Patterson Companies, Inc.

Ladies and gentlemen, thank you for standing by and welcome to the Paterson Company's fiscal year 2021 third quarter earnings call. At this time, all participants are in the listen-only mode. After the speaker's presentation, there will be a question and answer session. To ask a question during the session, you will need to press star one on your telephone. 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 of 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 Third Quarter Earnings Conference Call. Joining me today are Patterson President and Chief Executive Officer Mark Waltrick and Patterson Chief Financial Officer Don Zerbe. After a review of the fiscal 2021 third 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, March 3rd, 2021. Patterson undertakes no obligation to revise or update any forward-looking statements to reflect events or circumstances after the date of this call. Also, the 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 third 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 attributable 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 free cash flow, as defined in our earnings release, which is a non-GAAP measure, and also use the term internal sales to represent net sales adjusted to exclude the impact of foreign currency and changes in product selling relationships. 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 Third Quarter Earnings Conference Call. As we approach the one year mark of when the COVID-19 pandemic began to significantly disrupt our daily lives, I want to begin by acknowledging the tremendous resiliency of our customers and business partners and thanking our 7,000 plus Patterson employees for consistently upholding our purpose, vision, and values each and every day. These core principles have motivated our team to deliver on our commitments to all of our stakeholders. I'm incredibly proud of our organization's focus during these past 12 months and the resiliency our teams have exhibited in helping to overcome these historic challenges and continue to improve our performance. While I know we are all hopeful that the ongoing administration of the COVID-19 vaccine will help us fully emerge from this pandemic, our customers and the industries we serve are still managing through the disruption. and Patterson remains focused on continuing to be their trusted and indispensable partner to help them succeed. Even in light of the challenges we've all faced these past 12 months, Patterson's consistent and disciplined approach to strong execution and operational excellence, combined with our ongoing investments to drive sales productivity and enhance our value proposition, enabled us to build momentum across our entire business. Let me start by summarizing some of the key highlights from our fiscal 21 third quarter. First, on a year-over-year basis, total internal sales grew 7%. Dental segment internal sales increased approximately 4%, fueled by consumables growth of 14%. Animal health segment internal sales increased 10%, driven by companion animal growth of approximately 21%. Second, Our strong sales results and our continued expense discipline contributed to our adjusted operating margin growth of 30 basis points to 4.6%, reflecting continued year-over-year improvement in our consolidated operating margin. The dental and animal health segments each grew their respective operating margins during the third quarter, further reinforcing the strong execution taking place across both of our businesses. Next, We delivered adjusted earnings of 58 cents per diluted share, representing an increase of 23% year over year. And finally, we maintained our focus on the core principles that continue to guide us as we navigate the disruption from the pandemic. Protecting employee health and safety, ensuring business continuity for our customers, and doing our part to help reduce the spread of the virus in our communities. With that, I will now dive into the performance drivers in each of our segments during our third quarter. As I mentioned, internal sales in our dental segment increased about 4%. This increase was driven by growth of approximately 14% in the consumables category. This performance is the direct result of the continued strong execution of our field sales and operations teams and also reflects the health and resiliency of our customers and the increased demand for infection control products. Within the consumables category, sales of infection control products contributed 11% year-over-year growth of our 14% year-over-year total dental consumables growth, meaning the remaining year-over-year consumables sales growth was due to our non-infection control product categories. As we think about the consumables category going forward, I want to share some additional context. While we believe the rate of growth will moderate as we begin to lap the impact of COVID-19, we expect the increased demand for infection control products to continue over the long term as customers turn to Patterson to help them meet this new standard of care. Second, the consumables category overall, including non-infection control products, is also likely to benefit as patient traffic increases over time. Patient traffic continues to remain below pre-pandemic levels and we know that some patients are still hesitant to visit a dentist under the current conditions. As widespread vaccine administration advances, we expect these patients to begin returning to the dentist, driving improved demand going forward. Our total consumables product growth can also be attributed to the ongoing investments we've been making in our field sales and support teams to deepen their relationships with our customers as well as the increased enrollment in our Patterson Advantage customer loyalty program. During the third quarter, we also continued to see strong demand for our more profitable private label products, which grew at an even faster rate than our overall consumables category. Turning now to our equipment results, internal sales of equipment were down 7% year-over-year, with fairly consistent year-over-year sales performance across all three of our equipment categories, core equipment, digital X-ray, and CAD-CAM. As we previously stated during our fiscal 21 second quarter call, we expected a challenging equipment comparison for the fiscal third quarter due to our strong performance in this category during the 2020 fiscal year. Our strong performance last fiscal year was primarily driven by growth in the CAD-CAM category following certain new product introductions, which Patterson was very successful in promoting and selling. However, even with the tough equipment comparison and in light of the current environment, our equipment sales during the third quarter exceeded our internal expectations due to the strong execution by our team. Additionally, innovation in equipment, software, and technology remains a core driver of the modernization of today's dental practices. which provides a clear opportunity for Patterson to leverage our expertise in sourcing, selling, and installing the latest technologies. Patterson's unique ability to support our customers throughout the entire lifecycle of their equipment and technology investments is an important driver of Patterson's overall value proposition. And since the onset of the pandemic, our comprehensive network of local field service technicians and branch offices, coupled with the national support through our Patterson Technology Center, have continued to deliver the unmatched expertise and support our customers expect from Patterson. Looking forward, we remain encouraged by the resiliency of our customers and the overall dental market. While patient traffic remains below pre-pandemic levels, we expect demand to improve, and we are well positioned to continue serving our customers by focusing on strong execution, operational excellence, and leveraging our unmatched expertise, customer service, and support. I want to acknowledge and thank the entire dental team for another strong quarter. Turning now to our animal health segment, our animal health business achieved total internal sales growth of 10% during the third quarter, led by internal sales growth of nearly 21% in our companion animal business. Our top line results in companion animal can be attributed to a number of factors. First, the rise in pet ownership and pet adoptions during the pandemic has led to increased spending, veterinary clinic traffic, and pet wellness visits. In addition, our companion animal sales teams continue to do an excellent job promoting and executing new product launches and working closely with our preferred manufacturing partners to execute business plans that drive value across the supply chain. These efforts have not only enabled us to outpace the market, but also help drive demand toward our preferred manufacturing partners who reward us for our ability to move market share. We also improved our companion sales mix during the third quarter through our continued focus on selling more profitable product categories, including equipment, software and services, and private label products. Our companion animal team is clearly executing their business plan and delivering great value to their customers. On the production animal side, internal sales in the third quarter were slightly positive on a year over year basis. And there are several factors that are impacting our production animal performance. One factor in our beef segment during the quarter was the shift of the fall cattle run, which positively impacted our fiscal second quarter performance and created a more challenging year over year comparison during our fiscal third quarter. In addition, we are seeing continued improvement in the dairy market, as the price of milk has increased compared to the year-ago period. In the swine market, processing plant disruption due to COVID-19 created a greater shortage of market-ready animals being raised in production facilities, so the COVID-19 disruption in swine was more significant than these and will take more time to recover. However, we believe a swine market recovery will eventually serve as a tailwind for Patterson's production animal business once the overall herd size begins to normalize. While the pandemic-related end market challenges are evident in the food animal portion of our business, our production animal team continues to execute well, drive operational improvements, and deliver great value to our customers. We're pleased with the top and bottom line results in our animal health segment. The pandemic is impacting the animal health industry in different ways, but our teams remain steadfast on supporting our customers in this challenging environment. Our third quarter animal health performance is a direct result of the focus and passion of our team. And I also want to thank and congratulate the entire animal health group on their strong third quarter performance. To sum it up, Patterson delivered another strong quarter across both of our businesses. Our teams are engaged and focused on helping our customers and business partners succeed. And we remain confident in Patterson's long-term positioning in each of our end markets. 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 third quarter were $1.55 billion, an increase of 6.5% versus the third quarter a year ago. Internal sales, which are adjusted for the effects of currency translation and changes in product-selling relationships, increased 6.9% compared to the same period last year. As Mark already mentioned, Patterson's consistent and disciplined approach to strong execution and operational excellence, combined with our ongoing investments to drive sales productivity and enhance our value proposition, enabled us to continue our momentum across the entire business this quarter. Our third quarter adjusted gross margin was 20.9%, which was down 50 basis points versus the third quarter of fiscal 2020. This difference compared to the previous year was primarily attributable to the impact of segment mix. Adjusted operating expenses as a percentage of net sales for the third quarter were 16.3% and favorable by 80 basis points on a year-over-year basis. as we have continued to benefit from our efforts to drive operational improvements and expense discipline, along with the leveraging impact of higher sales volumes. In the fiscal third quarter, our consolidated adjusted operating margin was 4.6 percent, which represents a 30 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 improvements each of the past eight quarters as a result of our efforts to drive operational improvements in expense discipline, along with the added impact of improved mix within our business segments and the ongoing expense leveraging with higher sales volumes. We continue to be encouraged about our year-over-year margin improvement for another quarter. Our adjusted tax rate for the fiscal third quarter was 20.2%, which represents a decrease of 320 basis points compared to the fiscal third quarter of the prior year, and primarily related to the impact of excess tax benefit deductions. Reported net income attributable to Patterson Companies, Inc. for the third quarter of fiscal 2021 was $48.8 million, or $0.50 per diluted share, This compares to a reported net income attributable to Patterson Companies Inc. of $23.2 million, or $0.24 per diluted share, in the third quarter one year ago. Adjusted net income attributable to Patterson Companies Inc. in the fiscal third quarter, which excludes deal amortization, integration and business restructuring expenses, legal reserve costs, and accelerated debt-related costs, totaled $55.8 million, or $0.58 per diluted share. This compares to $44.5 million or $0.47 in the third quarter of fiscal 2020, and this represents an $0.11 or 23% year-over-year increase in our adjusted earnings per share over the prior year period. This increase over the prior year is primarily attributed to our strong sales execution and operating margin improvement across both of our business segments and the benefit of continued operating expense discipline. Now let's turn to our business segment, starting with our dental business. In the third quarter of fiscal 2021, internal sales for our dental business increased 3.6% compared to the third quarter of fiscal 2020. On that same basis, Patterson sales of consumable dental supplies were up 13.6% versus the same period one year ago. As Mark described earlier, this nearly 14% growth in consumer roles can be broken down into two components. growth of infection control products and non-infection control products. The growth of infection control products in the fiscal third quarter translated to approximately 80% of our year-over-year total consumables growth. Internal sales of equipment in the fiscal third quarter decreased 6.3% versus the same period a year ago. While we mentioned the difficult comparisons to the prior year on our fiscal second quarter earnings call, We were pleased that our equipment performance in the fiscal third quarter came in better than we had expected. And finally, internal sales of software and value-added services decreased 3.9% in fiscal third quarter. Adjusted operating margins in dental were 9.4% in the quarter, a 50 basis point improvement compared to the prior year. The primary drivers of this operating margin improvement were improved mix, continued expense discipline, and the leveraging impact of higher sales volume. Now let's move on to our animal health segment. During the fiscal third quarter, internal sales for our animal health business were up 10.0% compared to the same period a year ago. Increased pet adoptions and increased attention to pets, along with our strong sales execution, continue to drive our animal health results, with sales growth of 20.7% in our companion animal business compared to the same period last year. Adjusted operating margins in our animal health segment were 3.3% in the fiscal third quarter, an increase of 50 basis points compared to the third quarter of the prior year. Our animal health team continued to drive higher sales growth with our vendor partners who reward us for our value-added strategy. In addition, we benefited from improved product mix and the leveraging impact of higher sales volumes. Let me now cover several cash flow and balance sheet items. Through the first nine months of fiscal 2021, we used $604.9 million in cash from operating activities. We also collected deferred purchase price receivables of $634.5 million during the year, which is included in the investing activities section of the cash flow statement. To fully understand our free cash flow, the total of these two amounts is a generation of cash for the first nine months of fiscal 2021 of $29.6 million. Free cash flow, which we've explained and calculated in a table within our press release, has decreased $120 million through the first nine months of fiscal 2021 compared to the same period one year ago. The year-over-year decrease is primarily due to the elevated levels of accounts payable at the beginning of the fiscal year due to COVID-19 as we carefully managed our cash, which continue to normalize as we have progressed through fiscal 2021. As previously disclosed, we amended and restructured our credit facility and bank term loan. Transaction allows us additional financial capacity and extended the agreement through February of 2024 on substantially similar terms as our previous agreement. Turning to capital allocation, we continue to execute on our strategy to return cash to our shareholders. In the third quarter of fiscal 2021, we declared a quarterly cash dividend of $0.26 per diluted share, which was then paid during the first week of the fourth quarter of fiscal 2021. On a year-to-date basis, Patterson has returned $50.1 million in cash dividends 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 comments on our outlook for the remainder of 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. Now, before we take your questions, I want to take a few minutes and touch on the positive trends in our end markets as well as our investment priorities for the future. In the dental market, there are three factors we believe will impact demand and create expanded sales opportunity for Patterson going forward. First, we expect the increased demand for infection control products is here to stay. That said, while the infection control supply chain has stabilized from where it was a number of months ago, We are continuing to manage through some supply chain disruption and price fluctuations for certain infection control products. We continue to work closely with our supply partners to source the highest quality products and manage the price impact on our customers. Second, we expect that dentists will continue investing in the latest technologies to build and modernize their practices. And third, we believe that continued progress around vaccine administration will improve patient demand. We also expect that when patients return to the dentist after a long time away, they may require higher acuity procedures further driving product demand. In the companion animal market, we believe the growth of pet ownership and adoption rates that spiked during the pandemic is unlikely to continue at the current rate and will eventually stabilize. However, we expect the overall companion animal market to grow at a faster rate than prior to the pandemic. We are well positioned to take advantage of the incremental growth opportunity in this space through our comprehensive sales and support infrastructure and the value we bring to our veterinary customers every day. In the production animal space, we believe the market is poised to rebound as restaurants eventually reopen and schools return to in-person learning, which will drive demand for the protein and dairy products our customers provide. Now, with that context on our end markets, let me turn to our strategic investment priorities. As we think about leveraging our position across the attractive markets we serve to drive future value creation, we're focused on three key areas. First, we will continue to invest in the core areas of our business that have contributed to our accelerated performance, including investments in our people and service and support organizations. Second, our strong performance has enabled us to continue returning cash to our shareholders, even during the challenging period caused by the pandemic. and we continue to view our dividend as an effective means of delivering value to our shareholders. And third, we are also continuing to evaluate opportunities on how we can best position Patterson for sustainable growth. And given our ongoing actions to strengthen our financial position and improve our balance sheet, we have the flexibility to consider strategic investments that will accelerate that growth and value creation. As we wrap up, I want to again reiterate our enthusiasm about our position in each of our end markets, as well as our confidence in our team, our strategies, and the essential role we serve for our customers and business partners. We've made tremendous progress over the past several years in moving Patterson to a position of strength from our efforts to stabilize the core and build momentum to navigating through COVID-19 and to the accelerating performance we continue to deliver. Looking ahead, our entire team is aligned around our clear focus to create value for our customers, business partners, and shareholders. That concludes our prepared remarks, and Don and I now will be glad to take your questions. Operator, please open the line.