Patterson Companies, Inc.

Good morning. My name is Rob and I will be your conference operator today. At this time, I would like to welcome everyone to the Patterson Company's third quarter fiscal year 2022 conference call. All lines have been placed on mute to prevent any background noise. After the speaker's remarks, there will be a question and answer session. If you would like to ask a question during this time, simply press star followed by the number one on your telephone keypad. If you would like to withdraw your question, again, press star 1. Thank you. John Wright, Vice President, Investor Relations, you may begin your conference.

Thank you, Operator.

Good morning, everyone, and thank you for participating in Patterson Company's Fiscal 2022 Third 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 third quarter results and outlook by management, we will open the call to your questions. Before we begin, let me remind you that certain comments made during this conference call are forward-looking in nature and subject to certain risks and uncertainties. These factors, which could cause actual results to materially differ from those indicated in such forward-looking statements, are discussed in detail in our Form 10-K and our other filings with the Securities and Exchange Commission. We encourage you to review this material. In addition, comments about the markets we serve, including growth rates and market shares, are based upon the company's internal analysis and estimates. The content of this conference call contains time sensitive information that is accurate only as of the date of the live broadcast, March 2nd, 2022. 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 patersoncompanies.com. Please note that in this morning's conference call, we will reference our adjusted results for the third quarter of fiscal 2022. The reconciliation table in our press release is provided to adjust reported gap measures, namely operating income, other income expense net, income before taxes, income tax expense, net income, net income attributable to Patterson Companies, Inc., and diluted earnings per share attributable to Patterson Companies, Inc. 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. Now, I'd like to hand the call over to Mark Walsher.

Thank you, John, and welcome, everyone, to Patterson's fiscal 2022 third quarter earnings call. Before we begin our discussion, I want to first acknowledge the devastating situation in Ukraine. And while we do not have any specific operations in Ukraine or Russia, our thoughts are certainly with the Ukrainian people. and everyone affected by this tragic war. And I know we're all very hopeful for a fast and peaceful resolution. I'll turn now to our discussion of our third quarter. Patterson continued to deliver strong performance, this time in our fiscal third quarter, which ended on January 29, 2022. I'm very proud of the way our team continues to execute against the backdrop of a dynamic and market environment. And during this quarter in particular, given the acute disruption caused by the Omicron variant in the last several weeks of the quarter. Even in light of the Omicron impact in the quarter, our team remained focused on delivering value to our customers, highlighted by a number of key factors, including delivering solid top line growth and gross margin expansion across our total overall business, driving gross margin and adjusted operating margin improvement in both our dental and animal health business segments, and achieving adjusted earnings per share for the quarter of $0.55 and year-to-date adjusted earnings per diluted share of $1.56. Given our year-to-date performance and our confidence in the business going forward, we are again raising our adjusted EPS guidance expectations for fiscal 2022 from $2 to $2.10 per diluted share to $2.08 to $2.13 per diluted share. The midpoint of our updated adjusted EPS guidance range now represents a 10% year-over-year improvement over the prior fiscal year. With that overview, I'll now dive a bit deeper into the performance drivers in each of our segments during the fiscal third quarter, starting first with our dental business. During the third quarter, our dental segment achieved gross margin expansion of 120 basis points and adjusted operating margin improvement of 70 basis points compared to the prior year period. These results were primarily driven by favorable contributions from vendor rebates, driven by our continued revenue performance, improved product mix with stronger sales of our higher margin products, including private label products, software and value-added services, and overall strong execution across the business, even in light of the disruption from the Omicron variant and the ongoing industry-wide supply chain challenges in the core equipment category. With respect to our top line performance, internal sales in our dental segment increased slightly compared to the prior year. Internal sales of consumables declined about 2% year over year. Several factors contributed to our consumables performance during the quarter, so I'd like to provide some additional context. First, we continue to see the moderation of pricing and demand for the infection control category, which we anticipated in our fiscal 2022 forecast and guidance. excluding infection control products, our third quarter consumables internal sales grew nearly 4%. Second, our consumables performance during the quarter reflected the impact from the Omicron variant, which was particularly acute during the last few weeks of January in the final month of our fiscal third quarter. We estimate that the Omicron variant negatively impacted our overall consumables growth by about 2% during the quarter. Importantly, we anticipate the most notable impact from the Omicron variant is reflected in our fiscal third quarter results. And finally, our consumables growth rate in the third quarter is stacked on top of our strong performance during the year-ago period when we reported internal sales growth for consumables of nearly 14%. On a year-to-date basis, internal sales of our consumables category through the first nine months of fiscal 2022 increased by more than 8% compared to the same period in fiscal 21. Turning now to our equipment results. Equipment internal sales increased nearly 2% year-over-year, driven by double-digit growth of CAD CAM and digital technology products, partially offset by a double-digit decline in sales of core equipment products due to the supply chain challenges that have been felt throughout the industry. In my recent discussions with our key manufacturers, they expect these specific core equipment challenges to persist in the near term and may not be fully resolved until sometime in the second half of the 2022 calendar year. However, we remain very encouraged by the strong demand our team continues to generate for these products with our customers. In light of these ongoing challenges in the core equipment category, our dental equipment growth in the quarter is a testament to Patterson's value proposition, our leadership in the equipment category, and excellent execution by the entire dental team. Internal sales of value-added services increased approximately 4% compared to the prior year period, driven by higher sales of our higher-margin software and service offerings. One of the key drivers of our value proposition with our dental customers continues to be our software and business solutions portfolio. We offer a leading suite of practice management software, which serves as the nerve center of a modern dental practice. Patterson's portfolio of software solutions, which we call Revolve, provides a comprehensive suite of services and tools to help our dental customers drive success for their practice, including practice management, patient engagement, revenue cycle management, practice analytics, and security and compliance. Our FUSE cloud-based practice management platform is designed to unlock the growth potential of multi-location practices and connects everything they need to run both their clinical practice and their business across every location, every schedule, and every patient. These multi-location customers use our software to create more efficiencies and to scale their business for faster growth by eliminating redundant tasks and consolidating data and analytics into meaningful reporting to ultimately help streamline their front office workflow, improve staff efficiency, and increase profitability. Patterson Dental also provides the most comprehensive software and technology support in the industry. Our Patterson Technology Center is staffed with over 400 experts trained to work with dental practices to maximize their practice technology and software. And with our field-based technology advisors, we differentiate our support further by offering both in-practice and virtual onboarding and training services to meet their individualized customer service and training needs. Our software solutions are a key focus area for us as we continue to devote additional resources to grow this segment to support our customers and improve our mix. Across the entire dental equipment and software market, we believe there is strong demand for continued innovation in the marketplace. I recently had the opportunity to engage directly with many of our manufacturer partners and a number of customers at the Chicago Midwinter Dental Meeting. Our customers are optimistic about the future of their practices and the innovation and support available to them as they in turn seek to modernize their practices and offer enhanced clinical care to their patients. I was also encouraged in my discussions at the conference by the heightened awareness and momentum in the industry to help the general public better understand the connection between oral health and overall health, and more specifically, how oral health can help identify other health-related issues. Going to the dentist is not only important for a patient's oral health, but also for a patient's overall health care. Collectively, these trends continue to drive positive long-term fundamentals for the entire dental industry. Looking ahead, we expect the dental market will return to its historical growth pattern as we move beyond the pandemic. We remain confident in Patterson's strong position in the market, the depth and experience of our team, and our ability to drive continued momentum from these positive market fundamentals. To wrap up my comments on the dental segment, I'd like to congratulate our entire dental team for their fiscal third quarter performance and strong execution, especially in light of the Omicron disruption and supply chain challenges. Turning now to our animal health segment. Our animal health team continued their positive momentum and delivered a very strong third quarter. On the top line, our animal health segment delivered internal sales growth of more than 8% driven by the sixth straight quarter of double digit growth in the companion animal segment and continued strong growth in our production animal segment. In addition to this strong top line performance, our animal health team achieved gross margin expansion of 50 basis points and adjusted operating margin improvement of 10 basis points in the quarter, highlighted by several key factors. First, our continued focus to improve product mix by driving sales of our higher margin categories of equipment and value added services and growing our private label portfolio at an even higher growth rate than our overall animal health business. Second, by working closely with our strategic vendor partners, including driving share to those products and vendor partners that choose to reward Patterson's deep customer relationships and extensive value proposition, and third, through the ongoing and strong overall execution across the business. Our animal health performance reflects the compelling advantage of Patterson's animal health platform, which provides products and value-added solutions for all three of the industry's key channels, veterinarian, retail, and producer. The animal health market continues to evolve, and our customers are seeking access to the products and solutions from a variety of sources. The depth of our offering and breadth across all channels is one of the primary drivers of continued success in the animal health market. Our companion animal business continues to benefit from the considerable increase in pet ownership that has occurred in the past two years. According to statistics from pet adoption organizations, nearly 1 million pets were adopted during 2021 in the US alone, continuing a trend that began during the onset of the pandemic. In addition, pet owners have become more attentive, devoting considerable time, thought, and money toward caring for their pets. Recent industry research underscores that the overwhelming majority of today's pet owners believe their pet is truly part of the family, and they are committed to their pet's medical care even during challenging economic times. Overall, these attitudes towards pet ownership are driving continued strong traffic at vet clinics and higher spend per visit, and this gives us confidence in the long-term growth and durability of the companion animal market. Beyond these positive market fundamentals, Patterson's comprehensive product and technology offerings, combined with our team's expertise, service, training, and support, continues to differentiate Patterson and propel our growth, resulting in growth rates that continue to outpace the overall market. While the companion animal market growth rate is expected to moderate over the coming quarters, Patterson's ecosystem of products and services sets us up well to continue driving long-term growth in this market. Given the larger population of pet owners and the increased attention and spending on pets, we expect the market's normalized long-term growth rate will be higher than pre-pandemic levels. On the production animal side, our team delivered another excellent quarter, reflecting the strengths of both the overall production animal market's continued recovery and Patterson's value proposition for producers, particularly in a dynamic environment. Patterson brings a depth and breadth of services and capabilities to producers that span products, equipment, technology, services, and trusted expertise. Producers reward us with their business as we become an integral part of their team, helping them manage a sustainable and profitable operation and contributing to the health and safety of their animals. We found that deep partnerships with our producer customers are, in particular, built on having an omnichannel presence in the production animal market. Consistent with our overall animal health approach, Patterson's go-to-market strategy has solutions for large operations with on-site veterinarians, smaller owner-operators, along with a strong presence in the retail channel, to be serving our customers in the manner they prefer with a broad set of capabilities to meet and exceed their expectations. We're pleased with the pace of market recovery across all species, and as we look ahead, the production market is expected to steadily improve. Exports across all our production categories, cattle, swine and dairy, are running above the five-year average, and processing plant capacity has largely returned to pre-pandemic levels. This recovery is encouraging and we anticipate continued improvement going forward. So let me also congratulate our entire animal health team for their strong execution and results in the fiscal third quarter. As I wrap up my initial comments on our fiscal third quarter, I'm pleased with our performance across both business units and confident in our business momentum and competitive position to drive growth and margin expansion going forward. And with that, I'll turn the call over to Don to share more details about our fiscal 2022 third quarter performance. Don?

Thank you, Mark, and good morning, everyone. In my prepared remarks this morning, I will cover the financial results for the third quarter of fiscal 2022, which ended on January 29, 2022, and a revised outlook for the remainder of the year. Consistent with the past several quarters, due to the comparison dynamics to the market recovery from COVID-19 in the prior fiscal year, I will also refer to how our business is performing relative to the pre-pandemic period of the third quarter of fiscal 2020. We believe these additional data points are a helpful way to understand our business performance and illustrate how we have managed through the pandemic within each of our markets. Let's begin by covering the consolidated results for our third quarter of fiscal 2022. Consolidated reported sales for Patterson Companies in our fiscal 2022 third quarter were $1.6 billion, an increase of 2.9% versus the third quarter one year ago. Internal sales for our fiscal 2022 third quarter increased 4.3% compared to the prior year. As a reminder, internal sales are adjusted for the effects of currency translation, changes in product selling relationships, and contributions from recent acquisitions. Compared to the pre-pandemic third quarter of fiscal 2020, internal sales for our fiscal 2022 third quarter increased 11.5%. We believe our financial performance in the third quarter of fiscal 2022 is the result of continued business momentum and solid sales execution in both of our business segments, even as we dealt with some lingering effects of the global pandemic that Mark just described. Our third quarter fiscal 2022 gross margin was 21.1%, up 20 basis points compared to the prior year, and up 130 basis points sequentially from the second quarter. Our gross margin expanded on a year-over-year basis despite a 20 basis point headwind related to the impact of marking our equipment portfolio to market value. As we have discussed in the past, this impact on our gross margin is mitigated by a hedging instrument reflected in our interest and other expense line item in the P&L, which eliminates the impact to our bottom line. Importantly, we achieved gross margin expansion in each of our business segments on a year-over-year basis as a result of our focus on product mix and our ability to pass on the inflationary cost increases that we received from our manufacturer partners. Adjusted operating expenses as a percentage of net sales for the third quarter of fiscal 2022 were 16.7%, an increase of 40 basis points compared to the fiscal third quarter one year ago. On a year-to-date basis, our operating expenses as a percentage in net sales were 30 basis points lower than the prior year. In the fiscal 2022 third quarter, our consolidated adjusted operating margin was 4.4% and down 20 basis points compared to the third quarter of last year. Excluding the impact on our gross margin of marking our equipment portfolio to market value that was previously mentioned, our consolidated adjusted operating margin was flat with last year. As we've previously mentioned, we continue to focus on driving operating margin improvement through our efforts on expense discipline, mixed management within our segments, and ongoing expense leveraging as we continue growing the top line. As a result of these efforts, our operating margin in both of our business segments improved during the third quarter of fiscal 2022 versus the prior year. Our adjusted tax rate for the third quarter of fiscal 2022 was 24.7%. compared to 20.2% in the same period one year ago, representing a $0.03 per diluted share headwind compared to the prior year period. Reported net income attributable to Patterson Companies Inc. for the third quarter of fiscal 2022 was $57.0 million, or $0.58 per diluted share. This compares to reported net income in the third quarter of last year of $48.8 million, or $0.50 per diluted share. Adjusted net income attributable to Patterson Companies Inc. in the third quarter of fiscal 2022 was $54.2 million, or $0.55 per diluted share. As a reminder, adjusted net income excludes deal amortization and gains on investments. This compares to $55.8 million, or $0.58 per share, in the third quarter of fiscal 2021. Now let's turn to our business segments, starting with our dental business. In the third quarter of fiscal 2022, internal sales for our dental business increased 0.1% compared to the third quarter of fiscal 2021. On a year-to-date basis, our dental business is up 6.8% versus the same nine-month period in the prior fiscal year. Internal sales of dental consumables decreased 1.8% in our fiscal 2022 third quarter compared to the prior year. As we stated at the beginning of our fiscal year, we expected the revenue contribution of certain infection control products to decline on a year-over-year basis. To that point, during the third quarter, sales of certain infection control products decreased by approximately 20% compared to the third quarter of the prior fiscal year. When excluding the sales impact from infection control products, our consumable sales grew 3.6% year-over-year. As Mark previously mentioned, we estimate that the impact of the Omicron COVID-19 variant negatively impacted our consumables in the third quarter by approximately 2%. While it is difficult to isolate the impact of any one variable and the timing of the Omicron variant affected each geography differently, we did observe the most noticeable slowdown in our daily consumable sales from the last week in December through the entire month of January due to patient appointment cancellation and office staff shortages. As additional context, if you compare our third quarter dental consumables performance to the pre-pandemic period of the third quarter of fiscal 2020, internal sales increased 11.5%. During our fiscal 2022 third quarter, internal sales of dental equipment and software increased 1.6% compared to one year ago. While sales of CAD CAM and digital technology products were strong in the quarter, Our core equipment category continues to be impacted by the known supply challenges related to these products. As we've noted previously, the equipment category growth can vary by quarter. It is worth noting that even with these continued supply chain challenges, during the first nine months of fiscal 2022, sales of dental equipment increased 5.3% versus the same period in the prior fiscal year. Additionally, our average quarterly year-over-year growth rate for our equipment business over the past eight quarters is 5.2%. This performance continues to illustrate the strength of our value proposition for Patterson as the partner of choice when it comes to the selling, financing, training, and servicing of equipment for our dental customers. Adjusted operating margins in dental were 10.1% in the fiscal third quarter and up 70 basis points from the third quarter of last year, driven by improved gross margin and continued expense discipline. Again, we remain committed to driving operating margin improvement in our dental business for fiscal 2022. Now let's move on to our animal health segment. In the third quarter of fiscal 2022, Internal sales for our animal health business increased 8.2% compared to the third quarter of fiscal 2021. Internal sales for our companion animal business increased 12.4% compared to the third quarter of last year, while internal sales in our production animal business grew 3.6% in the third quarter compared to the prior year. For some additional context on this performance, let's go back two years ago to the comparable period before the impact of the global pandemic. Animal health internal sales for the third quarter of fiscal 2022 increased 19.0% compared to the third quarter of fiscal 2020. Adjusted operating margins in our animal health segment were 3.4% in the fiscal third quarter, an increase of 10 basis points from the prior year. Our animal health team continues to successfully drive higher sales growth with vendor partners who reward us for our value-added approach to both our companion and production animal customers. Additionally, our team also delivered improved product mix with stronger sales of private label products, equipment, and software. Moving on to free cash flow and capital allocation. Through the first nine months of fiscal 2022, our free cash flow was $57.7 million, an increase of $49.2 million over the first nine months of the prior year. Please note that our free cash flow for the first nine months of fiscal 2022 includes $36 million to settle our shareholder litigation in the second quarter. While our year-to-date free cash flow was running ahead of the same period last year, in the fiscal third quarter, we did choose to take advantage of some strategic purchases before we entered the new calendar year. During the third quarter of fiscal 2022, we declared a quarterly cash dividend of 26 cents per diluted share and returned $25.3 million to our shareholders. Through the first nine months of fiscal 2022, we have paid out $75.7 million in dividends. Our board continues to view our dividend as an important component of our capital allocation strategy to return cash to our shareholders. Let me conclude with some comments on the remainder of our fiscal 2022. Today, we are raising our GAAP earnings guidance from our prior GAAP guidance range of $1.69 to $1.79 per diluted share. to a new GAAP guidance range of $1.86 to $1.91 per diluted share. We're also updating our adjusted earnings guidance for a prior guidance range of $2 to $2.10 per diluted share to a new adjusted earnings guidance range for fiscal 2022 of $2.08 to $2.13 per diluted share. And now I will turn the call back to Mark for some additional comments.

Now, before we move on to Q&A, I want to again acknowledge and thank our employees for their continued dedication, focus, and execution of our strategy, particularly over the last few years as our business and in markets continue to face various obstacles and challenges. This mindset helps Patterson live out our purpose, vision, and values every day and is foundational to our success, employee engagement, and performance. I'm proud that Patterson Dental was recently recognized as the best overall dental supply company by VeryWell Health, based on our exceptional customer support. We also achieved a significant improvement on the Human Rights Campaign Foundation's Corporate Equity Index, which measures corporate policies related to workplace equity. And finally, Patterson recently joined the Forbes list of America's best large employers. This recognition is a testimony to the focus and passion of our entire Patterson team to serve our customers, our industries, and our communities. So to wrap up, as we head into Q4, we're optimistic about the momentum in our business and our ability to continue the successful execution of our strategy. We are well positioned to capitalize on the positive fundamentals in our end markets as we strive to be an indispensable partner for our customers. And we continue to look for opportunities to make thoughtful investments to drive top line growth, margin improvement, and value creation for our shareholders. And with that, Don and I look forward to taking your questions.

At this time, I would like to remind everyone, in order to ask a question, press star, then the number one on your telephone keypad. And your first question comes from the line of Michael Cherney from Bank of America. Your line is open.

Good morning, and thanks so much for taking the call. I would love to dive a little bit more into the margin progression over the course of the quarter. Clearly, given macro factors, the margins stood out in terms of upside you generated relative to at least our expectations. As you think now, and maybe Mark and Don for a look back as well, since you joined the company, where do you think you are in terms of the broad-based margin progression? And how should we think about the next leg of upside, especially as volume dynamics return towards normalized levels?

Yeah, thanks, Michael. Good question. I'm, you know, I think I would characterize us as really kind of in the middle innings of this process. We've made good progress. It's not always linear, but I think if you look over time, you know, we've made progress, particularly if you look at each business unit separately. But more opportunity to come. We think that for both of our business units, there's opportunity to continue to expand the margin. And we really look forward to that as we move forward.

Yeah, Michael, this is Mark. Thanks for the question. We spoke a fair amount about mix in our prepared remarks. And maybe just to, again, highlight the importance of this really across both of our businesses and really a key element is how we continue to drive margin expansion over time. And this will continue to be a strong focus for us in key areas that we've spoken to, like private label, equipment and technology, software and support services. All of these areas and others we will continue to invest in, align our goals around, track and monitor with KPIs, and importantly, incent our field sales and management teams to drive faster growth in these margin accretive areas. So

uh obviously margin improvement is a critical focus across the company and it's something that we'll continue to be very focused on going forward thanks and then just one more quick one and i don't think i heard this so i apologize if it's repeated do you give any commentary around february exit rates and where things stand as we sit today

Well, we're not commenting specifically on February, but certainly we saw what we kind of think of as a bit of a bell curve that related to the Omicron variant. We started to see some impacts in late December, early January, and then I think really the most acute period for us was in the last several weeks of January. And fortunately, not only from a business standpoint, obviously, but from a public health standpoint, it seems like the Omicron variant has gone away as fast as it came in. So, you know, we're pleased with the return to, you know, the pre-Macron levels, I would say, and certainly we've built any potential impacts from that into our fourth quarter guidance.

Great. Thanks so much.

Thank you. Your next question comes from a line of Aaron Wright from Morgan Stanley. Your line is open.

Great, thanks. And Dental, can you speak to what exactly you're experiencing in terms of supply chain challenges and can you quantify how big of an impact that was or will be over the next kind of several quarters and what sort of visibility you have on the dynamic as well as the key areas of focus or areas of impact? You mentioned strong CAD CAM, but I guess provide some level of detail where you're seeing the headwinds there. Thanks.

Yeah, sure, Erin. Thanks for the question. You know, We've spoken, I think, for a number of quarters regarding the core equipment category in dental and some of the ongoing supply chain challenges there. And I think as we indicated, we do expect to see those persist here through the first half and into the second half of the year. I was at the Chicago midwinter meeting last week, had an opportunity to speak with a number of our manufacturers on this topic. And they're certainly facing challenges not so much now from a labor standpoint, but primarily now with the availability of certain component parts. And I don't think Omnicron certainly didn't help the situation in December and January. And again, just due to the, I think, ongoing supply chain challenges, we expect these delays to continue on core equipment. I would, however, say the good news is that the demand for these products continues to remain strong, very strong, in fact. And so, The issue is not simply the supply chain, but there's also an issue of increased demand. Our customers are continuing to invest in their practices, which is a great sign on how they view the marketplace going forward and the comfort that they have in their businesses and their practices going forward. So while it's certainly an unfortunate delay in getting the orders produced and installed for our customers, the pipeline and backlog is very promising. We continue to stay very close to our manufacturers. We certainly are starting to see some supply chain impacts in some of the technology products. And again, we're staying very close to our manufacturers to continue to manage through that. And again, I would say we're just generally dealing with some significant supply chain issues around certain parts. But the good news for us and what keeps us very encouraged here is that the backlog and pipeline remain very strong. And we're just pushing some of these orders perhaps out a little further than we had originally expected.

Okay, great. And then on animal health, you mentioned some positive dynamics across companion animal with double-digit growth, but you were also mentioning some normalization and trends. Are you starting to see that now? And where do you think that long-term growth profile for animal health shakes out for you? And can you speak to also the opportunity for drivers of future margin expansion across that particular segment? Thanks.

Yeah, sure. Thank you. You know, I think we've been saying for a number of quarters that we didn't expect that 20 percent plus growth in the companion animal segment for forever. Obviously, we have seen that start to to moderate. But we also have delivered, I think, six straight quarters of double digit top line growth there. So our teams are doing a fantastic job in the field. We're working closely with our the strategic relationships we have with certain groups. key manufacturers there. Our comprehensive value prop, I think, is resonating with our customers. And obviously, you know, there are certainly some strong market tailwinds in that segment. Our teams are taking full advantage of those tailwinds, executing well, and we believe delivering growth that is clearly outpacing the market. In terms of the go forward, you know, we certainly believe there's been a step change in the kind of the fundamentals of the companion animal market. And certainly once we would you know, kind of get fully past the COVID dynamic. We certainly believe that that market will grow at a faster rate post-pandemic than it was pre-pandemic. So we're really, really encouraged by that. And our team, as I said, is doing a great job of taking advantage of those tailwinds. In terms of your question around margin enhancement, look, I think it also gets back to this discussion earlier, Michael's question around mix. We continue to focus our team's across both of our businesses on on mix and in the you know animal health space many similar opportunities around private label equipment technology software and services and our teams are really focused on driving mix improvements uh to to expand margins over time so we think there's um certainly opportunity and good runway uh there as well and hey aaron this is don let me just the only thing i'd add to mark's comments is also just uh

really the leveraging impact of continued sales execution and continued sales volume increases.

Okay, great. Thank you.

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

Thank you. Good morning, guys. Maybe a question on pricing and then on margins. So, Mark, starting with you on pricing, I think it's fairly accepted now that pricing probably up two to three percent in consumables this year, at least most places outside of the largest DSOs. You know, what's going on in pricing in the animal health segment? We're just not as familiar there, haven't heard as much about pricing there. Are you getting pricing power there? And even on dental equipment, we've heard kind of mixed things. So outside of dental consumables, just how should we think about the pricing environment over the next 12 months? Thanks.

Yeah, Jeff, thank you. Certainly, I think as we indicated and Don indicated, you know, the cost increase activity from both really dental and animal health came in generally as we anticipated and in the range that we expected and that we spoke of, I think, last quarter. You know, we did see some higher levels of normal cost inflation in late 2021 and into calendar 22 across both segments, probably a bit more in dental than perhaps animal health. So animal health was just maybe just a tick above average and dental health maybe a couple ticks above average there. And I would say primarily we did see it more so in the consumables categories, although we have seen some in the equipment category as well. And I think per my earlier comments, the fact obviously we're continuing to see strong demand in that area. You know, I think the manufacturers obviously have a number of inflationary pressures that they're dealing with, and obviously they make their decisions around the pricing in the marketplace and the recommended product price. So we have a very strong methodology and process to pass on cost increases. Our teams did a great job executing on that, so we feel real good about where we stand. We certainly are staying close to our manufacturers, and as things continue to evolve from a supply chain and inflationary standpoint, as there are other uh cost increases that perhaps would occur over the course of the year obviously we'll be ready for those and we'll take the same uh the same process that we did uh at the at the first of the year so feel real good about where we stand at this point and obviously we're staying very close to it and i would say at the same time working closely with our manufacturers to try to identify opportunities to to mitigate or to minimize those cost increases that ultimately do get passed on to to our customers

All right, that's helpful. Thank you. And Don, maybe just on the margin side, you know, you guys have touched a couple times on this call about the segment improvements, the 10 basis points in animal health, the 70 basis points in dental. And I think that's, you know, more or less been true over the last several quarters as well, that the segments have been, you know, flat up, at least as a general trend. But even this quarter, if we exclude those mark-to-market impacts, the company-wide margin flat in year over year, which would imply the corporate or the unallocated kind of pulled down those segment improvements. And I would think that the unallocated or the corporate would be kind of the more in-your-control kind of part of the expense line. So just what's going on on the corporate side and how should we think about that outside of just the segment margin going forward? Thanks.

Yeah, you know, Jeff, I think it's really less about the corporate segment and just more also about segment mix, you know, in terms of the way that the sales have progressed this year. I think if you look at it going forward, we think that that kind of headwind, if you will, to the overall operating margins versus the segment operating margins will moderate and, you know, not be quite as big a drag on us, but I think it has more to do with that in the math than the corporate segment. The corporate segment generally, other than some of the elements we've talked about with the interest rate hedging, hasn't really been a big change. There's not really big fluctuations or variances there that are really doing anything significant to our margin.

Okay. That's helpful. Thank you.

And your next question comes from a line of Jason Bednar from Piper Sandler. Your line is open.

Hey, good morning. Thanks for taking the questions. Mark or Don, I'm going to come back on the margin side. Those gross margin improvements in dental and animal health were really strong, but there's clearly some oddities here on a year-over-year basis with comps and rebates and things like that. So Maybe is there a way you can unpack for us just maybe how much this quarter, the strength we saw this quarter was a normalization of some of those things and things like those rebates and maybe product mix versus what is a reflection of things you're doing, such as improving sourcing, managing expenses, taking price actions, et cetera?

Yeah, I think it's really a little of all of it. We probably wouldn't break the pieces out. I think for us, both sides are contributing, and the things we're doing internally to help the margin is really what I look at on the go-forward basis.

Yeah, and I would just add, Jason, thanks. You know, I think it's a combination of factors and just good, strong execution across the business, both from a gross margin and operating margin standpoint. So many of the things that you mentioned, sourcing, mix, pricing, continuing to manage our expenses, getting leverage on the increased top line, those are all factors that are contributing both to our gross margin and operating margin performance. And, you know, It has been, it is, and it will continue to be a very strong focus for us going forward.

All right, that's helpful. And then maybe as a follow-up, a lot of us have been asking the last few quarters about your M&A interests, and you've been clear the appetite's certainly there. Could you help us with maybe where you're at in the stage of evaluating targets and Is there anything right now that's keeping transactions from getting across the finish line, whether it be valuations, strategic fit, cultural fit, just anything along those lines would be helpful. Thank you.

Yeah, Jason, thanks. I mean, we have noted our improved financial performance and obviously the strength of our balance sheet has certainly put us in a position to make those type of strategic investments. We continue to actively pursue these opportunities. And really, it gets to exactly what you said, when we find the right ones that fit strategically for us financially, culturally, we will certainly move forward. And we have and continue to evaluate a number of opportunities. But as we've also noted, we're not simply going to do a deal just for the sake of doing a deal. And so we have a disciplined approach around that. But certainly, I wouldn't want to suggest it's no longer a focus. It's absolutely a focus for us. And we'll continue to know evaluate opportunities and to your question about getting them across the goal line uh to this point we just haven't found uh the the right the right ones that again fit uh those those various elements i'll also tell you we're you know we're making uh internal investments to also help drive growth and profitability uh investments in our fulfillment center operations to improve productivity uh investments in our technology platforms to drive greater value for our customers and certainly investments in our sales and service teams to continue to really drive our value proposition in the marketplace. So we're going to continue to look for ways to drive inorganic growth through investments. We're going to continue to invest internally for organic growth and margin expansion, and it will remain an important focus for us going forward.

All right. Appreciate the color. Thank you. Thank you.

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

Great, thanks.

So yesterday, Dentsply hinted that they may take a larger price increase than they normally do and take it earlier in the year. And can you just walk us through how that might impact you if they were to, say, take a 5% increase in consumables and or equipment?

in may like what happens do you build up inventories ahead of that or just and how do you how does that would that impact the way you think about fiscal 23. uh yes kevin thanks um you know i'd say in general not to comment specifically on one manufacturer but certainly we do see cost increase activity that happens throughout the course of the year typically it does happen in Q4 or Q1, but it doesn't mean that manufacturers don't take price increases throughout the course of the year. And as we've indicated, we have a tight formal process that we use to manage through those situations. There's opportunities to, as Don indicated, make strategic purchases. We'll do so if that makes sense. And then we've spoken our pricing methodology with our customers both on the dental and animal health sides of the business, really allow us to pass on those manufacturer cost increases to our customers and our teams. This is not a new phenomenon for us. Our teams have done this consistently over the years, and we have a formal process to do that, and they executed it, again, very well this year. So if we were to see further price increase activity, then we'll implement the same process To this point, we're not anticipating that in our Q4, and to the extent that there's any elements of that for next year, we'll speak to it next quarter.

That's helpful. And just one quick follow-up. The chip shortages and the impact on that, can you guys quantify in any way how meaningful it is, or do you have any visibility on when that might start to clear up? and if it's been impacting you. You didn't really call it out specifically here, and I'm just wondering if you could or if it's not material enough to call out, and when you think if it is material, when it might clear up.

Yeah, I think as Kevin, as we indicated, we spoke a little bit to kind of certain component parts, and it certainly would be in particular the chip shortage. We're not as close to it as our manufacturers would be directly, but We're obviously staying very close to them as they're working through some of the challenges associated with chips and component parts. My discussions last week, as a matter of fact, with a number of manufacturers were specific on this topic, and it is a very challenging supply chain situation for a number of our manufacturers right now. As I indicated, I think we believe that the core equipment category challenges will probably persist into the early second half of the year. And we are starting to see some, I would say modest challenges with regard to some of the higher technology products. But as I indicated earlier, you know, we built that at this point into our Q4. And I would just, again, underscore a large part of the challenges from a supply chain standpoint and the timing of getting products to our customers and installed is because the demand is very strong across the entire equipment category. And so that continues to give us confidence in, you know, our customers investing in their practices. And obviously we feel very good about our competitive position as it relates to equipment and technology and our ability to work with our customers there. So hard to give you a specific date or timeline. Frankly, I think it is, you know, perhaps a bit of a moving target at this point. And obviously things are evolving across the supply chain that could affect that over time. But at this point, I think what we shared is what we know at this point, and we're obviously staying very close to our manufacturers as that situation may evolve.

Thank you so much. Yep, thank you.

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

Hi, good morning. Thanks for the questions. Don, maybe one for you on the guidance for the fourth quarter. It looks like a similar level of EPS relative to what you reported in the third quarter. I guess is there any detail you could kind of give us between revenue and margins, you know, given some of the, you know, supply headwinds that you talked about in dental equipment and also, you know, kind of the recent outperformance on margins? Maybe just how are you kind of thinking about that at a high level?

Yeah, I think if you look back at last year's Q4, there was some LIFO challenges and a few other things that we had called out. So we expect, if you look on a year-over-year basis, for the gross margin to be up fairly significantly. And then on the operating margin, same thing for the same reason. I think more if you look at it on a year-over-year basis, that's where you'll see some pretty significant margin improvement in the actual fourth quarter compared to last year. And then, yeah, I guess that's what I'd say on that.

Okay. And I guess maybe just following up on sort of a top line and I guess, is there any way to kind of, you know, talk about the magnitude of the slowdown that you saw in January relative to maybe what the business did in November and December? Kind of, I guess, particularly for the dental consumables business. And I guess, you know, would those kind of November-December rates be more appropriate as we think about, you know, going forward both fourth quarter and beyond?

Well, I think with regard to the impact in January and in our fiscal third quarter, but again, I think most acute in the last several weeks of January, I think we indicated we felt it had perhaps about a 2% impact in our consumables for the quarter. And we saw some lingering effects. What we're really pleased by, Nathan, is the The rate of patient demand, office visits, appointments, you're really, you know, back on track here after, you know, certainly some impact in the month of January. So in terms of our, you know, consumables, you know, we expect it to be back on track here, obviously pending no other further COVID-related impacts. And, you know, really that, you know, period from late December through, you know, the end of January. you know, we think is for the most part behind us at this point.

Makes sense. Thanks for the comments. Yeah, thank you.

Your next question comes from a line of John Block from Stiefel. Your line is open.

Yeah, hi. Good morning. First question, I'm going to actually follow up a little bit on some stuff that's been asked. But Don, just looking at the guidance, you know, you're no longer expecting fiscal 22 to to have sort of that 4Q EPS back-end weighted component. You know, I think the guide now implies sort of flat Q over Q EPS. And I just would love your thoughts. You know, is it just sort of a conservative nature? Why no longer the expected step up into 4Q, fiscal 4Q, considering, you know, based on what you guys said, you might get some Omicron delayed visits that hopefully surface in that February or March timeframe from the delays that you called out or that we all saw in December and January?

Yeah, I think we're just trying to strike a balance with that and some of them being a little bit cautious on some of the elements that we've talked about. And this year had a much different cadence than last year. So while we expect some increase Q3 or Q4, it's really not the same dynamic that we've had in the past, just given some of the timing dynamics we've seen.

Okay. Got it. And then, Mark, maybe for you, I know M&A was also asked earlier, but maybe just talk to us about M&A versus partnerships versus share repos or, you know, even increasing the dividend. You know, when I look at, you know, partnerships or what I call partnerships or There seems to be a lot of clear aligners that have hit the market that, you know, I think would really benefit from a broader reach into GPs, even some DTC companies that seem to be refocusing on the professional channel. There was, you know, Orfit that was somewhat announced recently. You know, and I don't think they have the broad reach and the breadth that you guys have. So just would love your thoughts on how you guys evaluate, you know, the M&A, the purchase versus, hey, we want to leverage our sales force versus putting capital to work. in a different way via share repo? Thanks.

Yeah, John, thanks. Good question. I'd say those are all part of the calculus that we consider in terms of ultimately driving growth and shareholder value over time. So opportunities to make, obviously, outright acquisitions. We've spoken on some of the things that we would prioritize there. areas that would strengthen our value proposition, build and expand our presence in margin accretive product, software, service areas, looking to build scale in our core business, just several examples of maybe the types of areas that would be good fits for us, but also the idea of how we can partner with manufacturers or new companies that are entering the space that have products or services that could really take advantage of the scale and reach that Patterson has across both our dental and animal health businesses. So that is also an area that we, you know, are focused on and consider and have ongoing discussions around. And then the third piece in terms of other ways to, you know, return cash to shareholders, I think as Don indicated, and I'll pass it to him here in a second, we certainly remain committed to our dividends. And, you know, in general, looking for ways that we can invest in the business, invest in organic growth, invest in inorganic growth partnerships, and also additional ways that we can, you know, return cash to our shareholders over time. So, Don, not sure if you have anything to add there.

No, I think that was pretty comprehensive.

Perfect. Thanks, guys. Thanks, John.

And your last question comes from the line of John Krieger from William Blair. Your line is open.

Hi, thanks very much. Mark, just to clarify the dental equipment supply chain issue. So from your perspective, should we assume that maybe it gets a little bit worse as it sounds like maybe it's creeping into some of the higher tech categories?

Well, John, I think... Certainly the Omicron situation in January in particular didn't help, primarily around the core equipment category. And so we have indicated we felt like it will go through the first half and probably into the second half, certainly calendar Q3 on the core equipment side. We did hear earlier this week, and we are seeing some, I would say, moderate impacts with regard to some of the imaging you know cad cam or high-tech digital products um what i would say is the the backlog continues to be strong and and we have uh you know opportunities to continue to install products uh that were you know ordered here over the over the past uh you know weeks and months um so hard to see at this point if it's getting getting worse uh we're staying very close to it uh it does literally uh change I think day by day for our manufacturer partners based on the accessibility to certain component parts, in particular chips. So really hard to predict at this point in terms of a timeframe. The thing that gives us good confidence, even to the extent that some of these orders may be pushed out a bit, is the fact that demand remains strong really across the entire equipment category. And I know I've probably said that a few times, but I really want to continue to underscore that. Our customers are continuing to invest in their practices. That gives us high confidence in the long-term growth opportunities in the segment. And while we're in the midst of working through some supply chain challenges, I think if you think about the long-term prospects for equipment and technology in the dental segment, it's very strong. We're very optimistic about that. And we're very focused on continuing to drive growth in that area. And our team does a fantastic job. The last thing I would say is sometimes it also depends on the manufacturer. Some manufacturers have had less issues than others. We sell a very broad product line of core and digital dentistry technology products, and so we'll continue to manage through that on behalf of our customers and work closely with our manufacturers to get those products shipped and installed as soon as possible.

Sounds good. Thanks. Maybe one other one. I know you guys have put a lot of effort into making your sort of corporate account offering more competitive across both animal health and dental. Can you just give us an update on how that's going? You know, any kind of key jump ball opportunities or renewal situations in the coming year that we should be thinking of?

Yeah, nothing that I would call out in particular around specific customers or specific opportunities in the months ahead. Really, as we've said, across both our businesses, the dental space with DSOs, in the animal health space with corporate accounts, our teams are doing very well there. We continue to invest in our teams, in the resources, the support functions to support customers in the DSO, our DSO, and corporate account space. We are doing very well in those spaces, growing, certainly, based on the strong execution of our team. So nothing's changed in that area in terms of our focus on it, our ability to continue to execute the investments that we have made and will continue to make to drive growth in that category and also to make sure that we continue to work with those corporate accounts, those RDSOs, those DSOs that really see the value proposition that Patterson can offer and find really good partnerships, strategic relationships and partnerships that can be built on mutual success for the long term. And we're excited about our continued progress there.

Great. Thanks much.

Yeah. Thank you.

This concludes our question and answer. I apologize. This concludes our question and answer session. I will turn the call back over to Malk Ward-Shirk, CEO, for some closing comments.

Yeah. Thank you very much. And thank you everyone for your time today and continued interest in Patterson Companies and We look forward to speaking to you again next quarter. Thanks very much.

This concludes today's conference call. Thank you for your participation.