Henry Schein - Q4 2022

Transcript

Operator (participant)

Good morning, ladies and gentlemen, and welcome to Henry Schein's Fourth 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 touch-tone phone if you would like to ask a question at that time. If anyone should require assistance during the call, please press the star key followed by zero on your touch-tone phone. As a reminder, this call is being recorded. I would now like to introduce your host for today's call, Graham Stanley, Henry Schein's Vice President of Investor Relations and Strategic Financial Project Officer. Please go ahead, Graham.

Graham Stanley (VP of Investor Relations and Strategic Financial Project Officer)

Thank you, Operator. My thanks to each of you for joining us to discuss Henry Schein's financial results for the fourth 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'd like to state that certain comments made during this call will include information that is forward-looking. As you know, risks and uncertainties involved in the company's business may affect the matters referred to in forward-looking statements. As a result, the company's performance may materially differ from those expressed in or indicated by such statements. These forward-looking statements are qualified in their entirety by the cautionary statements contained in Henry Schein's filings with the Securities and Exchange Commission and included in the Risk Factors section of those filings.

In addition, all comments about the markets we serve, including end market growth rates and market share, are based upon the company's internal 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 on 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 the website. The content of this conference call contains time-sensitive information that is accurate only as of the date of the live broadcast, February 16th, 2023. Henry Schein undertakes no obligation to revise or update any forward-looking statements or reflect events or circumstances after the date of this call. We have prepared slides summarizing our fourth quarter financial results, and these can also be found on the Investor Relations section of our website. During today's Q&A session, please limit yourself to a single question and a follow-up. With that, I'd like to turn the call over to Stanley Bergman.

Stanley Bergman (Chairman of the Board and CEO)

Good morning, thank you, Graham. Thank you all for calling in today. We closed our 2022 with a very good fourth quarter in which we continued to execute effectively on our 2022-2024 Strategic Plan goals. Achieving strong growth in earnings for the fourth quarter and of course, for the full year of 2022. Despite the macroeconomic concerns and of course, the foreign exchange headwinds. We overcame significant headwinds from lower sales of PPE products and COVID-19 test kits. Our sales were affected by a decline in sales of PPE products from COVID-19 test kits. Excluding sales of PPE products from COVID-19 test kits and taking out the 53rd sales week for 2022, we achieved very good internal growth of 5% in local currencies. That's internal.

There was a negative impact on dental visits for seasonal flu and COVID-19 last quarter, and this was both in North America and internationally. Dental visits were down because of the impact of flu, both the seasonal and the COVID. On the other hand, this was offset by a positive impact, at least from a product sales point of view, of visits to our physician customers. We experienced growth in each of our businesses across the board and overall, a sign that we generated some financial results for the quarter, reflective, I think, of a stable market in the markets that we serve. We made excellent progress in advancing our 2022-2024 BOLD+1 Strategic Plan.

The first year of the plan was 2022, where we advanced our One Distribution strategy to enhance the customer experience and improve operational efficiency, very important, by creating our North America Distribution Group led by Brad Connett and our International Distribution Group led by Andrea Albertini. We had good results across the board, both in North America Distribution and in our International Distribution Group. We strengthened our dental position with national DSOs, won new accounts, and had an excellent success with our technology solution and specialty products within this national DSO segment. On the medical side, we did expand our position with IDNs and large group practices.

On the digital side, the BOLD plan calls for a significant effort in this area. We created our global digital team, including the appointment of experienced veterans in this area, Trinh Clark as Chief Global Customer Experience Officer, Sara Dillon as Chief Data Officer, who are working closely with Leigh Benowitz, Chief Global Digital Transformation Officer, and Mark Hillebrandt, Chief Digital Revenue Officer. We made excellent progress designing and building our global e-commerce platform. This is an advancement of our current platform, which we expect to start rolling out in the latter part of this year. That's we start to roll out the upgrades to the current platform. At the same time, we had some exciting news on the AI side, where we launched our Dentrix Detect AI, an AI-enabled X-ray analysis tool powered by VideaHealth.

Last week, we were advised that VideaHealth has received 510(k) FDA clearance for its periodontic solution, which we expect will further advance the use of AI as a tool in dentistry. We were active on the M&A front. We acquired Midway Dental in the U.S. and Condor Dental in Switzerland. They've, you know, expanding our reach into under-penetrated areas of the market. We acquired a majority stake in Unitis and announced plans to acquire a majority stake in Biotech Dental. Both of these investments we'll address in a moment. We have begun implementing our restructuring plan to reduce our global real estate footprint to reflect TSM, that's Team Schein Member, preference for flexibility in work locations. In this connection, we have closed one of our two buildings in our Melville headquarters on Long Island.

We intend to invest in our remaining real estate footprint around the world to provide modern and flexible office space. We will also continue to invest in technology to ensure that we maintain and build on our strong competitive position from a technology point of view, in other words, the tools that we provide our team to operate. Of course, the tools we offer to our customers to interface with us. This past quarter, we disposed of an unprofitable business. We can redirect our resources to operations that are priorities in our 2022-2024 strategic plan. The cost associated with this exit are included in our restructuring costs for the quarter. If you look ahead a bit, we are introducing guidance for 2023, which Ron will discuss in a moment.

We expect operating income growth in the high single digits to low double-digit percentage range when excluding the contributions from PPE products and COVID-19 test kits. We anticipate the impact of lower selling prices of PPE products and reduced demand from COVID-19 test kits will largely be offset by earnings momentum in our underlying core businesses and the good momentum we have as we enter 2023. This gives us confidence in the 2023 guidance and specifically, the growth in our operating income when you exclude PPE products and COVID-19 tests. A little bit of specifics on our dental distribution business. Merchandise sales in North America grew slightly when excluding sales of PPE and taking out sales from the 53rd week.

In North America, we have a relatively stable market, and our market share, we believe, remains stable to slightly positive. We believe Global Dental consumable merchandise growth, as noted earlier, was impacted by the high incidence of flu and COVID-19 cases, which caused increased rates of patient appointment cancellations and accentuated the staffing shortages. Now, what's important is the rate of patient flow appears to have returned to more normal levels in January, this past January of 2023. The impact from manufacture merchandise price increases, we believe, lessened as last year's increase began to annualize. The depth and breadth of the Henry Schein product portfolio, of course, allows us to support our customers' needs when we have customers that are concerned with pricing, as we have offerings of alternative national and corporate brand products.

That's our own brands, as well as alternative national brands, where we experience customers' resistance to price increases. Having said that, price increases, we believe, that are sticking in the marketplace are relatively stable now and not anywhere near what they were at the beginning of last year. Demand for dental equipment in North America remains healthy, and our North American equipment order book is stable. Although we saw good sales from traditional equipment, and steady sales for digital imaging equipment, which we had challenges in, you know, in the past because of pricing issues, but this seems to be stabilized now. There was a decline in sales of digital restoration equipment compared to the corresponding period in the fourth quarter. Of course, we had good sales in the fourth quarter of last year.

The challenge has been customer demand is shifting from chair-side mills, quite expensive, to 3D printing, much less expensive, and a mix shift to lower-price intraoral scanners. There was also a supply chain issue with one of our important intraoral scanner suppliers that introduced a new scanner this in the last few months. All in all, the demand for digital restoration, that market is pretty hot, but there are these mixed challenges that I just described, and we can go into in greater detail if anyone has questions. The value of our North American order book for equipment is stable. We continue to see construction delays to some extent and a slight reduction in the number of planned new office openings amongst specifically some of our larger DSOs.

On the international dental merchandise sales side, the same impact as in the United States or North America. The COVID patient flow challenges we experienced also, as well as the lockdowns in China that were offset the, on the international side. Those were largely offset by good growth in the U.K., Eastern Europe, and Brazil. Towards the end of the quarter, dental office staffing, absenteeism, and patient appointment cancellations began to ease likewise in our international business. Demand for equipment internationally held up quite well, with sales moving to lower priced intraoral scanner units as well, the overall equipment sales essentially were in line with last year.

The fourth quarter equipment sales and our outlook was slightly impacted by purchase delays in anticipation, this is on the international side again, with the biannual IDS show in Cologne, where customers expect new promotions to be introduced and new products, and that show takes place at the end of the first quarter. The fundamentals in our dental end market remain solid. Of course, the aging population and the growing global awareness of the healthcare benefits of preventative care and oral health all play into our strategic benefits for Henry Schein, short, medium, and long term. Demand for dental services also generally correlated, we believe, with unemployment rates. In the developed world, these remain relatively consistent, historically low, if you will. We think the underlying base is okay supporting oral care.

Let me now turn a little bit to the dental specialty products business, where we were impacted, particularly with our, in our largest sector, implants and bone regeneration products with significant prior year growth, prior year comparisons. The BioHorizons Camlog premium value implant segment continues to grow in North America and Europe. We have some offset here with the decline in China, although I'll point out that our China business is not material, but it did impact the growth line to some extent. Sales to DSO customers in the United States for the Camlog, BioHorizons Camlog line remained solid, and our value brand, Medentis, primarily in Germany, but also to some extent in China, achieved double-digit sales growth. This was mainly coming, as I said, from Europe and a little bit from Asia.

When I refer to Asia, I'm specifically talking to Japan, where our implants are doing quite. Oral surgery products are doing quite well. In December, we announced plans subject to regulatory approval to acquire a majority ownership stake in the French dental solutions provider, Biotech. We look forward to bringing Biotech Dental's high-quality software. This is so important. It's the whole digital flow that is so important that Biotech Dental will contribute to Henry Schein, but also the general products and services that dentists and dental labs buy, are important for new geographies with respect to Biotech, specifically in France, where we believe we will be close, if not the leader in implants at some point in the near future. These will also have a line of product that is well received in that market.

Dental products, liners, implants, biomaterials, all are high growth, high margin products, Biotech will contribute to that as well as providing support, additional support for our leading digital workflow solution in dentistry, of course. On the endodontic side, sales growth remained strong, driven by new products introduced earlier in the year. Recent data suggests that the percentage of general practice practitioners in the US who perform root canal procedures is increasing. That plays right into our sweet spot as well. We believe that this trend, combined with an aging population intent on obtaining a deep bodes quite well for the Henry Schein Endodontic business. Turning to our technology and value-added business. The largest segment, of course, is Henry Schein One, our software business.

Growth was strongest in the international business due to the strength of our entirely cloud-based solution, which is doing very well outside of the United States. Growth in North America was driven by sales of our practice management software. Also the specifically the cloud-based software that we offer, Dentrix Ascend. And we see customers upgrading to Dentrix Ascend as the lifecycle of our Easy Dental product ends. So we're very pleased with the progress of progressing from Easy Dental to our Dentrix and Dentrix Ascend products. What is very important is we now see close to 6,000 customers on our cloud-based products, Dentrix Ascend and Dentally. We have noted in the past, these cloud-based systems drive demand for other Henry Schein One products. We also had nice customer wins during the fourth quarter with our Jarvis Analytics business.

eAssist did well, as well. This is the business that helps with revenue cycle management. eAssist made a significant investment in Unitas, a PPO solutions provider, and generally puts us in a very, very good position to help practitioners operate a more efficient practice, while, of course, they provide good clinical care. We've enjoyed a relationship with Unitas since 2014, and we're now delighted to be able to integrate these value-added services into our product offering at Henry Schein One. You'll see that the dental specialty products, technology, and value-added services business did well, record year this year, up against some tough comps towards the end of the year.

This is where we're placing a lot of emphasis on an important part of our 2022-2024 BOLD+1 Strategic Plan, which we'll talk about in greater detail at our Investor Day. The medical distribution business continued to see excellent growth. This did reflect higher patient traffic to urgent care sites, partially driven by the incidence of flu and COVID-19. Generally, the trends are there, moving from the acute care setting to the urgent care site. We had good sales, of course, as you would expect, in point-of-care diagnostics and other products associated with the flu. When excluding sales of PPE products and COVID-19 test kits, we experienced double-digit growth in local currencies, adjusting for that extra week.

Really absent any public health outbreaks, new ones, our medical sales should return to more normal mid-to-high range, single digits. We are pleased with the continued growth of new accounts across the independent and large group practices, as well as ambulatory surgical centers and urgent care facilities. Strong pharmaceutical sales were driven by pneumonia treatments, and equipment sales also continued to do quite well as practitioners invest in their practice and as the offerings of office-based practitioner equipment expands in terms of availability to treat and diagnose more diseases and other ailments in the office-based practitioner environment. Over the last several years, Henry Schein has been able to shift priorities and provide solutions needed to help our medical and dental customers, and the public, of course, during the COVID-19 crisis and last year's flu season.

During the crisis and, of course, last year's flu season. Even with this change, the impact of COVID-19 and flu, which required huge support from our team to deal with these currently significant inflows of orders. You know, it's important to realize that we delivered a compounded average sales growth, even with these inflows, unusual inflows of PPE COVID tests of about just over 6%, when you take out the PPE and COVID. Henry Schein's internal growth in general, excluding PPE and COVID, is quite solid. We also believe that the PPE and COVID efforts that we undertook helped us generate more customers, helped our customers understand that for healthcare products, it's better to go to a reliable source.

Graham Stanley (VP of Investor Relations and Strategic Financial Project Officer)

I want to thank the team for doing a remarkable job getting out the billions of dollars of unusual one-time, in respects, COVID tests and PPE products which help generate customer loyalty. With that, I'll turn over the call to Ron for a review of the fourth quarter results and our 2023 guidance.

Ron South (SVP and CFO)

Very good. Thank you, Stanley. Good morning, everyone. As we begin, I'd like to point out that I'll be discussing our results as reported on a GAAP basis and on a non-GAAP basis. Our fourth quarter non-GAAP financial results for 2022 and 2021 exclude restructuring and integration costs, as well as acquired intangible asset impairment charges. This is detailed in Exhibit B of today's press release and in the supplemental information section of our Investor Relations website. As Stanley mentioned, the fourth quarter of 2022 included one additional selling week compared to the fourth quarter of 2021, which was the holiday week between Christmas and New Year's Day. We report on a 52, 53-week fiscal year ending on the last Saturday in December. The next time our results will include an extra selling week will be in 2028.

With respect to sales growth, I will focus on LCI sales growth, which is internally generated sales in local currencies and excluding acquisitions. To facilitate more meaningful comparisons, the estimated extra week of sales will also be excluded from LCI sales growth figures. A detailed breakout of the components of our sales growth, including LCI growth, is included in Exhibit A of today's press release. Fourth quarter global LCI sales decreased by 1.8% versus the prior year. However, when excluding sales of PPE products and COVID-19 test kits, our LCI sales grew 5.0%. We sold approximately $161 million in PPE products and approximately $93 million in COVID-19 test kits, including MultiAssay flu and COVID-19 combination kits in the fourth quarter.

This compares with approximately $261 million in PPE products and approximately $187 million in sales of these tests in the fourth quarter of 2021. Our GAAP operating margin for the fourth quarter of 2022 was 2.15% at 387 basis point decline compared with the prior year GAAP operating margin. This was primarily a result of restructuring and integration expenses and the impairment of certain intangible assets incurred in the quarter. Our non-GAAP operating margin for Q4 was 6.74%, a 56 basis point improvement compared with the prior year non-GAAP operating margin. This improvement was driven by gross margin expansion, mainly as a result of sales mix favoring higher margin products, along with lower operating expenses as a perecent of sales.

Regarding income taxes, our reported GAAP effective tax rate for the fourth quarter of 2022 was 23.6%. This compares with a 22.5% GAAP effective tax rate for the fourth quarter of 2021. On a non-GAAP basis, our effective tax rate for the quarter was 22.2%. This compares with the prior year non-GAAP effective rate of 22.5%. Fourth quarter 2022 GAAP net income was $47 million or $0.34 per diluted share. This compares with prior year GAAP net income of $147 million or $1.05 per diluted share. Our fourth quarter 2022 non-GAAP net income was $165 million or $1.21 per diluted share.

This compares with prior year non-GAAP net income of $151 million or $1.07 per diluted share. Amortization expense of acquired intangible assets for the fourth quarter of 2022 was $30.7 million or $0.14 per diluted share. This compares with $32.6 million or $0.14 per diluted share for the same period last year, and this expense is included in the 2022 and 2021 non-GAAP net income results I just mentioned. A key goal to our 2022-2024 strategic plan is to invest in higher growth businesses that have a larger intangible asset component. Going forward, we believe earnings, excluding amortization expense of acquired intangible assets, better represents the underlying business results.

Beginning with the first quarter of 2023, we will be modifying our non-GAAP reporting to exclude amortization expense of acquired intangible assets. Using this method, our full year 2022 non-GAAP net income was $741 million or $5.38 per diluted share. We will include a reconciliation of our non-GAAP financial results with the new methodology in our quarterly presentation available on our Investor Relations website. Finally, foreign currency exchange negatively impacted our fourth quarter diluted EPS by approximately $0.04 versus the fourth quarter of last year. I'll now provide some detail on our fourth quarter sales results. Global Dental sales were $2.0 billion, and LCI sales decreased by 2.6%. Excluding sales of PPE products, our Global Dental LCI sales growth was 0.9%.

Global Dental consumable merchandise LCI sales decreased by 3.7%, but increased by 1.0% when excluding PPE products. Global Dental equipment LCI growth was 0.7%. North America dental LCI sales decreased 3.4% compared with the prior year, primarily due to a 5.1% decrease in consumable merchandise sales. However, when excluding sales of PPE products, North America dental consumable merchandise LCI sales grew 1.3%. North America dental equipment LCI sales also increased 1.3%. International dental LCI sales decreased by 1.4%, and consumable merchandise LCI sales decreased by 1.7%. When excluding sales of PPE products, international consumable merchandise LCI sales increased 0.7%. International equipment LCI sales decreased by 0.4%.

Sales of dental specialty products were approximately $247 million in the fourth quarter, with LCI growth of 0.3% compared with the prior year. Global technology and value-added services sales during the fourth quarter were $187 million, with LCI growth of 3.4% compared with the fourth quarter of 2021. Sales were negatively impacted by the expiration of a government contract, which we mentioned during our Q3 2022 conference call. Adjusting for this contract, the underlying sales growth was 9.1%. During the fourth quarter, our technology and value-added services businesses, together with our dental specialty products, achieved LCI sales growth of 1.6%, or 3.9% after adjusting for the expiration of the government contract.

Global Medical sales during the fourth quarter were $1.2 billion. LCI sales decreased 1.3% due to lower sales of PPE products and COVID-19 test kits. In North America, excluding sales of PPE products and COVID-19 test kits, LCI sales grew 14.9%, led by strong point-of-care diagnostics, medical equipment, and pharmaceutical sales. Regarding share repurchases, we repurchased approximately 3.6 million shares of common stock in the open market during the fourth quarter, buying at an average price of $79.55 per share for a total of $285 million. The impact of the repurchase of shares on our fourth quarter diluted EPS was immaterial. For the full year, we spent $485 million to repurchase 6.1 million shares.

At fiscal year-end, we had approximately $115 million authorized and available for future share repurchases. An additional $400 million was approved by the company's Board of Directors on February 8th, 2023. 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 our organic growth initiatives and strategic acquisitions while continuing to return capital to our shareholders. Operating cash flow for the fourth quarter was $254 million, compared with $277 million last year, with the decrease primarily due to an increase in working capital that was driven by the timing of accounts payable. For the full year, operating cash flow was $602 million, compared with $710 million in 2021.

Regarding our restructuring program, as part of our previously disclosed integration and restructuring initiative, we recorded a pre-tax charge in the fourth quarter of $121 million or $0.70 per diluted share. These expenses mainly relate to vacating one of the buildings at our Melville headquarters and the impairment of intangible assets associated with the disposal of an unprofitable business. There were also restructuring expenses associated with severance and costs related to the exit of some other facilities. Due to the disposal of certain assets and the lengthy remaining period of certain leases we exited, expense savings from this plan are expected to be realized over a longer period of time. We expect to continue to record integration and restructuring charges in 2023. An estimate of the amount of these charges has not yet been determined.

Any restructuring and integration charges are expected primarily to include severance pay and facility related costs. We also recorded an impairment expense for intangible assets of $34 million pre-tax, or $0.17 per diluted share, related to certain continuing operations. Let me conclude my remarks with our 2023 financial guidance. At this time, we are not able to provide estimates for costs associated with integration and restructuring for 2023. We are not providing GAAP guidance. As I mentioned, beginning with our Q1 2023 financial results, we will modify our non-GAAP treatment to exclude amortization expense of acquired intangible assets. This is in addition to the other adjustments we made in 2022 to our GAAP financial results. All guidance today reflects this change.

2023 non-GAAP diluted EPS excludes amortization expense of prior acquisitions of $0.56 a share in 2023, and this was $0.57 in 2022. For 2023, we expect non-GAAP diluted EPS attributable to Henry Schein, Inc. to be in the range of $5.25-$5.42 per share, reflecting growth of -2% to +1% compared with our 2022 non-GAAP diluted EPS of $5.38. Our guidance for 2023 assumes total sales growth of approximately 1%-3% over 2022, with sales of COVID-19 test kits declining approximately 35%-40% from sales in 2022. Additionally, PPE product sales are expected to decline about 20%-25%.

In the aggregate, revenues of these product groups are expected to decrease approximately 30%-35% from 2022. The impact on 2023 non-GAAP diluted EPS from the lower contribution to earnings from sales of PPE products and COVID-19 test kits is approximately $0.35-$0.40 per share. This impact will be much more pronounced over the first half of 2023, and especially in the first quarter, as we had sales of almost $500 million of PPE and COVID-19 test kits combined in the first quarter of 2022. We expect non-GAAP operating income will grow in the high single digit to low double digit range when excluding the contribution from PPE products and COVID-19 test kit sales.

Please note that 2023 will include one less selling week compared to 2022, which will occur in the fourth quarter. For 2023, we expect non-GAAP operating margin to be 10-15 basis points below our 2022 non-GAAP operating margin of 8.20%. This is largely a result of lower PPE products in COVID-19 test kit sales and profits. Our guidance reflects non-GAAP operating margin expansion when excluding income from PPE products in COVID-19 test kit sales. Our 2023 guidance includes higher interest expense than in 2022 as a result of higher interest rates and higher minority interest from our higher growth businesses, mainly Henry Schein One. We also expect an effective tax rate in the 23% range, assuming no changes in tax legislation.

Our guidance for 2023 diluted EPS is for current continuing operations as well as completed acquisitions, and does not include the impact of future share repurchases, the acquisition of Biotech Dental and other potential future acquisitions or integration and restructuring expenses, if any. Guidance also assumes that foreign currency exchange rates are generally consistent with current levels, the end markets remain consistent with current market conditions, and that there are no material adverse market changes associated with COVID-19. With that, I'll now turn the call back to Stanley.

Stanley Bergman (Chairman of the Board and CEO)

Thank you, Ron. We have about 20 minutes, a little over 20 minutes to answer questions. I'm sorry the call was that long. There's a lot going on. We're highly confident in the business and the business ex PPE and COVID test is doing quite well, even though there are challenges from a macro point of view. Having said that, I think we've got great momentum in the business and look forward to answering any questions. Operator.

Operator (participant)

Thank you. We will now be conducting a question-and-answer session. If you would like to ask a question, please press star one on your telephone keypad. A confirmation tone will indicate that your line is in the question queue. You may press star two 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. We ask that you please limit yourself to one question and one follow-up. Thank you. 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.

Jeff Johnson (Senior Research Analyst)

Thank you. Good morning, guys. Ron, maybe wanted to start just on the COVID testing kit and PPE guidance. You know, when I look at kind of the EPS impact this year, it seems like it's dropping through in a decremental margin in the mid, if not upper teens level. You know, I think over the last couple of years, those have been contributing positively, kind of those have been flowing through, or at least kind of you guys have signaled that those were dropping through kind of at corporate-wide margin rates. Why... You know, it makes some sense, I guess, when you're losing some of that inflated top-line growth, that there's a deleveraging impact there. But dropping through at that mid-upper teens decremental margin seems a lot bigger than I would have expected.

Any comments you can make there?

Ron South (SVP and CFO)

Yeah, certainly. I think that, you know, we could see a little bit of pressure on gross margins on both PPE and COVID test kits versus the prior year. I think, you know, the bigger issue there, Jeff, is just the, you know, the gross profit dollars. I mean, the compounded effect of the ongoing decrease in the revenues from these product categories in both 2022 and then continuing into 2023 results in fewer gross profit dollars. And I think that kind of dilutive effect begins to, you know, begins to hurt the operating margins a little more so than it makes it more difficult for us to cover it like we did in 2022.

Jeff Johnson (Senior Research Analyst)

Yeah. Understood. You know, historically, you guys have provided organic growth guidance, revenue guidance. You did last year anyway. I guess prior to that, not necessarily. A lot of moving parts this year with the selling week, one less selling week, the PPE updates, obviously, some acquisition contribution. If I look at that 1-3, we're kind of calking that at maybe a 3%-6% organic guidance, ex all that noise. You know, if I assume medical and tech VA a little above that, dental in kind of that low to mid-single digits. Are those kind of all at least ballparks we should be thinking about as we're setting up our models for 2023? Thanks.

Ron South (SVP and CFO)

Yeah. I mean, you're in range there. I think that, you know, I think we have a headwind from PPE and COVID test kits combined of probably 300-400 basis points, right? You also have a headwind from the 53rd week that's going to be somewhere between 1 point and 1.5 points in there. We'll get a little bit of benefit from acquisitions. That kind of leaves you with a number that could be 3%-6%, 4%-7% in terms of non-PPE COVID test kit growth that we would expect in 2023 versus 2022.

Jeff Johnson (Senior Research Analyst)

Dental a little below and medical above. Is that the way to kind of think about that? Thanks.

Ron South (SVP and CFO)

Yeah, that's probably a fair statement. Yes.

Operator (participant)

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

Elizabeth Anderson (Managing Director)

Hi, guys. Thanks so much for the question this morning. I had a question around sort of your utilization and visit assumptions. Could you help us parse that apart a little bit more for 2023? I'm thinking specifically on maybe sort of like medical visits and then sort of overall dental visits.

Stanley Bergman (Chairman of the Board and CEO)

Yeah. Those are very good questions. We did take a dip on visits in dentistry, and it was both in the United States and Europe. In the rest of the world, it wasn't so bad. Of course, China it was in the fourth quarter.

It is down a bit. There's been a recovery in January, quite nice recovery. It is down a bit from 2019 in the United States. Hard to get data outside of the United States. We are not 100% back to where we were, but the dip that we experienced in the fourth quarter has mostly, if not all, recovered. At least from what we can tell from the first 40 days or so of the year, and from what we're hearing from our customers, we're back to where we were in about the third quarter. Correspondingly, on the medical side, there was an increase in visits. People had flu, and they wanted to confirm that it wasn't COVID.

We experienced some growth in that respect in terms of flu tests, and you can see that information from the flu test manufacturers. A lot of them are providing that information. Again, we expect in January, February, that the visits were relatively back to where they were before in the third quarter, say, before these the flu. The businesses are relatively stable now and we had that temporary dip in dental visits and I think above a little bit in medical. On average amount, if you look at our internal growth, local currency is about 5% internal growth for the company. And I think, all things being equal, perhaps it'll be a little bit better in the first quarter.

Hard to tell, but it's looking quite positive for the first 40 days of the year.

Elizabeth Anderson (Managing Director)

Got it. Sorry, just to clarify [two] questions. One, your comments about sort of the dip and then a little bit of the recovery in January and early February, that also applies to Europe? Secondarily, you're assuming for your 2023 guidance that these current kinda January conditions continue ongoing? Thanks.

Stanley Bergman (Chairman of the Board and CEO)

As it relates to international, or Europe in particular, because the other international, you know, China and the other countries kinda cancel out. Although there's a bit of a positive impact in Brazil where we have a big market share. Not big market share, they're big business, so to say. Decent market share too. I would say the trends were very, very similar. Of course, our medical business is not material in Europe, so I would exclude that. I might even shift. We can give you data on that because it's so diffuse. Our dental business had similar trends to the United States and therefore to North America. What was your second question, sorry?

Elizabeth Anderson (Managing Director)

Is that January sort of rate of visits, et cetera, was sort of what you were using to underpin your 2023 guidance or just...?

Stanley Bergman (Chairman of the Board and CEO)

I'll have Ron answer the guidance question. I'm not sure whether the first 40 days really carried through for the full year or don't. Ron.

Ron South (SVP and CFO)

Yeah, I mean, it's a little early at this point. I think that, you know, our guidance is supported by, you know, our budgeting process. We do obviously monitor, you know, what's happening so far in 2023. I think that, you know, the assumptions, you know, the dental market, you know, last year suffered a little bit in January from Omicron. You know, there's some assumptions in there on Q1. At the same time, you know, last year, like I said in the prepared remarks, we did about $500 million in revenues in PPE and COVID test kits in Q1 that won't get, you know, it won't be nearly that much this year, right?

you know, Q1 still going to have a little bit of noise in it.

Elizabeth Anderson (Managing Director)

Got it. Thank you.

Stanley Bergman (Chairman of the Board and CEO)

When you flow through everything, Elizabeth, I think we're pretty comfortable with our budget for this year, which contemplates, at the end of the day, high single digit to low double digit operating income growth when excluding PPE and COVID. I think if you can see through the PPE and COVID, you'll see the business is pretty solid. That's actually better performance than we've had in the past. I still think that the whole of management of these PPE and COVID tests, where we put the accelerator down, generated over $2 billion or so in sales and pretty good profits, has paid off because our customers are understanding that they can rely on Schein during challenging times, and that the products we sell are compliant with regulations.

Very often, they were buying products during this PPE and during this COVID period that had regulatory issues, and quality issues. I think the strategy has played out well, in terms of focus on PPE and tests. At the same time, we garnered quite a bit, I think, of core business, and that's reflected in our expectations for 2023 in terms of growth of operating income.

Elizabeth Anderson (Managing Director)

Got it. Thank you very much.

Operator (participant)

The next question comes from the line of Jason Bednar with Piper Sandler. Please proceed with your question.

Jason Bednar (Senior Research Analyst)

Hey, good morning. Thanks for taking the questions. You know, maybe, Stan, I'll start with you. A lot going on here, as you said. You know, maybe with the outlook, you got, you know, 1%-3% of the top line. I know Jeff was digging in there on the organic growth. You know, core EBIT growing upper single, low double digits. You know, it implies some pretty nice core margin expansion, and that would seem to fit with the historical trend line of the business. Maybe double-clicking on Jeff's question there, you know, wondering if you can comment a bit further on how you see the core dental consumables and equipment lines performing in 2023 in North American International.

Are the drivers of the core margin expansion implied in your guide, are those more gross or operating, if you're willing to comment there?

Stanley Bergman (Chairman of the Board and CEO)

Yes. Let me deal with the first part. I think it's best for Ron to respond to the guidance from a mathematics point of view. As noted, in the prepared remarks, we believe the dental market in the developed world certainly is quite stable. We believe that generally we're growing some market share. There are puts and takes here, namely, the seasonal adjustment because of flu in the fourth quarter and a little bit of a rebound in or back to normal in the first quarter. Generally, I think the market is stable. I think specialty products are stable. You should not necessarily read anything into our specialty sales per se, because we had an exceptional fourth quarter for implants and bone regeneration products in 2021.

Generally, I would say the consumable markets in the developed world are relatively stable. There are a few markets where it's a bit down and a few markets where it's a bit up, generally it's stable. On the equipment side, traditional equipment is okay. We haven't quite run off the backlog yet. It's pretty stable. The area that in the past I was a little bit more concerned about is the imaging. I think it's relatively stable now. The prices are not going down as they did, the units, the demand is pretty good. The area where there'll be lots of ups and downs is in the digital area. There's enormous interest in digital dentistry. I've not seen the interest this high.

When it comes to the scanners, I think we're well beyond the first run of innovative type buyers and into standard of use buyers. There are many new entrants into this market. There are lower priced product for sure, and that's where the market is heading, but the demand for units is very strong. I would say that we were challenged a bit, and I think it's going to be that way for a few quarters with the, with a new product from our leading provider of scanners. I don't think we'll lose those orders. They'll come. On the other side, the mill market has really almost come to a halt. We're still selling mills, dentists that were looking at mills are now looking at 3D printing. We got a bit of a boost there in the United States.

Nathan Rich (VP in Global Investment Research)

The ADA has now provided a billing code. Dentists, they may not buy the 3D printer right away, but they're certainly looking at it. I think that that market is going to do well. It's technical use maybe for the front, I'm using a lay term, for the front teeth is not perfect yet, but this is a great opportunity for us, and we're doing well, and we expect to do even better, although it's not covering the reduction in mill demand. I'm dealing with the dentist. On the lab side, the mills are doing quite well. Generally that's what's happening in the equipment business. I think it's quite a good market on the traditional, on the 3D printing.

Stanley Bergman (Chairman of the Board and CEO)

mills are a challenge. There's a slight issue in Europe because of the IDS that occurs at the end of March. I think people are waiting to see what developments occur, but I don't think that's going to impact the whole year sales. That's just maybe a slight dip and a uptick. Generally, I would say dental is stable. On the medical side, we continue to see the migration from the acute care setting. I myself am having a partial knee replacement, and I'm told I'll be out on the same day. That was not the issue, not the situation perhaps, a year and a half ago. There is a migration, and we're benefiting from that.

Ron South (SVP and CFO)

Jason, with reference to your question on operating margin, yes, I do think that, you know, like we've said, we believe operating income is growing in the high single digits, low double digits when excluding, you know, the drag from PPE and COVID test kits. You know, that, yes, that should imply, if, you know, kind of a pro forma operating margin expansion as you inferred.

I think it really shows that the benefits of having the kind of broad product portfolio we have of, you know, not just being a distributor, but also having the specialty products, also being in the medical business, also being in the technology business, that we can, you know, we can continue to kind of offset some of these, you know, some of these market conditions that have adversely affected us a little bit with, whether it be in PPE or COVID test kits, you know, with the balance of the business.

Jason Bednar (Senior Research Analyst)

Got it. Just, Ron, just as a quick follow-up there. You're suggesting operating margin expansion. Totally get that. Is it gross margin driven or OpEx driven? Make sure the comprehensive answer, I'll hop back in queue after that.

Ron South (SVP and CFO)

Given that the, you know, the product mix aspect of it would be primarily gross margin driven.

Stanley Bergman (Chairman of the Board and CEO)

Thank you.

Operator (participant)

The next question comes from the line of Jon Block with Stifel. Please proceed with your question.

Jon Block (Managing Director)

Thanks, guys. Good morning. Ron, maybe just going on a similar path, the high single-digit to low double-digit 2023 non-GAAP EBIT growth for the core business. Can you talk to how much that benefits from the restructuring, you know, in the back part of 2022? I know you guys usually do restructurings. This seems a little bit bigger than normal. You know, when we think about going forward, more importantly, is the high single-digit to low double-digit, you know, a good representation of the business longer term once the PPE COVID headwinds abate. Then maybe in the interest of time, I'll just ask both up front.

You know, Stanley, on the implant side of the dental specialties, I know you guys had a very difficult comp, but I think just maybe in the back part of 2023, implants might be flattish, call it, in Q1, 2022 year-over-year to throw a dart. Just would love your thoughts on how that compares, you know, to market growth and if you feel like you guys are still taking share there? Thanks for your time.

Ron South (SVP and CFO)

Yeah. You know, Jon, I think in terms of. I'll paraphrase your question and tell me if I have it wrong. It's really kind of the sustainability of continued growth in the high single to low double digits in the balance of the business. We do have some confidence there that we can continue with that. I think that you may be aware that we have an Investor Day coming up on February 27th, and we'll provide, you know, more kind of some, you know, kind of midterm assumptions at that point in time in terms of what we are expecting beyond 2023.

Yeah, we, you know, this is, you know, again, kind of partially driven by the, you know, the mix of the business and the, and the fact that we're growing some aspects of the business faster than others and whether it be in specialties or in technology. Does that answer your question?

Operator (participant)

The question there has dropped off. The next question comes from the line of Nathan Rich.

Stanley Bergman (Chairman of the Board and CEO)

Let me just respond quickly to the specialty products. The implants and bone regeneration products are doing very well. We're very pleased with our internal growth in that area. I think the Biotech acquisition will help. That business continues to be strong, particularly in our core markets, which is United States and Germany, a couple of the Germanic countries, and Japan. On the endo products, we're doing well. We continue also there, like in implants, bone regeneration, to believe we are gaining market share. The aligners are so small, but I think we will get a boost with the Biotech acquisition. We will have certain synergies that I think will help drive more sales, but it's a very small business.

Operator (participant)

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

Nathan Rich (VP in Global Investment Research)

Great. Thanks for the questions. I'll ask both upfront as well. Both are related to the intraoral scanner market. You know, Stanley, where would you say we are in the shift to lower priced products? Can you just go into a little bit more detail on kind of what you're expecting from that market in 2023? Do we start to maybe see some signs of stabilization just in terms of ASP and mix? Could you go into a little bit more details on the supply issues you mentioned from that one supplier, just in terms of, you know, when if you have any visibility into kind of when that would potentially resolve or just what you're looking for there and what's assumed in the outlook? Thank you.

Stanley Bergman (Chairman of the Board and CEO)

Yeah. On the iOS side, on the scanners, I don't think we've seen the bottom yet in terms of mix change. I think the pricing relative to particular manufacturers may have stabilized, but there are entrants into this market, that have very good products that perhaps we didn't even sell much of in the past, that we're now carrying and selling. It's more of a mix to lower priced products rather than deflation of a particular manufacturer's existing product. Although there could be some of that. By the way, I think we estimate about 20%-25% of dentists in the developed world have one of these devices, and we think that's going to be standard of care within the next two years. We're very optimistic about units in that area.

These newer entrants that we're working with are doing quite well with us. As it relates to the manufacturer that has a supply chain issue, it's not a public company. I can't talk about it. They have a new product. It's actually on the upper end that has done quite well. That just goes to a little bit of a contradiction to what I said early on. For manufacturers that have unique technology, there is a demand for paying more. That's not generally for the whole market. The whole market, the 75% of people that don't have a device, they're interested more in a lower-priced product that has enough features for them.

The one that's on backorder is on the higher end of features, and we don't expect that to resolve for three quarters.

Operator (participant)

We have time for one last question coming from the line of Kevin Caliendo with UBS. Please proceed with your question.

Kevin Caliendo (Managing Director)

Thanks, and thanks for taking my question. Can you quantify in any way the impact of the 3D printing that you called out in the release and on the call, like, in terms of numbers and market share and the like? Because I know you've talked about it in the past, but I think this is the first time you really called it out in a press release as impacting the business. Just as a follow-up to all this, and appreciate all the color on the inventories and the equipment and iOS and the like, but your backlog grew in 3 Q, and you-- I believe you said it grew sequentially through the quarter.

What is the expectation, for equipment sales and where does your backlog sit now, relative to where you were at the end of 3Q?

Stanley Bergman (Chairman of the Board and CEO)

Let me deal with the backlog first. It is in North America, similar to what it was at the end of the third quarter. I don't think much has changed. I can't give you the exact timing. A lot of that is the result of traditional equipment, but we seem to be topping up whatever we ship, and so that market seems to be quite strong. In Europe, it's dipped slightly, but we think that's to some extent because of the IDS, because people are holding back. We're dealing at the margin here, so it's not material. The bottom line is the backlogs are good in both North America and internationally, and the equipment is strong.

As it relates to mills, I would say the mill market has significantly come down, and I'm referring to, as I know, chairside mills. That's just not doing well. I'm not referring to lab mills. We are the largest provider of products to dental laboratories, and that market seems to be relatively strong. The switch to 3D printing is not occurring [1:1] yet. What's happening is there's a lot of dentists that are saying, "I need to find out more about this." I expect that over the next couple of quarters, our team will be out there educating dentists on the opportunity for 3D printing. I suspect it will result a little bit in mills going up again, because right now it's a situation where dentists want to understand more about what's going on.

3D printing is going to be important, but not substitute completely for chairside milling. The market has just, I think, come to a little bit of an educational stumble. I think the mills will come back again, but not to where they were. 3D printing is at a relatively early stage, but I think we're doing very well in terms of growing our global market share. The sales that are out there, 3D printing will improve as various materials come to market and as the aesthetics improve. I think the message is that digital restorations are a hot product. Dentists are interested in investing. Our job is to make sure that we educate the dentist on the appropriate device for their practice and then close on sales.

Kevin Caliendo (Managing Director)

Thanks. If I can ask Ron a really quick follow-up. I just wasn't sure if I heard. Is the guidance include or exclude Dental Biotech, and what was the impact of that?

Ron South (SVP and CFO)

The guidance does not include, Dental Biotech. I think that, when we put the release out on Dental Biotech, we said it would be slightly dilutive to 2023 when excluding amortization expense.

Kevin Caliendo (Managing Director)

Okay, great. Thank you.

Ron South (SVP and CFO)

Yes.

Stanley Bergman (Chairman of the Board and CEO)

Okay, everyone. Thank you very much for calling in. The message I think we want to communicate, I know we want to communicate, is that our core business is in good shape. We expect decent internal growth rates, local currency, of course, in 2023. We'll cover this in more detail at our Investor Day. Our operating income to continue to grow quite nicely, high single digits, low double digits. Bottom line is, the business is in good shape in markets that are doing well. There are nuances that need to be understood. We're happy to deal with that in further detail at the Investor Day. If anyone wants to reach out to Graham, on the investor relations side, he'd be happy to provide further clarity on our remarks.

Thank you very much, and hopefully we'll see everyone on the call in our Investor Day in New York City, the following week. Thank you very much.

Operator (participant)

This concludes today's teleconference. You may disconnect your lines at this time. Thank you for your participation, and have a great day.