Patterson Companies, Inc.

FY22 First Quarter 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, you will need to press star 1 on your telephone. Please be advised that today's conference is being recorded. If you require any further assistance, please press star 0. I would now like to hand the conference over to your speaker today, Mr. John Wright, VP 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 2022 First Quarter Conference Call. Joining me today are Patterson President and Chief Executive Officer Mark Walchert and Patterson Chief Financial Officer Don Zerbe. After a review of the Fiscal 2022 First Quarter results and outlet 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, September 2, 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 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 2022. the reconciliation table in our press release is provided to adjust reported gap measures namely operating loss and income other income expense net, income before taxes, income tax expense, net income, net income attributable to Patterson Company, Inc., and diluted earnings per share attributable to Patterson Company, Inc. Four, the impact of gains on investments, inventory donation charges, deal amortization, legal reserves, and integration and business restructuring expenses, 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 use the term internal sales to represent net sales adjusted to exclude the impact of foreign currency, changes in product selling relationships, contributions from recent acquisitions, and the extra week of selling results in the first quarter of fiscal 2022. 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 11 a.m. Central Time for a period of one week. And now I'd like to hand the call over to Mark Welchert.

Thanks, John, and welcome everyone to Patterson's fiscal 2022 first quarter conference call. Patterson delivered very strong performance during our first quarter, which ended on July 31st, 2021. I'm proud of our results and the great work of our team. not just over the past several months, but over the past several years, that has helped put Patterson in the position of strength we are in today. So before we dive into the specifics of our first quarter, I wanted to provide some brief context on the momentum we have been generating over the past several years. First, we continued to drive a clear strategy focused on five key initiatives, improved sales execution, operational excellence, effective mix management, expense discipline, and working capital improvement. We've also made targeted investments to deepen our value proposition, build our culture, and assemble an experienced leadership team, all centered around our focus on the customer and the execution of our strategic plan. These efforts have proved successful. During fiscal 2020 and 2021, we executed our turnaround, stabilized our core business, returned to growth, improved our margin and earnings performance, and strengthened our balance sheet. And I'm especially proud of our team's ability to effectively manage through the significant disruption we experienced over the past 18 months throughout the pandemic while continuing to build momentum. That momentum continued during the first quarter of fiscal 2022, highlighted by a number of key performance metrics. We grew internal sales by 21% over the prior year and 14% over the pre-pandemic period two years ago. This performance was driven by effective sales and service execution across both of our business segments and across all key product categories. Our dental segment internal sales increased 30% year-over-year and increased 12% compared to the pre-pandemic period two years ago. Our animal health segment internal sales increased 17% year-over-year and increased 16% again compared to the pre-pandemic period two years ago. For the quarter, we generated adjusted earnings per share of 43 cents, an increase of 30% over the prior year. As a result of our strong start to the year, we are raising the lower end of our adjusted EPS guidance range and now expect fiscal 2022 adjusted earnings to be in the range of $1.95 to $2.05 per diluted share. Patterson's 30% growth in adjusted earnings per share is a reflection of our team's efforts during the first quarter and over the past several years. In fact, over the past 10 quarters, our quarterly year-over-year adjusted EPS growth has averaged 19%. As we look ahead, I'm confident in our ability to leverage the combined strength of our team, our strategy, and the essential role we serve for our customers to continue driving long-term growth and shareholder value. With that overview, I'll touch now on the key drivers of our results in each of our two business segments, starting with dental. As we already mentioned, our dental segment had a strong first quarter. In addition to solid execution by our field sales, service, and support teams, the ongoing recovery of the dental market also had a positive impact on our first quarter results. Our dental team continues to gain share in the consumables category. Total consumable sales grew 34% during the first quarter compared to the prior year and increased 14% when compared to the pre-pandemic period of two years ago. And I want to call out the fact that our consumables performance in our first quarter was driven by year-over-year growth of both non-infection control and infection control products. This performance is a testament to the strength of our core consumables business and the continued demand for PPE products. On the equipment side, Patterson achieved 28% internal sales growth during the first quarter compared to the first quarter of last year. Our equipment category has also grown 15% when compared to the pre-pandemic period of two years ago. As a reminder, our equipment performance can vary from quarter to quarter, particularly following quarters where Patterson has successfully promoted and sold new products. However, our dental team has consistently driven equipment growth over the long term. In fact, over the last eight quarters, our quarterly year-over-year internal sales growth for dental equipment has averaged 9%. We've spoken a lot about the momentum of our dental consumables business in recent quarters, so I'd like to spend a moment discussing Patterson's comprehensive equipment and technology value proposition and how it is a key driver of our performance. When customers are looking to invest in their practices, they want a partner they can trust with the expertise and support they need long after the initial purchase, and Patterson has earned that trust. A key differentiator is our unparalleled customer service and support infrastructure, highlighted by two key areas. First, our highly skilled team at the Patterson Technology Center delivers unmatched expertise for our customers around the clock. When a customer has a problem with their equipment or technology, our team is a phone call away to get the practice back up and running. And when an onsite service call is required, our local dental branch network of service technicians has the skill and expertise to fix whatever problem may arise. Our service and support infrastructure is second to none in the marketplace. all focused on helping our customers run their practices efficiently and productively so they can do what they do best, which is provide great oral health care to their patients. Put simply, our comprehensive equipment and technology ecosystem makes Patterson an essential partner to the day-to-day operations of our customers, creates deep customer relationships, and positions Patterson as the partner of choice for dentists looking to invest in and modernize their practices. Let me transition for a minute now to our view on the state of the dental market in North America. First, we believe patient traffic has generally returned to pre-pandemic levels for both hygiene appointments and restorative procedures. Second, we expect dentists will continue investing in the latest technologies and practice management software to build and modernize their practices and drive improved patient care. And finally, we are encouraged by the increasing dialogue around the direct linkage between a patient's oral health and overall health. We believe this mouth-body health connection will also help drive long-term demand for dental services. As evidenced by our performance in the dental business during the first quarter, we are confident about our position in the market and our ability to benefit from these positive trends going forward. Turning now to our animal health segment. As I mentioned earlier, our animal health segment also had a strong first quarter, achieving internal sales growth of 17% year-over-year, led by internal sales growth of 23% in our companion animal business, with strong performance across both the U.S. and the U.K., and internal sales growth of 8% in our production animal business. Across both companion and production, our differentiated value proposition, particularly around equipment and technology, which grew 49% year over year, enabled Patterson to outpace the growth of our end market and capture additional share. Our consumables category also performed well across the animal health business, driven by our expanding portfolio of private label products, which continued to over-index on growth within our own portfolio and also outperformed the broader animal health consumables market. On the companion side, pet adoptions during the pandemic have increased the number of pets in the pet health ecosystem, driving increased veterinary clinic traffic and pet spending. These market dynamics will serve as long-term tailwinds for our business, even as we expect the rate of new pet adoptions to stabilize. Our top-line performance during the first quarter reflects these supportive trends. Similar to our dental segment, Patterson's equipment and technology value proposition in our animal health segment has also positioned us well to drive growth in this category and improve our mix. A significant driver of our animal health equipment growth is the increasing number of clinics and animal hospitals being built as our veterinarian customers work to meet the growing demand for their services. Patterson is building a reputation as the indispensable partner of choice for those seeking to open a new clinic or hospital, and we work to provide our veterinarian customers with the resources they need from day one. As part of our established education platform, Patterson Veterinary University, we offer a comprehensive learning course called Guiding Practice Success. This educational offering helps our customers develop the skills and business knowledge they need to start their own independent vet practices. Enrollment in our Guiding Practice Success program has been growing steadily over the past several quarters, creating the demand pipeline for the value-added services we provide around practice design, equipment installation, technology training, and repair services. these veterinarians our team has the expertise the products and the capabilities they need to successfully get their new practices off the ground working alongside veterinarians during the critical months of opening their new practice also lays the foundation for a meaningful long-term partnership there are two other important items to note regarding our companion animal business first as we announced today We monetized a portion of our investment in Vetsource during the quarter, resulting in an investment gain. We are pleased with the value we were able to capture while remaining a shareholder in Vetsource. And most importantly, as part of this transaction, we've expanded our commercial relationship with Vetsource to help enable our customers to participate in the evolving trends in the companion market. Second, I also want to mention that Patterson is already benefiting from our recent acquisition of Miller Vet Holdings. MillerVet's complementary relationships in Midwest, Mid-Atlantic, and Southeast markets help us win new business during the quarter. We are right on track with our integration plans and continue to welcome the former Miller team into the Patterson family. Looking ahead, while the companion animal market growth rate is expected to moderate over the coming quarters as we lap the mid-pandemic pet adoption boom, we believe Patterson's sustained market momentum and ecosystem of products, services, and support position us well to continue driving long-term growth in this market. On the production animal side, Patterson executed well in a market that is recovering more quickly than we had anticipated, growing internal sales over 8% year-over-year. At the industry level, swine herds are rebuilding quickly, U.S. dairy herd sizes are continuing a nearly year-long growth streak, and beef cattle herds are working to catch up to growing demand. Exports across all species are running above the five-year historical average, and as we anticipated, the expanded reopening of restaurants and schools is also driving increased demand for protein dairy products. This rebound from what was an incredibly challenging period for our production animal customers is very encouraging and has given Patterson an opportunity to fully display our value proposition in this market. Patterson was there to support better herd health with customized delivery services and products during the onset of the pandemic, and we are well positioned to support our customers as they ramp back up with a full array of consumables, technology, and software. One example is our micro machine, where installations are increasing as our feed additive technology platform is adopted by even more cattle feedlot customers, driving additional market share growth for our production animal business. We also continue to expand partnerships and deepen our relationships with manufacturers that best recognize Patterson's value proposition, helping to embed Patterson more deeply within our customers' businesses, drive share gains for our partners, and at the same time enhance our profitability. As we look ahead to the rest of fiscal 2022, we continue to work toward returning our production animal business performance to historical growth levels, building on the speed of the recovery of the swine market and the improved consumer demand for protein and dairy. In summary, we're very pleased with Patterson's overall performance during the first quarter, the strength of our end markets, and our position within those markets. Our ongoing focus on deepening our value proposition to serve our customers is delivering results and driving value for all of our stakeholders. And with that, I'll turn the call over to Don to share more details about our fiscal 2022 first quarter performance.

Thank you, Mark, and good morning, everyone. In my prepared remarks this morning, I will cover the financial results for our first quarter of fiscal 2022, which ended on July 31, 2021. As we stated in our press release this morning, our first quarter contained an extra week of sales and a table in our press release breaks out the impact of that extra selling week in our reporting categories for both of our business segments. In addition, due to the significant impact of COVID-19 in the prior fiscal year, our year-over-year comparisons for our first quarter are difficult to interpret. As a result, in my remarks, I will also refer to comparisons to the pre-pandemic period of the first quarter of fiscal 2020 as a more helpful way to understand our business performance as we manage through the pandemic within our respective markets. So let's begin by covering the results for our first quarter of fiscal 2022. Consolidated reported sales for Patterson Companies in our fiscal 2022 first quarter were $1.61 billion, an increase of 29.6% versus the first quarter one year ago. Internal sales, which are adjusted for the effects of currency translation, changes in product selling relationships, contributions from recent acquisitions, and the impact of the extra selling week, increased 21.1% compared to the same period last year. As Mark already mentioned, we believe our performance in the first quarter is the result of strong sales execution and above-market growth in both of our business segments. For additional context, our fiscal 2022 first quarter internal sales growth was 13.9% above our first quarter of 2020, which is the comparable period prior to the COVID-19 pandemic. This comparison back to Q1 of 2020 before the pandemic also shows strong top-line growth in execution by our respective teams in both our dental and animal health business segments. Our first quarter fiscal 2022 adjusted gross margin was 20.2%, down 20 basis points compared to the prior year. Adjusted operating expenses as a percentage of net sales for the first quarter of fiscal 2022 were 16.7%, and up only 10 basis points compared to one year ago. Let me remind you that in the first quarter of last year, our operating expenses included the salary and furlough actions that we took to help mitigate the initial impact of the COVID-19 pandemic. These specific pandemic-related actions favorably impacted our adjusted operating expenses as a percentage of net sales and operating profit margin in Q1 of last year by 160 basis points. For additional context, our operating expenses this quarter are 170 basis points lower than the first quarter of fiscal 2020 as we continue to benefit from ongoing expense discipline and leveraging our cost structure over higher sales volumes. In the fiscal 2022 first quarter, our consolidated adjusted operating margin was 3.6% and down 20 basis points compared to Q1 of last year. Again, in first quarter of last year, our operating margin was aided by the salary and furlough savings I just mentioned. We remain focused on driving continued operating expense margin improvement through our efforts on expense discipline, mixed management, and ongoing expense leveraging as we keep growing the top line. Our operating margin this quarter was right in line with our budget and our forecast for the year. While these results are only after one quarter of our fiscal year, and there can be timing impact in any given quarter, we still intend to deliver operating margin expansion in both of our business segments and our total business for fiscal 2022. Our adjusted tax rate for the first quarter was 22.2%. Reported net income attributable to Patterson Companies Inc. for the first quarter was $34.0 million, or $0.35 per diluted share. This compares to reported net income in the first quarter of last year of $24.4 million, or $0.25 per diluted share, and a year-over-year percentage increase in reported net income of 39.3%. Adjusted net income attributable to Patterson Companies Inc. in the first quarter was $42.1 million, or $0.43 per diluted share. As a reminder, adjusted net income excludes gains on investments, inventory donation charges, deal amortization, legal reserves and integration and business restructuring expenses, along with the related tax effect of these items. This compares to $31.5 million, or $0.33 per share, in the first quarter of fiscal 2021 and represents a 33.8% year-over-year increase in adjusted net income. This increase is the result of our strong revenue growth and effective sales execution that we delivered across all product categories and both of our business segments. Let me explain a few additional items within our adjusted results in the first quarter of fiscal 2022. As Mark mentioned within his comments on our companion animal business, we took the opportunity to monetize part of our equity investment in BethSource, a commercial partner and a leading home delivery provider for veterinarians in the companion animal space. This part of our equity stake had a carrying value of 25.2 million and was sold for 56.8 million. We also recorded a pre-tax gain of 56.8 million to reflect the increase in value of the remaining portion of our equity stake in VetSource. Most importantly, we also enhanced our commercial relationship with VetSource to be more productive and profitable as we continue to partner with them to offer home delivery technology to our veterinarian customers. During the first fiscal quarter, we also committed to donate certain personal protective equipment products to charitable organizations to assist with COVID-19 recovery efforts. As a result, we recorded a pre-tax charge of $49.2 million to cost of sales, primarily within the dental segment. These charges are driven by the intent of management to not sell this inventory and instead direct it to charitable organizations. Now let's turn to our business segments, starting with our dental business. In the first quarter of fiscal 2022, internal sales for our dental business increased 29.7% compared to the first quarter of fiscal 2021. As you recall, in the comparable period one year ago, dental offices were reopening their practices after being shut down due to the initial impact of COVID-19. For some additional context on our performance, it is helpful to look back two years ago to a comparable period before the impact of the global pandemic. Dental internal sales for the first quarter of fiscal 2022 are up 11.6% compared to the first quarter of fiscal 2020. These numbers reflect our strong sales momentum in the dental market, and we believe we are outperforming the market across all product categories. Internal sales of dental consumables grew 34.4% in the first fiscal quarter compared to one year ago. As Mark mentioned, we grew consumables year-over-year in the non-infection control category and also grew sales year-over-year in the infection control category. If we compare the dental consumable performance to the pre-pandemic period of the first quarter of 2020, internal sales of dental consumables in the first quarter of fiscal 2022 increased 13.7%. In addition, it is important to note that when excluding the impact of infection control products, our consumable sales of non-infection control products grew 6.3% over the two-year comparison period. We consider our sales of dental consumables to be strong and ahead of the overall dental consumables market, reflecting the high level of commitment and execution of our team. Internal sales of dental equipment and software grew 27.8% compared to one year ago. Our performance in the equipment categories in the quarter was broad-based, with double-digit year-over-year percentage increases across all equipment product categories, core equipment, 2D and 3D digital imaging, and CAD-CAM. When you look at our dental equipment performance compared to the pre-pandemic period of the first quarter of fiscal 2020, sales in the first quarter of fiscal 2022 increased 15.1% over that period. Adjusted operating margins in dental were 7.9% in the fiscal first quarter. Similar to our overall company results, adjusted operating margins in the first quarter of last year for the dental segment included a significant benefit from the salary savings and furloughs. A more helpful comparison is back to the first quarter of 2020, and our adjusted operating margins in dental are up 50 basis points in that timeframe. Again, our margin performance this quarter is in line with our forecast and our intention to drive operating margin improvement for the fiscal year. Now let's move on to our animal health segment. In the first quarter of fiscal 2022, internal sales for animal health business increased 16.5% compared to the first quarter of fiscal 2021. Internal sales for our companion animal business increased 23.0% compared to the first quarter of last year. and internal sales in our production animal business grew 8.1% in the quarter compared to the prior year. As you recall, in the comparable period one year ago, vet clinic traffic was initially impacted by COVID-19, but then pet adoptions began to drive vet clinic visits and increased pet spending. In our production animal business a year ago, market demand was strong at the very beginning of the pandemic and then was negatively impacted by COVID-19 outbreaks at processing plants. For some additional context on our performance, let's also look back two years ago to the comparable period before the impact of the pandemic. Animal health internal sales for the first quarter of fiscal 2022 were up 16.2% compared to the first quarter of fiscal 2020. Adjusted operating margins in our animal health segment were 3.5% in the fiscal first quarter, an increase of 30 basis points from the prior year, even with the unfavorable comparison to the salary savings and furloughs last year. And our team also delivered improved product mix with stronger sales of private label products, equipment, and software. Now let me cover cash flow and balance sheet items. During the first quarter of fiscal 2022, we used $313.4 million in cash from operating activities. We also collected deferred purchase price receivables of $315.2 million during the quarter, 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 quarter of fiscal 2022, $1.8 million. Free cash flow, which we have explained and calculated in a table within our press release, was slightly negative in the fiscal first quarter and improved by $90.9 million compared to the same period one year ago. The year-over-year improvement is the result of increased collection of deferred purchase price receivables and our working capital returning to more normalized levels after the impact of the pandemic one year ago. Turning now to capital allocation. In the first quarter of fiscal 2022, we declared a quarterly cash dividend of 26 cents per diluted share, which was then paid in the second quarter of fiscal 2022. The dividend paid in the quarter totaled 25.1 million of cash returned to our shareholders. Our board continues to view our dividend as an important component of our capital allocation strategy as we continue returning cash for our shareholders. Let me conclude with some comments on our outlook for fiscal 2022. Today we are updating our GAAP earnings guidance from our prior guidance range of $1.61 to $1.76 per diluted share to a guidance range of $1.64 to $1.74 per diluted share. We are also updating our adjusted earnings guidance from our prior range of $1.90 to $2.05 per diluted share to a guidance range for fiscal 2022 of $1.95 to $2.05 per diluted share. While it is only the conclusion of our first quarter of fiscal 2022, we are pleased with our performance to date and the continued momentum and trends we are seeing in our business and our respective end markets. And now I will turn the call back over to Mark for some additional comments.

Thanks, Don. Let me add a few brief comments before we open it up for Q&A. First, I want to again thank our entire Patterson team for their continued focus and commitment. Our more than 7,500 employees live by the central tenets described in our purpose, vision, and values every day. And thanks to their hard work, we are earning our position as an indispensable partner to our customers and business partners. In fact, I had the opportunity to engage with many of our team members at our recent sales meetings and I can tell you our teams are energized and remain focused and passionate about supporting our customers. Second, I want to reinforce our optimism about Patterson's long-term position in each of our end markets and the strength of those end markets. As we detail today, we believe the dental market has returned to pre-pandemic demand levels, and dentists are continuing to invest in the latest technologies to build and modernize their practices. The companion animal market remains very healthy and well-positioned to benefit from the long-term tailwinds of increased pet ownership and pet spending, and the production animal market is recovering faster than we expected. And finally, as we look ahead, we're focused on continuing to invest in the core areas of our business that are accelerating our performance, including investments in our people and service and support organizations, returning cash to our shareholders through an attractive dividend, and leveraging our strengthened balance sheet to evaluate opportunities for strategic investment to help further accelerate our growth and value creation. That concludes our prepared remarks, and Don and I will now be glad to take your questions. Operator, please open the line.

At this time, if you would like to ask a question, you may press star 1 on your telephone keypad. Again, it's star 1 on your telephone keypad. Your first question comes from the line of John Crager from William Blair. Your line is open. Please ask your question.

Hey, guys. Thanks very much, and thanks for all the detail. Mark, I think you made the comment at the beginning that there's a growing kind of understanding about the link between oral health and overall health. Can you just comment on some of the proposals in Washington to expand Medicare coverage to dental health? And maybe more broadly, our view is dental insurance coverage has been pretty weak over the last several years. Are you seeing any trend there to maybe more favorable coverage across employer plans? Thanks.

Yeah, John, thanks for the question. With regard to the potential legislation that's taking place and the discussions around that, first of all, we're very supportive of expanding access to oral care to a broader part of the population and really making sure everyone has the opportunity to go to the dentist. We certainly believe that oral health care is a really crucial part of the overall health of the patient. But it's also important that any legislation would include reimbursement rates that take into account the quality of care, the broad range of services that dentists provide, and obviously dentists, the industry, need to be appropriately reimbursed for those services. So we'll continue to closely monitor the legislation, and hopefully a good balance will be forged between those two areas. With regard to the second part of your question, we certainly are very encouraged by the dialogue that I think is heightening around just the mouth-body connection and the importance of oral health to overall health. And I won't pretend to know the specific scientific facts here. But certainly it's documented and clear that dentists can really identify oral health issues that can, you know, turn into broader total health issues. And so I think the connectivity between the dentist and medical areas is an important dialogue that's being enhanced. And I think over time this is just a great opportunity to improve the overall health of the patient and certainly drive additional demand for dental services.

Great, thanks. That's helpful. And one quick follow-up. You gave us an update on how you've sort of restructured your relationship with VetSource, it sounds like. What's your longer-term view about migration among pet owner spending to other channels? Is that speeding up or slowing down?

Well, I think it's absolutely, you know, stabilizing. You know, through the onset of the pandemic, I think it, you know, it did speed up a bit. Certainly, I think it's stabilized. You know, we continue to view the veterinarian really to be at the center of pet care. And just with all the positive tailwinds that we've talked about, you know, more pets, more pet spending, more demand for pet care services, we think the vet channel has, you know, great, you know, growth opportunities in it. We certainly also recognize the evolving trends that are taking place and continue to benefit from those macro trends through our relationship with VetSource that we spoke of earlier. And really, again, focusing on helping enable our customers to take advantage of these evolving trends. So, you know, certainly the vast majority of pet care we expect will continue to be in the vet channel. We continue to support the vet channel. you know, implicitly, and we're also helping enable our VET customers to take advantage of some of these evolving trends as well.

Great, thanks.

Your next question comes from the line of Michael Cherney from Bank of America. Your line is open. Please ask your question.

Good morning. Can you hear me okay? Yeah, we can hear you. We'll hope it stays that way. Mark, I want to dive a little bit more into your commentary around dental equipment. Clearly, there's been a bit of a mixed pipeline, I would say, throughout COVID in terms of where dentists want to start purchasing, although it seems like things are coming back pretty nicely. When you talk about the modernization you're seeing in dental offices, are there any areas of product concentration or any themes you're seeing that overlays what drove the strong results, especially when compared to the pre-pandemic levels?

Michael, thanks. Look, I think first off, we're certainly pleased and optimistic with our customers and how they've continued to invest in their practices during the past year. As we indicated, we certainly believe we have a unique advantage to help our customers through the entire product lifecycle. and in particular when new and innovative products are launched in the market. I think Don also spoke to the fact that our results this quarter from an equipment standpoint were really strong across all of the categories. So I think that's an important point to make as well. And I think we just have a unique capability with regard to how we sell, how we service, how we support. you know, equipment and technology purchases, investments that our customers make. And, again, while certainly, you know, on a quarterly basis, the equipment numbers can be maybe a bit lumpy, but the fact that our teams have delivered average quarterly growth of 9% over the past eight quarters, I think, is a testament to the value proposition that we spoke of and our leadership in this category and the great work and execution of our teams.

I think the only thing I'd add is the dental office is really, you know, we're seeing they seem to be very focused on investing in areas where they can increase their productivity, you know, as patient volumes are increased here.

Absolutely. Perfect. And then just want to tie back against some of the balance sheet optionality. You talked about the Miller deal starting off well, which is great to hear. Clearly, you got some moderation out of the vet source, partial sale. Mark, in the past, you've talked about looking at outside opportunities and its potential to bolster growth over time. How is that landscape shaking out? And especially now as we move back towards normalized dental volumes, has anything else emerged in terms of areas where you think making inorganic investments makes even more sense?

Yeah, we're excited about being in a position, frankly, because of our financial performance, Michael, to really consider those types of strategic investments that will drive and accelerate our growth and value creation. And we're taking certainly a thoughtful approach as we think about deploying our capital, both from a strategic and financial standpoint. You know, as we've indicated over the past, I think, several quarters, that strategic rationale is really focused on pursuing opportunities that strengthen our value proposition, that build and expand our presence in margin-accretive product and service areas, that build scale in our core business. Obviously, the MillerVet deal being a prime example of that. Really, our intent is to, you know, again, be thoughtful about how we deploy our capital, but we certainly believe that there are opportunities there across both of our business segments and, again, focused on driving greater value for our customers, accelerating our growth and profitability, and obviously ultimately creating shareholder value.

Great. Thank you.

Thanks.

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

Thank you. Good morning, guys. Mark, maybe go back to that source. I just want to understand the rationale for selling part of the equity stake there. I mean, we've seen that as one of your maybe more strategically sound investments on the end. So why choose to maybe... reduce the stake in that here. And then, Don, as a follow-up to that, just on the cash flow side, you know, even with the receivable sales this quarter, free cash flow is a little bit of an extra selling week in there.

And I think, you know, we'd all probably agree that spend levels on travel are not back to normalized levels. So how do we think about free cash flow for the rest of the year? I know you don't guide there, but you're – So I don't know how much more can be factored off.

The other credit, the sale of that source, the cash you got from that, was that a driving source? And then how to think about free cash flow the rest of the year.

Thanks. Yeah, Jeff, maybe I'll start with the free cash flow. I think, you know, if you look at our history, Q1 is typically our lightest quarter. There's certain inventory investments we make in Q1 to kind of ramp for the the higher volume in Q2 through Q4. So I think if you look back, this would be in line with our historical precedent. So I would just call the Q1 cash flow timing. I think if you look for the year, again, as I've said, I think we expect free cash flow to really move with our earnings growth. And so I think you'll see that as the year progresses.

Yeah, Jeff, this is Mark. I think with regard to your vet source question, I think around the timing, certainly an opportunity presented itself, and we're very pleased with the outcome.

We were able to monetize.

as a portion of our investment, while at the same time maintain an equity stake and also strengthen our commercial relationship. So nothing has changed in terms of our ability to support our customers with this important service. And really, we view it as a win-win for Patterson. And our teams will continue to represent the technology in the market and work closely with VetSource going forward to benefit our joint customers.

All right. That's helpful. Thanks. And then just last one I could ask maybe on dental equipment. Just, you know, we continue to hear about some supply constraints, I think, especially on the basic equipment side and especially with, you know, one manufacturer you do do business with. I think one or two others that you have lesser exposure to. But just kind of what's the state of supply out there heading into the, you know, last few months here of the calendar year anyway and how to think about those supply constraints and how they might or might not impact the next quarter or two for you. Thanks.

Yeah, Jeff, you know, certainly we do note and expect some longer than normal lead times in the near term, and as you indicated in particular on the core equipment category. We do view this as a near-term issue and certainly working closely with our manufacturer partners to minimize the disruption and keep our customers informed. But it should also be noted that, you know, our funnel is strong, and the situation that we're dealing with here in the near term is not only related to, you know, supply chain issues, but also due to the strong demand for these products. So I think that's an important point to note as well.

Helpful. Thank you. Thank you.

Your next question comes from the line of Jason Bednars. From Piper Sandler, your line is open. Please ask your question.

Hey, good morning. Congrats on a nice start to fiscal 22 here, guys. You know, on dental, if I start there, I mean, Mark or John, you mentioned growth in infection control and non-infection control products, which is a real good result, especially accounting for the first full quarter impact from the Heartland shift. But, you know, first, sorry if I missed it, but wondering if you'd be willing to quantify these year-over-year growth rates at all for us and clarify whether these are including or excluding the extra selling week. And then second, Mark, it'd be good to get your view on where you see performance in each of these categories, you know, as we move forward and now that we've returned to pre-pandemic levels, and then I'll have a follow-up on that as well.

Yeah, Jason, thank you. You know, I think with regard to this overall category, you know, the infection control supply chain actually is continuing to stabilize as are, you know, pricing. And so looking ahead, assuming no significant change to COVID dynamics, we expect continued strong demand for PPE, but should also note we face some, as you know, some very difficult comps over the next couple of quarters due to the huge demand increase we saw last year. So we continue to focus on sourcing PPE key elements to improve our mix and profitability.

And then one additional point, nature of our consumables business, including both PPE and PPE products. On the growth rate, so dental consumables were up 34% year over year, 2% on non-

infection and 32% on infection control, and those exclude the extra selling week. Sorry. Oh, sorry. 2% on non-infection and 32% on non-infection, 2% on infection. And if you go back two years, over the two-year period, the consumables are up 14%. with non-infection up 6% and infection up 7%.

All right. Super helpful. Thank you very much for all that. Um, and then on animal health, I mean, it seems like there are several tailwinds right now in the production animal market with, with herd sizes expanding as you called out and demand rising as consumers turn to restaurants and kids get back to in-person learning. Um, you know, where do you think will be delivering in the market settles? Uh, and then can you talk about maybe investments you're making today ahead of where you think these market shifts, uh, you know, push the production animal market?

Well, again, uh, Jason, thanks. I mean, again, strong execution by our team. I think testament to the team's efforts here. You know, we were there during the real dark days in the midst of COVID to support our customers, obviously across all of our segments, but in production animals, as you asked. and really help them navigate through some really challenging times. And obviously we're there now to support them as their businesses are ramping back up. So, you know, we certainly are pleased with the bounce back here in the production animal space, generally good trends that we see across the beef, the swine, and the dairy categories. And obviously, to your point, and I think the point we've been making for a number of quarters, as restaurants reopen, as schools reopen, get back to in-person learning, you know, we would just expect the demand trends, you know, in our production animal business to be positive going forward.

All right. Thanks so much. Congrats again. Thank you.

Your next question comes from the line of John Block from Stifel. Your line is open. Please ask your question.

Thanks, guys. Good morning. Two questions. I guess the first one on dental trends, and I get it, we don't want to sort of get into the day-to-day, week-to-week cadence, but you guys actually have a very interesting look into sort of what's going on out there. You have maybe some COVID headwinds that, you know, sort of COVID headwinds that abated at the beginning of the quarter, pardon me, and then picked up with Delta more recently as we think about July and August. So, Mark or Don, can you just maybe give us a look into how trends proceeded throughout fiscal 1Q specific to dental, and if you're willing to provide some color even more recently into the month of August. And then I just got a separate follow-up. Thanks.

Okay, John. You know, certainly I'll start here. I mean, I think as we indicated, we believe the dental industry is generally back to pre-pandemic levels, both in terms of hygiene and restorative treatments and procedures. I think that's important to note. Our customers continue to show confidence in their practices by the investments they're making, which suggests that they're expecting continued demand, strong demand trends. clearly it's safe to go back to the dentist if you haven't been and we obviously remain very encouraged as we spoke about the heightened awareness around the connection between oral health and overall health so all these factors give us you know confidence in the long-term prospects for the health of the market we have not seen any specific COVID-related slowdown overall, perhaps a pocket here or there. We're not anticipating any broad industry shutdown that we saw 18 months or so ago. And so we're really optimistic about the bounce back, frankly, in the dental industry, the fact that we believe we're generally back to pre-pandemic levels of demand. Our customers, like I said, are investing in their practices, and we're optimistic about the macro trends there.

Thank you. That's great color. Thanks, Mark. And I'll totally shift gears for the second one, Don. I think this one's for you. Just the change in rep rack, I guess the growth to net that you called out in the release, and it seems most prominent or most specific to the animal health consumables. Just some color there. What is that? Is that buy-sell agency? Does that continue for the balance of the year? Maybe if you can just talk through that, please.

Yeah, it is. It's buy-sell agency. And I think some Miller Vets, I think if you look at, you know, that should continue through the balance of the year as well.

Okay. Fair enough. Thanks, guys. Thank you.

Your next question comes from the line of Elizabeth Anderson from Evercore. Your line is open. Please ask your question.

Hi guys, thanks so much. Obviously with all the changing dynamics in the dental end market, you know, should continue to smooth out hopefully as we go forward. But I was just wondering, you know, given that it seems like the consumables in dental is growing above the market average despite sort of maybe your guys' having less maybe some of the specialty products versus dumb. And I was just wondering, could you talk a little bit more about where you're seeing that outsized growth in sort of the core dental consumable business? That would be helpful. Thank you.

Yeah, Elizabeth, this is Mark. Thank you. Look, in terms of our dental performance, our team's and simply continue to execute well on our strategy. I think at the core, it's about our people who are laser-focused on being there for our customers and providing the comprehensive set of products, services, technology support to help our customers manage and run successful practices. And that's a core part of our approach. i think also our decision early on in the pandemic to keep our teams fully staffed continues to pay off we were there for our customers every step of the way throughout the pandemic our teams provided valuable insights and resources to help our customers navigate through obviously a very challenging period and so i think that those investments that focus is paying off I spoke earlier about the opportunity to engage with some of our field sales teams at our recent sales meetings, and I think our teams are energized and excited to continue to build on that momentum, again, all centered around helping our customers succeed. And, you know, it's certainly not – focused on one specific segment of the market or one geography. I think our teams are doing well across the board, whether it's in private practice, the DSO market, regional DSOs, et cetera. Again, the teams are executing well, and we're pleased with the performance so far.

Okay, that's super helpful. I was wondering if you could give us any commentary on the DSO market as we sort of pull out of hopefully the pandemic. Where are you seeing the most activity? Was there any change in sort of what they're interested in purchasing and any other competitive dynamics there?

Well, as I indicated, we're really pleased with the progress we're making in the DSO space as well. It continues to be an area of focus for us. We've spoken, I think, over some period of time about the investments that we're making to build out our teams and our support infrastructure there, both at the regional DSO and national DSO level. Like we've indicated, we're focused on working with those groups and customers that see the value proposition that Patterson can bring to the table to help support their operations. and their supportive practices. So we continue to be pleased with our progress here. We're winning business in this segment. We continue to expect to invest and build out our team and our capabilities to support this segment, again, with a real strong focus on, you know, working with those DSOs who find a good fit with our value proposition and where, you know, obviously both parties can benefit.

Okay. Thank you.

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

Good morning. Thanks for the question. Maybe just starting with the follow-up on the revenue outlook. Don, I guess if we look at the impact of the extra week, I think it added about $110 million to revenue. I guess if we adjust that out of the first quarter revenue base, is that $1.5 billion or so the right kind of jumping off point as we think about how to trend revenue sequentially in 2Q and over the balance of the year? I was just kind of going back to your comment around the end markets seem more normalized Should we think about kind of 2Q or sequential growth off of 1Q or kind of in line with what it's been historically, which I think has been in the 6% range or so?

Yeah, I think that, you know, in general terms, without giving too much sort of guidance, I guess I would say that your math seems pretty reasonable on all of that. And that would be a good way to think about the way that the year may roll out from Q1 into Q2 and 3 and 4.

Okay, great. And then a follow-up on growth margins. Can you help us think about how you're expecting those to trend? I think they are still running below sort of the pre-pandemic rate. Obviously, a lot has changed with respect to the mix of the business and waiting for infection control. But as we think about kind of the trajectory from here, how should we think about gross margins trending over the balance of the year? And have you seen any impact from inflation in freight costs or labor that would maybe factor into the gross margin levels?

yeah so on the inflation question i mean you know there's been some but but nothing that significant i think that if you if you look at um the trending of the gross margin throughout the year Typically, the first quarter ends up being, again, as with a lot of things, our most challenging quarter, and volumes are generally at the lowest. We did have the benefit of the extra week, so that was helpful. But I think if you look at how it may trend for the rest of the year, we expect there to be some increasing gross margin as you look to the rest of the fiscal year.

Great. Thanks very much.

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

Great, thanks. A little bit of a follow-up to Nathan's first question. If we had an extra week in one queue, do you lose those days in any of the other quarters? Should we contemplate calendar impacts in 2Q, 3Q, 4Q? No, no. It's a 53-week year versus a 52-week year. Got it. So you're basically getting a little bit of an extra benefit this year. Okay, that's helpful. So to that end, if we think about the beat in the quarter and the idea that production is maybe doing a little bit better than had expected and everything else seems to be at least in line, is when you think about your guidance range for the year and understanding that you just raised it and it's only the first quarter, should we say that that was really driven by the production beat or is it just the operations in the quarter? How should we, how should we think about where the business now is versus expectations that you set, you know, several months ago, back in June? Like what's changed? So we started the year with a 15 cent range and, um,

what we did this quarter is move this to a 10 cent range and basically, you know, took off the bottom 5 cents of the range. I think the way to read that is we're at the end of the first quarter. We feel very confident about where the business is headed. Um, we had a very good quarter and I think it's really just an expression of the confidence we have in, in, in the year and the trajectory of the business and more to come as we get further into the year.

Okay, that's helpful. And one last one. The PPE donation, can we assume that this would sort of put an end to the PPE write-downs and donations and the like? Like, do you feel comfortable that you're in a good spot with that from here? I guess we're just trying to understand sort of is there further risk to PPE? I don't know. I'm sure prices are down from where you bought it. That's why it happened. Are you seeing enough stability there and enough understanding of supply demands that will limit your risk to do this going forward?

Well, obviously, it's been a pretty dynamic situation. But I think that as we sit here today, we feel safe. good about where our inventory is and where our PPE kind of overall inventory sits in relation to the demand for the rest of the year.

Just one quick follow-up to that. Can you talk a little bit about what the prices were of the acquired PPE versus where they are now, even just generally?

Yeah, we haven't really gotten into that detail. Obviously, it varies widely depending on which type of PP you're talking about. So there's been a lot of dynamics. It would be hard to really quantify it in any kind of macro sense. Got it. OK, thank you.

There are no further questions at this time. You may continue.

Yeah, great. Thank you so much, and thanks, everybody, for your time today and your continued interest in Patterson Companies, and we'll speak with you again soon. Thank you very much.

This concludes today's conference call. Thank you for participating. You may now disconnect.