Henry Schein Inc (HSIC) — Q2 2023 Earnings Call Transcript

Thank you, Operator. And my thanks to each of you for joining us to discuss Henry Schein’s financial results for the second quarter of 2023. 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’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 Factors section of those filings. In addition, all comments about the market we serve, including end market growth rates and market share are based upon the company’s internal analysis and estimates. Today’s remarks will include both GAAP and non-GAAP financial results. We believe the non-GAAP financial measures provide investors with useful supplemental information about the financial performance of our business, enable the comparison of financial results between periods where certain items may vary independently of business performance and allow for greater transparency with respect to key metrics used by management in operating our business. These non-GAAP financial measures are presented solely for informational and comparative purposes and should not be regarded as a replacement for corresponding GAAP measures. Reconciliations between GAAP and non-GAAP measures are included in Exhibit B of today’s press release and can be found in the Financial and Filings section of our Investor Relations website under the Supplemental Information heading. For additional financial information, please refer to our quarterly earnings presentation also posted on our Investor Relations website. The content of this conference call contains answers to information that is accurate only as of the date of this live broadcast, August 7, 2023. Henry Schein undertakes no obligation to revise or update any forward-looking statements to reflect events or circumstances after the date of this call. Lastly, during the 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 for joining us today. We are reporting solid results for the second quarter, driven by our North American dental businesses with strong equipment and steady general merchandise sales, along with continued strength in sales of our technology and value-added services, including implants, biomaterials, and endodontic products. The underlying fundamentals in the U.S. dental market remain strong, and demand for dental services and customer confidence continues to improve, as evidenced by the ongoing investments our customers are making in their practices. Additionally, we are seeing growing demand for our implant systems, endodontic products, and integrated software and services solutions, which are generating strong growth by providing greater efficiency and a better experience for our customers. In the alternate care market, elective procedures are approaching normal levels, although second quarter visits to primary care physicians were down year-over-year, reflecting last year’s higher visits due to an extended flu season. As expected, sales of PPE and COVID test kits continue to decline; however, we are seeing these sales level off sequentially, and we expect the year-on-year impact to be much lower in the second half of 2023. When excluding these product categories, local currency internal sales growth for the company was 3.3%. Generally, our North American dental business performed better than expected at the start of the year, offset by some incremental COVID-related challenges facing our medical business. Our outlook reflects overall confidence in our business and the markets we serve, and we are affirming our non-GAAP diluted EPS financial guidance for 2023. Our financial results and guidance demonstrate the strength of the business and the advancement of our 2022-2024 BOLD+1 Strategic Plan. We are successfully executing key initiatives in the plan, including expanding our specialty products and value-added services portfolio, optimizing our distribution businesses, leveraging key customer relationships, and driving digital transformation. Year-to-date, we have committed over $1 billion to acquisitions that accelerate the implementation of our strategic plan, adding high growth, high margin products and services to our offerings. With this clear focus, we believe we are well positioned to enhance Henry Schein’s leadership in the markets we serve and to deliver long-term sustainable shareholder value. Among the larger transactions are our strategic partnership with Biotech Dental, which we closed in April, the acquisition of S.I.N. Implant System, which we closed in July, and the recently announced acquisitions of Shield Healthcare and Large Practice Sales, which we expect to close in the third quarter. These transactions significantly expand our implant, bone regeneration, and clear aligner product portfolio, digital workflow capabilities, and presence in distributing products directly to patients in the homecare arena, along with value-added services. Continuing our strategy of following the patient to provide healthcare services where it’s being delivered, we expect our recently announced agreement to acquire Shield will create an offering with more than $300 million in annual revenue that distributes medical supplies across the United States directly to patients at home. Once completed, this business will be led by Adam Hughes, who joined Henry Schein as Vice President, General Manager of Homecare Medical Products, and has significant experience in this area. We are enthusiastic about the fundamentals of this market, which supports a growing aging demographic facing more chronic diseases. Beyond added convenience for the patient, the trend of moving care to their home is expected to provide efficiency in the overall healthcare system. Importantly, many of our customers have requested us to provide this service. We have been offering it moderately until now, but we are committed to advancing our position in this market to support our customers who have asked us to enter the homecare arena as part of a continuum of care. Our homecare medical product offering will now include enteral, ostomy, incontinence, wound care, and diabetes products, and we plan to leverage our physician relationships, product distribution expertise, and corporate brand assortment to grow this area further. For many years, we have had a successful practice transitions group dedicated to existing smaller and midsized dental practices. I am particularly excited about the acquisition of Large Practice Sales, a leading transition advisory services business, which expands our capacity to advise dental practices on larger practice transitions, serving our DSO customers. We are also integrating our dental digital workflow software with our practice management software to create a unique digital solution for dental practitioners. To oversee this, we have appointed Andrea Albertini, CEO of our International Distribution Group, to lead the cross-company One Schein solution and accelerate our three-click integrated software solution for our customers. This simplified open architecture process begins with capturing any image from an intraoral scanner or 2D/3D Digital Imaging unit through our practice management software, followed by applying embedded artificial intelligence solutions for diagnosis, case acceptance, planning, and design, concluding with a direct connection to fabricate the prosthetic through milling, a 3D printer, or sending the digital file to the dental lab. Now, let’s review the quarterly highlights from each business unit, starting with dental distribution. In North America, dental offices were generally busy, aiding our second quarter dental merchandise growth, excluding PPE products. A major driver in equipment sales was our broad offerings, which enabled our customers to increase productivity to meet demand and enhance practice efficiency and clinical care. North American dental equipment sales were up significantly; traditional equipment sales remained strong, and we are pleased to report that sales of digital equipment returned to growth this quarter. International equipment sales were flat compared to last year. The equipment backlog in North America has remained steady, and our international equipment backlog is returning to pre-pandemic levels. Now, looking at our dental specialties, sales of dental implants and biomaterials were key contributors in the second quarter, complemented by endodontics and clear aligner business. We’re seeing increased implant demand in North America, with sales of our BioHorizons Camlog premium implant delivering mid-single-digit growth, an improvement over the first quarter. Internationally, demand for implant systems is still strong, generally favoring value-priced products. Our Camlog offering is well-positioned to meet this demand shift, reflected in the double-digit growth from our Medentis provider of dental implants and bone regeneration products. Recent transactions, including our deal with Biotech Dental, bring a leading portfolio of dental implants and clear aligners to Henry Schein, along with digital workflow software. Similarly, our transaction with S.I.N. Implant Systems provides entry into the large Brazilian implant market and complements our successful Brazilian general dental consumables and equipment business. Both Biotech and S.I.N. provide high-quality implants at attractive prices, with exciting opportunities to expand these cost-competitive products into other regions, including the United States, enhancing our competitiveness in the implant and bone regeneration space. This quarter, growth in our endodontic business continued, driven by our Brasseler and Edge brands in both North America and internationally. Our orthodontic business is making steady progress with our aligner business, which, while still a small component of our global revenues, is growing. We are witnessing increased demand for our specialty products from DSOs, particularly among our DSO customers, where we hold a significant market share. There is a continued adoption of specialty procedures among dental practitioners, and we've grown our global implant bone regeneration and related products and services into over $800 million in revenue, with our specialty products nearing $1.2 billion in revenue collectively on an annualized basis. We now offer a broad selection of premium and value alternatives to North American and international practitioners. We expect dental specialty growth to accelerate in the second half of the year due to these acquisitions and easing year-over-year comparisons. Next, let’s turn to the technology and value-added services business, the largest component of which is Henry Schein One. Global growth in Henry Schein One is driven by the ongoing migration to our cloud-based practice management software solutions, Dentrix Ascend and Dentally, and growth in our revenue cycle management business as increased patient traffic boosts e-claims volumes. Dentrix Ascend and Dentally have grown to about 7,000 customers, representing approximately 40% year-over-year growth. Customers are particularly enthusiastic about incorporating our artificial intelligence solution into their practice management software. We believe our embedded solution is best-in-class. We have grown our technology and value-added services businesses into a nearly $900 million revenue portfolio on an annualized basis. In addition to Henry Schein One’s technology solutions, we also offer a wide range of value-added services through businesses such as eAssist, which provides revenue cycle management, and Unitas, which advises on PPO agreements with insurance providers, along with other services including financial services, practice transitions, staffing services, education, and remote patient monitoring for dental and medical practitioners. We expect sales growth in technology and value-added services to accelerate during the second half of the year. Turning to the medical business, our medical sector achieved low single-digit growth in the second quarter, excluding PPE products and COVID-19 test kits, compared to mid-double-digit growth last year. This year saw a more typical flu season, resulting in much lower sales of flu, COVID-19, and multi-assay diagnostics and related products. Sales growth was also impacted by the shift of certain pharmaceuticals and related products to lower-priced generics and corporate brands with a higher gross profit margin, a trend across healthcare. Medical equipment sales remained relatively soft in the market, which temporarily paused to assess future demand. However, investment interest has returned as of July. In summary, the fundamentals of our core business remain solid and the team is effectively executing our 2022-2024 BOLD+1 Strategic Plan. I will now turn the call over to Ron to discuss specifics regarding our quarterly financial results and provide full-year guidance. Thank you. Ron, please.

Thank you, Stanley, and good morning, everyone. I will be discussing our results as reported on a GAAP basis and also on a non-GAAP basis. Our second quarter non-GAAP financial results for 2023 and 2022 exclude integration and restructuring costs and amortization expense of acquired intangible assets. This is detailed in Exhibit B of today’s press release. With respect to sales growth, I will focus on LCI sales growth, which is internally generated sales in local currencies compared to the prior year and excludes acquisitions. Second quarter global sales were $3.1 billion, or an LCI sales decrease of 0.2%. However, when excluding sales of PPE products and COVID-19 test kits, our LCI sales grew 3.3%. We sold $138 million in PPE products in the second quarter of this year, a decrease of approximately 28% year-over-year, and we sold $26 million in COVID-19 test kits, a decrease of approximately 62% year-over-year. Our GAAP operating margin for the second quarter of 2023 was 6.5%, an 81-basis-point decline compared with the prior year GAAP operating margin. On a non-GAAP basis, the operating margin for the second quarter was 8.2%, a 14-basis-point decline compared with the prior year non-GAAP operating margin. Excluding the impact from lower PPE and COVID-19 test kit sales, we estimate that non-GAAP operating margin expanded 27 basis points. Second quarter 2023 GAAP net income was $140 million, or $1.06 per diluted share. This compares with prior year GAAP net income of $160 million, or $1.16 per diluted share. Our second quarter 2023 non-GAAP net income was $173 million, or $1.31 per diluted share. This compares with prior year non-GAAP net income of $179 million, or $1.30 per diluted share. These results were impacted by a decreased contribution from lower PPE and COVID-19 test kit sales, estimated to be $0.08 per diluted share relative to the prior year period. The foreign currency exchange impact on our second quarter EPS was immaterial. As Stanley mentioned, we have committed over $1 billion in the acquisitions we have announced so far this year, with $250 million invested in equity investments and business acquisitions in the second quarter of this year, and we have subsequently signed agreements committing another $800 million. The increased capital deployment for acquisitions has impacted quarterly financial results more than in previous years. The second quarter 2023 GAAP and non-GAAP financial results included high acquisition activity that resulted in acquisition expenses of $6 million, or $0.04 per diluted share, which were offset by net acquisition related fair value adjustments of $16 million, or $0.09 per diluted share, including a related re-measurement gain resulting from the purchase of a controlling interest of a previously held equity investment. This resulted in a net favorable impact of $10 million, or $0.05 per diluted share for the quarter, as illustrated in Exhibit C to our press release. On a year-to-date basis, the favorable net impact of these acquisition expenses and acquisition-related fair value adjustments, including the related re-measurement gain resulting from the purchase of a controlling interest of a previously held equity investment was only $0.01 per diluted share. We are confident that these strategic investments will drive enhanced growth and value creation over the long term as we accelerate the implementation of our 2022-2024 BOLD+1 Strategic Plan. Turning to our second quarter sales results. Global dental sales were $2.0 billion and LCI sales increased by 2.0%. Excluding sales of PPE products, LCI sales growth was 3.7%. Global dental merchandise LCI sales increased by 0.7%, but increased by 2.8% when excluding PPE products. North America dental merchandise sales were flat compared to the prior year and grew 2.6% when excluding sales of PPE products, with good underlying growth offset by lower growth in our dental lab business as a result of digitalization and in our traditional orthodontics business. International dental merchandise LCI sales increased by 1.9% and by 3.2% when excluding sales of PPE products. Global dental equipment LCI growth was 6.4%. Our North America dental equipment LCI sales increased 9.8% as we continue to see strong sales growth for traditional equipment, and sales of digital equipment in North America returned to growth. International equipment LCI sales increased by 1.6%. Dental specialty products, including implants, bone regeneration materials, orthodontic products, and endodontic products, saw sales of approximately $270 million in the second quarter, with growth of 15.7% driven by acquisitions and good implant sales in both North America and internationally, particularly in Austria, Switzerland, and Germany, where we have a leading market position. Global technology and value-added services sales during the second quarter were $193 million, with LCI growth of 5.5%. Sales were again negatively impacted by a government contract that expired early in the third quarter of 2022. LCI sales growth was 6.9% when adjusting for this contract. In North America, sales growth was driven primarily by our Dentrix Ascend, practice management and revenue cycle management businesses. Growth internationally was driven by our Dentally cloud-based solution. Global medical sales during the second quarter were $950 million, and LCI sales decreased 5.3% 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 2.0% and were impacted by lower flu cases versus the prior year, which resulted in lower point-of-care diagnostic tests and related product sales. Keep in mind, this was against a very difficult comparison as LCI growth, excluding PPE products and COVID-19 test kits, grew 14.3% in the second quarter of 2022. Regarding stock repurchases, we repurchased approximately 638,000 shares of common stock in the open market during the second quarter, buying at an average price of $78.36 per share for a total of $50 million. At quarter end, we had approximately $365 million authorized and available for future stock repurchases. Turning to our balance sheet and cash flow. We continue to benefit from significant liquidity, providing our businesses with the financial flexibility and stability to execute on organic growth initiatives and strategic acquisitions, while continuing to return capital to our stockholders. We further strengthened our balance sheet by recently extending the maturity date of our $1 billion revolving credit facility to July of 2028 and also closed on a new $750 million credit facility. Operating cash flow for the second quarter was $274 million, compared with $157 million last year, primarily as a result of lowering inventory levels. Restructuring expenses in the second quarter were $18 million, or $0.10 per diluted share, and were incurred as part of our previously disclosed restructuring initiative. These expenses mainly relate to severance benefits and costs related to exiting facilities. We now expect restructuring activities to extend through 2024. Let me conclude my remarks with our 2023 financial guidance. At this time, we are still unable to provide estimates for costs associated with integration and restructuring for 2023; therefore, we are not providing GAAP guidance. We are affirming our guidance for 2023 non-GAAP diluted EPS attributable to Henry Schein, Inc. of $5.18 per share to $5.35 per share, which is down 1% to 4% compared with our 2022 non-GAAP diluted EPS of $5.38, and includes the previously announced $0.05 to $0.10 dilution from 2023 acquisitions, which is consistent with our prior guidance and has been updated to include second quarter results and the impact of all acquisitions announced so far. The net impact of acquisition expenses and acquisition-related fair value adjustments, including the related re-measurement gain resulting from the purchase of a controlling interest of a previously held equity investment, is expected to be insignificant for 2023 and has been included in guidance. We expect these acquisitions to contribute to earnings growth beginning in 2024. It is important to recognize that we expect year-over-year growth in diluted EPS to be higher in the fourth quarter than in the third quarter of this year. Our guidance for 2023 assumes total sales growth of approximately 1% to 3% over 2022. As a reminder, our guidance reflects one less selling week in 2023 than 2022. Our sales growth reflects a larger decline in sales of COVID-19 test kits, which we now expect to decrease by approximately 70% to 80% from 2022 versus our previous guidance of a 65% to 70% decrease. Additionally, PPE product sales are expected to decrease about 25% to 30% versus our previous guidance of a decrease of 20% to 25%. Despite the expected lower PPE and COVID-19 test kit sales, the impact on 2023 non-GAAP diluted EPS from PPE products and COVID-19 test kits is still estimated to be $0.35 per share to $0.40 per share due to higher-than-anticipated gross margins on PPE sales relative to our original guidance. We are driving strong earnings momentum in our underlying core businesses and we still expect non-GAAP operating income to grow in the high single-digit to low double-digit range when excluding the contribution from PPE products and COVID-19 test kit sales. We continue to expect non-GAAP operating margin contraction of 10 to 15 basis points from the 2022 non-GAAP operating margin of 8.2%, which was largely a result of lower PPE products and COVID-19 test kit sales and profits. Our guidance reflects non-GAAP operating margin expansion when excluding income from PPE products and COVID-19 test kit sales. Our 2023 guidance includes higher interest expense than in 2022 due to higher interest rates and borrowing levels. We also expect an effective tax rate for the year in the 23% range, assuming no changes in tax legislation. Our guidance is for current continuing operations as well as acquisitions that have been announced and does not include the impact of future share repurchases and potential future acquisitions. Guidance also assumes that foreign currency exchange rates are generally consistent with current levels and that end markets remain consistent with current market conditions. With that, I will now turn the call back to Stanley.

Thank you, Ron. We are here to answer any questions which investors may have. So, Operator?

Hi everyone. Thank you for the question. I have one short-term question and one long-term question. Regarding the short-term question, the fair value adjustment was new this quarter, and I want to clarify whether this was known last quarter when you updated your guidance or if it caused a downward adjustment in guidance. For my long-term question, it's interesting to see the addition of new capabilities and geographies. How do we view the timeline for S.I.N. and plans to introduce those implants in the United States? Additionally, how do you plan to expand the new medical products across your portfolio? Thank you.

Certainly, Elizabeth, I will take the first question and Stanley will respond to your second question. So the re-measurement gain was something we contemplated in our guidance. We didn’t have a definite amount for it, just like we weren’t sure how much our acquisition costs were going to be either. So, ultimately, as we have kind of demonstrated in that exhibit to the press release, those amounts once we realized the higher expenses and we also realized the net re-measurement gain have largely offset on a year-to-date basis. So, yes, our guidance does contemplate the effect of those items. And Stanley, if you want to take the second question.

Thank you. The S.I.N. Implants, while not the entire product line, are a significant part of our approved portfolio in the U.S. and are starting to gain traction with our DSO customers. Last week, we secured a solid DSO that’s interested in the S.I.N. Implant System. This transaction enhances our competitive position, as we were previously missing a more economical option in our implant offerings. Now, with the S.I.N. line, we are well-equipped, and I believe we will also launch the Biotech line in the U.S. within the next year. Although these target different market segments, we are certainly in a strong competitive position and are already beginning to see sales growth.

Very helpful. Regarding Shield, does that follow a similar timeline, and could you incorporate it into your broader portfolio later this year, or should we consider it more of a 2024 development?

No. I think we acquired Prism about a year or so ago or two years ago, which was mostly an East Coast business with a relatively limited portfolio. Shield puts us into the West Coast with a broader portfolio. And Shield was missing the wound care offering that Prism had. So we believe we will create synergies relatively quickly. There are costs, of course, on the integration, which we have taken into account in our guidance, mostly one-time costs. But I think in 2024, we should be able to start adding accretion in a nice way. This has really been an area that our customers, our big IDN customers have wanted us to perform, and we didn’t undertake these kinds of services. We have one IDN in New York that we service in the homecare area, but we didn’t really have the full capabilities. Between these two acquisitions and another small one which we hope to announce soon, we will have a pretty good offering in products for the home and it will be a great extension to our physician and urgent care business.

Hi, everyone. Thanks for taking the question. Maybe first on one high-level question just on the macro backdrop. Can you guys talk about where you are seeing some strengths and weaknesses in the environment today? I think maybe equipment looked pretty strong in the U.S., but maybe a little weaker internationally and then consumables globally looked kind of stable low single digits. So curious how all these segments on the dental side are playing out from the macro side?

Yes. Thanks for that question. On the macro side in North America, I believe there is stability in the dental side. That’s what our team believes in general. Consumables, patients are returning to the dental office if data is not perfect. But if you look at the latest ADA survey and some recent analyst reports and studies, it suggested that patient traffic picked up throughout the second quarter after the steady volumes in the first quarter of 2023. July, from our point of view, was a good month. Our e-claims data also suggests that, what I have just described is backed up again by e-claims data from Henry Schein One. If you peel on in a little bit further, at least from our point of view, implant sales continue to grow well in North America, same for endodontics. Our small aligner business is showing similar trends. If you look at international, it’s slightly more tepid. It’s hard to tell, because we are now in the summer months when Europe is largely closed. Having said that, we did suffer in the second quarter because of the strikes in France. I would say Germany is okay. We had pretty strong numbers in 2022 from a comp point of view because we had the trade-in the second quarter of 2022. Patient traffic in Germany, which is our biggest market outside of the U.S., seems to be steady. There is somewhat of a staff shortage. But again, it’s really hard to tell. This is the vacation month now, July and August, and it’s very hard to tell exactly what is happening in Europe, especially Germany. But from our checks, it’s pretty steady. We don’t see much of a deterioration at all. In fact, it could be on the positive side. So, generally, dental and medical are okay. On the medical side, a little bit more cautious. We did have high comps last year, almost 15% growth. So the medical is not going to present that kind of growth going forward. There is some trading to more generic products, specifically on the pharmaceutical side. It doesn’t impact the absolute dollar profits. But I think medical is at least with the ASC business is back to where it was before COVID. If you take out the unusual visits experienced in the first half of last year because of flu, I think medical is stable as well. I think on the other hand, our market share is growing. On the specialty products side, again, we don’t see any major impact from the units’ point of view. It is trading to lower priced products specifically from our DSO customers. But in general, our markets are stable, and I think we are quite comfortable at this moment. Our backlog on equipment year-on-year in North America is pleasing, similar to where it was at the end of last quarter, and on the international side, is building up again to pre-COVID levels. So I would say, stability all around would be our view at this moment. Thank you.

Thank you very much. I have a quick question for Ron. Could you clarify what the EPS growth is for 2023? I want to ensure we understand the underlying dynamics as we consider our 2024 models, particularly regarding the potential stabilization of PPE and COVID sales and a return to more normalized growth rates. Thank you.

Yeah. Our full-year guidance is still $5.18 to $5.35, and that includes an expected $0.35 to $0.40 headwind versus the prior year impact on EPS from contributions from PPE sales and COVID-19 test kit sales. That remains unchanged from a guidance standpoint. While we have adjusted some of our revenue assumptions on those products because of the better-than-expected margins on the PPE sales, we haven’t had to adjust the $0.35 to $0.40 expected headwind that was built into our original guidance.

Thank you. Good morning, guys. Stanley, maybe I would like to dig a little deeper on your North American comments. Consumables, you described that market as fairly stable, I think that fits with a lot of our survey data as well. The consumables number, though, did come down to 2.5% on an organic basis excluding PPE this quarter; last quarter it was 6.5%. Do you think that’s just the comps from the Omicron stuff in the first quarter last year that really helped inflate that first quarter number? Was there any change in the pricing dynamics? Any other factors kind of bridging from the 6.5% first quarter to the 2.5% consumables this quarter? Thanks.

Thanks for the question, Jeff. To understand the situation, we should look at the fourth quarter of 2022 and the first quarter of 2023 and average them out, considering the cut-offs. The first quarter leans slightly higher, reflecting a 6.5% growth on a comparable basis, which we've mentioned before. It's worth noting that inflation in the dental consumable sector has moderated. While some individual products from certain brands have increased in price, these increases aren't necessarily consistent across the board, as manufacturers cannot always sustain higher prices. Additionally, there is a trend towards corporate and generic brands doing well, with some smaller brands even reducing their prices. Therefore, assessing the mix accurately on a quarterly basis can be challenging. We should consider the fourth quarter cut-offs of 2022 and recognize that there has generally been some deflation in merchandise prices. This trend seems particularly noticeable among larger and mid-sized dental service organizations, who are now much more informed consumers than before. This does not significantly affect our margins relative to the DSOs. There’s a lot of complexity in this situation. We'll need to see how things unfold in the third and fourth quarters, but I believe the trend I described is likely to remain consistent.

Is there more deflation expected, or have we reached a point where we can maintain stability? Also, regarding the non-recurring items, the $0.05 to $0.10 dilution remains the same based on the gross amount. You mentioned that the net impact from acquisition activity will be roughly flat this year. If you had provided that net guidance last quarter, would it have also been flat? Essentially, you're not altering your gross or net acquisition guidance for the year, correct? I just want to clarify that.

Jeff, it’s difficult to determine the exact impact of deflation, whether it will be through price reductions on specific branded products or a shift to generic options or different manufacturers for certain products. I suspect we might see a swing in the range of 100 to 200 basis points, but I don’t expect it to deviate much from that. Therefore, I don’t anticipate significant inflation in the dental consumable sector. There might be a slight decline towards deflation, but we are within that margin. Unit sales are fairly stable. From our perspective, we are expanding our specialty business, but this growth doesn’t materially affect the total sales of dental consumables since it is not significant compared to the overall consumable offerings. That said, specialty products are positively influencing our margins, along with our corporate brands and some smaller manufacturers.

And Jeff, to answer the second part of your question, the $0.05 to $0.10 that we referred to after the first quarter when we amended guidance was specific reference to the expected dilutive effect during the year from biotech. We are holding that $0.05 to $0.10, but it now is for all the acquisitions that we have announced so far this year. Apart from that, we have higher-than-expected acquisition expenses, which are largely offset by the re-measurement gain that we recorded in the second quarter as well. We kind of have set those aside, and that was the purpose of Exhibit C to the press release so people could see the components of that, and we are holding to the $0.05 to $0.10 of dilution, but now it captures all of the acquisitions that have been announced to date.

Good morning. Thank you for the question. I would like to follow up on what Jeff was discussing, but first, Ron, regarding gross margins, they remain at multi-year highs despite some inventory step-up costs associated with the Biotech Dental acquisition. Could you provide an estimate of how much the inventory step-up impacted the quarter's gross margin and earnings? Additionally, considering the dilutive S.I.N. transaction and your updated guidance, could you share some insights on the expected dilution from that deal? Is it just a few cents, a nickel, or a dime? Any details would be appreciated.

I will start with the quantifiable one first. The step-up charge that we have and it will be disclosed in the 10-Q as well, in the second quarter for Biotech was $2 million. So not a real significant effect on gross margin. In terms of S.I.N, it is absorbed within that $0.05 to $0.10. There’s also going to be a step-up on S.I.N, but they don’t turn their inventory as quickly. So we don’t expect it to have as dramatic of an effect quarter-to-quarter. S.I.N without kind of disclosing the modeled dilution on that, I can tell you that it is absorbed within that $0.05 to $0.10.

Okay. And then on the $2 million, I guess, just a quick follow-up there. Is that $2 million steady as we go forward for the next quarter or two for Q3 and Q4? Or does that need to move higher as we think about how to model gross margins for the back half of the year?

Biotech churns our inventory about twice a year. We have about another quarter of that inventory increase left, which will add another $2 million in Q3, after which we will be able to move on from that.

Got it. Perfect. And then as we think about the composition of the equipment backlog, you mentioned it’s holding steady, but it sounds like maybe that’s starting to shift back towards high-tech equipment. Could you drill down into what areas of high-tech you are seeing that recovery leading? I would assume it’s mostly in iOS. But just wondering if you are starting to see any better results on the digital imaging or anything on the milling or 3D printing side that’s maybe influencing some of your comments today?

We are very pleased with the growth in our equipment. In North America, we saw an equipment growth of 9.8% on an LCI basis, which is quite significant given the current environment. Traditional high-tech equipment growth was even higher at 14.6%, despite no changes in our backlog, which has remained constant from the start to the end of the quarter. This strongly indicates continued high demand for traditional equipment. On the high-tech side, we are experiencing some challenges with scanners mainly due to pricing issues. While scanner prices are favorable, revenue has declined. Digital restoration sales are down 12.1%, and scanner revenue has decreased 40% year-over-year, primarily for pricing reasons. Nonetheless, we did see slight growth in high-tech equipment, albeit modest, thanks to progress across various categories. This includes some growth in mills and 3D printing, all contributing positively to our results.

Great. Thanks, guys. Good morning. Maybe just the first question on dental specialties. I think the reported was up 15.7%. I don’t know if I missed it, but do you have a precise internal number for that division? And then just to go a little bit further down the road, how implant growth shook out within whatever that internal number was? Was it above overall internal below? And just maybe your thoughts on ongoing share gains or implant share gains, pardon me, now that you have got some of those investments in the more robust implant portfolio to work with going forward? And then I will ask a shorter follow-up.

Certainly, with regard to our specialty growth, we have chosen to maintain our focus on total sales growth to align with the message we communicated during our Investor Day. Therefore, we are concentrating on total sales growth rather than just LCI sales growth, as we believe it better represents our strategy for that product portfolio. We remain very optimistic about implant sales, having seen growth both in North America and internationally for implant systems. Endodontic sales in the specialty segment continue to be strong for us, both domestically and abroad. Stanley, do you have anything to add regarding the specialty segment?

Thank you for the question, Jon. In North America, our BioHorizons Camlog premium implants achieved mid-single-digit growth, which is an improvement from the first quarter, and they are priced slightly lower than our competitors. Internationally, demand for implants is strong, although we have a small presence in China. Overall, the demand for dental implants tends to favor lower-priced options, but we performed well in Germany, Austria, and Switzerland, which are our largest markets. Medentis also had a good performance in Germany at the lower price point. We are very optimistic about our growth in the implant business. It's difficult to assess our performance relative to others, as the association's data on premium implant sales for the second quarter isn't available yet. However, I believe we have gained market share in both units and revenue. Regarding our competitiveness, we have been lacking in the lower-end segment in North America, but I am confident that S.I.N will enhance our competitiveness, especially with large and mid-sized dental service organizations.

That was helpful. Thank you. I'll try to ask a brief second question. For the medical division, excluding PPE and COVID, there was a 2% increase. I understand that the flu had a year-over-year impact, but in the last few quarters, it has fallen a bit short of our expectations. You mentioned long-term perspectives during the Analyst Day, but in the short term, how should we consider this division for the remainder of 2023? You are still dealing with a couple of comparisons, but could you share your views on how you see it progressing for the rest of the year, again excluding PPE and COVID? Thanks.

Yeah. It’s very hard to give you specifics. I think we are doing well in terms of units with our existing customers. We are gaining customers. But the whole area of visits unrelated to steady visits relative to urgent care centers and normal type medical visits is hard to gauge because of the impact of the seasonality of flu. We sell quite a bit of flu-related products, be it the test or the related products that go with the test. At the moment, it seems pretty steady. I wouldn’t want to say this in the wrong way, but COVID is growing a little bit. So people are going more to the physician's offices to check things out. So July was a lot better. But you can’t draw conclusions. There was a lull in equipment sales. We had good inquiries in July. But it’s hard to give you a specific number. The impact of generic pharmaceuticals is quite a bit on the injectable side, not the vaccine side. We don’t sell many tablets and capsules, not our business. So overall, it’s a good business, and whether it’s 3% or 5% or 6%, I don’t think that impacts the overall profitability in a meaningful way. There are many puts and takes in our medical business. But we feel very good about our medical business and continue to believe that on a unit basis we are growing market share.

Great. Thanks for fitting me in at the end. I will ask both upfront. First, I wanted to go back to the commentary around traditional equipment and the equipment backlog in North America stabilizing. It has obviously been coming down, I think, as we cycle through some of the supply constraints. I’d just be curious about the outlook for demand, though, how you are thinking about that over the balance of the year and what you are seeing with respect to kind of practice formation and remodels just in the current environment that we are in? And then, Ron, maybe a clarification on the margins, any commentary on the margin outlook between Q3 and Q4, I guess, especially as it relates to potential timing of acquisition and expenses between those two quarters? Thank you.

So, Nathan, regarding the equipment, I think demand is good and consistent. Some of the larger Dental Service Organizations (DSOs) are continuing to invest. There may have been a brief pause a few months back when some DSOs, possibly with high leverage, were assessing whether they should proceed with investments. However, there is a clear demand for dental care, and I see our larger DSOs expanding. A couple of them faced operational challenges, but I believe those issues are largely resolved, and they are now investing. I'm referring to both the largest and mid-sized DSOs, and while smaller practitioners are not seeing as much growth, overall, there is a steady demand for traditional equipment. On the digital front, DI scanner units are increasing. Although there is a shift toward lower-priced units, there has not been significant discounting of specific units. It's important to acknowledge the high comparison we faced in the DI sector last year, which we mentioned in our call. Regarding mills, demand remains steady; it may not be as strong as before, but there has been some trade-up activity. 3D printing is gaining traction again. Overall, our performance indicates that we are a significant player in the dental lab market, where there is a shift from consumables to digital solutions. This transition is also impacting consumable sales, leading to a rise in equipment sales. I think our equipment backlog in the United States, which is comparable to last quarter's figures, reflects dentists' commitment to investing in their practices to enhance efficiency and deliver improved digital results. A good indicator of this is the investment in AI, particularly related to our Henry Schein One software, which incorporates AI that is seeing growth in units sold. This all aligns with practitioners' willingness to invest in their operations. Therefore, I view the market as stable to growing. Internationally, the situation is more complex due to varying issues across countries. In places like Germany, where there is significant government support, it appears stable, even though there is a shortage of dentists. We hope France resolves its issues after Labor Day. Other markets are stable as well. Australia has shown some growth due to recently introduced incentives, while Brazil and Canada remain stable. In summary, the dental markets appear to be solid and stable overall.

Nathan, I want to add a point about the backlog. As I mentioned earlier, our backlog in North America has remained relatively stable throughout the quarter, and we have seen strong sales growth. Honestly, I would prefer that backlog to decrease, not only for the revenue boost it would provide but also for our customers, as reducing the backlog would mean faster equipment delivery and ultimately enhance capacity in the end market, particularly for new equipment rather than just replacements. Currently, our backlog in North America remains consistent. Regarding your question about Q3 and Q4 margins, I believe we can maintain our current gross margin levels. This reflects the increasing significance of our dental specialty products within our overall offerings, along with growth in our technology segment. I anticipate we can sustain this as we move into the latter half of the year. That said, we have a diverse portfolio, and various factors can influence this. For instance, Q4 tends to have higher equipment sales compared to other quarters, and these sales usually come at slightly lower margins than our current overall margin. While this may slightly reduce margins, we will gladly accept it for the additional sales. My general expectation is that we will be able to maintain the margins we've achieved in the first half of the year into the second half.

Thank you all for your time today. We appreciate everyone joining us. We are very pleased with our progress in the business, including our core, specialty, and software sectors. The markets are stable, with some fluctuations, but overall we feel secure about our current position. We have reaffirmed our guidance. I apologize for any confusion caused by the complexities surrounding PPE, testing, acquisitions, expenses, and related income. We aim to clarify these points for our investors and simplify things for the rest of the year. Next year should be more straightforward, and we believe our confidence in the business will be validated. Thank you for tuning in; Graham and Ron will be available to discuss with investors in the coming days. We remain optimistic about our team and appreciate their hard work as we transition out of COVID and implement our strategic plan. Thank you again, and enjoy the rest of your summer.