Envista Holdings Corp Q3 FY2023 Earnings Call

Hello. My name is Chelsea and I will be your conference call facilitator this afternoon. At this time, I would like to welcome everyone to the Envista Holdings Corporation's Third Quarter 2023 Earnings Results Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers’ remarks, there will be a question-and-answer session. I will now turn the call over to Mr. Stephen Keller, Principal Financial Officer of Investor Holdings. Mr. Keller, you may begin your conference.

Great. Thank you. Good afternoon and thanks for joining the call. With me today is Amir Aghdaei, our President and Chief Executive Officer. I want to point out that our earnings release, the slide presentation supplementing today's call and the reconciliations and other information required by SEC Regulation G related to any non-GAAP financial measures provided during the call are available on the Investors section of our website, www.envistaco.com. The audio portion of this call will be archived on the Investors section of our website later today under the heading Events & Presentations. It will remain archived until our next quarterly call. During the presentation, we will describe some of the more significant factors that impact year-over-year performance. The supplemental materials describe additional factors that impacted year-over-year performance. Unless otherwise noted, references in these remarks to company-specific financial metrics relate to the third quarter of 2023 and references to period-to-period increases or decreases in financial metrics are year-over-year. During the call, we may describe certain products and devices that have applications submitted and pending certain regulatory approvals are available only in certain markets. We will also make forward-looking statements within the meaning of the federal securities laws, including statements regarding events or developments that we believe anticipate or may occur in the future. These forward-looking statements are subject to a number of risks and uncertainties including those set forth in our SEC filings. Actual results might differ materially from any forward-looking statements that we make today. These forward-looking statements speak only as of the date that they are made and we do not assume any obligation to update any forward-looking statements except where as required by law. With that, I'd like to turn the call over to Amir.

Thank you, Stephen. Good afternoon and welcome to Envista's third quarter 2023 earnings call. We appreciate you taking the time to join us today. In the third quarter, we delivered positive core growth and an adjusted EBITDA margin of 19.6%. Driven by outperformance in our orthodontic business and continued strength in consumables, we were able to mitigate the challenges of an uncertain macro environment, while setting up our business for long-term success. As discussed in previous quarters, we are proactively adjusting the focus of our imaging business to deemphasize specific product categories in selected geographies where we have less competitive advantage. By focusing our resources in our broader and more differentiated diagnostic solution, we will be able to create sustainable competitive advantage and improve our long-term growth and margins. While long-term our global implant business is well-positioned our performance in the quarter was below expectation. This was due to both continued macro uncertainties specifically impacting higher-end full-arch restorations as well as underperformance in North America. While our results in North America were disappointing, we believe this will be temporary. We have an incredibly strong brand, a leading product portfolio, a passionate and capable team and a dedicated community of implant specialists. Starting in the third quarter, we have made targeted investments to improve our commercial execution in North America to refresh our approach to marketing, improve our training and education and further support our clinical community. We see a clear path through invigorating growth and aim to be growing with the market as we move through 2024. Before I turn it over to Stephen to discuss our third quarter results in more detail, I want to take this opportunity to provide further perspective on the current operating environment and then offer an update on our progress towards our strategic priorities. Globally, the market remains very dynamic with concerns around the macroeconomic backdrop and geopolitical risks weighing on market sentiment. While patient demand remained generally stable in the third quarter, we did see a continuation of a slowdown in higher-end dental procedures including both adult orthodontic cases and full arch implant restorations. Private practice doctors and DSOs are monitoring patient traffic, as well as the overall macro environment and are being thoughtful about near-term investments in both equipment and clinic-level inventories. While this has created a more challenging operating environment in the short-term, longer term we are confident that patients will continue to prioritize dental care and our clinicians to proactively invest in areas that help them digitize their practice, making them more productive and ensuring that they can provide the highest-quality personalized care. Focusing on our progress in Q3. Our uniquely positioned orthodontic business continues to perform well, driven by sustained performance in Spark Clear Aligners. In April of 2022, we announced a long-term target of tripling our Spark business by the end of 2024. I'm pleased to announce that we are on track to reach that milestone in the fourth quarter of this year, over a year ahead of schedule. Orthodontic specialists continue to see the value of our comprehensive portfolio of solutions and are working hard to be the partner of choice for orthodontists worldwide. Envista Business System, EBS, drives the Spark growth formula and we are consistently adding new doctors, increasing case volume with the existing doctors and growing our revenue per case. Given our success today and our overall trajectory of Spark, we're now focused on delivering our next long-term growth milestone. By the end of 2026, we intend to double our Spark business. In support of this ambitious growth, we continue to make investments to support the growth and long-term profitability of Spark, as well as our broader orthodontic business. In Q3, we received regulatory approval to produce Spark in our facility in the Czech Republic and achieved our first clinical case orthodontic factory. This new factory will improve the customer experience for our European customers, increasing manufacturing flexibility and help expand margins in the medium term. In addition to opening a new factory we are also investing in additional automation, as we look to optimize production and further improve our margins. While the Spark margins remain below our fleet average we continue to make sequential improvements and our focus on balancing long-term growth, maximizing near-term profitability. As expected in Q3, we delivered a solid sequential improvement to our adjusted EBITDA margins. This 50 basis points expansion occurred, despite our long-term investments, the impact of China VBP price reductions and the commercial underperformance of our implant brands in North America. We leverage EBS to manage margins through a systematic focus on price optimization, expense controls and structural cost reductions. Our performance in China is a perfect example of EBS in action. Despite the significant price pressure from the VBP program, we were able to expand our local operating margins by streamlining our organization, significantly reducing our expenses and focusing our efforts in areas where we have the most competitive advantage. This focus on driving growth and margin expansion, despite macro challenges epitomizes how we use EBS to execute every day. As we move into Q4 and next year, we will continue to maintain a balanced approach to growth investments and margin improvements. As I previously mentioned, we expect to accelerate investments in both Spark and our commercial capabilities supporting implants in North America. While these investments will put some short-term pressure on our planned margin expansion, they will help position us for faster growth while also setting the foundation for further significant margin expansion. Long-term, our priority is building a stronger, more differentiated and more growth-oriented portfolio. By focusing on providing comprehensive solutions for orthodontists as well as implant specialists, we'll continue to shift our portfolio to the most attractive segments of Dental. We are also transforming our imaging business to a diagnostic solutions business that supports clinicians as they digitize their offices. With a comprehensive set of imaging and software solutions, our DEXIS business delivers simplicity, productivity and diagnostic confidence. In the third quarter, we launched a range of new products including the OP 3D LX and DEXIS IS 3800 wired Intra Oral Scanner. We also released The DEXassist solution to integrate AI features into the DEXIS 10 Imaging Software Suite. The DEXassist solution helps practitioners to detect six pathologies in 2D Intraoral X-rays including caries, calculus bone loss, radiolucency, root canal, filling deficiencies, and discrepancies at the margin of existing restoration. DTX Studio Clinic Software was awarded the Celerant Best-Of-Class Technology Award for the third consecutive year recognizing the innovation we are bringing to the dental community. While we are excited about the strategic move that we have made today, we see additional opportunities to further improve our portfolio both organically and inorganically. We utilize an EBS-driven M&A approach to manage our robust pipeline of partnerships and investment opportunities and we are currently cultivating new opportunities. We're committed to pursuing a disciplined and strategic approach to capital deployment. I will now turn the call over to Stephen to go through our third quarter financials and provide more details on our segment performance.

Thanks Amir. In the third quarter, we delivered sales of $631.3 million on a reported basis. This represents a slight increase over the third quarter of 2022. Adjusting for the impact of currency exchange rates core sales for the quarter grew 0.8%. This reflects continuing growth in our Specialty Products & Technology segment, offset by a low single-digit decline in our Equipment & Consumables segment. From a geographic perspective, Western Europe grew double-digits, while North America declined low single-digits. Our emerging markets grew low single-digits, anchored by China which grew despite a difficult year-over-year comparison as well as the impact of VBP on implant pricing. Russia declined in the quarter due to both a difficult year-over-year comparison and a lingering impact of changes to US sanctions and licensing requirements. We remain focused on obtaining the appropriate licenses to fully supply Russia and we continue to take steps to optimize our supply chain to allow us to compliantly serve our customers and their patients. In Q4, we expect both Russia and China to grow and we expect full year sales to be modestly down in these two important and dynamic markets. Our third quarter adjusted gross margin was 57.7%, which is down 150 basis points from the prior year. The decline in gross margin was primarily attributable to an unfavorable product mix, VBP-driven price declines, and continued investment in our long-term growth. Our adjusted EBITDA margin was 19.6%, which represents a 60 basis points decline versus Q3 of 2022 and a 50 basis point sequential improvement from Q2 of 2023. Our adjusted diluted EPS in the quarter was $0.43 compared to $0.47 in the comparable period of the prior year. The reduction in EPS for the quarter was driven partly by an increase in interest expense from higher interest rates. In the quarter core revenue in our Specialty Products & Technologies set grew by 2.2%. Our orthodontic business accelerated double-digit growth with Spark continuing to expand rapidly. Our traditional bracket and wire business declined low single-digits with solid growth in China being offset by weaker demand in the rest of the world. Our implant business declined low single-digits in the quarter. As Amir mentioned previously, at or above market performance in most geographies was offset by weakness in North America in both our premium and value franchises. Western Europe performed well in the quarter and our China business grew strongly despite the negative pricing impact from VBP. Adjusted operating profit in this segment was 19.7% in the third quarter. This is down 110 basis points versus Q3 of 2022 but is up 100 basis points sequentially versus Q2 of 2023. We will continue to invest in this segment to support our long-term growth. Turning to our Equipment & Consumables segment. Core sales in the second quarter declined by 1.6% compared to Q3 of 2022. Our consumables business grew low single-digits led by strong performance in emerging markets. Globally, we are focused on driving sellout and we believe that our sell-out performance is consistently at or above the market in most geographies around the world. In the Equipment business, we declined high single-digits as higher interest rates and concerns around the macroeconomic environment reduced global demand for larger imaging equipment. Our performance in developed markets improved and we delivered solid growth in Western Europe in the third quarter. Emerging markets saw a larger decline in the quarter, reflecting both tougher macro conditions as well as the refining of our focus. Our intention is to deemphasize non-strategic geographies and solutions in order to concentrate our efforts in markets where we can build and maintain a sustainable competitive advantage. While this will create a modest headwind to core growth in the short-term, long-term this will allow us to accelerate both growth and margins. Our IOS business saw strong year-over-year growth in units this quarter, as we expand our global reach and partner with our distributors to help clinicians digitize their offices. While unit growth was very robust, it's important to note that ASPs in this segment have fallen faster than anticipated, putting short-term pressure on our revenue growth ambitions for this business. That said, we believe that prices are beginning to stabilize and we remain confident that DEXIS IOS will be a long-term growth driver for Envista. In the third quarter, adjusted operating profit margin in our Equipment & Consumables segment was 24.6%. This represents a 150 basis point decline year-over-year as lower equipment revenue was only partially offset by EBS driven productivity gains and cost controls. Turning to cash flow. In the third quarter, we generated greater than $75 million in free cash flow and ended the quarter with over $800 million in cash. The year-over-year improvement in free cash flow was driven by improvements to working capital as well as the deferral of federal tax payments until the fourth quarter. Overall, we remain pleased with our progress improving our cash flow management and are committed to our longer-term goal of delivering annual free cash flow in excess of net income. It is important to note that in Q3, we also took important steps to update our capital structure. We issued $500 million in new convertible notes at 1.75% due in 2028. And we exchanged around 77% of our prior 2.375% convertible notes due in 2025. We also refinanced our two term loans and revolver extending the maturity dates to 2028 and improved tariffs. The goals of these actions was to reduce the current and future dilution related to our convertible debt, manage our overall interest expense and ensure our long-term financial flexibility. Our strong balance sheet and significant cash flow provides us the flexibility to make appropriate investments as they become available. While we do have financial flexibility, our intention is to be very disciplined in our capital deployment. Turning to our full year outlook. We are revising our guidance for 2023 to reflect the increased impact of macro uncertainty, volatility in the North American distribution channel and the importance of making investments that will drive long-term shareholder returns. We now see full year core growth being down slightly and we expect adjusted EBITDA margins to be between 18% to 19% for the full year. Our updated guidance reflects the increased macroeconomic risks in our developed markets, continued challenges in Russia and the additional risks brought on by the new conflict in the Middle East. Regarding the Middle East, it is important to note that Israel represents a local commercial market of around $20 million annually, and that Israel further represents an important production location for our Alpha Bio Tec implant brand. While we've taken steps to stabilize our supply chain, we do anticipate some volatility in the region and this could impact our Q4 performance. Our updated guidance reflects the impact of accelerating investments in Spark as well as additional investments in our North American implant business. We expect these investments to continue into 2024 as implants in North America return to market-level growth within the next year. While it is too soon to provide guidance for 2024 a we are focused on delivering growth and margin expansion next year. Now, I'll turn the call back to Amir to discuss our long-term outlook and provide additional closing comments.

Thanks Stephen. Moving forward our priorities remain the same, accelerate growth, expanding operating margins, and continue to transform our portfolio through disciplined capital deployment. Our intention is to partner with dental professionals to improve lives and we believe that our diversified and comprehensive portfolio positions us as a partner of choice for clinicians globally. In our orthodontics business, we are focused on building on the strength of both our traditional bracket and wire solutions as well as our Spark clear aligner business to offer the orthodontic specialists the most comprehensive and integrated suite of treatment options available. We will support orthodontic as they build strong practices that provide personalized care and improve patients' smiles. In our implant businesses, we are focused on improving our short-term execution in North America, while continuing to drive innovation, partnership and community. There is a significant opportunity to address the under treatment of tooth plaque and ensure that implants are the treatment of choice. We are well positioned to lead the future of implantology. In our diagnostics business, we will continue to streamline our focus while accelerating the digitization of dental offices. Our goal is to provide clinicians with diagnostic confidence, simplicity and productivity. We will drive penetration of IOS solutions globally. Further leveraging our strong installed base, we will provide differentiated digital workflows that are augmented by assisted intelligence and support clinicians in providing superior care and improved clinical outcomes. Finally in our consumables business, we will continue to focus on driving above-market growth in sellout by offering a comprehensive portfolio of restorative orthodontic and infection prevention solutions. By supporting clinicians with workflows that are designed to deliver simplicity, high aesthetics and great clinical outcomes, we will continue to be the brand of choice for clinicians globally. Our purpose is to partner with dental professionals to improve patients' lives by digitizing, personalizing and democratizing dental care. We are focused on delivering long-term value for patients, our customers, our employees and our shareholders.

Thanks Amir. That concludes our formal comments. Operator, we are now ready for questions.

And our first question will come from Elizabeth Anderson with Evercore ISI. Your line is open.

Hi, everyone. Thank you for the questions. I have two inquiries. The first concerns the current macro environment. We've seen that there has been a notable decline in the environment in September. Could you provide more insights on those trends as you've observed them through October, and now approaching November? The second question is related to the guidance you reiterated for the full year about eight weeks ago. What prompted the change in that guidance within such a short period? Is it due to the decline or a combination of other factors? More details on this would be greatly appreciated. Thank you.

Of course. Thank you, Elizabeth. Let's talk about the macro first. We have a tremendous amount of insight by talking to a large number of DSOs, group practices, doctors around the world. Despite the fact that they remain bullish in the long term, they're mindful of what's going on in current macroeconomics. What they're seeing is stability in general in unrestorative care, most recently in the past probably eight to 12 weeks more weakness in higher-end dental procedures. Adult orthodontic cases have declined and the full RS implant restorations, which were challenged to begin with, we have seen a further step down. Clinicians are cautious. They're very cautious about inventory management in their offices, around implant and bracket and wires. And one of the key elements of the growth was DSOs expanding the footprint around the de novos; there have been more cautious recently about borrowing money, investing and expanding that business, which is directly impacting some of our equipment business in the long run. On the business side and the implant side, we are seeing stable demand. But as I mentioned, high end is really challenged. And we have a really good feel on a number of implants that they're placed worldwide specifically, in North America we are seeing some challenges that started in Q2 and continue throughout Q3 and most recently. In ortho, generally resilient for teens, adult cases has been weaker. On diagnostics, we're not seeing anything radically different than we have communicated before, major concern on higher interest rates, macro challenges and our consumable is stable and resilient. And I can take you through geography by geography, the solid developed market, stable demand for basic procedures, high-end procedures lower demand for it. China, we saw a really rapid pent-up demand coming out of COVID, and specifically after the VBP. The key issues that everybody tells us and throughout our visits, we were communicated too that the consumer sentiment, remains a challenge in China. So, the long-term visibility is a little bit more difficult in that geography. Russia demand is soft, continuing conflict and we are working through some of the challenges that we have around licensing. Emerging markets outside Russia and China, demand is stable. We're happy with what we have seen so far and continue that progression. Unfortunately, the recent challenges in Israel have caused additional commercial execution issues and manufacturing issues for Envista. Now coming back to your question about what changed in the last eight weeks, four specific elements. One, the macro environment is increasingly volatile and more concerned that we had seen in the past. Geopolitical complexity has become even more challenging than it was eight weeks ago, 10 weeks ago. Normally after summer, we expect to see a ramp-up around some of the procedures specifically in Europe and some high-end procedure in North America we are not seeing that. And last but not least the North America distribution challenges have put in a tremendous amount of uncertainty in our review of what we see in the near-term and rest of the year. Combining all of that together, we thought it would be prudent for us to consider the challenges and take advantage of the opportunity that we have and make sure that we continue to make investments accelerating Spark. That ramp that we talked about Spark, a year ahead of plan has ramifications for mix. The Spark margins are below fleet average so the higher that volume more challenging in our margin. And then investment that we have made a decision to make on North America implant around marketing, training education, community development, we thought the timing is right for us to do that in order to build the foundation for growth as we go forward. That combination of those challenges, positive decision that we have made, we thought it is the right time for us to adjust our guidance to build a stronger, more resilient business in the long run.

Got it. Thank you very much.

You’re welcome.

Thank you. Our next question will come from Jeff Johnson with Baird. Your line is open.

Thank you. Good afternoon. Can you hear me, guys?

Yes.

All right. Great. Amir, you and I have known each other a long time, so I'm going to ask you two maybe tough questions but I think fair questions here. So on the Equipment & Consumables side, looks like it's going to be down for the year on a core growth basis. It was down last year year-over-year. And even if I go back to the three years pre-COVID, 2017, 2018 and 2019, you were negative in E&C on a core growth basis. My sense is most of those years that's a couple of few points below market, although hard to tell each of those years. So I guess my question is when the market recovers, whether we get back to a 2% to 3%, 3% to 4% kind of market growth rate in E&C for the broader market, do you think you can be at market? Or is there something structurally disadvantaged in your product categories or your positioning that's going to make it tough to even get back to market when the market improves eventually?

I appreciate the question. You get to the heart of it and I'd love to be able to answer that question and tell you that we went through a radical transformation of our Equipment & Consumable business. You have been with us since 2015 in the past eight years that I've been around, the first two or three years of this journey of building Envista as a SaaS today was a lot of transformation, moving away from product categories, geographies that really wasn't advantage moving away and selling obviously the cohort business moving from animal healthcare and many other businesses. So if I take a look at the last nine months as an example and then compare it to 2022, here's what I see, here's what we see. If I take the exits of the geographies that we have moved, we have a really good feel for what's going on in inventory on consumable and the sellout. About, I would say, two-thirds of our business, of our consumer and equipment is in North America. We have a tremendous amount of insight about the sellout. We are at or above sellout in the past nine months in almost every category. So I appreciate the perspective and looking back but that's the reality of what we see on the ground. We watch that very carefully. We watch inventory. We watch sell out. You may see a quarter-to-quarter ups and downs but in the past quarter-to-date our consumable at or above sellout and categories on imaging at or above sellout. But now I want to turn to the discussion forward and tell you what we expect to see. Majority of deemphasizing some of the product categories in some geographies, it's going to be behind us. We're going to manage this business to get it to a more stable differentiated. We're there with the consumable with infection, with prevention, with endo, with resto. Last piece of this equation is around imaging. We believe we will be in a strong position starting in 2024, with innovation playing a crucial role. In the past three months, we have introduced a new category, OP3D LX, which will help us expand our presence. We have launched a new intraoral scanner and received FDA approval for an AI that we are implementing in a large installed base of sensors. A combination of marketing strategies focused on innovation and the ongoing implementation of our work will position this business at or above market levels as we move forward. We are very confident that this is the direction we are headed in and the future we are anticipating.

All right. Well, that's great to hear. And let me ask the second question then on your North American implant business. And obviously, you have the Nobel Biocare business here. You have the implant direct business. It seems like a bit of a gap at least in my view a gap in kind of that premium minus category maybe the $350 to $400 price point something like that. And I think as practice profitability has come under pressure here in the past 12 to 18 months at a lot of these offices. That's $100 $150 savings off the premium price points, maybe starting to appeal to some implant docs out there. So my question is you're putting more channel support out there. You're putting more investments in the North American business, training, education, things like that. Is that enough do you need to fill that product gap in that premium minus? And if you do how do you do it?

Yes. Great question, Jeff. What we did? What we have done in the past probably six to nine months, we went back and said let's take a look at 2016 to 2019. Let's assume that's norm. That's what the world before COVID would look like. We look at the number of implants, we look at the prices, we look at premium versus value. And we say okay, erase 2020, look at 2021, 2022, 2023 I'd like to see what that looked like in order for us to be able to look at what the new world order look like in 2024 to 2026. What we see in here, the pricing in implant, we're purely talking implant on the premium side it hasn't dropped as radically as anticipated. Value prices have dropped a lot quicker, a lot faster. Volume if you look at the volume, volume on the value side has increased a lot quicker, a lot faster. The expected shift towards value hasn't occurred as anticipated. However, if we focus on the dollar spent, which includes prosthetics and regenerative products, premium offerings remain a significant part of the overall equation. The spending on both patient and practitioner sides continues to favor premium products and hasn't changed drastically. Additionally, if we examine the cost of replacing a single implant from 2016 to the present, despite market changes and price reductions, the prices have actually increased. This indicates that businesses are charging more now than before. As a result, this sector remains healthy with high margins. As for why we've recently acknowledged this challenge, the pent-up demand post-COVID led us to misinterpret some of the reality. All the changes that we did on the commercial execution, customer experience, training, education, VBP in China it's paying off. Over 50% of our business outside North America is performing at proxy or above proxies. When we start digging into the North America who is placing this implant, the specialists, those high-volume GPs, the DSOs. The value proposition what you need to do for each segment is radically different and we need to change and adjust our approach. We need to become a lot localized. We need to be on the ground in front of these people. Customer experience becomes a lot more important, relationship with reps, supporting infrastructure, local training and specialists and referral network and lab, building a community of the future, younger oral surgeons more diverse these are the things that are going to build the future of this business. We need to focus on building that community and providing opportunities for people to learn, teach, and positively influence the environment. We have been working on this for some time and wanted to ensure we fully understand the situation on the ground before taking significant actions. We have gained that understanding now. Regarding the portfolio, Nobel is a recognized brand. Through our interviews with numerous individuals, we've learned that while addressing product gaps is important, it is not our top priority. I remain committed to innovation and believe there are both short-term and long-term strategies to pursue. In the short term, enhancing customer experiences, teaching people how to place implants, and building impactful communities are crucial. We also need to consider our portfolio while integrating insights from N1 and assessing current needs to strengthen partnerships and fill gaps in key areas. We feel confident in our understanding, which is a significant aspect of the challenge we face. We believe we now grasp the core issues. We have begun implementing actions, making investments, adding resources, and establishing training and educational programs, and you will notice improved performance as we move forward.

Appreciate that. Thank you.

Thank you. Our next question will come from Jon Block with Stifel. Your line is open.

Thanks, guys. Good evening. Maybe the first one it sounds like the expectations for modest growth for revenue and EBITDA expansion in 2024 Stephen if I heard you correctly. So what do we think about the LRP EBITDA margin of 22.5% for 2026? And that implies greater than 100 bps off the new 18.5% this year. And next year doesn't seem like that's teed up for 100 bps. So it would be wildly back-end weighted. So let me maybe start there. Do we take that off the table which arguably was on the table only nine or 10 months ago? And then I'll ask the follow-up.

Yes. I'm happy to answer that, Jon. We provided guidance indicating that in the long run, we aim for high single digits reaching 22.5% by 2026. We communicated our intention to double the size of our Spark business, which is crucial for achieving that core milestone in the long run. Over the next three years, we see significant opportunities for expansion and growth in that area. Additionally, the margin on our Spark is currently below the fleet average. Looking at the last seven quarters, including the most recent one, we've seen improvement in margins each quarter. While we continue to invest and enhance automation and our EBS network, our goal is to improve margins to align with the fleet average in the coming years. As significant investment and growth in a portion of our portfolio getting to more fleet average really make that equation work. So that's the first element of this. Second, our implant business has been operating performing below market proxies. The plan that we have to go execute it. But the plan that is in place to get that to the market proxies over the next couple of years start improving that in 2024. It's such a high-margin business. That by itself is going to make a huge difference. The third piece of this equation is around diagnostics. We course correct and deemphasize some of the product categories region, that's going to be behind us. We're going to see a better performance. You have seen that in the past three quarters our Equipment & Consumable has better margins and continued to deliver. Now imagine getting to market proxies to single-digit market improvement and higher margin in that area. That is going to add to the proxy add to that long-term view. We're not counting on any radical changes. We do that math. We execute the program that we have in place we deliver on what we have in our long-term view without any acquisition we think that long-term goal is achievable. We need to go on and execute it in the short term. We have to make some trade-off between growth and margin in order to build the foundation for the long run. This organization has proven that they have track record of confidence in building credibility and operational excellence. 450 basis points of operating margin improvement we have done that. We can do that again moving forward.

Okay. That was great. That was very helpful. I mean, the second question might just be a little bit more straightforward, and I apologize in advance for it. But I just really don't understand the implant commentary. So it seems like you've been the main share donor in the industry of late. You're poorly weighted in terms of call it premium versus value. How do you expect to get back to market growth as early as 2024? Maybe if you can detail how you do that so quickly. And then I feel like getting back to market growth in 2024 is actually odd with modest revenue growth because it's such a big chunk of your portfolio, Amir. 40% of your biz is going to grow mid single-digit and Spark is still doing really well it's hard not to land at mid single-digit growth for you guys when you sort of weight everything out. So I find them at odds maybe if you can talk to that. And then that's a really quick turn to get back to market growth considering your starting point with mix against you? Any details would be great. Thanks guys.

Thank you for your confidence, Jon. I really appreciate it. Let me clarify this for you. You mentioned 40%, which is absolutely correct. Of that, 50% represents the 20% of the business related to operating and market measures. This isn't a complete overhaul; it's roughly 50% of the business that is operating below market benchmarks in North America. We can analyze the market measures over the last nine months across each segment, and we estimate that around 80% of our business is currently performing according to market benchmarks. The 20% of the business in North America is below those standards. You have a clear understanding of the upcoming announcements regarding North America. We recognize that we are indeed operating below market measures, and there's no doubt about that. We need to take a step back to understand what's causing this and why. Is it something temporary that we can address quickly while also focusing on the long term? We are not promising to gain market share in the lab, but we are committed to improving quarter by quarter. We have stopped the decline in specific areas, such as acquiring new customers, enhancing training and education, and improving the customer experience over time. These are steps we have taken. Jon, we implemented this approach in Europe with our implant business, starting in 2021, and we saw positive results in 2022. In 2023, our performance exceeded expectations, and in some regions, we outperformed benchmarks. This is not new for us. We have not yet provided guidance for 2024, as we are still evaluating that. By February, when we meet with investors, we will offer a clearer outlook. Following the release of our Q4 results, we will share our guidance for 2024. However, we believe the actions we have initiated will begin to yield results throughout 2024.

Okay. That's great color. Thanks, Amir. Appreciate it.

Our next question will come from Nathan Rich with Goldman Sachs. Your line is open.

Hi. Good afternoon. Thanks very much for the questions. I maybe wanted to start with the fourth quarter guidance. It looks like it implies a low single-digit decline in core growth. Could you maybe help us think about the impact by segment? You called out macro weakness. It seems like that would be more targeted on the specialty segment with implants and aligners. The distribution challenges I'd imagine impact E&C. So could you just maybe help us think through the relative performance of the two segments in Q4? And a couple of specific ones related to that. Obviously, Henry Schein has been impacted by disruption to their order management. Has that had an impact on your fourth quarter business? And as it relates to Israel I guess it wasn't clear is there a specific headwind embedded in the Q4 guidance? Or were you just highlighting that as an additional swing factor? Thanks very much. And sorry for the long questions.

Of course, Nathan three questions. I'll answer the first two and I'll have Stephen talk to Q4. Let's just start with Henry Schein. This is my year eight being in this industry. Stanley Bergman has been a friend, a mentor to me and somebody that I have a tremendous amount of respect for. We have reached out to them. We have offered our support. We have told them that we are here to help any way that we can is an unfortunate situation. We have a very close relationship with them. And we are trying to figure out how we can mitigate some of this negative impact. But Henry Schein is our largest distributor in North America. But as I mentioned two-thirds of our Equipment & Consumable businesses in North America. And given that dynamic as something that we cannot forecast and really see how that's going to impact us. We're working with customers. We're working with all the distribution, but visibility is really very, very difficult to make for us to be able to say when that recovery is going to take place. They can't take order; they have some other challenges. It's directly impacting us. Let me talk about ABT a little bit. ABT is an Israeli company that Nobel bought prior to our acquisition. We have an incredible manufacturing site in Modlin outside Tel Aviv. Our people have come to work and they're working but the environment is really difficult. We have about a $20 million business as a whole in Israel. Obviously, we're not expecting to see anything in Q4, but also it's a huge manufacturing site for us for our ABT business which is present in Latin America, Europe, and China. We're trying to build inventory trying to manage through that but it's the realities that we are dealing with. That conflict has caused uncertainty that we didn't face eight weeks ago. Now let's talk a little bit Q4 and the gap that we see there.

In the fourth quarter, we expect continued robust growth in Spark, consistent with our performance so far, but this growth will be moderated by some macroeconomic challenges that Amir has mentioned. Additionally, we do not anticipate a turnaround in our North American implant business during this quarter and expect it to continue underperforming as we prepare for improved results next year. Furthermore, on the engineering and construction side, we are planning exits or reducing emphasis on certain regions and products, which will modestly hinder our growth. As Amir noted, there is also uncertainty in the North American distribution channel, particularly regarding the variability in potential sales of consumables. All of these factors will contribute to a slight decline in growth. On the margin front, we will continue to invest in both Spark and implants, which will affect our margin profile.

Great. Thank you.

Thank you. Our next question comes from Jason Bednar with Piper Sandler. Your line is open.

Hey, good afternoon. Thanks for taking the questions. I want to start here on EBITDA margin for the year. And apologies, I know we've covered this in a few different ways already maybe but just trying to understand the message and really consider where we're at versus where we've been all year long. The last nine months the message has been for Envista we've got EBS. We're lean. We're restructuring the business in certain geographies these are paying off. We're going to deliver an improvement in EBITDA margins in the second half of this year. It's back-half weighted but we know that. But today's message seems like a pivot where you're meeting a tougher operating environment with higher spending in business reinvestments. So look I understand it's a tough question and there are things that are outside of your control like we're just talking about with Henry Schein, but can you help with the cadence of decisions in messaging here around EBITDA margins?

Yes, I'm happy to address that. The mix is very important here, particularly with Spark growing significantly faster, which is why we are committed to opening a new factory and expanding while we enhance fleet averages. As Stephen mentioned, we do not anticipate any drastic changes, but rather a steady improvement each quarter. The uncertainty we discussed regarding North American distribution is critical. These high-margin products, if we cannot reliably deliver them to customers, will have consequences. It's not only about our continuous improvement; we are doing everything we can to ensure that gross margins, particularly in areas like Spark, keep improving each quarter. Our imaging business is becoming increasingly profitable. Our consumables are optimized in terms of on-time delivery, quality, and margin structure. However, the challenges we face in these areas are having a significant impact. We may need to reconsider what we can confidently achieve in Q4. We aim to build this business sustainably in the long term. Yes, we have commitments, and we want to meet our guidance, but we must also balance investment with margin growth. The investments we're making now in Spark and North American commercial activities will have long-term benefits, and we expect to see results from that in 2024, 2025, and ultimately toward our goals for 2026.

Okay. Amir, are you able to quantify maybe how much the distribution disruption is impacting profitability as that seems like the biggest delta versus where we were at three months ago? And then I did want to piggyback off Jon Block's question. Are you saying that your LRP for 2026 is intact? Or are the goalposts moving here where your LRP is now the definition long-term rather than aligning the sand like 2026?

We do not provide specific guidance by segment. We are anticipating challenges in North America related to distribution, as well as other risks we've discussed in relation to the LRP. This is how we adjust our forecast. The milestones for 2026 are still in place, and we have a plan to achieve them. There are several activities necessary to reach this goal. If the macro environment does not worsen beyond our expectations, the strategies and innovations we've implemented should enable us to meet the guidance we set for 2026. We have a lot more work to do, a lot more opportunities to have that discussion when we meet in February and after Q4 results. Right now we are focused on trying to do the best that we can to take care of our customers to make sure that our team sees the future of what we can do as a company making a huge difference. We have come a long way in the past four years. We're not stopping in here. And we think what we see in the short-term is a blip in what we need to do to build the future of this industry and the future of Envista. Thank you so much.

Thank you. With that, we're going to conclude the call. I really appreciate everyone's time. We look forward to talking to you in the coming weeks.

Thank you. Ladies and gentlemen, this concludes the Envista Holdings Corporation's Third Quarter 2023 Earnings Results Conference Call. You may now disconnect.