

Mar.12.13 | About: Henry Schein, (HSIC)

Henry Schein, Inc. (NASDAQ:HSIC)

Barclays Global Healthcare Conference

March 12, 2013 10:45 am ET

Executives

Steven Paladino - Chief Financial Officer, Principal Accounting Officer, Executive Vice President and Executive Director

Analysts

Elliot Feldman - Barclays Capital, Research Division

Elliot Feldman - Barclays Capital, Research Division

Hello. Good morning, everyone. Welcome to Day 1 of the Barclays Health Care Conference. My name is Elliot Feldman, I work on the health care distribution and technology team here at Barclays. Our next presenting company will be Henry Schein. Pleased to, once again, have Steve Paladino with us, Executive Vice President and CFO of Henry Schein. Just to let you know, this is going to be a fireside chat format. I'll ask Steve a few questions and then we'll head down the hallway in about 20, 25 minutes or so, to the breakout session, where you guys can feel free to ask him anything you like. So Steve, welcome back, and thank you very much for being with us. I appreciate it.

Steven Paladino

Thank you for having me.

Question-and-Answer Session

Elliot Feldman - Barclays Capital, Research Division

First off, maybe a bit of reflection. You guys embarked on a sort of new strategic plan, a restructuring, January 1st of last year. So now, a year and a few months into it, can you give us a sense of how it's gone, and also to initial expectations, what you saw, what to do? And perhaps what benefits you may see maybe 2013 and 2014?

Steven Paladino

Sure. So we're well into our strategic initiatives. They center around a few different things. First thing that we've completed is organizational structure. So today, we're structured where each of our Global, Dental, Medical and Veterinary businesses are under one leadership team. And separately, we have our Technology business, which has kind of a dotted line for its responsibly into each of Dental, Medical and Vet, but also has a separate leader in order to produce initiatives across all the technology businesses. So that went well. We think it was important for a couple of reasons. If you look at each of our health care providers, the supplier relationships are generally global. Many of our manufacturers span more than just one country. So having access to one point of contact within Henry Schein, the supplier relationships we think will be beneficial. Second thing is custom and needs are very similar. So best practices, country-by-country, can be shared. Previously, we had geographic responsibilities, so all of our European and international businesses were under one leader and that didn't allow for sharing of best practices. So we feel that all of that is complete and went very smoothly. And there's 2 or 3 main focus for us. One is to be bigger in each of our specialty areas, in each of our disciplines, so dental specialties, as well as on the medical and veterinary side, to grow that, since we tend to be a little bit underpenetrated on specialties. We still believe that expansion on a geographic basis is very important for us. Most people know us by our U.S. dental presence because it's our best biggest business and largest market share, but there's plenty of parts of the world where we do not have a presence, either on a dental side or in those areas, so we feel that, that's a very good opportunity for us. And maybe, just to conclude that, one last thing. We feel that we have a highway to our core customer, the practitioner. And being able to get high margin products that we can source from, really, anyone who needs access to the customer, is more advantageous we believe going through us, than anywhere else because we really are touching the customer so frequently that they can piggyback ourselves in marketing activities and we think that it would be the most efficient way of getting product to market is through our network.

Elliot Feldman - Barclays Capital, Research Division

Great. Maybe switching gears, as you mentioned to dental, particularly here in the U.S. and North America, clearly saw some strong growth in that category in Q4 even with some of the puts and takes you mentioned. So given that backdrop, can you discuss some of your expectations for equipment growth in dental here in 2013, in the U.S.? And maybe, perhaps what product categories have been performing well? And in particular, if you can focus around the CAD/CAM space? You mentioned some good growth out of E4D product line, maybe how that's doing, as well as your partnership with 3M product?

Steven Paladino

Sure. So the U.S. equipment market has been very strong. We grew by 22% in Q4. Now certainly, that was aided a little bit by the medical device excise tax that went into effect January 1, as well as some tax benefits that was scheduled to expire at the end of the year, the Section 179, and it turned out they did not expire. But even with that, it was very strong growth. And we saw growth in equipment categories, very broad-based. So certainly high-tech equipment was the strongest growth categories, but we also saw very good growth on traditional and basic equipment. So on the high-tech, first of all, the strongest product category was CAD/CAM, and for us, in the U.S., that's E4D. That has been our fastest-growing product category for a number of quarters, maybe the last 3 or 4 quarters, for us. But other high-tech equipment, digital imaging, has also been very strong. What we are very pleased with, is that it wasn't just high-tech equipment. Then again, we saw basic chairs, dental units, lights and cabinetry, traditional equipment also being strong. And we think that's for a few reasons. One, if you look at the last few years, we did see, I think, a slowdown of equipment purchasing in the U.S. market because of economic conditions. And I think, now, customers are comfortable that their practice is doing well. Yes, it could even be doing better if the economy would improve additionally. But I think people are comfortable with making investments, and you could only delay equipment purchases so long. So if you delayed an extra year or 2 or 3, eventually you need to replace or upgrade your equipment because, if you have too much downtime on equipment and requires repair, it actually is more costly to a practice to have that downtime than just buying a new equipment because productivity is significantly reduced. So we are looking for a strong equipment year in 2013 also. Now certainly, we won't put up 22% growth like we did in Q4 but we still think that, that will be the fastest-growing piece of the U.S. dental business for us.

Elliot Feldman - Barclays Capital, Research Division

Great. And maybe switching gears to the consumables front, in the U.S., as well. I know you guys also saw some slight sequential deceleration in Q4. I know there's some puts and takes there as well. Can you give us a sense of what you're hearing in terms of overall volumes and patient traffic here in the U.S.? And is it a fair statement to say that overall volumes are still sort of flattish to maybe, slightly growing sort of here in the U.S., as we've entered into the new year? Is that a fair statement?

Steven Paladino

I don't think that Q4 was indicative of patient traffic going forward. We did have the storm Sandy which, in certain parts of the northeast, part of the country, certainly, negatively impacted patient traffic and consumable demand. But we certainly think the market is stable. We also believe that there's opportunity for the market to improve as 2013 continues on. And probably more so in the second half of 2013. I think, patient traffic, again, is stable. I think the market in Q4 grew slightly, in the low-single digits, but I do think it has the potential to grow a little bit faster for the balance of the year. So we're relatively optimistic on that. Now, we did not, in our guidance, we assumed that the markets would continue to be stable, so we didn't really -- put into our guidance an increase in market improvements, whether that be in the U.S. or internationally, but I do think, especially in the U.S., that that's a real possibility.

Elliot Feldman - Barclays Capital, Research Division

Great. And maybe switching gears across the pond here to Europe. I know you guys and Stanley mentioned, still a cautious spending environment in Europe, particularly in the equipment side. Maybe with the backdrop of the International Dental Show this week, are those sort of still your expectations going into this year? That equipment growth will somewhat still be capped by those macro pressures? And maybe any broad comment on the IDS this week, given your big scale presence there?

Steven Paladino

Well so, as everyone knows, it's no secret that there's a number of countries in Europe, southern European countries, that their overall economies are challenged. What we saw in the dental market is, that where the dental market was soft, it was mostly in the equipment. That the consumables were relatively stable, whether that's slightly up or slightly down, it's hard to precisely predict that. But we really saw, in a number of markets, Italy and Holland, for example, where equipment really declined. We're not expecting improvements, although we are expecting the rate of decline to be less. But we're still expecting the countries that are struggling to continue to struggle. I personally believe that Europe will take a little bit longer for an overall recovery than the U.S. markets. I'm a little bit more bullish in the U.S. market than the European market. But eventually, Europe will recover also. So whether it's a few quarters later, or whatever, is difficult to assess. For us, the larger countries, Germany, seems to be still stable. France and the U.K., while their markets are probably in the dental market, really not growing that much, to probably flattish. We have been able to take market share. So overall, for us, Europe, we think, will be stable and, eventually, will be stronger as the overall economies improve.

Elliot Feldman - Barclays Capital, Research Division

Maybe switching gears now to your Medical segment. It's been a great performer for you guys. You may have given some recent changes in the competitive landscape, a recent acquisition and maybe, as well as the industry sort of braces for health care reform, can you give us kind of a sense on how you see the competitive dynamics in the medical space, maybe playing it out, changing, if at all, maybe in the next 1, 2, 3 years or so?

Steven Paladino

It's a really good question because I think there's a lot of unknowns in what's going to happen in the overall health care market. There was a big merger in our space, McKesson and PSSI combined. Now while they are clearly the largest physician distributor in the U.S., from our perspective, not a lot changes, because even though they are larger, there's nothing really unique that combining the 2 companies bring. So we still feel that we're very well-positioned. We're really the only other national player that can compete. We've been doing very well in our last quarter. Our Medical business grew by 7% organically. That market is relatively flat, so all of that is market share gains. We believe that we're taking market share. I'm not sure where it's coming from because it's difficult to assess that, but we're definitely taking market share. And we've been really focused on what we call, internally, the up market strategy, which is really to focus on these larger group networks, these physician-owned or affiliated with IDN networks' practices, and we've been winning business in that area. So we feel like we can compete very effectively. We feel that, if there's any fallout from the merger, that maybe we can benefit from that in the short- to medium-term. And we also feel that overall health care, or the Affordable Care Act, is driving patients, really, to more preventative care, which will be in our customer setting, the physician office setting. We feel that it's an exciting area for us. There's going to be a lot of change. Today, practices are more and more less individually-owned and more of more, again, large group networks and IDN's owned affiliates. But that has been good for us. We feel good about the medical space, going into 2013.

Elliot Feldman - Barclays Capital, Research Division

Okay. And maybe switching to the other segment, U.S. Animal Health. You guys and your competitors continue to post very solid results. I know Stanley mentioned on the Q4 call, I think the market is growing in that mid-single digit range. So is it fair to assume, coming up against some more difficult comparisons here, this year, relative to last year, but given kind of that market growth and your scale, and you guys continue to take market share there, that you still expect to see a robust growth there in, at least, the mid, if not for the high-single-digit range? That there are no Is that fair? I know you guys don't guide to individual sort of segments, but kind of given the way things are going, is that kind of a rough way to think about it?

Steven Paladino

Well so, interestingly enough, animal health, or veterinary medicine, is the fastest growing market that we're in, the U.S. Animal Health business, it's our fastest growing business. Last quarter, we grew by 18% in the U.S. Now to be fair, that 18% was aided by a shift from some product categories which were agency sales to normal buy-sell relationships. So for us, it effectively went -- goes buy-sell. The sales effectively grossed up like a normal sell would be. But even with that, we grew double-digits, when you normalize for that. And we think that we can -- we are still taking market share, so if the market is growing, half that and we're growing double-digits. We feel like that, that opportunity to continue to take market share is still available. One of the interesting things is that we are just beginning to try to take advantage of the very large footprint we have in Veterinary Practice Management software in the U.S. And I'm not sure everyone knows, but today, with 2 smaller acquisitions that we made last year, McAllister and ImproMed, we literally have more than 50% of companion animal veterinary clinics using one of those software systems. So we think that's very powerful and like, in the dental space, where we use that software, really, to bring more value to our customers, as well as to increase the overall distribution business. We're just beginning to optimize that. We do think that will give significant benefit because we are clearly the leading practice management veterinary system in the U.S. So that's something that should be rolled out during between 2013 and beyond.

Elliot Feldman - Barclays Capital, Research Division

Great. And maybe switching to below the top line here, maybe around operating margin. So can you guys have a good history on sort of expanding your operation margin. So can you guys give us a sense about the next 2, 3, 4 years? Some of the levers you can pull, some of the initiatives you have in place to kind of keep improvement in those operating margins? And secondly, to that note, we know you've seen some of the headwinds of some of these lower margin international acquisitions you've made, like AUV, I think, which is almost a year ago. So could you give us some perspective on some of those international acquisitions which had been lower margin. Have you seen some of those expected synergies and some of those margin uptakes in those businesses as well, which, obviously, is an important part to your story as well?

Steven Paladino

Sure. So first, we still believe that over the next several years, or really, for the foreseeable future, we think that operating margin is still a big part of the growth story for Henry Schein. To be fair though, in 2012, we were a little bit low -- below our targeted range of 30 basis points of improvement. I think we actually came in at 27 basis points. But we got there really because of a very strong fourth quarter and very strong equipment sales in the U.S. market. So I think we'll see something similar in 2013. I think we will get operating margin expansion. We may be below our goal of 30 to 50 basis points, so we're at the low end of that goal. But if you do the math, we can still achieve our overall guidance, if we get less operating margin expansion than that 30 bps. And the reason is because a lot of our margin expansion these days comes from incremental sales growth, which is leveraging the expense, the SG&A expenses. And because, in some markets, sales growth is more muted, especially Europe, and the first 2% or 3% of sales growth really keeps us even with expense growth. And if you look at it, that a big chunk of our expenses are people costs, commissions and other payroll-related items. And even if we don't hire a person, salaries go up 2% or 3% each year. So we really need to be in the 4%, 5% sales growth before we begin to get some leverage on the expenses. And quite frankly, Europe, in 2012, did not see any margin expansion because sales growth was lower than normal. But going forward, once again, Europe comes out of its macroeconomic issues. We think we can begin to get margin expansion also in Europe. But today, the U.S. and the North American business is carrying most of the margin expansion. So we feel very good about that. It is a key part of our growth rate. Everyone at Henry Schein is focused on growing operating margins. We have an initiative that we call optimization, which is really what we're looking really across all parts of the company in order to see what we can do more efficiently, how we could optimize the business. And that's beginning to pay dividends. So we think that margin expansion is still doable for us for a number years.

Elliot Feldman - Barclays Capital, Research Division

Great. And maybe speaking of dividends, want to turn to capital allocation, if I could, for a second. I know, Stanley was here last year and he made the remark that you might still have a few more countries to go in terms of expanding your footprint, particularly overseas, in dental and animal health. So if you remind us, again, of sort of in view of the next in the near-medium-term sort of capital allocation priorities, should we still expect some M&A, particularly overseas, but as well as in the U.S., share repurchases obviously gives you some flexibility and some of your competitors, do have a dividend as well? So I was wondering if you have any thoughts on that as we go forward.

Steven Paladino

Sure. So right now, we think that the 2 main uses of capital will continue to be stock buyback and acquisitions. We bought back about $300 million of our stock in 2012. We also have said that we expect to buy $200 million to $300 million back in 2013. And we think we can consistently do that over a number of years. And we want our shareholders to rely on the fact that there will be some growth somewhere in the 1% to 2% of growth related to that stock buyback. And it is a continuous plan, at least as of now, we feel because the balance sheet is very strong, the cash flow is very strong and we think that there's good opportunities to continue that. Acquisitions, now we're still in relatively fragmented markets. There's still big parts of the world that we're not in. So we'd like to continue to spend $200 million to $300 million of cash per year to do our strategic acquisitions. Now, as I think everyone knows acquisitions are lumpy so you can't really always get exactly that amount. And there is opportunity for some larger acquisitions that could happen. So we think those 2 uses of cash, really, are what's best suited for us. I think, in the short- to medium-term, we really don't see a dividend as something that we're looking to do. But I do think, longer-term, that there is a possibility for us to consider a dividend.

Elliot Feldman - Barclays Capital, Research Division

Great. Still got a few minutes left here and maybe just one last question from me, if we can go back to Dental for a second, one component of the dental market that's sort of gotten a lot of buzz lately is the implant market, and you guys are involved with your Camlog, and your new investments as well. Can you provide us maybe some of your expectations from where you sit on maybe sort of the broader implant market and maybe how Camlog is positioned to purchase some of the bigger, more premium global health empires.

Steven Paladino

Sure. Well first, dental implant is part of the strategy that we have been talking about as to get larger in overall dental specialties. There's 3 primary dental specialties that we think we can do a good job of. One of them being dental implants, one of them being orthodontics and the last being endodontics. So those product lines have traditionally been manufactured direct, but we're in all 3 of them today and we think that we can continue to gain market share there. Specifically with implants, I think we're pretty well-positioned. Our positioning is that, compared to the large, well-known branded manufacturers, we think our product is as good. We think our technical support, that the dentist requires, is as good. But there is a little bit of a pricing advantage in our product versus them. And there seems to be a little bit of pricing competitiveness in the market, not just from us, but from what's called clone implants. Clones are like generics, where there really is no technical support that's provided to the dentist. And the dentist really, they know what they want to buy and how to use it. They can save significantly more. But the bulk of the market really is the combination of a quality product and very good technical support. So we think we're kind of in the sweet spot for that. We'd like to get bigger, whether that's organic growth or acquisition, both are alternatives for us. Camlog's brand in Germany, we've been at it for a number of years. But today, we're the #2 selling dental implant in Germany. And I think that's a really good outcome. And we're not a distant #2, we're kind of neck-and-neck with the #1 player. So the goal, really, is to replicate that success in other markets, the U.S. and some other European markets, and again, we'll probably do it with organic and acquisition activities.

Elliot Feldman - Barclays Capital, Research Division

Well, great. I think we'll wrap it up there. We're going to head to a breakout session just down the hall in Poinciana 4 [ph]. Steve, as always, thank you much for joining us. We really appreciate it. Thank you, everyone.

Steven Paladino

Thank you, Elliot.

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