Patterson Companies, Inc. (NASDAQ:PDCO) Q1 2024 Earnings Call Transcript

Patterson Companies, Inc. (NASDAQ:PDCO) Q1 2024 Earnings Call Transcript August 30, 2023

Patterson Companies, Inc. reports earnings inline with expectations. Reported EPS is $0.4 EPS, expectations were $0.4.

Operator: Good morning, and welcome to the Patterson Companies Inc., First Quarter Fiscal 2024 Earnings Conference Call. All lines have been placed on mute to prevent any background noise. After the speaker’s remarks, there will be a question-and-answer session. [Operator Instructions] I will now turn the conference over to John Wright, Vice President of Investor Relations. You may begin your conference.

John Wright: 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’s President and Chief Executive Officer, Don Zurbay, and Patterson’s 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 conference call are forward-looking in nature and subject to certain risks and uncertainties. These factors which could cause actual results to materially differ from those indicated in such forward-looking statements are discussed in detail in our Form 10-K and our other filings with the Securities and Exchange Commission.

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 and is accurate only as of the date of the live broadcast, August 30, 2023. Patterson undertakes no obligation to revise or update any forward-looking statements to reflect events or circumstances after the date of this call. Also, 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 first quarter of fiscal ‘24. A 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 deal 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 results. This call is being recorded and will be available for replay starting at 10:00 AM, Central Time for a period of one week. Now, I’d like to hand the call over to Don Zurbay.

Don Zurbay: Thanks, John and good morning, everyone. Patterson had a strong start to fiscal ‘24, building upon our momentum across the business as we continue to deliver value for our customers and shareholders. A few highlights from our first quarter. 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. We returned $55 million to shareholders in the form of cash dividends and share repurchases and we delivered adjusted EPS growth of 25% from 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 ‘24 first quarter illustrates the continued execution of our proven strategy, which as I shared last quarter is designed to achieve four core objectives: First, drive revenue growth above the current end market growth rates. Second, build upon the progress we’ve made to enhance our margin performance. Third, evolve our products, channels, and services to best serve the customers in our end markets. And fourth, 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. First, our focus on private label. During the first quarter, we benefited from continued growth in our private label portfolio, which includes the 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 in 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. In fact during fiscal ’24 we expect to add more private labe; products to our animal house offering than ever before. Over the past several years, our private label sales growth 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 labels 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.

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 U.K., we call the [Big Shed] (ph) 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 expanse facility in Montreal, Canada.

In addition, we have similar projects underway in several other locations. These strategic investments in our fulfillment centers can help alleviate capacity constraints and the modernization of our facilities is expected to enhance growth. These are only a couple examples of some of the many initiatives we have underway. Taken together, our strategic areas of focus build upon our strong foundation and success 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 first quarter. Let’s start with dental. Dental segment internal sales increased 2%, compared to the first quarter of fiscal ’23, due to strong growth in consumable and value-added services, which includes our software offerings.

We also achieved year-over-year adjusted operating margin expansion in the fiscal first quarter, 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 product and solutions that help dental practices grow, become more efficient, and provide improved patient care. In the consumables category, dental internal sales increased approximately 5% in the fiscal first quarter, compared to one 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 first quarter of fiscal ‘24 decreased 6%, compared to the year ago period. Our team delivered growth in our core equipment and CAD/CAM categories that was more than set by a decline in digital technology, which experienced a sequential decline in sales following a strong fiscal 2023 fourth quarter. 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 that demand for equipment and technology will drive our manufacturing partners to continue introducing new innovations and technologies. 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 category are testament to our customers recognizing the full life cycle support and services that Patterson provides. And as an added benefit, these valuable offerings are mixed favorable to our P&L. Maximizing our value-added service offerings, particularly in the software category, is a key part of our strategy with a meaningful opportunity for growth. Looking ahead, we believe the dental market remains stable with healthy underlying fundamentals, including an aging population, practice modernization and the direct link between a patient’s oral health and overall health, 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 first quarter of fiscal ‘24 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. We benefit from the depth of our offering and omnichannel presence expands a wide range of animal species and offers comprehensive solutions for diverse customers. In companion animal, our internal sales in the 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 first quarter 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. 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.

Kevin Barry: Thank you, Don, and good morning, everyone. In my prepared remarks this morning, I will cover the financial results for our first quarter of fiscal ’24, which ended on July 29th 2023, and then conclude with our outlook for the remainder of the fiscal year. So let’s begin by covering the results for our first quarter of fiscal ‘24. Consolidated reported sales for Patterson Companies in our fiscal ‘24 first quarter were $1.6 billion, an increase of 3.5% over the first quarter of one 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. Gross margin for the first quarter of fiscal ‘24 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 equipment financing portfolio is nearly offset by our corresponding hedging instrument, which is reflected in the other income net line on our P&L, so the net results has a minimal impact on our adjusted earnings per share. This dynamic also occurred in the first fiscal quarter of last year, and the positive impact of the mark-to-market accounting calculations of 10 basis points. When normalizing for the mark-to-market accounting adjustment in both periods, our gross margin rate in the first quarter of fiscal ‘24 was 20 basis points higher than the first quarter of fiscal ‘23.

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 first quarter, both of our business units posted a year-over-year increase to their respective gross margins, compared to the prior year period. Adjusted operating expenses as a percentage of net sales for the first quarter of fiscal ’24 were 17.2% and favorable by 40 basis points compared to the fiscal first quarter of ‘23. In the first quarter of fiscal ‘24, our consolidated adjusted operating margin 3.0%, an increase of 15 basis points, compared to the first quarter 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 first quarter of fiscal ‘24 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 first quarter of fiscal ‘24. 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 first quarter of fiscal ‘24 was 23.5%, an increase of 110 basis points, compared the prior year period.

Reported net income attributable to Patterson Companies, Inc. for the first quarter of fiscal ‘24 was $31.2 million or $0.32 per diluted share. This compares to reported net income in the first quarter of last year of $24.6 million or $0.25 per diluted share. Adjusted net income attributable to Patterson Companies, Inc. in the first quarter of fiscal ‘24, was $38.6 million or $0.40 per diluted share. This compares to $31.7 million or $0.32 per diluted share in the first quarter of fiscal ’23. This 25% increase in adjusted earnings per diluted share for the fiscal first quarter is primarily due to the 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 first quarter of fiscal of ’23, internal sales for our dental increased 2.1%, compared to the first quarter of fiscal ’23. Internal sales of dental consumables in the fiscal first quarter increased 4.6% compared to one year ago and were impacted by continued price deflation of certain infection control products. Internal sales of non-infection control products increased 6.9% in the first quarter of fiscal ’24, 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 ‘24. In the first quarter of fiscal ‘24, internal sales of dental equipment decreased 5.7%, compared to one year ago.

As Don mentioned, sales in the equipment category can vary from quarter-to-quarter and these dynamics apply to each of the specific product categories as well. This quarter, core equipment and CAD/CAM 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. Internal sales of value-added services in the first quarter of fiscal ‘24 increased 5.8% over the prior year period, led by the increased year-over-year contribution from our technical service team and continued growth of our software business. Value-added services, including our software offerings, represent 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 mixed favorable to our P&L.

The adjusted operating margin in dental was 7.4% in the first quarter of fiscal ’24, which represents a 35 basis point improvement over the prior. 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 first quarter of fiscal ‘24. Now let’s move on to our animal health segment. In the first quarter of fiscal ‘24, internal sales for our animal health business increased 4.0%, compared to the first quarter of fiscal ‘23. Internal sales for our companion animal business in the first quarter of fiscal ‘24 increased 5.1% over the prior year period, which included strong sales performance from our [NVS] (ph) business in the U.K. Internal sales for our production animal business in the first quarter increased 2.5% in the quarter, compared to the prior year period.

Our production animal team continues to execute well in the market, and internal sales in the first quarter of fiscal ‘24 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 ‘24 first quarter, 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 first quarter of fiscal form. Now let me cover cash flow and balance sheet items. During the first three months of fiscal ‘24, our free cash flow improved by $35.7 million compared to the same period one year ago.

This was primarily due to a decreased level of working capital in the first three months of fiscal ’24, compared to the year ago period. Turning now to capital allocation. Our capital spending in the first quarter of fiscal ‘24 was $17.1 million and $2.5 million higher than the first quarter of fiscal ‘23. 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. In the first quarter of fiscal ‘24, we declared a quarterly cash dividend of $0.26 per diluted share, which was then paid at the beginning of the second quarter of fiscal ‘24. We also repurchased $29.5 million of shares during the first quarter of fiscal ‘24, thereby returning a total of $54.9 million to shareholders to dividends and share repurchases.

Let me conclude with our outlook for the remainder of fiscal ‘24. Today, we are reaffirming our fiscal ‘24 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’m going to turn the call back over to Don for some additional time.

Don Zurbay: Thanks, Kevin. Before we open it up for Q&A, I want to thank the entire Patterson team for a great start to fiscal 2024 as we made progress to build upon our momentum across the business. We’re continuing to deliver on our proven strategy 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. Kevin and I will be glad to take questions. Operator, please open the line.

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Q&A Session

Operator: [Operator Instructions] And your first question comes from the line of Jason Bednar from Piper Sandler. Your line is open.

Jason Bednar: Hey. Good morning, thanks for taking the questions. Yes, Don or Kevin, I want to start, you know, the dental consumable performance was really strong really seems to defy expectations that I think many have out there on the dental market at the moment. I heard the private label commentary, but could you unpack a bit more where the strength is coming from that’s supporting that 7% underlying growth in consumables? Any procedure categories to call out where you’re seeing notable strength or anything of note on, you know, BSOs, pricing, share gains, anything like that?

Don Zurbay: Yes. Thanks, Jason. You know, we’re trying to be helpful here. We’re not going to probably break down pieces, but quite honestly, we saw strength across the board. I think, you know, patient traffic is steady. We feel really good about that. All customer types performed, you know, and the salesforce really, I think, is just, hitting on all cylinders right now. We think the momentum, the key to this quarter and last quarter are just kind of where we’re at right now is just, the continued momentum in the business. So, you know, not to be able to break that down for you, but, honestly, it was across the board.

Jason Bednar: Okay. Alright. No, that’s helpful. I’m sure others will have 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 don’t think we’ve heard, you know, those kind of specifics in the past that 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 for some of those investments?

Don Zurbay: Yes. Well, if you look at, our CapEx spending this quarter is above last first quarter. And I think what you’re going to see is as we go through the year, that’ll continue to be the case, you know, all of these projects go through a rigorous process, that we have internally to make sure that the ROI, you know, gets above our cost of capital and that it had all, you know, is the financial payoff, as well as all the other benefits we’re getting from it. So we’re pretty excited about each of these investments. Obviously, you know, 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, you know, pretty excited about all of them. I think more to come and what I really like is the team is continues to think about the next thing and the next opportunity.

Jason Bednar: Okay, great. Helpful. Thank you.

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

Nathan Rich: Great. Good morning. Thanks for the questions. 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. 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?

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