Patterson Companies Q1 2024 Earnings Call Transcript

Quartr
Provided by Quartr
August 30, 2023

There are 13 speakers on the call.

Operator

Good morning, and welcome to the Patterson Companies, Inc. First Quarter Fiscal 20 24 Earnings 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 Thank you. John Wright, Vice President of Investor Relations, you may begin your conference.

Speaker 1

Thank you, operator. Good morning, everyone, and thank you for participating in Patterson Companies' fiscal 2024 First Quarter Conference Call. Joining me today are Patterson President and Chief Executive Officer, Don Zerbe and Patterson Chief Financial Officer, Kevin Barry. After a review of our results and outlook by management, we will open the call to your questions. Before we begin, let me remind you that certain comments made during this These factors, which could cause actual results to materially differ Those indicated in such forward looking statements are discussed in detail in our Form 10 ks and our other filings with the Securities and Exchange Commission.

Speaker 1

We encourage you to review this material. In addition, comments about the markets we serve, including growth rates and market shares are based upon the company's internal analysis and estimates. The content of this conference call contains time sensitive information that is accurate only as of the date of the live broadcast, August 30, 2023. Patterson undertakes no obligation to revise A financial slide presentation can be found in the Investor Relations section of our website at pattersoncompanies.com. Please note that in this morning's conference call, we will reference our adjusted results for the Q1 of fiscal 2024.

Speaker 1

The reconciliation table in our press release is provided to adjust reported GAAP measures, namely operating income, other income expense, net, Income before taxes, income tax expense, net income, net income attributable to Patterson Companies Inc. And diluted earnings per share attributable to Patterson Companies Inc. For the impact of dealer amortization along with the related tax effect of this item. We will also discuss free cash flow as defined in our earnings release, which is a non GAAP measure and use the term internal sales to represent net sales adjusted to exclude the impact of foreign currency and contributions from recent acquisitions. These non GAAP measures are not intended to be a substitute for our GAAP This call is being recorded and will be available for replay starting at 10 am Central Time for a period of 1 week.

Speaker 1

Now, I'd

Speaker 2

like to hand the call over to Don Zerbank. Thanks, John, and

Speaker 3

good morning, everyone. Patterson had a strong start to fiscal 'twenty four, Building upon our momentum across the business as we continue to deliver value for our customers and shareholders. A few highlights from our Q1. On the top line, year over year internal sales increased approximately 3% with growth across both the Dental and Animal Health segments. Our initiatives to drive margin improvement were successful as we achieved year over year adjusted operating margin expansion across the company and the Dental and Animal Health segments.

Speaker 3

We returned $55,000,000 to shareholders in the form of cash dividends and share repurchases. And we delivered adjusted EPS growth of 25% in the same period a year ago. Given these results, We remain on track to achieve our fiscal 2024 earnings guidance. As a reminder, our guidance accounts for our commitment to deliver year over year internal sales growth and adjusted operating margin expansion for the total company and across both our Dental and Animal Health segments. Our performance during our fiscal 2024 Q1 Illustrates the continued execution of our proven strategy, which as I shared last quarter is designed to achieve 4 core objectives.

Speaker 3

1st, drive revenue growth above the current end market growth rates. 2nd, build upon the progress we've made to enhance our margin performance. 3rd, evolve our products, channels and services to best serve the customers in our end markets and 4th, improve efficiency and optimization. Our team is aligned around various strategic initiatives to advance each of these core objectives. Today, I'd like to highlight just a couple of specific examples that we've been working on in early fiscal 2024 to demonstrate our progress.

Speaker 3

First, our focus on private label. During the Q1, we benefited from continued growth in our private label portfolio, which includes a collection of owned brands with strong market equity. These include brands we've built like the Patterson brand in dental in the Aspen and Pivotal companion vet products as well as acquired brands like Dairy Tech and the Production Animal business. We have invested in this important category by adding new SKUs and our sales team is highly engaged and motivated to drive sales growth in this margin accretive category. We continually evaluate opportunities across our businesses, but believe there is a distinct opportunity within Animal Health to further expand the private label portfolio to meet evolving consumer preferences.

Speaker 3

In fact, during fiscal 'twenty four, we to add more private label products to our Animal Health offering than ever before. Over the past several years, our private label sales groups outpaced the Sales growth of products manufactured by our strategic partners. The results are paying off and in addition to generating above market growth, Our focus on private label supports our other core objectives. Another recent example relates to our efforts to improve efficiency and optimization. As we've said before, this objective includes not only a rigorous focus on cost discipline, but also targeted investments to leverage best practices and advance operational excellence across the enterprise.

Speaker 3

We have recently been implementing a strategic modernization of our Fulfillment Facilities and Capabilities. This includes investments in new technology such as robots and cobots to automate order picking, Enhancements for our teams to ensure the right skills and expertise to operate the more modern facilities and substantial expansions of our fulfillment capacity. Just this week, we are opening a brand new fulfillment center in the UK we call the Big Shed that will double our capacity in the region. This fully automated next generation facility is not just larger, it's more sustainable, more efficient and further advances our channel capabilities. We also recently completed a technology overhaul to our fulfillment center in Southern California and are close to opening an expanded facility in Montreal, Canada.

Speaker 3

In addition, we have similar projects underway These are only a couple of examples of some of the many initiatives we have underway. Taken together, our strategic areas of focus build upon our strong foundation and Over the past several years to further differentiate our position in the market and drive enhanced growth, profitability and value creation over the long term. Now I'll provide some updates on each of our segments during the fiscal Q1. Let's start with Dental. Dental segment internal sales increased 2% compared to the Q1 of fiscal 2023 due to strong growth in consumables and value added services, which includes our software offerings.

Speaker 3

We also achieved year over year adjusted operating margin expansion in the fiscal Q1 due to our dental team's ongoing focus on our margin enhancement initiatives. Our value proposition continues to resonate with all types of dental customers From individual practices to group practices, we seek to create a seamless experience by offering a comprehensive suite of products and solutions In the consumables category, dental internal sales increased approximately 5% in the fiscal Q1 compared to 1 year ago. Excluding the moderating deflationary impact of infection control products, internal sales for our non infection control consumables Increased nearly 7% year over year. Overall, we believe the demand we are seeing for consumables products speaks to the resiliency of the dental market and our ability to drive growth above the current end market. Looking at dental equipment, internal sales in the Q1 of fiscal 2024 decreased 6% compared to the year ago period.

Speaker 3

Our team delivered growth in our core equipment and CADCAM categories that was more than offset by a decline in digital technology, which experienced a sequential decline in sales following a strong fiscal 2023 Q4. This dynamic is typical of the variability of the equipment category and further demonstrates how equipment sales can fluctuate quarter to quarter for a variety of factors. Over the last eight quarters, our average quarterly equipment internal sales growth was 4%. Dentists continue to invest in their practices and look to Patterson when they do. We anticipate the demand for equipment and technology will drive partners to continue introducing new innovations and technologies.

Speaker 3

Patterson is uniquely positioned to capitalize on this demand, thanks to our expertise in selling, financing, installing, training and servicing the latest technologies and equipment. And finally, dental internal sales in our software and value added Services category increased approximately 6% over the prior year period. Value added services represent the entire suite of offerings We provide to our customers that help make Patterson an indispensable partner to their practice, including our leading technical service offering. This category continues to grow at a rate exceeding the overall rate of the Dental segment. The strong results we have been delivering in the value added services Our testament to our customers recognizing the full lifecycle support and services that Patterson provides.

Speaker 3

And as an added benefit, these valuable offerings are a mix favorable to our P and L. Maximizing our value added service offerings, which we believe will continue to serve as tailwinds and help drive performance across our dental segment over the long term. Now let's move on to our Animal Health segment. During the Q1 of fiscal 'twenty four, Animal Health internal sales increased 4% year over year with growth in both Companion Animal and Production Animal Businesses. We also achieved year over year adjusted operating margin expansion in the Animal Health segment, building upon our excellent track record of margin improvement over the past few years.

Speaker 3

We benefit from the depth of our offering and omni channel presence It spans a wide range of animal species and offers comprehensive solutions for diverse customers. In companion animal, our internal sales in the first Fiscal quarter increased by mid single digits as we executed well within this healthy and growing market. As we've said before, we've been modeling mid single digit revenue growth for our companion business over the long term. On the production animal side, fiscal 2024 Q1 internal sales grew by low single digits. Despite ongoing headwinds within the cattle market, we have continued to deliver sales growth in this part of the Animal Health business.

Speaker 3

This is a testament to our team's performance and the diversification of our production business. Across the Animal Health segment, Our value added services category achieved strong growth that can be attributed to sales of our software solutions and equipment service as well as operational efficiencies. Expanding our investments in software and value added services remains a priority for us and is core to our objective to position Patterson Animal Health As the leading provider of technology, software, data insights, services and products to the animal health industry. Our team stands ready to help our customers identify the right set of solutions to streamline their workflows and run their practices efficiently, all backed by our unbeatable service and support. Now, I'll turn the call over to Kevin Barry to provide more detail on our financial results.

Speaker 2

Thank you, Donna, and good morning, everyone. In my prepared remarks this morning, I will cover the financial results for our Q1 of fiscal 2024, which ended on July 29, 2023, and then conclude with our outlook for the remainder of the fiscal year. So let's begin by covering the results for our Q1 fiscal 2024. Consolidated reported sales for Patterson Companies in our fiscal 2024 Q1 were $1,600,000,000 an an increase of 3.5% over the Q1 of 1 year ago. Internal sales, which are adjusted for the effects Currency translation and contributions from recent acquisitions increased 2.8% compared to the same period last year.

Speaker 2

Gross margin for the Q1 fiscal 2024 was 20.2%, a decrease of 25 basis points compared to the prior year period. Our gross margin was negatively impacted by 40 basis points this quarter by the mark to market accounting adjustment from rising interest rates on our equipment financing portfolio. As we have mentioned in prior earnings calls, any positive or negative impact related to our cobalt financing portfolio is nearly offset by our corresponding hedging instrument, which is reflected in the other income net line in our P and L.

Speaker 1

So the net results have

Speaker 2

a minimal impact on our adjusted earnings per share. This dynamic also occurred in the 1st fiscal quarter of last year and the positive impact of the mark to market accounting calculation was 10 basis points. When normalizing for the mark to market accounting adjustment in both periods, our gross margin rate in the Q1 of fiscal 2024 was 20 basis points higher than the Q1 of fiscal 2023. Remember, the accounting impact of the mark to market adjustment impacts our total company gross margin, but not the gross margin within our business segments. Importantly, during the fiscal Q1, Both of our business units posted a year over year increase to their respective gross margins compared to the prior year period.

Speaker 2

Adjusted operating expenses as a percentage of net sales for the Q1 of fiscal 2024 were 17.2% and favorable by 40 basis points compared to the fiscal Q1 of 'twenty three. In the Q1 of fiscal 'twenty four, our consolidated adjusted operating margin, 3.0 percent, an increase of 15 basis points compared to the Q1 of last year. Again, when normalizing for the impact of the mark to market accounting In both periods related to gross margin, our consolidated adjusted operating margin in the Q1 of fiscal 'twenty four expanded by 60 basis points over the prior year period. I am pleased with the team's efforts to continuously improve and deliver on our commitment to drive operating margin expansion within our business segments and for the total company overall In the Q1 of fiscal 2024, the initiatives we put in place to improve gross margin, to work more closely with strategic vendors who reward us for our sales performance, Drive improved mix, exercise expense discipline and leverage our cost structure has certainly translated into a higher level of profitability and financial performance for Patterson. Our adjusted tax rate for the Q1 of fiscal 2024 was 23.5%, an increase of 110 basis points compared prior year period.

Speaker 2

Reported net income attributable to Patterson Companies, Inc. For the Q1 of fiscal 2024 was 31,200,000 or $0.32 per diluted share. This compares to reported net income in the Q1 of last year of $24,600,000 or $0.25 per diluted share. Adjusted net income attributable to Patterson Companies Inc. In the Q1 of fiscal 'twenty four was $38,600,000 or $0.40 per diluted share.

Speaker 2

This compares to $31,700,000 or $0.32 per diluted share in the Q1 of fiscal 2023. This 25% increase in adjusted earnings per diluted share The fiscal Q1 is primarily due to sales execution and operating margin expansion in both of our business segments. Now let's turn to our business segments, starting with our dental business. In the Q1 of fiscal 2024, Internal sales for our dental business increased 2.1% compared to the Q1 of fiscal 2023. Internal sales of dental consumables in the fiscal 1st quarter increased 4.6% compared to 1 year ago and were impacted by continued price deflation of certain infection control products.

Speaker 2

Internal sales of non infection control products increased 6.9% in the Q1 of fiscal 2024 compared to the year ago period. This negative impact from infection control product deflation has continued to moderate over the past year and we expect the year over year deflationary effect to Continue moderating and fully normalized by the end of fiscal year 2024. In the Q1 of fiscal 2024, Internal sales of dental equipment decreased 5.7% compared to 1 year ago. As Don mentioned, sales in the equipment category can vary from quarter to quarter These dynamics apply to each of the specific product categories as well. This quarter, core equipment and CADCAM sales posted positive year over year sales growth, but were more than offset by a decline in the digital X-ray category compared to the prior year period.

Speaker 2

Internal sales of value added services And the Q1 of fiscal 2024 increased 5.8% over the prior year period, led by the increased year over year contribution Our technical service team and continued growth of our software business. Value added services, including our software offerings, represents the entire suite of offerings we provide to our customers to help make us an indispensable partner to their practice and these valuable offerings are also most favorable to our P and L. The adjusted operating margin in dental was 7.4% in the Q1 of fiscal 2024, which represents a 35 basis improvement over the prior year period. This operating margin performance reflects the efforts of our dental team to improve margins through effective pricing and mix management and continued expense discipline to deliver operating margin expansion for the Q1 of fiscal 2024.

Speaker 4

Now let's move

Speaker 2

on to our Animal Health segment. In the Q1 of fiscal 2024, internal sales for our Animal Health business increased 4.0% compared to the Q1 of fiscal 2023. Internal sales for our companion animal business in the Q1 of fiscal 2024 increased 5.1% over the prior year period, which included strong sales performance from our NVS business in the U. K. Internal sales for our production animal business in the Quarter increased 2.5% in the quarter compared to the prior year period.

Speaker 2

Our production animal team continues to execute well in the market Nantral sales in the Q1 of fiscal 2024 delivered particularly strong growth in the swine category compared to the prior year period. The adjusted operating margin in our Animal Health segment was 4.0% in the fiscal 2024 Q1, an increase of nearly 80 basis points from the prior year period. Our Animal Health team continues to drive business with strategic manufacturer partners who value our ability to deliver increased sales, While also exercising expense disciplines, they delivered operating margin expansion for the Q1 of fiscal 2024. Now let me cover cash flow and balance sheet items. During the 1st 3 months of fiscal 2024, our free cash flow improved by $35,700,000 Compared to the same period 1 year ago.

Speaker 2

This was primarily due to a decreased level of working capital in the 1st 3 months of fiscal 2024 compared to the year ago period. Turning now to capital allocation. Our capital spending in the Q1 of fiscal 2024 was $17,100,000 $2,500,000 higher than the Q1 of fiscal 2023. This increased spending reflects the investments we are making in our distribution capabilities as well as our software and value added services. We continue to execute on our strategy to return cash to our shareholders.

Speaker 2

In the Q1 of fiscal 'twenty four, we declared a quarterly cash dividend of $0.26 We also repurchased $29,500,000 of shares during the Q1 of fiscal 2024, thereby returning a total of $54,900,000 to shareholders

Speaker 1

Let me conclude with our outlook for

Speaker 2

the remainder of fiscal 2024. Today, we are reaffirming our Fiscal 'twenty four GAAP earnings guidance range of $2.14 to $2.24 per diluted share and our adjusted earnings guidance range of $2.45 to $2.55 per diluted share. And now, I will turn the call back over to Don for some additional comments.

Speaker 3

Thanks, Kevin. Before we open it up for Q and A, I want to thank the entire Patterson team for a great Our first question comes from the line of John Franzreb with Baird. Please go ahead. Thank you, And combined with the resilient end markets in which we operate, I'm confident that we are well positioned to drive enhanced growth, profitability and value creation over the long term. That concludes our prepared remarks.

Speaker 3

Kevin and I will be glad to take questions. Operator, please open the line.

Operator

And your first question comes from the line of Jason Bednar from Piper Sandler. Your line is open.

Speaker 5

Hey, good morning. Thanks for taking the questions.

Speaker 3

Don or Kevin, I want

Speaker 5

to start. The Dental consumables performance was really strong. It really seems to I heard the private label commentary, but could you unpack a bit more where the That's coming from that supporting that 7% underlying growth in consumables. Any procedure categories to call out where you're seeing notable strength or Anything of note on DSOs, pricing, share gains, anything like that?

Speaker 3

Yes. Thanks, Jason. We're trying to be helpful here. We're not going to probably break down pieces, but quite honestly, we saw Soft strength across the board. I think patient traffic is steady.

Speaker 3

We feel really good about that. All customer types performed And the sales force really I think is just hitting on all cylinders right now. We think the momentum, The key to this quarter and last quarter and just kind of where we're at right now is just the continued momentum in the business. So not to not be able to break that down for you, but honestly, it was across the board.

Speaker 5

Okay. All right. That's helpful. I'm sure others will probably have questions there as well. But maybe just for a follow-up, I did want to ask, I mean, Don, you highlighted those corporate investments.

Speaker 5

Don't think we've heard those kind of specifics in the past. It sounds like you have a lot of wheels in motion across your facilities, your distribution network. Are you able to quantify all the investments you've made with some of that automation work and What the ROI or payback you're expecting from some of those investments?

Speaker 3

Yes. Well, if you look at our CapEx Ending this quarter is above last Q1. And I think what you're going to see is as we go through the year, that will continue to be the case. All of these projects go through a rigorous process that we have internally to make sure that the ROI It's above our cost of capital and that it is a financial payoff as well as all the other benefits we're getting from it. So we're pretty excited about each of these investments.

Speaker 3

Obviously, we're not going to see the benefits of these Quite yet, but wanted to highlight some examples of the types of things that we have that are going to keep the margin improvement Moving in the right direction and when we make the commitment to continuously improving the margin, I think this is an example of how that works. So pretty excited about all of them. I think more to come. And what I really like is the team continues to think about The next thing and the next opportunity. Okay, great.

Speaker 3

Helpful. Thank you.

Operator

And your next question comes from the line of Nathan Rich from Goldman Sachs. Your line is open.

Speaker 6

Great. Good morning. Thanks for the questions. I wanted to start with a question on margins. Don, you reiterated expectations for operating margin expansion for the total company, as well as both segments.

Speaker 6

I guess any Change in your expectations for the overall level of margin expansion, I guess, particularly with respect to the dynamics you're seeing in the corporate segment? And then any comments or thoughts on just cadence of margin improvement over the balance of the year?

Speaker 3

I'll maybe let Kevin get into a little of that. I think overall, we're still committed to the margin improvement story Both at the corporate level and in each of the business units. And if anything has changed, it's It's minor. I think our expectations are the same as they were as we entered the year.

Speaker 2

Yes. We got off to a good start here in Q1 with both of our business units Expanding both their gross margins and their operating margins. And so we're seeing that momentum at the business unit level. You alluded to the corporate segment. Just a reminder, this is a dynamic that we have related to our equipment financing portfolio, where as the forward Interest rate curve changes, we have to mark that portfolio to market, which does create some noise in our corporate segment and our overall margins, which is offset with the hedge we have in our other income line below operating profit.

Speaker 2

This quarter, it was a bit of a headwind as the forward rate curve increased in that portfolio. And so and that's why we Try to give you guys kind of the adjusted number, so you can see kind of what that noise taken out of that, how we're performing underneath it. So We're not going to guess where interest rates are going to go from here, but we'll continue to kind of have that dynamic as interest rates change. But again, I think, Wes, you You can strip that out and see the underlying momentum there.

Speaker 1

And then the other thing

Speaker 2

on phasing, I'd say is that, I think we expected Similar cadence where we typically see some leverage as we go through the year. Q1 is typically our lowest Margin levels for the year, but as we have higher sales quarters, we typically see leverage on the op margin line for the rest of the year.

Speaker 3

I think I just maybe want to reiterate, when you take out the dynamics of the Accounting that Kevin mentioned, which you need to do, and look at our margin. I mean, our gross margin was up 20 basis points in the quarter, like Kevin mentioned an operating margin up 60%, which I think was notable and I want to make sure people understand that dynamic. It's kind of confusing.

Speaker 6

Great. That's helpful. And then I wanted to ask on the U. S. Companion animal business.

Speaker 6

I know you said Overall companion was up 5.1, but I think Kevin you kind of called out NVS as maybe the main driver of that. Could you comment on how the U. S. Companion Animal business did? And any change to your outlook for That business, just given kind of the overall kind of traffic and level of demand that you're seeing in the market?

Speaker 2

Sure. I can jump in and Don can add We saw growth in both segments. We saw particularly the strong growth in our NBS business, which is we want to All of them out there performing really well in that market, and this is an advance of some of the investments Don mentioned, which you think are even going to accelerate that business further. But the U. S.

Speaker 2

Companion business also did grow in the quarter. Now, as you'd expect, we're not seeing the same level of growth as we have over the past couple of years as that market Has kind of moderated a bit from the heights of the pet pandemic boom. But And in the overall market, we still see spending up, even as visits have come down a bit. So that teams are executing really well And they are growing in the market. So

Speaker 3

Yes, I think the 5% is off a fairly tough comp, as Kevin mentioned, Some of the dynamics in the market that were in place last year.

Speaker 6

Great. Thanks very much.

Operator

Your next question comes from the line of Jeff Johnson from Baird. Your line is open.

Speaker 7

Thank you. Good morning, guys. Don, I wanted to start on your equipment numbers down 5.7%. Obviously, We've seen many times in the past from you and other companies push hard at kind of the fiscal end of year to make some numbers and then the next quarter has a bit of an overhang here. How much of that did was it an impact this quarter?

Speaker 7

I mean, obviously, you talked about digital X-ray being down, but I'm hoping you can help us maybe disaggregate kind of End market tenure of end markets versus just some timing of when you closed your fiscal year and then made a big push last year and had a bit of an overhang deal with in this Q1? Thanks.

Speaker 3

Yes. No doubt, Jeff, and I think you've seen that in the past. And there's a lot of reasons for it. Obviously, Yes, there can be a 4th quarter push. We do budget and forecast for that.

Speaker 3

And I think, as you mentioned, The digital category sometimes is the one that you may see more variability on that kind of dynamic. So this gets back to for me just back to the whole notion of looking at it in the 3 month increments, particularly as You're bringing up in the Q4, Q1 kind of realm. I think the I think if you just looked across the 6 month period, which might be A better way to think about all that, our equipment sales were up 8% Q4 and Q1 over last year. And then I think that I would just highlight that we keep watching this category As you all do, I think in terms of the economy and things, but all we're seeing is just the Our customers desire to continue investing in their practice and that's just not slowing down. It's good patient traffic and it's

Speaker 7

That's helpful. Thank you. And then just on the EPS guidance for the year, obviously up 25% year over year this quarter. I think your guidance The year is low single digit to mid single digit growth year over year for the full year. So that would kind of imply kind of flattish EPS over the next 3 quarters on a year over year basis.

Speaker 7

Just remind us, 1, why would that be the right level of EPS Growth after a strong start here on the EPS line of the year and 2, how much conservatism versus other factors we might have to be taking into account there? Thanks.

Speaker 3

Yes. I think this really actually is I think this mostly relates just to a bit of phasing on the year. I think that we had a tough comp in or we had an easy comp Q1 and obviously a tough comp in Q4 and there's some other dynamics within The year, but I think it relates more to that than anything. And so when we kind of look back and say even with all that phasing, We're comfortable with the guidance we've given for the year and that growth, even though it comes in a little

Speaker 2

bit different form each quarter. Yes. I think the only thing I'd add, Jeff, is there are some while we do expect the business to continue to grow over the course of the year, there are some internal investments we're making that will Ramp up a bit here into the rest of the year, that we think are great investments for the long term of the company, but we're going to have a little

Operator

And your next question comes from the line of Kevin Caliendo from UBS. Your line is open.

Speaker 8

Hey, guys. Thanks for taking my question. I guess one question I had to ask is around what you saw in July, That's the month we don't get to see from anybody else. And just wondering if trend through the quarter was consistent Or not, I understand on the equipment side what happened with ordering and timing. I'm just wondering, as you exited the quarter, did you think that demand for Equipment had changed at all from the beginning of the quarter or from Q2.

Speaker 8

We're just trying to get a read on what's going to happen over the So the calendar year into next year?

Speaker 3

Yes. No, Kevin, I appreciate the question and good one. For us, I think the quarter really played out kind of in normal I wouldn't highlight and we probably wouldn't say too much about intra quarter phasing, but I guess I would say that I don't think that there was nothing notable from my perspective on how the quarter played into the 1st 2 months versus The last one.

Speaker 8

Okay. That's helpful. And also just thinking about With equipment, where are you in terms of relatively speaking in terms of backlog, whether it's core or Digital, has that normalized? Or do you feel like the backlog in either of those are Elevated or lower or normal? Any color around that would be super helpful.

Speaker 2

I think This is Kevin. I think what we say, the core equipment demand continues to be strong. Those supply chains have Normalized, I think we'd say, compared to what we were talking about a couple of past year or 2. So the lead times aren't as long as they used to be. So that sales cycle is shortened for us, which is good.

Speaker 2

And then for the digital categories, those sales cycles are pretty quick. We can turn around those orders and installs fairly rapidly. The install is Not as complicated as a new office build out. So we don't really think about those in terms of backlogs just because the cycle is pretty quick. But I'd say, like Don said, we're seeing healthy demand in the market.

Speaker 2

Our sales teams are executing really well to help their customers find The right investment for the practice and feel good about the rest of the year.

Speaker 8

Do you think that interest rates or the economic Situation has held up ordering in any way, shape or form on some of the higher cost equipment In the category, I'm just we've heard anecdotally this from in the channel and from some of your peers and manufacturers. Just wondering how real you see that as being any kind of impact on the market?

Speaker 3

Yes. I think marginally, Not in a significant way though. And again, We're pleased with the momentum in the business, but the momentum in the market too in terms of Again, in terms of practices willing to invest in their business and it continues. It's a little more challenging, I think, but still makes sense, I think, when they run the math.

Speaker 8

Fantastic. Thanks so much, everyone.

Operator

And your next question comes from the line of Jon Block from Stifel. Your line is open.

Speaker 9

Great. Thanks, guys. Good morning.

Operator

I guess I'll go back to

Speaker 9

the underlying Dental consumables, which were seemingly, I guess, the revenue highlight for the quarter. You Got inflation impact starting to diminish. I guess where I'm trying to go with this is, what was the approximate price contribution in fiscal 2023 for Dental consumables and how do you see that playing out in fiscal 2024? I'm just trying to focus on that pricing contribution because I think we all want to arrive at how underlying volumes are trending and if the price contribution for consumables is sort of closer to normalized Levels as we currently sit here today.

Speaker 2

Yes, John, it's Kevin. Yes, I think

Speaker 1

we would say that the pricing certainly

Speaker 2

It is kind of more at historical norms, the kind of low single digit pricing. As we've looked at our internal data Here, we certainly part of our Q1 performance was price contribution, but it was also positive volume contribution. So we saw units grow This quarter as well. So it wasn't just one or the other. I think we expect that For some of those infection control products that we've been tracking, that year over year deflationary impact is going to continue to be a drag The next couple of quarters, the prices have stabilized, but we're still going to be comparing back to a higher ASP basket for those products from last year.

Speaker 2

So I think as we so we'll be dealing with that dynamic for the next couple of quarters. But I think for if you kind of look at the category as a whole, we'd We're seeing volume contribution as well as kind of more normalized historical price contribution for dental consumables.

Speaker 9

Okay, got it. Thanks for that. And then just maybe a small handful as part of the second question. For Dental equipment, Should we still expect mid single digit growth for the year? Obviously, fiscal 1Q was down.

Speaker 9

You got a really tough comp in 4Q. So do we still think You can land at mid single digits for the year. And Kevin, still tax rate of 25% for the year. Is that correct? You were shy of that for the quarter.

Speaker 9

And did your messaging change a little bit on the deflationary for the infection control? I thought before It was supposed to ease in the back part of the year. And maybe in your prepared remarks, you sort of said that continues to the end of the fiscal year, maybe some clarification there. Thanks, guys.

Speaker 10

Yes, I'll tackle a couple

Speaker 2

of those. So yes, on the deflation, I think what I'd say is, we really saw the prices kind of stabilize at a new level in our Q4 of fiscal 23. So it's probably Q2 will have a headwind, Q3 will have a smaller headwind. Yes. Q4, it should be pretty marginal, sort of how we see the pricing dynamics playing out there, John.

Speaker 2

And then on the tax rate, yes, we'd still say about 25%. We're seeing a step up this year in our tax rate due to some changes in the UK tax law as well as some And equipment. Yes. And I think, yes, you're right. We do have some tough comps coming up in equipment.

Speaker 2

The team is still pushing hard on that. I think mid single digit long term and again given some not looking at quarter to quarter, but over a reasonable timeframe is what we'd expect. And I just keep reiterating what we're saying is, I think the market is looking for these investments. And so we're still pushing to get to that mid single digit long term growth rate for equipment.

Speaker 3

I think the I think the metric we've kind of brought out every quarter is what does it look like if you look over the last eight quarters. I think the equipment growth is 4% in that time and it has been, so you can kind of think about it like that. I think The ups and downs here of the year we deal with, but over an 8 quarter period, that's still we still think that's a pretty good number.

Operator

And your next question comes from the line of Elizabeth Anderson from Evercore ISI. Your line is open.

Speaker 11

Hi, guys. Thanks so much for the question. Just a quick question. How are you guys thinking about obviously, you haven't Interest expense in the quarter, how are you sort of expecting that to trend for the rest of the year?

Speaker 2

Yes. So interest expense, we'd expect it to be maybe a little above What we carried here in Q1 for the rest of the next three quarters as we've kind of reforecast where we expect rates to go. And so really if you look at it versus last year, there will still be a bit of a headwind here in Q2 and Q3, a little bit less on Q4.

Speaker 11

Okay. That's helpful. And maybe on the longer term side, one of the things that maybe come out in the last couple of years Is that you seem to have a sort of different M and A strategy for the Animal Health business versus the Dental business. Seems like sort of more tuck ins on a or more regular cadence of tuck ins on the Animal Health side. Can you talk to us a little bit more about sort of Maybe why that is?

Speaker 11

Why you're seeing is this availability of assets? Is it just something unique about that business versus some the dental, which is obviously just had more core benefit?

Speaker 3

Yes. Okay. I think they're 1st of all, I would start off by saying in terms of our We're agnostic to some extent between animal health and dental. We're looking for the right opportunities that It hit our metrics and that check the box on what we're thinking about in terms of M and A. So, I mean, I would put this particular dynamic and kind of where we've been over the last few years is just the timing of opportunities that come up and When we're ready to do something and how they check the box.

Speaker 3

I don't know that there's anything particularly Unique about Animal Health that would put us into a position where there's some good tuck in acquisitions versus dental. But We're doing a lot of work. There's a lot of work going into all kinds of potential acquisitions. I know we've been saying this, but We're careful. We want to make sure we make the right investments.

Speaker 3

And so far, this is what we have. But again, I don't think there's anything unique about Animal Health and Dental, they are different businesses, but we're looking for the right opportunities.

Speaker 11

Got it. More for me. Just how do you think about the private label opportunity? I know you sort of talked about that particular stuff. Is there something you can sort of like Quantify there and I know you said you're adding more products than before, but how do we think about that as like a driver of margins in that business?

Speaker 3

Well, I think what you're going to see is private label becoming a more prominent part of our program. I mean, It's slow. We're not accelerating at a significantly rapid pace. So I mean, we move carefully, but definitely there's a strategic objective to make that a bigger part Of our business and our sales in both the Animal Health and Dental businesses.

Speaker 11

Got it. Thanks.

Operator

Your next question comes from the line of A. J. Rice from Credit Suisse. Your line is open.

Speaker 12

Thanks. Hi, everybody. Obviously, you had really solid strong growth in consumables on the dental side and Your equipment sales down for all the reasons we talked about and need to normalize that. I wonder though in the quarter, Does that dynamic, is it enough on the product mix shift you saw to have an impact on the margin? Is that part of why the margins Show the improvement that they did in dental?

Speaker 10

Yes, Ajay.

Speaker 2

It is. I mean, we see typically within our dental business, our consumables margins and our value added services margins, Gross margins are higher than our equipment gross margins. Now they're somewhat interrelated, I'd say, because when we look at equipment, We also think about all the services that we provide with regard to the equipment that actually shows up on our value added services. So in a quarter where we have Slightly lower equipment sales that quarter, we might see a little bit of a mixed benefit. But we know In our model, it accrues to mix benefits going forward when we sell a lot of equipment because we get the failure added services, we get the technical service Revenue from that relationship.

Speaker 12

Okay. The company continues to put in its press release The nod to uncertain macro backdrop and some inflationary pressures, we've talked on the call already about Inflation impact or deflation impact in the infection control and you've said you don't think you're seeing any impact on the equipment sales. Are you just Making those statements to sort of keep a cautionary tone on things? Or is there any place that hasn't come up Where those two dynamics, the uncertain macroeconomic and inflationary pressures are having an impact now that you wouldn't want to call out?

Speaker 3

No, I think we are putting that out there as just sort of a caution that kind of These forces are out there and we have a lot of ways that we're looking at whether those are impacting our business and looking forward do we think they're going to and We're not seeing that. I think again, I go back to I've been out in the field. I've Been with our top salespeople recently, and I just tell you that the momentum in the business right now, The optimism momentum are extremely high and they're just not seeing it. So we'll continue to monitor it. I think we want to put that out there So, I mean, not that people don't, but so people keep that in mind, but it's not showing up.

Speaker 12

It sounds like to an earlier question, when you think about the laying out the rest of the year, It doesn't sound like you're taking you're making any adjustments that things get tougher in any particular area Because of these factors later in the year, I just want to confirm that the variation that would be there is more because of the year to year comps, Not so much because you're making an assumption about the macro environment changing. Is that right?

Speaker 3

Right. Absolutely.

Speaker 12

All right. Thanks a lot.

Operator

And your next question comes from the line of Allen Lutz from Bank of America. Your line is open.

Speaker 4

Thanks for taking the questions. I wanted to follow-up on Jeff's question from earlier. So over the past 6 months, equipment sales have been about 8% and that's Higher than what it's been over the past 8 quarters. And so as we think about what we've seen so far on interest rates, you've said there's been a marginal impact. As you think about the guide for the remaining three quarters of the year, is there any expected incremental impact from higher interest rates?

Speaker 4

And then kind of more thematically and longer term, is there any way to think about how dentists react if interest rates stay higher for Maybe a few quarters? Thanks.

Speaker 3

Well, I would say, first, The concept of any kind of marginal impact on the equipment Business, given interest rates, is something that we spent a lot of time modeling and is all really built into our guidance. So I think it would unless there's a fairly dramatic change there, that we built some of that into our guidance and That's fair. What was the second part of the question?

Speaker 4

Just how Dennis would historically how they react if interest rates stay higher for longer. We haven't really seen An environment where rates have been elevated for more than a few quarters, just curious your perspective there. Thanks.

Speaker 3

Yes. Well, again, what we keep seeing and it's not just in the numbers, it's really just as we interact with our customers that There's a lot of interest in continued investment in the practice. We'll monitor that. I mean, I think If we start to see something happen there that changes that dynamic, then we'll build that into the expectations. But again, for right now, that's just again, there's a lot of interest in investment.

Speaker 3

Great. Thank you.

Operator

And your final question today comes from the line of John Stansl from JPMorgan. Your line is open.

Speaker 10

Thank you for taking the question. I wanted to look into production a little bit more. I appreciate you called out the headwind around cattle. So how did that sequential decline in herd count kind of translate to traffic? And then When you're having conversations with customers, how are you thinking about this?

Speaker 10

Is this something you see as kind of persistent through the year or more of a kind of a near term?

Speaker 2

Thanks. Yes. So, certainly, our customers are seeing those lower herd counts on the cattle business, and Our production team is doing a fantastic job managing through that. I think the thing for our business is that We do have a diverse kind of portfolio of customers and species that we serve. We've got a large cattle business, but we also So the swine markets, the dairy markets.

Speaker 2

And so as we look at our business, even if one of those markets is relatively down, we see strength like We did in this quarter in the swine market, the dairy markets have come back. So we'll be able to kind of manage through with our portfolio. And so there's a bit of a headwind here in 1 for a couple of quarters as those herd counts normalize. We're confident we've got the plan to manage through it.

Speaker 10

Great. And then just quickly on working capital. I think you called out that it was proved in the quarter. Is there anything specifically that you're doing to drive this working capital improvement?

Speaker 2

Yes. No, the team did a good job this I think we're at a place with our working capital. I'd say that we're always looking for the right opportunities To make sure we've got the right inventory levels, we're balancing our service levels with good Not getting too long on certain inventory categories. So I'd say there's opportunities that we look at more kind of opportunistically on the margins. I'd just say this quarter, our receivables team is doing a really good job.

Speaker 2

And I think as we go through the year, We'll continue to find some probably some opportunities to take inventory down a bit, balancing that need to service the demand we see. Great. Thank you.

Operator

And we have reached the end of our question and answer session. I will now turn the call back over to CEO, Don Zerbe, for some final closing remarks.

Speaker 3

Just want to thank everybody for their time today and their interest in

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Earnings Conference Call
Patterson Companies Q1 2024
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