Patterson Companies, Inc.

earnings call at this time all participants are in a listen-only mode after the speaker's presentation there will be a question and answer session to ask a question during this session you'll need to press star one on your telephone please be advised that today's conference is being recorded if you require any further assistance please press star zero i would now like to hand the conference over to your speaker today john wright vice president investor relations thank you please go ahead sir thank you operator good morning everyone

and thank you for participating in Patterson Company's fiscal 2021 second quarter earnings conference call. Joining me today are Patterson President and Chief Executive Officer Mark Walter and Patterson Chief Financial Officer Don Zerbe. After a review of the fiscal 2021 second quarter 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 that is accurate only as of the date of the live broadcast, December 2, 2020. 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 second quarter of fiscal 2021. The reconciliation table in our press release is provided to adjust reported gap measures, namely operating income, income before taxes, income tax expense, net income, net income attributable to Patterson Companies, Inc., and diluted earnings per share attributed to Patterson Companies, Inc., for the impact of deal amortization, integration and business restructuring expenses, legal reserve costs, accelerated debt-related costs, and an investment gain, along with the related tax effects of these items. We will also discuss pre-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. The reconciliation of our reported and adjusted results can be found in this morning's press release. 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 today at noon Central Time for a period of one week. Now, I'd like to hand the call over to Mark Walter.

Thank you, John, and welcome, everyone, to Patterson's Fiscal 2021 Second Quarter Earnings Conference Call. First off, I hope you and your families all had a happy and safe Thanksgiving and that everyone is staying healthy amidst the evolving coronavirus trends. Patterson achieved very strong performance in the second quarter of fiscal 2021. Our results reflect the resilience of our business and our customers and the continued momentum from our focused investment to drive sales execution and operational excellence across our platform. Even amidst the continued challenges due to the COVID-19 pandemic, our team performed at a very high level. We are leveraging our differentiated value proposition and providing trusted guidance and expertise to our customers, while also deepening our relationships with our manufacturing partners. Before we dive into the details, let me touch on several of the key highlights from the quarter. First, on a year-over-year basis, internal sales grew 9%. This included internal sales growth of 12% in dental and 7% in animal health. Second, we grew our adjusted operating margin year over year by 130 basis points to 5.3%. Third, we delivered adjusted earnings of 63 cents per share, representing an increase of 62% over the prior year period. Fourth, it continued momentum on our top and bottom line has further strengthened our balance sheet and overall financial position. And importantly, we maintained our focus on the core principles that have helped guide our response throughout the COVID-19 pandemic. Protecting the health and safety of our employees, ensuring business continuity and support for our customers, and doing our part to help reduce the spread of the virus in our communities. As cases are unfortunately rising across the world, we remain committed to adhering to these principles and confident they will help us continue to safely and effectively navigate through this period. Our results this quarter are not simply the product of our team's great work during the past three months. They instead reflect the consistent and focused approach we have taken over the past several years to drive improved sales execution, operational excellence, effective mix management, expense discipline, and working capital improvement. all while making targeted investments to deepen our value proposition, build our culture, and deliver an outstanding customer experience. Our enterprise-wide commitment to improving these core foundational elements has enabled Patterson to stabilize and build momentum in our businesses, strengthen our balance sheet, and capitalize on opportunities to outperform in our end markets. We are creating a stronger Patterson that is well positioned to deliver enhanced value for all our key stakeholders. With that overview, I will now drill down a bit deeper into the performance drivers in each of our segments during the second quarter. In our dental segment, as I mentioned earlier, internal sales increased 12% driven by strong sales growth in all three categories, consumables, equipment, and value-added services. This performance reflects the continued recovery of the dental market from the earlier closures at the onset of the pandemic And fortunately, this market recovery has been faster and broader than we expected. The market recovery combined with our strong sales and service execution as we believe allowed us to outperform the industry and increase our market share. When dental offices safely reopened after widespread shutdowns, patients returned, driving increased demand for dentistry and for Patterson's range of products and value-added services. We're hearing from our customers that their patients are comfortable visiting their dental practices again with the enhanced infection control procedures, screening protocols, and safe patient communication tools our customers have implemented. Patterson's ability to serve as a comprehensive, value added provider of consumables, equipment, practice management software, and technology service and support made us a critical partner for our customers as they reopened and ramped back up their practices. Further, our decision to fully maintain our customer-facing sales and support teams throughout the pandemic provided tremendous support to our customers as they navigated this new operating environment. Our dental business delivered year-over-year internal sales growth of nearly 18% in the consumables category, and it is worth noting that our sales growth of consumables was fairly consistent across all three months of our fiscal second quarter. As expected, a key contributor of this growth was increased sales of infection control products, including masks, gowns, gloves, face shields and disinfectants that are more essential in dental practices today than they were prior to the onset of the pandemic. In our fiscal second quarter, approximately two thirds of the 18% year over year growth in consumables was driven by increased sales of infection control products. However, Even after the anticipated widespread distribution of a safe and effective COVID-19 vaccine, we believe there has been a permanent shift in the expectations for infection control measures for dental practices going forward. While demand for infection control products may moderate from their current levels over time, we expect the new normal to remain well above pre-pandemic demand levels over the long term as dentists and their patients embrace this new standard of care. More importantly, our year-over-year sales growth in the consumables category extended beyond the increased sales of infection control products. In fact, if you exclude the sales growth contribution from infection control products, we delivered approximately 6% year-over-year sales growth in our non-infection control consumables products. We believe this healthy mid-single digit growth of non-infection control products is due to the continued investments we've made in our field sales and support teams, which is driving market share gains and increased enrollment in Patterson's Advantage Customer Rewards Loyalty Program. Our Advantage Program has made it easier and more affordable for our customers to invest in their own practice growth with benefits in equipment repair, service and support, and other rewards. During the quarter, we also continued to see increasing demand for our expanding and highly profitable private label portfolio of products. The strength of our consumables business, combined with our expectation of elevated demand for infection control products going forward, and the gains achieved from our customer engagement and retention programs give us confidence in our long-term positioning in the consumables category. Internal sales of equipment grew over 5% in the second quarter, led by double-digit growth in the core equipment and digital technology categories. We are very pleased with these results, especially given that beginning in October, we began a difficult equipment comparison with the same period last year. As a reminder, last year during the second quarter of fiscal 2020, we delivered 12% year-over-year growth in overall equipment sales. That performance was primarily driven by growth in the CAD-CAM category through our strong sales execution following the introduction of several innovative new products. The success of our efforts last year also drove strong performance in the third and fourth quarters, which will create a more challenging comparison for the balance of this fiscal year, particularly in the CAD-CAM category. However, our second quarter equipment results demonstrate that our customers remain committed to investing in their practices and believe in the future of the market and their businesses. Due to the pandemic, we have adapted to find new and creative ways to collaborate with our manufacturing partners on financing strategies, education initiatives, online training, and prominent social media and online events. Patterson continues to be the partner of choice in delivering new product launches and technology integration in today's modern dental office environment. As you know, Patterson's expertise in dental equipment and technology integration starts well before and continues well after the initial sale. We have the unique ability to support our customers throughout the entire lifecycle of their equipment and technology investments, which we believe is a distinct competitive advantage and an important driver of our overall value proposition. We are very encouraged by the recovery and resiliency of the dental market in calendar 2020. Facing serious challenges, dentists have proactively and enthusiastically adapted to operating in this new environment, ensuring that their patients feel safe in their practices. We are proud to be a part of helping our customers succeed in this environment and will continue to focus on our core operational principles, strong execution, operational excellence, and leveraging our differentiated value proposition to help drive practice success. Turning now to animal health. Our animal health segment generated total internal sales growth of 7% during the second quarter, led by strong internal sales growth of nearly 12% in our companion animal business. Our top line results in companion animal underscore the underlying strength of the pet market realized from increased pet ownership and spending, as well as new product innovation. Our animal health sales teams have done an incredible job ensuring that their customers have access to a broad array of products, and prescription medications, technologies, and services to help their practices succeed in the face of increased market demand. Our field reps, inside sales, and support teams work collaboratively every day with our customers through multiple touchpoints. We also continue to leverage deep relationships with our preferred manufacturing partners to develop strategic business plans that are aligned with our respective goals and objectives and drive value across the supply chain. Looking ahead, we believe the growth of pet ownership rates that has occurred over the past two quarters is unlikely to continue at the current rate. However, while these growth rates may stabilize, going forward we believe the overall companion animal market, with our veterinary customers at the center, will grow at a faster rate than prior to the pandemic, enhancing the growth opportunity for our companion animal business over the long term. On the production animal side, internal sales in the second quarter turned positive growing 2% on a year-over-year basis as the market continued to recover from the prior disruption caused by COVID-19. One factor worth noting that positively impacted our second quarter performance is the shift of the fall cattle run and movement to feed yards earlier in the year. As a result, some sales volume moved from our fiscal third quarter into the second quarter. We are pleased with these improving top-line results in the production markets but expect the timing benefit from the earlier fall run may create a more challenging production animal comparison during our fiscal third quarter. As a reminder, on last quarter's call, we discussed supply chain challenges in the swine market associated with the shutdown of packing plants due to COVID-19 outbreaks. While beef and pork packing plants are currently operating and processing near capacity, they have not yet been able to catch up with inventory at the producer level. As the pandemic continues to spread in parts of the US where many packing plants operate, we are working closely with our customers to support their continuing operations. While any significant pandemic-related supply chain disruption would further impact the backlog of market-ready animals being held in production facilities, particularly in the swine market, we believe packing plants have enhanced safeguards in place and are better equipped to more effectively address any impact than they were earlier in the year. We are pleased with the results in our animal health segment, despite some expected variability in the production market dynamics, and we are confident our full service and support value proposition will continue to position Patterson as an indispensable and trusted partner for both our companion and production animal customers. Before turning it over to Don, I would like to touch briefly on our ongoing response to COVID-19. As I mentioned earlier, the rise of COVID cases points to the need to stay vigilant in our safety measures and risk mitigation efforts. In keeping with our COVID principles, we continue to follow our comprehensive health and safety protocols, including working from home where possible, mask wearing, temperature checks, reducing close contact in our operations, and proactive deep cleanings at our facilities. While our facilities remain open and fully operational, We have specific plans in place to ensure we can continue to support our customers should our operations be directly impacted due to COVID-19. We are also working closely with all our industry partners to help ensure the safety of our customers' operations so they can continue to provide their vital and essential services. As we have throughout this pandemic, Patterson is prepared to continue to support our teams and our customers as the situation evolves. And with that, I'll turn the call now over to Don for a deeper dive into our financial results. Thank you, Mark, and good morning, everyone. Consolidated reported sales for Patterson Companies in our fiscal 2021 second quarter were approximately $1.6 billion, an increase of 9.5% versus the second quarter a year ago. Internal sales, which are adjusted for the effects of currency translation, increased 9.0% compared to the same period last year. As Mark mentioned, we believe our results this quarter can be directly attributed to the investments we have made in our business and the focus and commitment of our people to deliver these outstanding results. Our second quarter adjusted gross margin was 20.6%, which was down 90 basis points versus the second quarter of fiscal 2020. Dental gross margins were slightly impacted by higher delivery costs related to COVID-19, And on the animal health side of the business, unearned calendar year rebate dollars in the production animal business also contributed to lower gross margin. However, we consider these factors to be somewhat temporary in nature and believe the strength of our full service value proposition will continue to support our gross margins for the long term. Adjusted operating expenses as a percentage of net sales for the second quarter were 15.3%. and favorable by 220 basis points on a year-over-year basis. Last quarter, we discussed the expense savings related to salary reductions, furloughs, and reduced work hours that ended in Q1, with those expenses coming back into the P&L in future quarters. While that impact has occurred, just as we stated, we have continued to benefit from ongoing expense discipline and from leveraging our cost structure over higher sales volumes. In fiscal second quarter, our consolidated adjusted operating margin was 5.3%, which represents 130 basis point improvement over the same period in the prior year. As you recall, our consolidated adjusted operating margin has improved for a number of quarters, posting year-over-year improvement for each of the past seven quarters as a result of our efforts to drive operational improvements and expense discipline, along with the added impact of segment mix and the leveraging of higher sales volume. We continue to be encouraged about our year-over-year margin improvement for another quarter. Our adjusted tax rate for the second quarter was 23.7 percent, which was a decrease of 100 basis points compared to the second quarter of the prior year. Reported net income attributable to Patterson Companies Inc. for the second quarter of fiscal 2021 was $54.1 million, or $0.56 per diluted share. This compares to a reported net loss of $33.1 million, or $0.35 per diluted share, in the second quarter one year ago. Adjusted net income attributable to Patterson Companies in the second quarter, which excludes deal amortization, integration and business restructuring expenses, legal reserve costs, and accelerated debt-related costs, totaled $61.1 million, or $0.63 per diluted share. This compares to $36.6 million, or $0.39, in the second quarter of fiscal 2020 and represents a $0.24, or 62%, year-over-year increase. This increase over the prior year is primarily attributed to our strong sales execution, improved mix, and the benefit of continued operating expense discipline. Now let's turn to our business segment, starting with our dental business. In the second quarter of fiscal 2021, internal sales for our dental business increased 12.1% compared to the second quarter of fiscal 2020. On that same basis, Patterson sales of consumable dental supplies were up 17.7%, with strong growth in both infection control products and our base consumables category. Internal sales of equipment in the second quarter increased 5.4% versus the same period a year ago, led by strong growth in core equipment and digital equipment categories. For modeling purposes, keep in mind that we had very strong equipment sales in fiscal 2020, and we will be coming up against a difficult year-over-year comparison for the coming third and fourth quarters of fiscal 2021. And finally, internal sales of software and value-added services increased 5.6% in the fiscal second quarter. Adjusted operating margins in dental were 11.7% in the second quarter, 190 basis point improvement compared to the prior year. While we did experience increased freight and delivery costs related to COVID-19 in the fiscal second quarter, we also benefited from the expense leverage related to the increased sales volume, as well as continued operating expense discipline. Now let's move on to our animal health segments. During the fiscal second quarter, internal sales for our animal health business were up 6.9% compared to the same period a year ago. Increased pet adoptions and increased attention to pets along with our strong sales execution drove our improved performance in the quarter versus the same period one year ago. Adjusted operating margins in our animal health segment were 2.9% in the fiscal second quarter, a decrease of 60 basis points compared to the second quarter of the prior year as lower operating expenses were offset by lower gross margins, primarily due to less rebates earned calendar year to date within our production animal business and slightly lower point of sale margins in our companion animal business. Now let's look at several cash flow and balance sheet items. During the first six months of fiscal 2021, we used $423 million in cash from operating activities. We also collected deferred purchase price receivables of $409 million during the year, which is included in the investing activity section of the cash flow statement. To fully understand our free cash flow, the total of these two amounts is the use of cash for the first six months of fiscal 2021 of $14 million. Free cash flow, which we have explained and calculated in a table within our press release, decreased $203 million during the second quarter of fiscal 2021 compared to fiscal 2020. The year-over-year decrease is primarily due to elevated levels of accounts payable at the beginning of the fiscal year due to COVID-19 as we carefully managed our cash and which have normalized during the first two quarters of fiscal 2021. Turning to capital allocation, we continued to execute on our strategy to return cash to our shareholders. In the second quarter of fiscal 2021, we declared a quarterly cash dividend of 26 cents per diluted share, which was then paid during the first week of the third quarter of fiscal 2021. On a year-to-date basis, Patterson has returned $25 million in cash dividend to our shareholders. Our board continues to view our dividend as an important component of returning value to our shareholders. And the current dividend yield provides a meaningful baseline return to shareholders as we continue focusing on our plans to drive improved performance in the business. Let me conclude with some comments on our outlook for fiscal 2021. Due to the continued uncertainty surrounding the COVID-19 pandemic and its potential impact on business operations, we are not providing fiscal 2021 financial guidance at this time. And now I will turn the call back over to Mark. Thanks, Don. As we look ahead, I am enthusiastic about our position in each of our end markets and confident in Patterson's long-term value creation potential. We have the right team and the right strategy in place to capitalize on the positive fundamental opportunities of our end markets over the long term, while also being well prepared to manage through potential changes in near-term market dynamics. While our near-term focus remains centered on driving execution, and supporting our customers through the pandemic, we are also looking ahead to the future and excited about the opportunities that exist. Our ongoing actions to strengthen our financial position have created improved balance sheet flexibility, which puts us in a strong position to consider strategic investments that will accelerate future growth and value creation. Before we wrap up, I want to take a moment to express my gratitude for the hard work, passion, and focus of the 7,000-plus members of the Patterson team. I'm incredibly proud of how our team has stepped up to support our customers and business partners these past nine months, and I'm confident our We Are Patterson spirit is one of the key ingredients to our success. I also want to thank our customers and acknowledge their tremendous resiliency during these challenging times. It's a privilege to serve them and to do our part to help them succeed. That concludes our prepared remarks, and Don and I will be glad to take your questions. Operator, please open the line.