Henry Schein Inc (HSIC) — Q3 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 third quarter 2023. With me on today's call 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 on 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 Financials 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 time-sensitive information that is accurate only as of the date of the live broadcast, November 13, 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 today's Q&A session, please limit yourself to a single question and a follow-up. And with that, I'd like to turn the call over to Stanley Bergman.

Thank you, Graham. Good morning, everyone, and thank you for joining us. Before reviewing our third quarter performance, I'd like to update investors on the cybersecurity incident that was discovered on Saturday, October 14, primarily affecting some of our distribution businesses. That morning, we initiated our business continuity plan when we promptly took precautionary actions, including taking certain systems offline and other steps intended to contain the incident, which led to temporary disruption of some of our operations. The following week, our distribution centers were processing orders with temporary interim processes and were generally delivering orders to customers within one to two business days. In accordance with our business continuity plan, we activated a previously identified team of leading cybersecurity experts to assist in the investigation and recovery of the systems and to advise us through the recovery process. Over the past weeks, we have worked to create a clean network in a controlled manner from the backup data we maintained. Our distribution businesses are now operational and we are initiating our e-commerce platform early this week, and we're indeed hopeful that the website will come up tomorrow morning. We've also made significant progress resuming the high levels of service our customers expect from us. Over the last week, orders from our distribution businesses were approximately 85% to 90% of what they were pre-incident. We expect orders to increase with the reactivation of our e-commerce platform. Of course, our field sales consultants and telesales representatives have deep relationships with our customers, and our complementary software and other value-added services bring value that we believe continues to make us the best choice for our customers in the areas of services we provide. As a reminder, this incident mostly affected the operations of our North American and European dental and medical distribution businesses. Our distribution operations in Australia, New Zealand, Asia, and Brazil were generally not affected. Henry Schein One, our practice management software, revenue cycle management, and patient relationship management business was not affected. Our manufacturing businesses and our equipment sales and service operations were mostly unaffected. We are now aware that a significant amount of information was obtained by an unauthorized third party in the cybersecurity incident. Bank account information for a limited number of suppliers was misused, and we have already separately addressed this with those impacted. More details have been posted on our Investor Relations website. We are continuing our investigation of the cybersecurity incident. In a moment, Ron will speak about the financial impact of the cybersecurity incident, which will affect our fourth quarter financial results. I would like to extend a heartfelt thanks to our customers as well as our suppliers and team members for their patience and the incredible support we've received from all of our constituents during this period. Our customers, our suppliers, and our team understand that a cyber incident could occur to any business and has been particularly prevalent in the healthcare arena over the last six months. Turning now to the third quarter, we're reporting solid financial results for the third quarter. We achieved good total sales growth and non-GAAP diluted EPS growth despite continued lower sales of PPE and COVID-19 tests. Our internal sales growth slowed in the third quarter due to some market softness in September as a result of general macroeconomic weakness as well as lower sales of PPE products at COVID tests. However, we believe that the dental and medical markets that we serve are relatively recession-resilient. Sales of PPE products and COVID-19 test kits continue to decline but at a lower rate compared to the earlier year. Increased customer demand for lower-priced corporate brand merchandise and generic products, along with growth of equipment technical service revenue, also has helped our profitability this quarter. Profitability for the quarter benefited from our technology, value-added services, and dental specialty products as we continue towards our goal of achieving 40% of operating income from sales of high-growth, high-margin products. We are now more than halfway through our three-year gold BOLD+1 strategic plan. Despite current macroeconomic conditions and the cybersecurity incident, we have confidence in the stability of the dental and medical markets and remain committed to our strategic priorities and long-term financial model, which includes high-single digit to low double-digit growth in operating income. Year-to-date, we have closed several strategic investments, and just last month, we were pleased to announce the closing of the acquisition of Shield Healthcare, a business that distributes medical products to patients in the home including continuous glucose monitoring. Overall, these acquired businesses are performing well. So let me turn to a review of our quarterly highlights from each of our business units, beginning with dental distribution. In North America, dental offices generally remain busy. However, dental patient traffic somewhat slowed in September. This seemed to be the result of an increase in patient cancellations, which we believe were partially due to the seasonal uptick of flu cases and COVID-19. And our overall consumable merchandise sales, excluding PPE products reflected this. Looking at our international dental business, overall volumes of consumable merchandise held steady across the regions. Sales of traditional dental equipment in North America have largely reverted to pre-pandemic levels with growth in the mid-single digits. Dental equipment sales continued to be impacted by lower average selling prices, and we expect this to normalize in the first quarter of 2024. The equipment backlog was sequentially slightly higher and included strong orders taken at the DS World Show held at the end of September 2023. This increase reflects typical seasonality as we head into the fourth quarter. International dental equipment sales reflect a slowdown in sales in large equipment, and this is in parts of the world outside of North America, not everywhere. Our equipment sales vary quarter-to-quarter, of course, partially as a result of purchasing dynamics of large DSOs. But over the long term, we continue to expect equipment sales growth in the range of low to mid-single digits. Dentistry is undergoing a significant transition to integrate high-tech digital workflow systems in the dental practice. Henry Schein is well positioned to be the brand of choice for our customers who are seeking an integrated digital clinical workflow, and we remain confident in the long-term outlook for dental equipment in general. Turning now to the dental specialties. Overall, we believe we continued to gain global market share during this quarter. Our global implant business grew 40%, predominantly through acquisitions. BioHorizons Camlog continued to outperform the market, growing sales in the mid-single digits. Our acquisitions of Biotech Dental in France and S.I.N. in Brazil are showing strong growth in implants and related products in the local markets. Our value brand, The Dentist, is also growing well. This is offset by somewhat slower sales in North America. The performance of our endodontic business continued to be strong, and the clear aligner segment of our orthodontic business grew by double digits, albeit on a small base. So we're optimistic about the long-term growth prospects for the specialty markets as we continue to see the adoption of specialty procedures among general practitioners and the growing adoption by DSOs of specialty procedures due to demographic macro trends. We're also optimistic about the dental specialty products in 2024 as we have a robust new product line with upcoming launches in various geographies. So we are really optimistic about our specialty businesses in 2024 driven by macro demographic trends and our robust new product pipeline. Let's now turn to our technology and value-added services businesses. We had excellent sales growth in our technology and value-added service businesses, driven by the Henry Schein One practice management software sales and by Large Practice Sales, the practice brokerage business we acquired at the close of this quarter. Henry Schein One's growth continues to be driven by practice management software solutions and, of course, particularly by Dentrix Ascend and Dentally, our cloud-based solutions, which provide an opportunity for their practices to integrate clinical workflow, which is very important throughout the dental office. Once again, the customer base of cloud solutions increased by about 40% this quarter compared to the prior year. DSO accounts in particular are seeking integrated platforms along with the tools that are enhanced by artificial intelligence. In this connection, we recently formed a DSO Strategic Advisory Council, which is strategically focused on growing practice revenues and solving operational issues for large group practices. We, of course, have similar programs for midsized practices and for smaller practices, where this advisory kind of service is provided by our field sales consultants. During the third quarter, we introduced new features and upgrades, including the launch of Lighthouse 360. This new platform facilitates integrated patient communications, reputation management, and overall practice success. This feature-rich product includes online patient scheduling, digital customized forms for patient intake, payment reminders, and more. Henry Schein One's goal is to continue to grow our practice management customer base and to increase the breadth of solutions offered to our existing customers. Our priorities regarding software integration are critical to achieving this goal, and we are well on our way towards an integrated clinical offering for the clinical aspects of the practice with a focus on specialty procedures as well. Turning to our medical business, third quarter growth was in the low single-digits, excluding sales of PPE and COVID-19 tests, similar to recent quarters. This growth reflects high prior year comparison sales growth and higher sales on lower-priced products, including generics and corporate brands, albeit with higher margins. Of note, we are now distributing COVID-19 vaccines, although we do not expect this low margin product category to have a significant impact on sales or profits. In September, we saw an uptick in sales of COVID-19 test kits, which we expect to continue into the fourth quarter. So in summary, the underlying fundamentals of our core business remain solid. We are executing ahead of schedule with our 2022-2024 BOLD+1 strategic plan. So with that in mind, let me ask Ron to discuss the quarterly financial results and our full-year guidance. Ron, please?

Very good. Thank you, Stanley, and good morning, everyone. As you may have seen on November 2, we notified the SEC that we will not be filing our Q3 Form 10-Q until later in November due to our recent cybersecurity incident. We completed our consolidated income statement before deactivating our systems, but we have been delayed in finalizing our consolidated balance sheet and statement of cash flows, which are typically included with our earnings release. These statements will be made available once our Q3 Form 10-Q is finalized. The non-GAAP financial results for the third quarter of 2023 and 2022 exclude integration and restructuring costs as well as amortization of acquired intangible assets, detailed in our press release. Importantly, the cybersecurity incident did not affect our Q3 results since it occurred in October. Regarding sales growth for the quarter, I will mainly address LCI sales growth, which reflects organic sales in local currencies compared to the prior year and excludes acquisitions. Global sales totaled $3.2 billion, showing a decrease in LCI sales of 1.2%. However, when we remove sales from PPE products and COVID-19 test kits, LCI sales grew by 1.1%. We recorded $131 million in PPE product sales in the third quarter, which is a 19% year-over-year decrease, and $44 million in COVID-19 test kit sales, down 46% year-over-year. Our GAAP operating margin for Q3 2023 was 6.3%, a decline of 52 basis points from the previous year. Non-GAAP operating margin for Q3 was 8.1%, a decline of 12 basis points due to higher gross profit margins being offset by increased operating expenses, mainly from acquisitions. Q3 2023 GAAP net income was $137 million or $1.05 per share, compared to $150 million or $1.09 per share the previous year. Non-GAAP net income for Q3 2023 was $173 million or $1.32 per share, compared to $177 million or $1.29 per share the prior year. Acquisition expenses and related adjustments for the quarter and year-to-date can be found in our press release. The foreign currency exchange impact on our Q3 EPS was minimal. Now, turning to our Q3 sales performance, Global Dental sales were $1.9 billion, with LCI sales down by 0.2%. Excluding PPE sales, LCI growth for Global Dental was 0.3%. Global Dental merchandise LCI sales were up 0.3% or 1.1% when excluding PPE. North American dental merchandise LCI sales decreased by 1.2% year-over-year and decreased by 0.1% excluding PPE sales. International dental merchandise LCI sales grew by 2.9% or 3.2% when excluding PPE. Global Dental equipment LCI sales declined by 2.0%, with traditional equipment experiencing mid-single-digit growth while digital equipment sales fell due to lower intraoral scanner prices from new product launches late last year. North American dental equipment LCI sales rose 0.2%, which is a challenging comparison as it was up 12.8% in Q3 2022. International equipment LCI sales dropped by 5.9% due to macroeconomic uncertainty in Europe affecting digital equipment sales. Sales of dental specialty products, which include implants and orthodontic items, were around $268 million in Q3, reflecting a 25% growth driven by acquisitions. Global Technology and value-added services sales in Q3 amounted to $210 million, with LCI growth of 9.6%. In North America, growth was mainly from our Dentrix Ascend practice management business, while internationally, it was driven by our Dentally cloud solution. Technology, value-added services, and specialty products constituted about 35% of total operating income in Q3. Global Medical sales during the third quarter were $1.1 billion with LCI sales down 4.6%, primarily due to reduced sales of PPE and COVID-19 test kits. In North America, when eliminating sales of these products, LCI sales grew 1%. This is a tough comparison, as the LCI growth excluding those products was 9.7% in Q3 2022. Regarding stock repurchases, we bought back approximately 660,000 shares in the open market during Q3 at an average price of $75.79 per share for a total of $50 million. At the end of the quarter, we had about $215 million available for future stock repurchases. Our significant liquidity supports our businesses' financial flexibility and stability, allowing us to pursue organic growth and strategic acquisitions while returning capital to shareholders. As mentioned last quarter, we have allocated over $1 billion for the announced acquisitions this year, with $417 million spent on business acquisitions that closed in Q3 and $668 million invested year-to-date. Restructuring expenses for Q3 totaled $11 million or $0.06 per share, related to our ongoing restructuring initiative. These expenses mainly arise from severance benefits and costs associated with exiting facilities, and we expect restructuring activities to continue through 2024. To conclude, our 2023 financial guidance is affected, as we are currently unable to estimate costs related to integration and restructuring or expenses stemming from the cybersecurity incident. As a result, we are not issuing GAAP guidance. Our updated non-GAAP guidance for 2023 is between $4.43 and $4.71 per share, reflecting a narrowing range for non-GAAP diluted EPS for the underlying business from $5.18 to $5.26, updated from $5.18 to $5.35, due to declining macroeconomic conditions and an estimated impact of $0.55 to $0.75 per share from business interruptions caused by the cybersecurity incident. As Stan noted, we believe our teams have contained the cybersecurity incident, and we have mostly restored operations. While we anticipate that a notable portion of sales was disrupted due to certain systems being offline, we estimate that overall sales growth for the year will be negatively impacted in the low to mid-single digits. The estimated fourth-quarter impact of $0.55 to $0.75 per share does not cover certain expenses directly tied to the cybersecurity incident, which we expect to report as non-GAAP in Q4. The financial impact does not account for any future insurance claim recovery. We expect to file an insurance claim under our cyber insurance policy, although a final resolution is subject to insurer approval. This policy has a $60 million claim limit after a $5 million retention, and any recovery will likely not be recognized until late 2024. We now expect our 2023 net sales to be 1% to 3% lower than in 2022, a change from our previous guidance of 1% to 3% growth. This adjustment primarily stems from lower sales due to the cybersecurity incident, which we project will reduce full-year 2023 sales growth. Additionally, our guidance takes into account one less selling week in 2023 compared to 2022, and includes higher interest expenses due to rising rates and increased borrowings. We expect an effective tax rate around 23% for the year, with no anticipated changes in tax legislation. Our guidance encompasses current operations and announced acquisitions and does not factor in potential future share repurchases or specific expenses related to the cybersecurity incident. It assumes that foreign currency exchange rates remain stable and that market conditions stay consistent. We plan to introduce our 2024 financial guidance when we report our Q4 and full-year financial results. With that, I'll now turn the call back to Stanley.

Thank you, Ron. I appreciate that. Operator, we are ready to take any questions that investors may have.

Hey, guys. Good morning. Thanks for taking questions. Maybe the first one, just high level. Stan, what are you guys hearing from the customers? The ordering frequency from a practice might be, I don't know, maybe roughly every two to three weeks. So some customers might have encountered the issues pretty minimal number of times, maybe one time, possibly twice at most. What have you guys heard regarding, call it, customer retention? Or do you think you don't have a better feel for that until the actual website is back up and running, which seems, to your prior point, tomorrow morning? And then I'll just ask a follow-up.

Yes. That is a very important question. We believe we are at an 85% to 90% stable level. Our larger, more sophisticated customers are either using our e-commerce systems or finding workarounds. The same goes for midsized customers. Smaller customers have typically depended on field sales consultants for order collection, or they did until recently, along with telesales representatives. Consequently, their ordering approach isn't as broad as digital ordering. However, we expect to see increased business from smaller customers, who are crucial to our business, as the website becomes operational again. We maintain strong relationships with our customers, supported by our field sales consultants, strong telesales connectivity, and value-added services. Generally, we have not seen customers leaving us, although some have explored alternative options. For instance, certain pharmaceutical buyers needed to move forward with controlled drugs sooner than we could provide. We anticipate our controlled drug system to be ready soon. Overall, we are encouraged by the support we've received from our customers. Unfortunately, cyber issues in healthcare have been widespread. In the first six months of this year, there were over 300 incidents in the healthcare sector alone. Our customer base is quite aware of this situation, and it will require significant effort from our field sales representatives, telesales team, and e-commerce group to win back all our customers. There might be some lag in that process, but we are overall very optimistic about the support we receive, not just from our customers but from the entire industry as well.

That's great color. Thanks, Stanley for that. And maybe I'll pivot, Ron, to you for the second question. Any really high-level thoughts around 2024? And not a specific number, but just maybe just the construct. Should we think about it as sort of growth on the core underlying EPS of $5.22, the revised midpoint, and then offset by, call it, the lag hit on the cybersecurity incident? And on that second point, I just want to make sure, the $0.55 to $0.75, in 4Q '23 cyber hit, that's all, call it, decremental low sales? I think you said no expenses in there. That would be excluded from non-GAAP. Is there any promotional stuff in there? Sorry, and last sort of question, tack-on, how do we think about the exit impact for December? Because you talked about the top-line impact for the quarter, but obviously December would likely be much lower than what you've experienced in October. So any color on the cadence for the trailing throughout the fourth quarter. Thanks, guys.

Yeah. Thanks, Jon. Yes, you're correct in that the $0.55 to $0.75 that we've called out as Q4 impact is attributable to business interruption impact. It does not include the one-time costs that we are incurring that are directly attributable to reactivating the systems. And right now, it's our intent that when we report the Q4 results, we'll be calling out those particular costs as part of our non-GAAP reconciliation. In terms of run-rate into '24, that will be something that really is largely contingent on the level of business that we see with One web being back up. That is a very important turning point for us. It's something we're very excited about in the organization this week. And I think that we'll have greater intelligence in terms of what's happening with customer retention with One web back up. I do anticipate we will likely have some, whatever you want to call them, customer retention programs or promotions in the quarter that may put a little bit of pressure on margins. I wouldn't expect it to be significant. But having said that, we do want to show some appreciation to our customers, and we do want to ensure that we go into 2024 with the solid base of businesses that we can possibly have.

Hi, guys. Thanks so much for the question. So as we think about the cybersecurity, you said the website's back up tomorrow, that's great to hear. Now if we think about just sort of like the broader operations that support that, is that something that you feel like is also kind of in a similar place? And obviously, you probably wouldn't put the website up if you're having a ton of internal issues. So I just want to make sure how you feel about sort of the rest of the systems that are supporting that ordering process. And then sort of as we think about 2024, you obviously have the BOLD initiative. I just wanted to see if, given the cybersecurity situation or the current demand environment, how do you sort of think about that conceptually, whether there are places there you can accelerate cost cuts? Any color there would be helpful. Thank you.

Thank you, Elizabeth. Those are two very good questions. To provide some context, we experienced a cybersecurity incident that raised suspicions. Our CTO made a smart decision by taking down the entire system immediately, knowing that our backups were reliable. Fortunately, our backups have proven to be effective. We are now in the process of bringing applications back online one by one. Before reactivating each application, we conduct necessary forensic work to ensure there are no hidden issues. Currently, aside from the website, we are largely back to normal. A few areas still need to be activated, particularly related to invoicing and returns. The only area where we cannot provide services at the moment is controlled drugs, although we have an affiliate unaffected by the incident that can handle shipping if necessary. We anticipate that these areas will be operational this week. Some isolated challenges remain, mainly unrelated to customers, such as parts of our WMS systems not being fully functional yet. However, the E3 system, our primary purchasing platform, is operational and has been for some time. It’s just requiring more manpower to manage receiving, storage, and picking of products. We expect these areas to be resolved in the coming weeks. Overall, from a customer perspective, we are in decent shape today. If a customer asks about past purchases, we might need time to research through backups for immediate answers. Operationally, we were doing quite well just two days after the cyber incident. It’s important to note that our backups are solid, and we are confident in our approach of reactivating the systems incrementally. Our IT team is exceptional, and our consultants are top-notch. We are optimistic about stabilizing these systems and believe the process won't take long. I am quite confident that, from a customer standpoint, aside from the issues I mentioned, we should be in good shape tomorrow once the website is back up.

Elizabeth, I'll take the second half of your question. I believe you were asking if in 2024, did I anticipate we would be accelerating any cost cuts. Did I understand you properly?

Yeah. That's what I was asking. Thank you.

I believe we will proceed with our plans for 2024 as initially intended. As stated earlier, we have $1 billion allocated for acquisitions, and typically in the short term after acquisitions, we seek synergy opportunities. Some of these acquisitions will operate independently, while others will offer synergy opportunities that we plan to implement throughout 2024, along with our usual processes to identify cost efficiencies. In light of the cybersecurity incident, I don't believe there is a necessity for us to expedite any cost-saving measures in 2024.

Thank you. Good morning, guys. Can you hear me okay?

Yeah, Jeff.

Thank you for joining the call and for your questions. Let me start with two that are somewhat connected, to ensure we all understand your outlook moving forward. First, if we could set aside the cybersecurity issue for a moment, though I know that’s not entirely feasible and I will address it in a follow-up question. For the third quarter, dental organic growth appears to be relatively flat globally, and the overall company growth is around 1%. If you were advising us on how to approach our 2024 models, would you suggest that these figures serve as initial benchmarks for us to consider when projecting organic growth rates excluding cybersecurity for next year?

So Jeff, we've shared a lot of insights on this topic, as have analysts and the industry as a whole. Generally speaking, we view our business as relatively resilient during a recession. There may be some decline, but it will recover. As you mentioned, our North American dental consumable business experienced flat internal growth. We noticed a slight drop in patient traffic in North America mainly due to appointment cancellations, particularly in September, and it seems similar patterns persisted in the first two weeks of October. However, following the cyber incident, it's difficult to make projections. Focusing on North America, sales of traditional dental equipment have returned to pre-pandemic levels, and we anticipate growth in the mid-single digits. Digital equipment sales are still affected by lower average selling prices, and we cannot definitively say when this will stabilize. Our equipment team suggests it may normalize in the first quarter of next year. Looking at our international business, overall volumes of consumable merchandise remained stable across most regions. However, there is a slowdown in large equipment sales in certain parts of the world, influenced by unique factors, such as the ending of a tax incentive in Australia. We are seeing some caution among our customers in various regions due to macroeconomic concerns, particularly in Europe. This doesn't seem to be a significant issue in any specific country. Overall, health insurance in the U.S., typically provided through employment, could influence activities as a lagging indicator, particularly affecting higher-end procedures. We have noticed some softness in the premium implant side in North America. Outside the U.S., where government support is more prevalent, it's challenging to determine how much economic views affect dentistry. Historically, these impacts haven't been substantial. We are observing similar trends between private practices and larger operations, although equipment sales for DSOs have weakened due to interest costs. It's important to recognize that DSO sales can be unpredictable, as they always have been. Regarding patient traffic, the ADA survey indicated a slowdown in the third quarter, mainly in September, which could be attributed to viruses like the flu and COVID-19. In Europe, implant sales appear stable, so there's no clear decline, but some caution remains. We should keep this perspective in mind and plan accordingly.

Yeah. That's helpful. Thank you, Stanley. And so that kind of helps maybe level set us on the core assumptions. Ron, just my follow-up then is, as I see it, and correct me if I'm wrong, there's three variables on the cyber that we need to think about heading into next year. Do you continue to run any kind of customer retention programs on the spending side? Do you have any kind of just higher core spending on cybersecurity that you have to put in place here that you have to put in place that's going to structurally take the OpEx side higher? And then three, is there any kind of customer loss? Do you lose maybe 1% or 2% of revenue or something like that? Because not everybody comes back either for risk-mitigating reasons or other reasons. So just any comment on kind of the two spending categories. Will those be higher next year? And the customer retention, I know it's hard to predict, but would it be safe to build in maybe just a little bit of bleed away of customer? Or do you think you get pretty much most of that back in? Thank you.

Sure, Jeff. I'll address the topics of customer retention and potential customer loss together. We expect to have a clearer picture in the coming weeks. The restoration of our website will provide us with more insights into customer retention and the likelihood of customer loss, which will help us determine the necessary investments to regain some of that business and those customers. This will factor into our 2024 guidance that we will share in February of next year. Regarding increased spending on cybersecurity, we will evaluate what we believe is the right investment and adjust as necessary. For now, we are still in the process of investigating the causes, and we will invest appropriately based on our findings. If we need to increase that investment, we will do so.

Good morning, guys. Thanks for taking my question. I just want to talk about some of the swing factors that could move you from the $0.55 to $0.75 in the cybersecurity headwind. What are some of the factors that you could see? Is it really just a time to ramp back up to 100% of like pre-incident levels? Or is there anything else built in there that we should be thinking about as we look at that?

I would highlight two key factors. First, we have a number of customers who exclusively use our website to place orders. When the website was down, those customers couldn't order, but now that it's back up, we anticipate a significant portion of them will return. We may need to offer incentives to encourage that return. The second factor involves margins; any discounting during the quarter could affect our gross margins. These are the main elements influencing our projections for Q4. We have run several scenarios and currently estimate an impact in the range of $0.55 to $0.75. We expect to gain more insights in the coming weeks regarding the website's performance.

Great. And then just on the kind of the 85% to 90% of pre-incident volumes, can you give us kind of a sense qualitatively of how that's trended since that, I think, the 24th and onwards when you were generally operational? Has that kind of increased week-over-week? Has that been kind of static? And then, I guess, you kind of indicated there that a big portion of this may just be people who prefer to use the online portal. Is that how you're thinking about the remaining customers who kind of haven't been ordering with you?

We've been operating for four weeks since deactivating the system. The most notable result is that we've seen improvement. In week two, there was a significant boost, which continued into week three. Week four's processing volumes were similar to week three. I believe we have a maximum limit of 85 to 90 percent of our pre-incident volumes that we can handle with One web up. Over the next few weeks, we need to gather data on which customers have returned in order to move from that 85 to 90 percent up to 100 percent. That's our current focus.

To build on Ron's comment, there was a time when our customers could only place orders through a field sales representative or telesales. A significant portion of our orders, around 70%, now come through digital channels, which is positive as we have trained our customers to prefer this method. However, during that period, many of the 70% of orders were reliant on our field representatives and telesales, which created a bottleneck for a few weeks. Consequently, not all customers could make purchases. As we enhanced our digital ordering capabilities and improved the efficiency of our field sales team, we implemented effective workarounds quickly, although they weren't available initially. The telesales team had limited capacity, but we successfully expanded it following a model and procedures that were tested during COVID, allowing us to increase capacity almost overnight. The issue was that for a few days, the funnels weren't large enough to handle all the orders. Now that we can accept orders more efficiently directly through our website, we anticipate that customers who previously sought urgent products elsewhere will return. Some smaller customers may have delayed their orders, but we expect them to come back as we work to stabilize our systems by the end of the fourth quarter.

Hey, thanks for taking questions. Sorry for the background noise. I wanted to ask, of the 85% to 90% that you're talking about, Stan and Ron, are there certain categories that have been slower to come back or certain geographies, maybe bifurcate North America versus Europe or dental versus medical, just anything there. And then I have a follow-up.

I would say on balance, it's spread out reasonably. There are parts of the world where electronic ordering is not as large as, say, in the United States. So those customers have been more comfortable ordering through telesales representatives or field sales representatives. But it's more or less okay. Actually, on average, Europe is a little bit higher but then actually don't have all the systems we have in the U.S. So I don't think you can read anything into that. This is a period when we started out with minimal systems on the first day. And by the end of the third day, we had a lot of systems working. And then as the month went by, more and more systems came up. So it's been a period of the customers adjusting to what's available, some places that may be adjusted faster than others. But I don't think we can read anything from the first month of this incident, anything specific. And some products are more elective than others, aesthetic products or maybe products relating to like toothbrushes, etc. They're not necessarily that urgent. So we'll see how this materializes. But I don't think, Jason, I wish we could give you some conclusive information. But there's too many puts and takes here to understand exactly whether these trends are related to particular products or regions. Let me remind you that our equipment business was operational throughout this period, and we did not have full support of systems. But mainly for customer needing service, they've got it. Not all the equipment orders that we received are being installed right now. There will be a catch-up in the next couple of months. We went into the period with a pretty decent backlog of equipment, partially driven by the very successful show.

That's really helpful. Thanks for that information. As you consider the exit rate renewal and what 2024 might look like, can you provide any insight into the 10% to 15% of customers who are still operating at low pre-cyberattack levels? Specifically, how many of those customers are under contract, particularly large accounts in the dental or medical sectors, or those using your practice management software? It would be great to understand how these factors might help the industry retain the business you expect to recover. Thank you.

Yes, Jason, our larger customers have really remained loyal during this time, and we are very grateful for that. Therefore, we don't anticipate any significant loss in that area. As I mentioned earlier, 85% to 90% of the orders are from customers who do not depend on FSCs or our sales representatives in the dental sector. That’s the performance level we aim to enhance as we head into 2024, and we will incorporate any assumptions into our guidance for that year when we release it.

Great. Thanks very much for the questions. I just wanted to follow up there on the cybersecurity incident. Have you had any issues with getting supplier product? I recall you mentioned something in the prepared remarks about some supplier accounts. Just wondering if that's had any impact on inventory. And from a balance sheet perspective, would you expect any impact on inventory levels in the near term or capital deployment in the near term just as you work through these issues?

Yes, I think this is a good question, Nathan. We did not have E3 operating for the first week, so we were relying on historical data that was about a month old. The system was up and running fairly quickly. There were some challenges in the receiving department because we didn't have the complete software operational on that side. However, aside from one or two suppliers who had concerns about system corruption, we are back to electronically ordering. One supplier I worked with swiftly allayed their concerns. We've been acquiring products in a systematic manner. For some manufacturers, we started the quarter with strong inventory for various reasons. Overall, our suppliers have been very supportive, and we have received the products we need. We may have slightly increased inventories in some areas. Ron can provide details on the balance sheet, but I must emphasize the remarkable support we have received from our manufacturers, including those who assisted with drop shipments in the initial weeks. We wanted to reduce the load in our warehouses as a precaution, but it ultimately wasn't necessary.

I don’t expect this to have a significant impact on our inventory levels. The only area we might see a slight impact, which we've incorporated into our Q4 guidance, is that it could slightly reduce our rebates. This is because our rebates, especially in North America, are now primarily sellout rebates instead of purchasing rebates. Therefore, if we do not recover some of the sales in the fourth quarter, it could affect our rebates during that period. Regarding capital deployment, I don't anticipate any changes. The balance sheet is strong, remains strong during this situation, and will be strong afterward. I don't foresee any significant changes in how we're deploying capital as a result of this.

Great. And if I could just follow up quickly, I think it was Jeff's question earlier, just on the outlook for the dental business. I think the revised revenue range didn't really incorporate a significant impact from the macro environment. And I guess I'm just wondering if we should interpret this as the variability that you saw, whether it was patient traffic or equipment sales in certain international markets just hasn't been significant enough to kind of change your view of the overall trajectory of the end market at this point.

Nathan, reflecting on our Investor Day last February, our dental growth assumption was in the 2% to 4% range. It seems we are now closer to the lower end. Regarding dental specialties, which are included in our dental merchandise figures, there is some softness in the implant market that is affecting our growth expectations in that area. As we finalize our numbers for 2024, we still remain optimistic about long-term growth, but we anticipate that 2024 may trend towards the lower end of that range.

Thanks for taking my question. I appreciate it. Before the cyberattack, what percentage of your revenues typically came from the e-commerce platform? I would assume it was over 10% to 15%, correct?

Yeah, much more.

Absolutely. Absolutely, Kevin. So if you take EDI plus the web combined, so essentially electronic type of ordering, it's in the 70% to 75% range. Well, I think the 85% to 90% on the orders we're talking about, kind of that missing 10% to 15%, we think, is largely attributable to customers who exclusively ordered electronically and did not have a rep. They didn't want a rep. They perhaps use multiple distributors. And so because they didn't have a rep who could assure that they were getting the product that they wanted, they simply ordered from someone else. So I think that's the question, is how much of that business can we get back. That's what we're working to get back.

Okay. That's helpful. I just wanted to understand the bend Venn diagram here, who we were talking about.

Yeah. A lot of those others were able to, through their rep or otherwise, were able to place orders through our telesales channel, or their rep was able to make sure that their order got put in accurately and completely.

I appreciate the comments regarding the lower end. It sounds more positive than what many of your competitors have publicly shared about their observed trends for October and November in the fourth quarter. I would like to ask Stanley a broader question. What do you believe is driving the slowdown in demand in the dental sector, even if your experience isn't as impacted as some others, likely due to your mix and positioning? How often have you encountered a macro environment like this, and how long do you anticipate it will continue? What do you think is responsible for the current situation? I would love to hear your perspective on this and your thoughts on its duration. Certainly, those are good questions. In the third quarter, specifically in September in the U.S., we noticed a decline in sales of consumables. While there is patient data from the ADA, it’s challenging to determine precisely how much of this decline can be attributed to a shift towards generics or price resistance due to rising costs. Additionally, factors like flu and COVID might be playing a role, although it's not a significant impact. It's difficult to draw clear conclusions from September and early October as sales trends can be unpredictable. Historically, consumable sales may dip for quarters, but these declines rarely persist for long. The current recession is unusual; on one hand, consumers seem hesitant to spend, but on the other, retail sales aren't falling apart. In Europe, government support influences elasticity, though there is some unease with the geopolitical climate. Looking specifically at Germany, conditions aren’t too bad. We've noticed that there's some resistance to pricier equipment, leading to a preference for lower-cost options. While this may slightly affect gross profit, various factors in the equipment sector mean I can’t definitively say that trends in Europe will significantly impact our equipment business profitability. In fact, enhancing the efficiency of our service network presents better profit opportunities. Regarding North American equipment, traditional sales remain stable. Digital devices see some transition to newer, lower-cost options. While there’s some volatility, demand for digital equipment is healthy, particularly for IO devices. The market isn’t purely shifting from mills to 3D printing, though the latter is performing well. I expect that over time, more DSOs will adopt 3D printing, although this transition may not occur in a steady manner. Summarizing all these factors into a single conclusive figure is challenging, but my long experience leads me to believe that negative trends in dental consumables are usually short-lived. In the medical sector, demand remains strong, particularly in ultimate care settings where many procedures are moving away from hospitals. It’s important to keep in mind that last year we had nearly 10% growth, so if we average, we might expect something in the realm of 4% to 6%. Overall, the business remains relatively stable, which is a promising note to end on. Thank you for the question.

Before we conclude, I want to highlight a few important points. Overall, our business maintains strong branding and a solid strategic plan. Our IT team has performed exceptionally well. As a nation and globally, we need to address cyber threats; it's a top concern for CEOs, and we will need to increase funding for law enforcement in this area. We have received commendable collaboration from law enforcement. This is a developing sector, and the frequency of attacks is rising significantly. Our team managed the situation effectively, ensuring that systems were restored, backups were functioning, and data was verified as safe before going live. It does take time, but I believe we've handled it swiftly and with high quality. We have experienced advisers on our board, including two members with direct experience in this field who have been guiding us for years. Our BOLD+1 plans are still on track, and Henry Schein One continues to perform well, especially in the clinical workflow area. I anticipate that artificial intelligence will soon be embraced within the DSO movement, and I believe we have a strong product offering in this domain. The equipment is stable, and I've shared our views on consumables. Our next step is to bring all systems online and ensure a smooth recovery for our customers. Our sales force is prepared to engage in the field, while our telesales and digital teams are also working to activate and support customers. I appreciate our investors' patience throughout this process. Although I wish we hadn’t faced these challenges, our organization has responded admirably, and the support from our customers has been outstanding. Thank you all very much. We will return with our fourth quarter figures, expected at the end of February. Mid-February.

I believe our filings with the SEC, despite a slight delay in one aspect, will still be submitted on time. Thank you very much for your patience.