Henry Schein, Inc.

Good morning, ladies and gentlemen, and welcome to Henry Schein's third quarter 2022 earnings conference call. At this time, all participants are in a listen-only mode. Later, we will conduct a question and answer session. Please press the star key followed by one on your touchtone phone if you would like to ask a question at the end of the call. If anyone should require operator assistance during the call, please press the star key followed by zero on your touchtone phone. And as a reminder, this call is being recorded. I would now 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, sir. Please go ahead, Graham.

Thank you, operator, and my thanks to each of you for joining us to discuss Henry Schein's financial results for the third quarter of 2022. 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 would like to state that certain comments made during this call will include information that's 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 factor 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 analyses and estimates. Our conference call 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 can be found in the supplemental information section of our Investor Relations website and in Exhibit B of today's press release, which is also available in the Investor Relations section of our website. The content of this conference call contains time-sensitive information that is accurate only as of the date of the live broadcast, November 1st, 2022. Henry Schein undertakes no obligation to revise or update any forward-looking statements to reflect events or circumstances after the date of this call. Finally, we have prepared slides summarizing our third quarter financial results. These also can be found in the investor relations section of our website. During today's 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.

Thank you, Graham. Good morning, everyone, and thank you, everyone, for joining us on this call today. Our financial results for the third quarter of 2022 reflect solid underlying growth across our business and actually in most geographies. We grew our non-GAAP diluted EPS compared with the third quarter of 2021, and this is despite the significant currency headwinds and lower sales of PPE and COVID test kits. Today, we are narrowing our 2022 non-GAAP diluted EPS guidance range, which reflects our confidence in the underlying strength and the stability of our business. Overall, we feel very good about the outlook for the company and remain highly focused on delivering on our bold plus one strategy, which we're happy to go into details during the Q&A period, and as we continue to increase the sustainable profitability of the business. Importantly, current market demands in both our dental and medical businesses are generally stable and actually have been this way for a while. We continue to receive price increases from various suppliers with additional price changes towards the end of the second quarter. The depth and breadth of the Henry Schein portfolio allows us to satisfy our customers' needs and to offer alternative national brand and corporate brand products to price-sensitive customers, thus positioning us to also protect our gross profit. This is reflective of the deep and lasting relationship we have with our customers and our suppliers. As we commented in previous quarters, market prices for gloves continue to decrease. However, we believe at a reduced pace, while our unit volume for gloves is relatively stable, and this is driving lower sales and profits in the PPE category. remember the PP&E category is largely gloves. Similarly, sales and profit of COVID test kits have declined compared to the prior year, but pricing and volume for these products is also stabilizing. So generally, the PP&E market on gloves has deflated, volumes are definitely stable, and tests, COVID-19 tests, are relatively stable from a pricing point of view and a volume point of view compared to the previous year. So we will of course provide further information on the whole PP&E and COVID test category. Having said that, our business excluding PP&E and COVID tests did perform quite well as we will discuss in detail during this call. So let me start by reviewing performance highlights for each of our business units, starting with the dental distribution business. Internal growth in local currency of global dental sales, excluding PPE, was good. Consumable merchandise growth, excluding PPE, was solid, and we were especially pleased with the excellent growth of our North American equipment business and continued strength in our global equipment order book. That's the backlog. We had a strong growth in sales of traditional equipment during the third quarter. We are also experiencing continuing good demand for high tech equipment, an area where Henry Schein is a global leader. And this is because dental practices look to secure and maintain a competitive advantage. And the product offering available in this space has expanded. And there is practically something for every dental practice. So this growth was largely driven by volume as we are seeing new innovation in digital dental equipment come to market at somewhat lower average selling prices. But the market is significant, big opportunity, lots of units, and we have a very good offering. We believe that consumable merchandise sales growth in Europe was impacted this year because of the summer holiday season, as dental practitioners and patients took more vacation days than in the previous year. But we also believe that our consumable merchandise growth in Europe will remain stable, leaning slightly positively. On the other side of the coin, other parts of the world International growth did benefit from ongoing strength in Australia, New Zealand, and Brazil, which was partially offset by continuing lockdowns in China, having said that, our China business is relatively small compared to our total business. Our North American equipment order book remains robust and continues to grow from last quarter, and this is partly a result of quite a successful DS world from our point of view. This event was held late in the third quarter compared to the previous year when it was earlier. And we saw continuing demand for intraoral imaging, chair side mills, 2D, 3D digital, extraoral imaging devices. 3D printing with a number of other manufacturers was too. And of course, all the CAD CAM lines did well also from an order taking point of view, leading to probably a stronger, we believe, fourth quarter in a market that we're doing quite well in generally. Lead times for additional equipment are reducing slightly, although installations are still being affected by delays with dental office construction. So we expect our demand and our sales in the equipment area to continue to be strong. Our international equipment order book is also solid. So dental growth during the third quarter was aided by, as our investors know, Midway dental acquisition, which strengthened our longstanding presence in the Midwest of the United States, provided dental customers of Midway with access to an expanded portfolio of solutions, and of course, a highly competitive pricing. Midway built an excellent reputation within the industry over the past 35 years, and the vision of senior executives at Midway strongly aligns with the Head & Shine commitment to helping dentists operate a more efficient practice while allowing a focus by the dentists on delivering high-quality patient care. We have successfully completed the integration relatively quickly of the Midway dental business, distribution business, and the Condor Dental business, that we recently acquired in Switzerland that is on the distribution side is also largely completed from an integration point of view. So we continue to invest in our dental specialty portfolio and add new customers. Sales to DSO customers in the United States once again were good in the specialty areas and demonstrate success of our one-shine strategic initiative. We are seeing some signs of economic caution in several specialty markets regarding high-end oral surgery procedures. I would not say this is the case as it relates to endodontics, but in oral surgery, there is some caution on the high-end side of implants. And our orthodontic business is relatively small. I'll cover that in a minute. But importantly, we believe that Henry Schein is well positioned to capitalize on these shifts, specifically in the oral surgery market, as we offer a full range of dental implant options at various price points. So we think on the unit side, we will continue to do well, and also on the profit side. So we had strong growth in our clear aligner business. Of course, let me remind those participating in today's calls, A line of business is relatively small, but it is growing nicely and specifically with some DSOs. And again, as I mentioned, we are seeing solid demand for our endodontic specialty products, which is driven by sales of new products, particularly our Triton irrigation solution and our Edge pro-laser system. Both of these have done well, but I would also say units of endo have done relatively well. And so we believe that our dental specialty business is doing quite well from a foundation point of view, and we always need to look at comparable quarters in previous years, trends, et cetera. And I think the business is in pretty good shape. Let's move on to the technology and value-added services. Our technology and value-added services businesses had good underlying sales growth in the third quarter. sales growth was impacted by the expiration of a modestly profitable but significant large government contract. The largest business in the segment is Henry Schein 1, a software business, which once again posted solid sales growth domestically and internationally, driven by our Dentrix practice management software and our Dentrix Ascend and entirely cloud-based solutions. During the quarter, We surpassed 5,000 cloud-based customers and in more than 1,000 new customers year-to-date and currently exceeding 100 new installations per month. We have launched entirely across the United Kingdom and in Australia, New Zealand as well, over the past six months and remain on track to further geographic expansion in 2023. Ascend has been growing its customer base by double-digit percentages quarter-to-quarter, Notably, these cloud-based practice management systems also drive traction for other Henry Schein 1 solutions and for, in fact, stickiness to the entire Henry Schein portfolio. We recently announced that Dentrix Ascend was selected as the exclusive cloud-based practice management system of Smile Brands, a dental service organization, a DSO organization, with more than 700 locations, reflecting the competitive advantage of this product offering. So an important part of the Bold One strategic plan is to place greater emphasis on these high-growth, high-margin products and services. Of course, no guarantees, but this is an area of focus for inorganic growth, and we feel that we're on track to deliver on our expectations in that area with inorganic growth, although we will announce that any opportunities in that area or anything any deals in that area once those deals are closed and there's no certainty as to when that may be. So another bright spot in the organization in our performance of sales growth in local currencies and our medical business, which continued to be excellent during the third quarter when excluding PPE and COVID test kits, largely pricing issues, PP&E related to gloves, and test kits just relating to demand for the test kits, which we've discussed on several calls in the past, our expectations were relatively in line on the test kits specifically. So we are continuing to deepen our relationships with existing large IDN customers while nicely growing our other medical businesses. We are especially pleased with strong growth in our government sector athletic schools accounts, and we continue to make solid progress in gaining business from independent physicians. Although several years ago this group reduced, there is still a reduced number of independent physicians. It is a relatively stable group today, and we continue to gain market share within that group. And, of course, these smaller medical groups are also areas where we're adding customers and market share, we believe. Our focus on equipment, pharmaceutical products, and point of care diagnostics remain bright spots in this business, although I must say the whole of the medical business was doing well. And of course, the volatility of sales in COVID-19 test kits, which went down dramatically in earlier quarters, has moderated, but of course, at a lower level of sales. And on the PP&E, the glove side, The volume is stable, but the pricing is still somewhat unstable or less volatile than we saw in earlier quarters. Third quarter sales growth had a challenging prior year comparison when patient traffic to physician offices was bolstered by a surge in Delta variants, and that tough comparison will continue in the fourth quarter. Yet we expect medical sales growth, excluding PPE and tests, to continue at healthy levels, reflecting volume gains, some price increases, but generally growth in our market share in this area, this important area for growth for Henry Schein. Most experts are expecting a high coincidence, the high incidence of flu this year, the illness in the United States, due to winter experience in the southern hemisphere. We would expect strong flu season to drive patient visits to the physician offices and, in turn, increase demand for a host of products we provide, specifically tests, the traditional point-of-care tests for flu and other diseases, including our multi-assay COVID-19 influenza diagnostic test kits. So with that overview on our business, I will turn the call over to Ron for more detailed review of our financial results. Ron, please.

Very good. Thank you, Stanley, and good morning, everyone. As we begin, I'd like to point out that I will be discussing our results as a reporter on a GAAP basis and on a non-GAAP basis. Our third quarter non-GAAP financial results for 2022 and 2021 exclude certain items detailed in exhibit B of today's press release and in the supplemental information section of our investor relations website. I will focus my comments on sales, primarily to LCI sales and LCI growth, which is internally generated sales in local currencies and excluding acquisitions compared with the same quarter in the prior year. A detailed breakout of the components of our sales growth, including LCI growth, is included in exhibit A of today's press release. Our third quarter global LCI sales decreased 2.4% versus the prior year. However, when excluding sales of PPE and COVID-19 test kits, our LCI sales grew 6.8%. Third quarter combined sales of PPE and COVID-19 test kits were $260 million lower than in the third quarter of the prior year. Our GAF operating margin for the third quarter of 2022 was 6.86%, a 23 basis point improvement compared with prior year GAAP operating margin. Our non-GAAP operating margin for the third quarter was 7.18%, a 55 basis point improvement compared with prior year non-GAAP operating margin. Operating margin improvement was driven by gross margin expansion, mainly as a result of increased growth in sales of higher margin products. Turning to taxes. Our reported gap effective tax rate for the third quarter of 2022 was 22.7%. This compares with a 23.9% gap effective tax rate for the third quarter of 2021. On a non-gap basis, our effective tax rate for the quarter was 22.8%. And this compares with a prior year non-gap effective rate of 23.9%. Third quarter 2022 GAAP net income was $150 million, or $1.09 per diluted share. This compares with prior year GAAP net income of $162 million, or $1.15 per diluted share. Our third quarter 2022 non-GAAP net income was $157 million, or $1.15 per diluted share. This compares with prior year non-GAAP net income of $155 million, or $1.10 for diluted share. Amortization from acquired intangible assets for the third quarter was $31.6 million, or 15 cents, for diluted share. This compares with $30.1 million, or 13 cents, for diluted share for the same period last year. Foreign currency exchange negatively impacted our third quarter diluted EPS by approximately two cents versus the third quarter of last year. I'll now provide some detail on our third quarter sales results. Global dental third quarter sales were $1.8 billion, with LCI growth of 1.2%. LCI growth excluding sales of PPE was 5.8%. Global dental consumable merchandise LCI sales decreased by 0.8%, but increased by 5.1% when excluding PPE. Global dental equipment LCI growth was 8%. North America dental LCI sales decreased 0.1% compared with the prior year, primarily due to a 3.6% decrease in consumable merchandise LCI sales. However, when excluding sales of PPE, North America dental consumable merchandise LCI growth was 3.8%. North America dental equipment LCI sales increased 12.8%. primarily driven by traditional equipment sales. The equipment backlog in both our North America and international businesses remains strong. International dental LCI growth was 3.3% driven by consumable merchandise LCI growth of 3.9%. Consumable merchandise LCI growth was 6.9% when excluding sales of PPE and was driven by strength in Australia, New Zealand, and Brazil. International equipment LCI growth was 1.4%. Let me point out that this was against the tough comparable, as international equipment LCI growth in the third quarter of 2021 was 23.9%. Sales of dental specialty products were approximately $223 million in the third quarter, with LCI growth of 2.5% compared with the prior year. Global technology and value-added services sales during the third quarter were $176 million, with LCI growth of 4.2 percent compared with the third quarter of 2021. Sales growth was impacted by the expiration of a government contract. Adjusting for this contract, underlying LCI growth was 8.5 percent. In North America, technology and value-added services LCI growth was 2.5 percent and was 7.3 percent when adjusting for the impact of the government contract with strength in our revenue cycle management, patient relationship management, business solutions, and practice management businesses, including Dentrix and Dentrix Xsend. Internationally, technology and value-added services LCI growth was 16.5%, driven by strength in the UK. During the third quarter, our technology and value-added services businesses, together with our dental specialty products, achieved total sales growth of 0.8% and LCI sales growth of 3.2%. Global medical sales during the third quarter were $1.1 billion, and LCI sales decreased 8.8% due to lower sales of PPE products and COVID-19 test kits. In North America, LCI growth was 9.3% when excluding sales of PPE and COVID-19 test kits. led by strong growth in sales of pharmaceuticals, medical equipment, and point of care diagnostic products. We sold approximately $81 million in COVID-19 test kits in the third quarter, including multi-assay flu and COVID-19 combination tests. This compares with approximately $207 million of test kits sold in the third quarter of 2021. Regarding stock repurchases, we repurchased common stock in the open market during the third quarter, buying approximately 1.2 million shares at an average price of $76.42 per share for a total of $90.5 million. The impact of the repurchase of shares in our third quarter diluted EPS was immaterial. As of the end of the quarter, we had approximately $400 million authorized and available for future share repurchases. Turning to our balance sheet and cash flow, we continue to benefit from significant liquidity, providing our businesses with the flexibility and financial stability to execute on organic growth initiatives and strategic acquisitions while continuing to return capital to our shareholders. Operating cash flow for the third quarter was $98 million compared with $211 million last year, with the decrease primarily due to an increase in working capital driven by timing of accounts payables. With reference to restructuring, as part of our previously disclosed integration and restructuring initiative, we recorded a pre-tax charge in the third quarter of $10 million, or 5 cents per diluted share. This plan focuses on the strategic plan and streamlining operations and other initiatives to increase efficiency. The company expects to continue to record integration and restructuring charges for the remainder of 2022 and in 2023. However, an estimate of the amount of these charges has not yet been determined. Any restructuring and integration charges are expected to primarily include severance pay and facility-related costs. The expense savings from this plan are expected to be realized mainly in 2023 and beyond. Turning to 2022 financial guidance, as we are not able to provide estimates at this time for costs associated with integration and restructuring for the remainder of the year, we are not providing gap guidance. Also, our guidance for the balance of 2022 is for completed or previously announced acquisitions and does not include potential future acquisitions or integration and restructuring expenses. Guidance also assumes that foreign currency exchange rates will remain generally consistent at current levels. However, additional headwinds from foreign currency exchange rates may further impact our sales and EPS. On a non-GAAP basis, we are narrowing our diluted EPS guidance range to $4.79 to $4.87, reflecting growth of 6 to 8 percent compared with our 2021 non-GAAP diluted EPS of $4.52. This includes 10-cent adverse impact from foreign exchange rates versus 2021. We also continue to expect full-year 2022 non-GAAP operating margin expansion of 20 to 25 basis points over 2021 non-GAAP operating margin. We are revising our full-year sales guidance and now expect sales growth of approximately 1.5% to 2.5% versus our previous guidance for sales growth of 3% to 6%, which mainly reflects a strengthening US dollar and lower PPE sales. We continue to expect 2022 full-year sales of COVID-19 test kits to be 25% to 30% lower than in 2021, and 2022 full-year sales of PPE are expected to decrease 30 to 35% from 2021. 2022 full year sales of PPE and COVID-19 test kits combined are expected to be approximately 30% lower than full year sales in 2021. This trend of lower sales may continue in the coming year versus 2022. We do expect to continue to achieve gross margins on these products that are generally consistent with our dental and medical businesses. Despite these meaningful market-related headwinds, we continue to be confident in the strength of our underlying businesses, and we are taking additional time to finalize our view of the overall effect of PPE pricing and COVID-19 test kits volume for next year. As we have seen in 2022, this has a meaningful impact on our business, and we want to ensure we give it appropriate consideration along with ongoing analysis of macroeconomic trends. We intend to issue 2023 financial guidance with our fourth quarter earnings results. With that, I'll now turn the call back to Stan.

Thank you, Ron. So before we open the call to questions, I would like to take a moment to note the passing of our board director, Diane Rico, in August. Diane was an internationally known authority on aesthetic and restorative dentistry, as well as an early pioneer in digital dentistry. She served on our board since 2014 and brought a valuable perspective to Henry Schein, and was a wonderful human being. I would also like to spotlight that early last month, Henry Schein was named to Fortune Magazine's annual Change the World list. We were recognized for our leadership initiatives to advance health equity for individuals with disabilities, and in particular, our engagement with our key stakeholders in support of this work. Our CSR report, which was released in mid-August, aligned with two of the most common disclosure standards, SASB and GRI. This is an important milestone as we prioritize transparency and accountability in our ESG work. So in conclusion, while there are a number of external factors at play, specifically as it relates to PP&E and test kits, and FX. Our bold plus one strategy remains our north star and our team is executing according to plan. As a result, we feel very good about our position in the markets we serve and generally the team is focused on priorities and delivery. So with that review of our third quarter financial results and some commentary on our future, And I'd like to open the call to questions. Operator, please.

Thank you, sir. We will now be conducting a question and answer session. If you would like to ask a question, please press star 1 on your telephone keypad. A confirmation tone will indicate that your line is in the question queue. You may press star 2 if you would like to remove your question from the queue. For participants using speaker equipment, it may be necessary to pick up your handset before pressing the star keys. One moment, please, while we poll for questions. Our first question comes from the line of Jeff Johnson with Baird. Please proceed with your question.

Thanks.

Good morning, guys.

Can you hear me okay?

Yes, very well. All right.

Great. Well, good morning. Congratulations on the quarter. You know, I guess a two-part question. They're not really connected, but I want to shove both of them together because I do want to ask both questions. But the first one, Ron, just on the gross margin up 110 basis points year over year, could you help us bridge, you know, how much FX was weighing on that gross margin versus how much maybe price increases in the lower PPE and COVID testing? might be offsetting and helping. Those are the three big variables outside of just kind of normal operations that I think we're all trying to understand what the impact is on the gross margin side. And then if I go back to our September healthcare conference, Stanley, I think you and Ron had made the comment that you would provide at least some framework for 2023. I'm not really hearing a lot of that. And I know end markets are a little uncertain right now. But if I look at the street, Ron, the street is modeling 6% EPS growth next year. We're admittedly closer to flat year over year in our model. You know, just can you help us kind of peg between where the street's at at that 6% where maybe I'm modeling closer to flat? Just how to think about maybe the ups or downs from either of those numbers. Thanks.

Well, Jeff, I'll start with your gross margin question first. I think that, you know, especially given our portfolio, you get a kind of a broad mix, a change of products, and that obviously is going to impact that gross margin. So we did see some benefit from some of the higher margin products. We did see, I think, some benefits in the third quarter on merchandise, primarily in the non-PPE area, obviously, because gloves were down in pricing. But from, you know, from inflation that we estimate to be in kind of that 3% to 4% range, you know, benefiting there as well. So I think that gave us a little bit of a lift on the gross margin versus last year. You know, in terms of 2023, you know, as you mentioned, there's a lot of different moving parts. And as we kind of work to and look to 2023, we just considered it to be prudent at this point in time to to provide guidance with our Q4 release so that we can better understand the dynamics of the PPE market, what's happening with COVID-19 test kits. These are all things that have a significant influence on our income. So when we provide our fourth quarter earnings release, we'll provide 2023 guidance at that point in time. Understood. Thank you.

Jeff, let me just highlight. Can't give guidance now. But in general, we're feeling pretty good about our core businesses, that is our distribution businesses in the United States globally, our specialty businesses, although I would say in the implant field, there is a greater demand at this moment for the lower-priced, also premium implants, and our software businesses and other value-added service businesses. Having said that, the price of PP&E, namely primarily gloves, is highly volatile, although we think it's stabilizing. And test kits we think have stabilized over the last few quarters, but I think it wouldn't be appropriate right now to provide guidance for 2023, taking into account the volatility in PP&E and tests. I wish we could do more, but I think it would be irresponsible to try to predict those areas.

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

Hi, guys. Thanks so much for the question. Stanley, I think you sort of alluded to it in Jeff's question a little bit. If we think about sort of, you know, October and sort of the beginning of the 4-2 results, how would you say the trajectory compares to the third quarter? And then just in general on the overall visibility of the business right now, obviously one question many investors have been asking is, has there been, you know, ex-COVID, any like broader changes in how you sort of think about the visibility of the business right now? Thanks.

Yeah, I think, Elizabeth, that's, together with Jeff's question, is the core, which we ponder. And I think we're quite comfortable. Look, October dental consumable merchandise internal sales growth, excluding PP&E, grew relatively consistent with the third quarter. And that's both in North America and internationally. So those businesses are relatively stable. Of course, what we can't We just don't have visibility on the price of gloves. And it could swing in a number of directions. Having said that, I think it's better to look at the core business. And we'll break out for you sales of these gloves and the test categories. And so you'll be able to figure out how we're doing in the core business and we're saying that that is pretty stable. We gave you, and actually doing quite well, we gave you sales excluding those items and excluding foreign exchange. Foreign exchange, and Ron can give you the number, did have an impact in all three quarters. We're contemplating in our guidance that we've reached a stable foreign exchange, which is, of course, reflective of very strong in the markets that we serve. Now, if I wasn't clear, I'm happy to give you more clarity, or Ron can do that. Now, as it relates to, and that's dental, by the way, and medical also, if you take out PPE and tests, October was more or less in line with the third quarter as well, and global technology, value-added services, sales not that material, but in the scheme of Henry Schein, but the profits seem to be stable as well from the third quarter. So patient traffic. It's very hard to get this precise. If you take a look at the ADA survey, and we don't know 100% how this works, some recent analyst reports suggest that patient traffic has slowed modestly since the end of August. Somewhere we're reading between 3% to 4% if you take the ADA and analyst reports into account. And that, according to certain analysts, perhaps reading into the ADA report, translates into approximately 6% below pre-pandemic levels. Now, our e-claims data also suggests that volume is down but approximately 3% to 4% compared to the previous year. So that is down from where it was going into the year. In addition, the ADA survey identifies that there's a growing number of dentists in the US that are concerned with staffing shortages, particularly of hygienists. Although hygienists are not material, it is a factor. They're having a problem getting dental assistance. And so there is a concern with satisfying the traffic. But if you look at our US dental merchandise, and everything I've said now relates to the US. If you take a look at our US merchandise sales, They're growing, if you take out PP&E, by about 4% and holding steady. So our inflation expectations are that we had, not expectations, our view is that we had 3% to 5% product inflation. And so it means our volumes are relatively flat. We are seeing a slowdown, as I mentioned, in the implant. business, but it's off a strong 2021. So, you know, the business is basically stable. We believe we're gaining some market share, can't prove it to you. The earnings power of the business, I think, has positive upside in that we are working on managing expenses and moving towards higher margin earnings. So that's sort of basically the US side. Outside of the US, it seems pretty stable as well. Countries are different, but it seems relatively stable. So that's a long answer, but you cut through it all. It's relatively stable with us being optimistic on the positive side removing PPE and E on the dental side, and removing PPE and tests on the medical side, and that relates to both domestic and international. I can't give you a crisp answer. Those are the puts and the takes.

Thanks so much. Appreciate it.

Our next question comes from the line of Brandon Vasquez with William Blair. Please proceed with your question.

Hi, everyone. Thanks for taking the question. In terms of profitability, you know, there's a lot of macro headwinds that are uncertain here, and I can appreciate it's hard to put a finer point on those. But how do you guys think about balancing investments in future growth and kind of balancing those near-term headwinds to deliver some profitability in EPS? So what are some key investments you'll continue to put capital into regardless of what happens and kind of the trajectory of things you can't change and where areas that you can pull back on spend?

Well, when you say investments, let me deal with the M&A side. As I noted earlier on, deals are not done until they sign and announce. But we have a view that we wish to spend $300 million, $400 million a year on M&A. We've done approximately that on average. Some years it's been a little higher. Last year it was a bit higher. During COVID it was a bit lower. but we want to continue to invest in M&A at that kind of a rate. The pipeline is relatively full. Specialty products is an area of focus. We've already announced two fold-ins on the distribution side, but I would say it's the high margin, high growth areas that we're most interested in. It doesn't mean we will not continue to fold in businesses or expand our geography on the distribution side. Again, we remain quite optimistic in that the pipeline is full, but we can't commit to closing anything. As it relates to investments in the business, I would ask Ron to cover that. We have specific areas where we're focusing on reducing expenses, but other areas where we're going to move investments towards that we believe will impact the long-term sustainable profits of the business run. On the investment in the business, your thoughts?

Yeah, you know, Brandon, you know, part of this restructuring initiative we have in place is to give us an opportunity to redirect some investment internally in the business to those areas where we see greater opportunities for growth, greater opportunities for higher profitability. So that's part of it. But we're also, you know, like I mentioned in the prepared remarks, we have $400 million authorized for share repurchases, and we will expect that to continue to be an important part of our capital allocation going forward as well. So, you know, part of this is, you know, share buyback together with, you know, I think, you know, kind of targeted M&A, as Stanley pointed out. But plus also, some reallocation of internal investment as we proceed through 2023.

And our next question comes from the line of AJ Rice with Credit Suisse. Please proceed with your question.

Hi, everybody. Thanks for the question. I wondered if... maybe to expand a little bit on your comments on inflation. And I know in the prepared remarks you talked about seeing some price increases at the end of the quarter. Are you still able generally to pass those along? Are you seeing any significant shift toward the national brand or your corporate brand as an offset to those inflationary pressures? And maybe also as you progress through the year, Is the trend of that inflationary increase has been pretty steady throughout the year? I know year to year it's up, but pretty steady throughout the year, or you've seen it build over the course of the year?

Okay, so good question. They've all been good, actually. Let me begin with the end. We did see from national brands a bunch of increases, at the end of the second quarter by some manufacturers. And I would say that there's a growing awareness amongst our customer base of manufacturers that have increased significantly multiple times and those that have held their prices back. So there's a much more acute understanding of price increases in the marketplace now than I would say six months ago, two or three quarters ago. There's nothing, very little, that is so unique in dentistry that a customer can't move from one manufacturer to another. Obviously, certain brands provide more comfort, as brands generally do, a statement you can generally make about branding, than other brands. So generally, we've been able to pass on price increases, and we manufacturers have not been supportive of that. In other words, they may not want to recognize the chargeback. It's very rare. I can't think of too many manufacturers where that's not occurred. It's generally the norm in medicine. It's been the case in medicine for two decades. There are a couple of, well, maybe one or so manufacturers that are in dentistry that are having an issue with that. But generally, we're able to pass them along. And where we're not, I would say the customers are working with us. And where there isn't a national brand option, we do offer our private brand. some customers look to our private brand in any event so it's not a crisp answer in that there's not one shoe that fits all but generally we're able to move price increases along and the suppliers are understanding where manufacturers are going further than others that there are options whether it's with other national brands big ones smaller ones or our private brand so I believe we have very good relations with our customers, with most of our suppliers, and are managing through this in a rather effective way. Our margins gross profit has done okay. It's not only because of this particular issue that we described, but it's also a movement towards our higher growth, higher margin businesses.

Okay. Maybe just to follow up on the comment you made that lead times on the equipment side are starting to improve a little bit. Does that change the dynamic in the marketplace? Were there potential customers that just said, look, it's a long lead time, so I'm not going to order now, but may now start to order? Or does it affect the sales process in any other way?

Yeah, I think we mentioned our order book is stronger at the end of this quarter, a while stronger at the end of this quarter than last quarter. It's a combination of areas. Some of it is the CAD camp to a large extent. The digital side was because the Serona, Densply Serona World Meeting was in a different quarter. That's to some extent, not a large extent, but some of it. So generally, you know, because we did have a pretty strong quarter, both here in the U.S., by the way, international relative, it was held back a bit. in the percentages because of prior numbers. But generally, the quarter was good and the buildup went up. Again, some of it because of Dentsply world moving around. But in general, it's good. You know, on the traditional equipment, if a customer really needed something, we could supply them. If there wasn't a rush, we asked them to wait. I would say the challenge was US traditional. I would say that the manufacturers in that, the two major manufacturers in chairs, units, and lights, one has not had any backorder issues now for a while. I believe they treat us with the priority. And the other one also treats us very well. They've improved their capacity. but it's still backlogged. The bigger issue is less the availability of the products and more the delays in the sites of installation where there is, I think, in line with the general economy, labor shortage, delays by contractors, and so we haven't been able to necessarily deliver. But I think these are all marginal issues because generally equipment from our point of view is strong. To some extent, it's probably from gaining market share. But in general, our equipment business here in the United States and globally is quite strong.

Okay, great. Thanks a lot. Our next question comes from the line of John Block with Stiefel. Please proceed with your question.

Great. Thanks, guys. And good morning. Appreciate the time. Maybe just two quick questions. First, on the dental consumable side, it seems like your LCI growth premium between specialty and basic consumables, XPPE, has compressed. And Stanley, I think you talked about some implant headwinds. Should we expect that, call it that ratio compression, I guess, to continue in coming quarters? And if so, why, Stanley? Is that just sort of teasing out some shifts going on in the dental industry of maybe that move back to call it bread-and-butter dentistry or more hygiene dominating the chair versus higher-end procedures. And then I've got a quicker follow-up on equipment. Thanks.

Yeah, hard to tell. We haven't seen the data yet on worldwide sales of implants. There is some data available. We haven't seen the report yet. But my sense is the units, in oral surgery have not gone down significantly, maybe slightly. But there's a greater interest in the lower priced implants. And it's a little bit strange in that the actual cost of the implants is insignificant compared to the procedure. But I guess dentists in certain markets are looking at that. We're still optimistic about the oral surgery business, very optimistic. The market is stable, and because we continue to do well in parts of Europe and in North America on implants. And I think the lower-priced units, again, our business in that area is doing very well. So we're also dealing with high comps. The previous 21 was very high comps. very high numbers. So I wouldn't draw any specific conclusions as to the strength of those businesses from our point of view. I think they are pretty solid. On the other side, our endo business has done very well. And our traditional wires and brackets business, although it's very small, has not done well. But our liners have done well, let me hasten to say, with a very small market share. but we have a couple of DSO contracts where they work almost exclusively with us.

Got it. Got it. Very helpful. And maybe just a follow-up, and I'll try to push you a little bit. You know, your dental equipment comments, they continue to, I don't know, I think be pretty upbeat overall on dental equipment, and that's contrary at least just to our checks. And, you know, Stanley, your conviction that this is true, call it end-user demand, it's not a function – of a catch-up from the supply issues of six to 12 months ago, and do you think that equipment strength continues into 2023? Thanks for your time, guys. Yeah.

You know, we're talking about, at the margin, relatively small percentages one way or the other, but generally I think the business is solid. We also do well with DSOs globally on the equipment side. I think that helps. We have capabilities, I think, on installations, able to bring up many new DSOs, practices on one day. If they buy practices, a whole group of practices, we're able to help install new equipment relatively quickly. We work very well with our suppliers. I would say not all, but most of our suppliers on the equipment side who view us as a great way to market. So there's a lot of factors in there, but I would say at least for the foreseeable future, our dental conviction is pretty good. I can't comment on the rest of the market. There are many players. There are some private players. Even the public players don't disclose exactly what's going on. And again, the chairs, units, and lights are largely private companies, and so it's very hard to give you a comparison to the market. Having said that, we do feel comfortable with our equipment growth. As I sit here, Oh, good.

Thanks for the time.

And our next question comes from the line of Erin Wright with Morgan Stanley. Please proceed with your question.

Erin Wright Great. Thanks. I have a quick question on the medical segment. What's driving the high single-digit growth? I guess it was a little bit slower than what we saw in the first half. that's excluding the COVID related dynamics and what's the sustainability of this growth? Are you seeing market share gains or what are some of the factors driving that? Thanks.

Yes, that's also another good question. We don't get many questions on the medical business, which we think is a great franchise. We're doing very well with IDNs. Now, IDNs generally use other distributors, big hospital distributors, for their hospital acute care needs, but for their alternate care needs, the physician practices primarily, but other alternate care sectors other than long-term care, which we're not in generally. We are viewed as an important player. We don't win every contract, but we win a lot. It's based on our service, our relationship with suppliers, efficiency, chargeback systems that we have in place with suppliers that work very well with us on that side of the house, where there's been chargebacks, for example, in place for years as a way of doing business. And we just do it very well on the alternate care side, particularly the physician side. So with the large IDNs, we don't win too many new ones. We have won a few in the last few years. But they don't switch that often. Having said that, there's a growing part of the IDN business that is moving from the acute care setting into this alternate care specifically physician ASC side of the provider side. And we do well with that. We also made a comment that our other medical businesses are doing well. Government business, we do quite well in that area. We have some unique businesses in that area. They're not huge, but they're doing well. We've also indicated that our sports medicine, there are parts of the EMS business that we're in that do well, podiatry, the smaller practices, the smaller group practices. These are all areas where we have folks directly focused on these businesses that are doing well. So... I think we do well in this marketplace. We have scale, and we have sophisticated supply chain. I'm not sure if anyone does it really better than us from a logistics point of view, combining med-surg, pharmaceuticals, equipment, installation, the whole package all in one from one distributor with formeries, chargebacks that really work very well.

Okay, thanks. Thanks. And then on 2023, I get it there's limited visibility on PPE and test kits and also the macro kind of heading into 2023, but are there other factors that could be limiting your visibility there? For instance, are there upcoming changes in DSO or manufacturing contracts that would impact your ability to provide guidance into 2023 now? Or do you anticipate that it's a fairly normal environment next year from a customer and manufacturer relationship standpoint? Thanks.

No, hi, Aaron. It's Ron. I would say that it's more the latter from what you just said. We're not anticipating any other significant changes in the market. We're just trying to better digest what's happening on PPE and on the COVID-19 test kits. I mean, we're happy with how the business is doing. We're happy with the quarter. We've We faced a $260 million revenue headwind this quarter in terms of decreased revenues in PPE and COVID test kits and grew non-GAAP EPS from $1.10 to $1.15. So we're happy with the core business, but we want to better understand the whole dynamics of what's happening with PPE and COVID test kits, and we'll be able to provide I think detail that will be helpful to people when we include 2023 financial guidance with our Q4 earnings release.

Okay, got it. That's fair. Thank you.

Thank you. We have time for one last question coming from the line of Jason Bednar from Piper Sandler. Please proceed with your question.

Hey, good morning. Thanks for squeezing me in here and congrats on the results today. I'll go with a two-parter here and I'll just ask both of them up front and they're both follow-ups to prior questions. So maybe with the forward-looking question here and I'll take a different crack here than what Jeff did on 2023. Are you willing to commit at all to earnings growth for next year or is there any reason to think operating margins don't expand in 2023 given the restructuring that you have underway? And then building on John Block's question, if we're thinking about the sales contribution shifting maybe on the margin away from the more profitable specialty areas, those parts of the business softening up a little bit, it sounds like. Can you reconcile or fill the gap on how profitability and margin expansion is still remaining as solid as you see it for 2022 in spite of this dynamic? Thank you.

Yeah, you know, Jason, regarding 2023, like I said, we'll be providing plenty of details around our 2023 financial guidance with our Q4 earnings release. So I think at this point in time, we're not prepared to provide anything directional. You know, with reference to your question on, you know, the kind of dental margins and the influence of specialty products, I think something to keep in mind is that you know, the specialty products are likely going to have or historically may have a little more volatility in their growth versus merchandise. Merchandise, you know, can fluctuate a few points year over year, while specialty products might have a little greater, you know, volatility than that. And as Stanley said, you know, we had pretty good growth last year in the third quarter of the specialty products. So you're right in terms of, you know, this particular quarter, maybe there's a little more kind of – I'm not sure what the right word is, but how the margins kind of come together. But I don't know if we're to the point of saying that's going to be kind of the long-term trend here.

Okay, fair enough. Thanks, Ron.

We still are highly bullish about high-growth, high-margin businesses. There may be some volatility, as Ron indicated, but generally the market Oral surgery business is a good one. We believe we're growing our market share globally. And endo is very strong also. Ortho is obviously some volatility in wires and brackets. And aligners seem, although small for us, seem to be also a positive area. I wouldn't read anything into one or two or three quarters. I think we've shown that long-term these businesses are growing, and we expect the commitments to add inorganic growth to that. Okay. Greg?

Thank you. I would like to turn the floor back over to Stanley Bergman for any closing comments.

Thank you, operator. Thank you, everyone. for your participation. I think you've said it a couple times today, many times. We have confidence in our core businesses. We just don't know the degree of volatility in the PP&E, primarily gloves, and the COVID test area, the rapid test area. But excluding that, we feel strength, stability, We're feeling good about our dental consumable businesses around the world, the equipment business. We're feeling good about our medical business and our value-added services businesses. We covered specialty. So obviously we're in volatile times, but we're also focusing on our expenses, as we've announced in the past, relative to our restructuring. And this is something Henry Schein has gone through many times in the past. We have a good management team in place, focused on the priorities, at the center of which is our Build Plus One initiative. So with that in mind, thank you all again for calling in. We'll speak to you at the beginning of...

Mid-February.

Mid-February. Oh, it's the longer period. Mid-February, but I think we'll be at a couple of conferences. Will we be? Two or three conferences? That's right, Jim. Right. And again, if anyone has any specific questions, please feel free to reach out to Graham, to Ron, to Graham and Ron. And thank you very much. And since we won't have another one of these calls, have a safe holiday season. And thank you very much for your interest in Henry Shire.