Patterson Companies, Inc.

Good morning and welcome to the Patterson Companies Inc. first quarter fiscal 2024 earnings conference call. All lines have been placed on mute to prevent any background noise. After the speaker's remarks, there will be a question and answer session. 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 the star one. Thank you. John Wright, Vice President of Investor Relations. You may begin your conference.

Thank you, operator. Good morning, everyone, and thank you for participating in Patterson Company's fiscal 2024 first quarter conference call. Joining me today are Patterson President and Chief Executive Officer Don Zerbe and Patterson Chief Financial Officer Kevin Barry. After a review of our results and outlook by management, we will open the call to your questions. Before we begin, let me remind you that certain comments made during this conference call are forward-looking in nature and subject to certain risks and uncertainties. These factors, which could cause actual results to materially differ from those indicated in such forward-looking statements, are discussed in detail in our Form 10-K and our other filings with the Securities and Exchange Commission. We encourage you to review this material. In addition, comments about the markets we serve, including growth rates and market shares, are based upon the company's internal analysis and estimates. The content of this conference call contains time-sensitive information that is accurate only as of the date of the live broadcast, August 30th, 2023. Patterson undertakes no obligation to revise or update any forward-looking statements to reflect events or circumstances after the date of this call. Also, a financial slide presentation can be found in the investor relations section of our website at pattersoncompanies.com. Please note, that in this morning's conference call, we will reference our adjusted results for the first quarter of fiscal 24. 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 deal amortization along with the related tax effect of this item. We will also discuss free cash flow as defined in our earnings release, which is a non-GAAP measure, and use the term internal sales to represent net sales adjusted to exclude the impact of foreign currency and contributions from recent acquisitions. These non-GAAP measures are not intended to be a substitute for our GAAP results. This call is being recorded and will be available for replay starting at 10 a.m. Central Time for a period of one week. Now, I'd like to hand the call over to Don Zerbe.

Thanks, John, and good morning, everyone. Patterson had a strong start to fiscal 24, building upon our momentum across the business as we continued to deliver value for our customers and shareholders. A few highlights from our first quarter. On the top line, year-over-year internal sales increased approximately 3% with growth across both the dental and animal health segments. Our initiatives to drive margin improvement were successful, as we achieved year-over-year adjusted operating margin expansion across the company and the dental and animal health segments. We returned $55 million to shareholders in the form of cash dividends and share repurchases. And we delivered adjusted EPS growth of 25% from the same period a year ago. Given these results, we remain on track to achieve our fiscal 2024 earnings guidance. As a reminder, our guidance accounts for our commitment to deliver year-over-year internal sales growth and adjusted operating margin expansion for the total company and across both our dental and animal health segments. Our performance during our fiscal 24 first quarter illustrates the continued execution of our proven strategy, which, as I shared last quarter, is designed to achieve four core objectives. drive revenue growth above the current end market growth rates. Second, build upon the progress we've made to enhance our margin performance. Third, evolve our products, channels, and services to best serve the customers in our end markets. And fourth, improve efficiency and optimization. Our team is aligned around various strategic initiatives to advance each of these core objectives. Today, I'd like to highlight just a couple specific examples that we've been working on in early fiscal 2024 to demonstrate our progress. First, our focus on private label. During the first quarter, we benefited from continued growth in our private label portfolio, which includes a collection of owned brands with strong market equity. These include brands we've built, like the Patterson brand in dental and the Aspen and Pivotal companion vet products. as well as acquired brands like Dairy Tech and the production animal business. We have invested in this important category by adding new SKUs, and our sales team is highly engaged and motivated to drive sales growth in this margin accretive category. We continually evaluate opportunities across our businesses, but believe there is a distinct opportunity within animal health to further expand the private label portfolio to meet evolving consumer preferences. In fact, during fiscal 24, we expect to add more private label products to our animal health offering than ever before. Over the past several years, our private label sales growth has outpaced the sales growth of products manufactured by our strategic partners. The results are paying off, and in addition to generating above-market growth, our focus on private labels supports our other core objectives. Another recent example relates to our efforts to improve efficiency and optimization. As we've said before, this objective includes not only a rigorous focus on cost discipline, but also targeted investments to leverage best practices and advance operational excellence across the enterprise. We have recently been implementing a strategic modernization of our fulfillment facilities and capabilities. This includes investments in new technology, such as robots and cobots, to automate order picking. enhancements for our teams to ensure the right skills and expertise to operate the more modern facilities, and substantial expansions of our fulfillment capacity. Just this week, we are opening a brand-new fulfillment center in the UK we call the Big Shed that will double our capacity in the region. This fully automated next-generation facility is not just larger, it's more sustainable, more efficient, and further advances our channel capabilities. We also recently completed a technology overhaul to our fulfillment center in Southern California and are close to opening an expanded facility in Montreal, Canada. In addition, we have similar projects underway in several other locations. These strategic investments in our fulfillment centers can help alleviate capacity constraints and the modernization of our facilities is expected to enhance growth. These are only a couple examples of some of the many initiatives we have underway. Taken together, our strategic areas of focus build upon our strong foundation and success over the past several years to further differentiate our position in the market and drive enhanced growth, profitability, and value creation over the long term. Now I'll provide some updates on each of our segments during the fiscal first quarter. Let's start with dental. Dental segment internal sales increased 2% compared to the first quarter of fiscal 23, due to strong growth in consumable and value-added services, which includes our software offerings. We also achieved year-over-year adjusted operating margin expansion in the fiscal first quarter, due to our dental team's ongoing focus on our margin enhancement initiatives. Our value proposition continues to resonate with all types of dental customers, from individual practices to group practices. We seek to create a seamless experience by offering a comprehensive suite of products and solutions to help dental practices grow, become more efficient, and provide improved patient care. In the consumables category, dental internal sales increased approximately 5% in the fiscal first quarter compared to one year ago. Excluding the moderating deflationary impact of infection control products, internal sales for our non-infection control consumables year-over-year. Overall, we believe the demand we are seeing for consumables products speaks to the resiliency of the dental market and our ability to drive growth above the current end market. Looking at dental equipment, internal sales in the first quarter of fiscal 24 decreased 6% compared to the year-ago period. Our team delivered growth in our core equipment and CAD-CAM categories that was more than offset by a decline in digital technology. which experienced a sequential decline in sales following a strong fiscal 2023 fourth quarter. This dynamic is typical of the variability of the equipment category and further demonstrates how equipment sales can fluctuate quarter to quarter for a variety of factors. Over the last eight quarters, our average quarterly equipment internal sales growth was 4%. Dentists continue to invest in their practices and look to Patterson when they do. We anticipate that demand for equipment and technology will drive our manufacturing partners to continue introducing new innovations and technologies. Patterson is uniquely positioned to capitalize on this demand, thanks to our expertise in selling, financing, installing, training, and servicing the latest technologies and equipment. And finally, dental internal sales in our software and value-added services category increased approximately 6% over the prior year period. Value-added services represent the entire suite of offerings we provide to our customers that help make Patterson an indispensable partner to their practice, including our leading technical service offering. This category continues to grow at a rate exceeding the overall rate of the dental segment. The strong results we have been delivering in the value-added services category are testament to our customers recognizing the full lifecycle support and services that Patterson provides. And as an added benefit, these valuable offerings are mixed favorable to our P&L. Maximizing our value-added service offerings, particularly in the software category, is a key part of our strategy. It's a meaningful opportunity for growth. Looking ahead, we believe the dental market remains stable with healthy underlying fundamentals, including an aging population, practice modernization, and the direct link between a patient's oral health and overall health. which we believe will continue to serve as tailwinds and help drive performance across our dental segment over the long term. Now let's move on to our animal health segment. During the first quarter of fiscal 24, animal health internal sales increased 4% year over year, with growth in both companion animal and production animal businesses. We also achieved year over year adjusted operating margin expansion in the animal health segment, building upon our excellent track record of margin improvement over the past few years. We benefit from the depth of our offering and omni-channel presence that spans a wide range of animal species and offers comprehensive solutions for diverse customers. In companion animal, our internal sales in the first fiscal quarter increased by mid-single digits as we executed well within this healthy and growing market. As we've said before, we've been modeling mid single digit revenue growth for our companion business over the long term. On the production animal side, fiscal 2024 first quarter internal sales grew by low single digits. Despite ongoing headwinds within the cattle market, we've continued to deliver sales growth in this part of the animal health business. This is a testament to our team's performance and the diversification of our production business. Across the animal health segment, Our value-added services category achieves strong growth that can be attributed to sales of our software solutions and equipment service, as well as operational efficiencies. Expanding our investments in software and value-added services remains a priority for us and is core to our objective to position Patterson Animal Health as the leading provider of technology, software, data insights, services, and products to the animal health industry. Our team stands ready to help our customers identify the right set of solutions to streamline their workflows and run their practices efficiently, all backed by our unbeatable service and support. Now I'll turn the call over to Kevin Berry to provide more detail on our financial results.

Thank you, Dan, and good morning, everyone. In my prepared remarks this morning, I will cover the financial results for our first quarter of fiscal 24, which ended on July 29, 2023, and then conclude with our outlook for the remainder of the fiscal year. So let's begin by covering the results for our first quarter of fiscal 24. Consolidated reported sales for Patterson Companies in our fiscal 24 first quarter were $1.6 billion, an increase of 3.5% over the first quarter of one year ago. Internal sales, which are adjusted for the effects of currency translation and contributions from recent acquisitions, increased 2.8% compared to the same period last year. Gross margin for the first quarter, fiscal 24, was 20.2%, a decrease of 25 basis points compared to the prior year period. Our gross margin was negatively impacted by 40 basis points this quarter by the mark-to-market accounting adjustment from rising interest rates on our equipment financing portfolio. As we have mentioned in prior earnings calls, any positive or negative impact related to our equipment financing portfolio is nearly offset by our corresponding hedging instrument, line on RP&L, so the net result has a minimal impact on our adjusted earnings per share. This dynamic also occurred in the first fiscal quarter of last year, when the positive impact of the mark-to-market accounting calculation was 10 basis points. When normalizing for the mark-to-market accounting adjustment in both periods, our gross margin rate in the first quarter of fiscal 24 was 20 basis points higher than the first quarter of fiscal 23. Remember, the accounting impact of the mark-to-market adjustment impacts our total company gross margin, but not the gross margin within our business segments. Importantly, during the fiscal first quarter, both of our business units posted a year-over-year increase to their respective gross margins compared to the prior year period. Adjusted operating expenses as a percentage of net sales for the first quarter of fiscal 24 were 17.2%, and favorable by 40 basis points compared to the fiscal first quarter of 23. In the first quarter of fiscal 24, consolidated adjusted operating margin 3.0 percent an increase of 15 basis points compared to the first quarter of last year again when normalizing for the impact of the mark to market accounting adjustment in both periods related to gross margin our consolidated adjusted operating margin in the first quarter of fiscal 24 expanded by 60 basis points over the prior year period i am pleased with the team's efforts to continuously improve and deliver on our commitment to drive operating margin expansion within our business segment the first quarter of fiscal 24. The initiatives we put in place to improve gross margins, to work more closely with strategic vendors who reward us for our sales performance, drive improved mix, exercise expense discipline, and leverage our cost structure has certainly translated into a higher level of profitability and financial performance for Patterson. Our adjusted tax rate for the first quarter of fiscal 24 was 23.5%, an increase of 110 basis points compared to the prior year period. Reported net income attributable to Patterson Companies Inc. for the first quarter of fiscal 24 was $31.2 million, or $0.32 per diluted share. This compares to reported net income in the first quarter of last year of $24.6 million, or $0.25 per diluted share. Adjusted net income attributable to Patterson Companies Inc. in the first quarter of fiscal 24 was $38.6 million, or $0.40 per diluted share. This compares to $31.7 million, or 32 cents per diluted share in the first quarter of fiscal 23. This 25% increase in adjusted earnings per diluted share for the fiscal first quarter is primarily due to the sales execution and operating margin expansion in both of our business segments. Now let's turn to our business segments, starting with our dental business. In the first quarter of fiscal 24, internal sales for our dental business increased 2.1% compared to the first quarter of fiscal 23. Internal sales of dental consumables in the fiscal first quarter increased 4.6% compared to one year ago and were impacted by continued price deflation of certain infection control products. Internal sales of non-infection control products increased 6.9% in the first quarter of fiscal 24 compared to the year-ago period. This negative impact from infection control product deflation has continued to moderate over the past year year deflationary effect to continue moderating and fully normalized by the end of fiscal year 24. in the first quarter of fiscal 24 internal sales of dental equipment decreased 5.7 percent compared to one year ago as don mentioned sales in the equipment category can vary from quarter to quarter and these dynamics apply to each of the specific product categories as well prior year period. Internal sales of value-added services in the first quarter of fiscal 24 increased 5.8% over the prior year period, led by the increased year-over-year contribution from our technical service team and continued growth of our software business. Value-added services, including our software offerings, represent the entire suite of offerings we provide to our and these valuable offerings are also mixed favorable to our P&L. The adjusted operating margin in dental was 7.4% in the first quarter of fiscal 24, which represents a 35 basis point improvement over the prior year period. This operating margin performance reflects the efforts of our dental team to improve margins through effective pricing and mixed management and continued expense discipline to deliver operating margin expansion for the first quarter of fiscal 24. Now let's move on to our animal health In the first quarter of fiscal 24, internal sales for our animal health business increased 4.0% compared to the first quarter of fiscal 23. Internal sales for our companion animal business in the first quarter of fiscal 24 increased 5.1% over the prior year period, which included strong sales performance from our MVS business in the UK. Internal sales for our production animal business in the first quarter increased 2.5% in the quarter compared to the prior year period. Our production animal team continues to execute well in the market, and internal sales in the first quarter of fiscal 24 delivered particularly strong growth in the swine category compared to the prior year period. The adjusted operating margin in our animal health segment was 4.0% in the fiscal 24 first quarter, an increase of nearly 80 basis points from the prior year period. Our animal health team continues to drive business with strategic manufacturer partners who value our ability to deliver increased sales, while also exercising expense disciplines they delivered operating margin expansion for the first quarter of fiscal 24. Now let me cover cash flow and balance sheet items. During the first three months of fiscal 24, our free cash flow improved by $35.7 million compared to the same period one year ago. This was primarily due to a decreased level of working capital in the first three months of fiscal 24 compared to the year ago period. Turning now to capital allocation. $17.1 million and $2.5 million higher than the first quarter of fiscal 23. This increased spending reflects the investments we are making in our distribution capabilities as well as our software and value-added services. We continue to execute on our strategy to return cash to our shareholders. In the first quarter of fiscal 24, we declared a quarterly cash dividend of 26 cents per diluted share, which was then paid at the beginning of the second We also repurchased $29.5 million of shares during the first quarter of fiscal 24, thereby returning a total of $54.9 million to shareholders through dividends and share repurchases. Let me conclude with our outlook for the remainder of fiscal 24. Today we are reaffirming our fiscal 24 GAAP earnings guidance range of $2.14 to $2.24 per diluted share, and our adjusted earnings guidance range of $2 to $2.55 per diluted share. And now I'm going to turn the call back over to Don for some additional comments.

Thanks, Kevin. Before we open it up for Q&A, I want to thank the entire Patterson team for a great start to fiscal 2024 as we made progress to build upon our momentum across the business. We're continuing to deliver on our proven strategy and combined with the resilient end markets in which we operate, I'm confident that we are well positioned to drive enhanced growth profitability, and value creation over the long term. That concludes our prepared remarks. Kevin and I will be glad to take questions. Operator, please open the line.

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 Jason Bednar from Piper Sandler. Your line is open.

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

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

Okay. All right. That's helpful. I'm sure others will probably have questions there as well. But maybe just for a follow-up, I did want to ask, I mean, Don, you highlighted those corporate investments. I don't think we've heard those kind of specifics in the past. It sounds like you have a lot of wheels in motion across your facilities, your distribution network. Are you able to quantify all the investments you've made with some of that automation work and what the ROI or payback you're expecting from some of those investments?

Yeah, well, if you look at our capex spending, this quarter is above last first quarter. And I think what you're going to see is as we go through the year, that'll continue to be the case. You know, all of these projects go through a rigorous process that we have internally to make sure that the ROI, you know, gets above our cost of capital and that it all, you know, is a financial payoff as well as all the other benefits we're getting from it. So we're pretty excited about each of these investments. Obviously, you know, we're not going to see the benefits of these quite yet, but wanted to highlight some examples of the types of things that we have that are going to keep the margin improvement moving in the right direction. And when we make the commitment to continuously improving the margin, I think this is an example of how that works. So pretty excited about all of them. I think more to come. And what I really like is the team is is continues to think about the next thing and the next opportunity. Okay.

All right. Helpful. Thank you.

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

Great. Good morning. Thanks for the questions. Wanted to start with a question on margins. Don, you reiterated expectations for operating margin expansion for the total company as well as both segments. I guess any change in your expectations for the overall level of margin expansion, I guess particularly with respect to the dynamics you're seeing in the corporate segment? And then any comments or thoughts on just cadence of margin improvement over the balance of the year?

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

Yeah, we got off to a good start here in Q1 with both of our business units, expanding both their gross margins and their operating margins. And so we're seeing that momentum at the business unit level. You alluded to the corporate segment. Just as a reminder, this is a dynamic that we have related to our equipment financing portfolio, where as the forward interest rate curve changes, we have to mark that portfolio to market, which does create some noise in our corporate segment and our overall margins, which is offset with the hedge we have in our other income line below operating profit. This quarter it was a bit of a headwind as the forward rate curve increased in that portfolio. And so, and that's why we try to give you guys kind of the adjusted numbers so you can see kind of with that noise taken out of it, how we're performing underneath it. So, you know, we're not going to guess where interest rates are going to go from here, but we'll continue to kind of have that dynamic as interest rates change. But again, I think, Wes, you can strip that out and see the underlying momentum there. And then the other thing on phasing I'd say is that, you know, I think we expect a similar cadence where we typically see some leverage as we go through the year. You know, Q1 is typically our lowest margin level for the year, but as we have higher sales quarters, we typically see leverage on the out margin line for the rest of the year.

I think I just, you know, maybe want to reiterate, when you take out the dynamics of the accounting that Kevin mentioned, which you need to do, I mean, look at our margin. I mean, our gross margin was up 20 basis points in the quarter, like Kevin mentioned, and operating margin up 60, which I think was notable. And I want to make sure people understand that dynamic. It's kind of confusing.

Great. That's helpful. And then. I wanted to ask on the U.S. companion animal business. I know you said overall companion was up 5.1, but I think, Kevin, you kind of called out NVS as maybe the main driver of that. Could you comment on how the U.S. companion animal business did and, you know, any change to your outlook for that business, you know, just given kind of the overall kind of traffic and level of demand that you're seeing in the market?

Sure, I can jump in, and Don can add. We saw growth in both segments. We saw particularly the strong growth in our NBS business, which is we want to call them out. They're performing really well in that market, and this is in advance of some of the investments. Don mentioned what you think are even going to accelerate that business further. But the U.S. companion business also did grow in the quarter. Now, as you'd expect, we're not seeing the same level of growth as we have over the past couple of years as that market has been. kind of moderated a bit from the heights of the pet pandemic boom. And in the overall market, we still see spending up even as visits have come down a bit. So that team's executing really well, and they are growing in the market.

Yeah, I think the 5% is off a fairly tough comp, as Kevin mentioned, with some of the dynamics in the market that were in place last year.

Great. Thanks very much.

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

Thank you. Good morning, guys. Don, I wanted to start on your equipment number, the down 5.7%. Obviously, we've seen many times in the past from you and other companies push hard. It's kind of the fiscal end of year to make some numbers, and then the next quarter has a bit of an overhang here. How much of that was an impact this quarter? I mean, obviously you talked about digital x-ray being down, but I'm hoping you can help us maybe disaggregate kind of end market, you know, tenor of end markets versus just some timing of when you closed your fiscal year and then made a big push last year and had a bit of an overhang to deal with in this first quarter. Thanks.

Yeah, no doubt, Jeff, and I think you've seen that in the past. And there's a lot of reasons for it, obviously, you know, there can be a fourth quarter push. We do budget and forecast for that. And I think, as you mentioned, the digital category sometimes is the one that you may see more variability on that kind of dynamic. So this gets back to, for me, just back to the whole notion of looking at it in the three-month increments, particularly as you're bringing up in the fourth quarter, first quarter kind of realm. I think if you just looked across the six-month period, which might be a better way to think about all that, you know, our equipment sales were up 8% Q4 and Q1 over last year. And then I think that, you know, I would just highlight that we, you know, we keep watching this category, as you all do, I think, in terms of the economy and things. All we're seeing is just our customers' desire to continue investing in their practice, and that's just not slowing down. It's good patient traffic, and it's kind of translating to the practices wanting to continue to invest.

That's helpful. Thank you. Just on the EPS guidance for the year, obviously up 25% year-over-year this quarter. I think your guidance for the year is low single-digit to mid-single-digit growth year-over-year for the full year. So that would kind of imply kind of flattish EPS over the next three quarters on a year-over-year basis. Just remind us, you know, one, why would that be the right level of EPS growth after a strong start here on the EPS line of the year? and two, you know, how much conservatism versus other factors we might have to be taking into account there. Thanks.

Yeah. Yeah, I think this really actually is, I think this mostly relates just to a bit of phasing on the year. I think that, you know, we had a tough comp, or we had an easy comp Q1, and obviously a tough comp in Q4, and there's some other dynamics within that. the year, but I think it relates more to that than anything. And so, you know, when we kind of look back and say, even with all that phasing, we're comfortable with the guidance we've given for the year and that growth, even though it comes in a little bit different form each quarter.

Yeah, I think the other thing I'd add, Jeff, is there are some, you know, while we do expect the business to continue to grow over the course of the year, that you know we think are great investments for for the long term of the company but we're going to have a little bit of spending that will come through in the back end here too and your next question comes from a line of kevin caliendo from ubs your line is open hey guys thanks for taking my question um

I guess one question I had to ask is around what you saw in July. That's the month we don't get to see from anybody else. And just wondering if trend through the quarter was consistent or not. I understand on the equipment side what happened with ordering and timing. I'm just wondering, as you exited the quarter, did you think that demand for equipment had changed at all from the beginning of the quarter or from second quarter? We're just trying to get a read on what's going to happen over the rest of the calendar year into next year. Yeah, no, Kevin, appreciate the question and good one. You know, for us, I think the quarter really played out, you know, kind of in normal fashion. I wouldn't highlight, and we probably wouldn't, you know, say too much about intra-quarter phasing, but I guess I would say that I don't think that there was nothing notable from my perspective on how the quarter played into the first two months versus the last one. Okay, that's helpful. And also just thinking about with equipment, where are you in terms of, relatively speaking, in terms of backlog, whether it's core or digital? Has that normalized or do you feel like...

the backlog in either of those are elevated or lower or normal. Any color around that would be super helpful.

I think, this is Kevin, I think what we say, you know, the core equipment demand continues to be strong. You know, those supply chains have normalized, I think we'd say, compared to what we were talking about a couple, you know, past year or two. So that the lead times aren't as long as they used to be. So that sales cycle is shortened for us, which is good. And then for the digital categories, those sales cycles are pretty quick. We can turn around those orders and installs fairly rapidly. The install's obviously not as complicated as a new office build-out. So we don't really think about those in terms of backlogs just because the cycle's pretty quick. But I'd say, like Don said, we're seeing healthy demand in the market. Our sales teams are executing really well to help their customers find the right the right investment for their practice and feel good about the rest of the year.

Do you think that interest rates or the economic situation has held up ordering in any way, shape, or form on some of the higher cost equipment? In the category, we've heard anecdotally this in the channel and from some of your peers and manufacturers. Just wondering how real you see that as being any kind of impact on the market. Yeah, I think, I think, you know, marginally, um, not, not in a significant way though. Um, and again, uh, you know, we're, we're pleased with the momentum in the, in the, in the business, but the momentum in the market too, in terms of, um, again, in terms of practices willing to invest in their business and, um, it continues. So, um, It's a little more challenging, I think, but still makes sense, I think, when they run the math. Fantastic. Thanks so much, everyone.

And your next question comes from the line of John Block from Stiefel. Your line is open.

Great. Thanks, guys. Good morning. I guess I'll go back to the underlying dental consumables, which were seemingly, I guess, the revenue highlight for the quarter. You've got inflation impact starting to diminish. I guess where I'm trying to go with this is what was the approximate price contribution in fiscal 23 for dental consumables and how do you see that playing out in fiscal 24? I'm just trying to focus on that pricing contribution because I think we all want to arrive at how underlying volumes are trending and if the price contribution for consumables is sort of closer to normalized levels as we currently sit here today.

Yeah, John, this is Kevin. Yeah, I think we would say that the pricing certainly is kind of more historical norms, you know, the kind of low single-digit pricing. As we've looked at our internal data here, you know, we certainly, you know, part of our Q1 performance was price contribution, but it was also positive volume contribution. So we saw units grow this quarter as well. So it wasn't just one or the other. You know, I think we expect that for some of those infection control products that we've been tracking, that year-over-year deflationary impact is going to continue to be a drag for the next couple of quarters. The prices have stabilized, but we're still going to be comparing back to a higher ASP basket for those products from last year. So I think as we – so we'll be dealing with that dynamic for the next couple of quarters, but I think for – if you kind of look at the category as a whole, we'd say – You know, we're seeing volume contribution as well as kind of more normalized historical price contribution for dental consumables.

Okay, got it. Thanks for that. And then just maybe a small handful as part of the second question. For dental equipment, should we still expect mid-single-digit growth for the year? Obviously, fiscal 1Q was down. You got a really tough comp in 4Q, so do we still think you can land at mid-single digits for the year? You know, still tax rate at 25% for the year. Is that correct? You were shy of that for the quarter. And did your messaging change a little bit on the deflationary for the infection control? I thought before that was supposed to ease in the back part of the year. Maybe in your prepared remarks, you sort of said that continues to the end of the fiscal year. Maybe some clarification there. Thanks, guys.

Yeah, I'll tackle a couple of those. So, yeah, on the deflation, I think what I'd say is, you know, we really saw the prices kind of stabilize at a new level in our Q4 fiscal 23. So it's probably Q2 will have a headwind. Q3 will have a smaller headwind. Q4, it should be pretty marginal, sort of how we see the pricing dynamics playing out there, John. And then on the tax rate, yeah, we'd still say about 25%. We're seeing a step up this year in our tax rate due to some changes in the UK tax law, as well as some historical deductions that have expired for us. So I think that's still the right number for your estimate. And equipment. Yeah. And I think, yeah, you're right. We do have some tough comps coming up in equipment. You know the team still pushing hard on that. I think mid single digit long term and again given some, you know, not looking at quarter to quarter, but over a reasonable time frame is what we'd expect. And you know, I just keep reiterating what we're saying is, you know, I think the market is is looking for these investments and and so we're still pushing to get to that mid single digit long term growth rate for equipment.

I think the, John, I think the The metric we've kind of brought out every quarter is, you know, what does it look like if you look over the last eight quarters? I think the equipment growth is 4% in that time, and it kind of has been. So you can kind of think about it like that. I think the ups and downs here of a year we deal with, but over an eight-quarter period, we still think that's a pretty good number.

And your next question comes from the line of Elizabeth Anderson from Evercore ISI. Your line is open.

Hi, guys. Thanks so much for the question. Just a quick question. How are you guys thinking about, obviously you have an interest expense in the quarter. How are you sort of expecting that to trend for the rest of the year?

Yeah, so interest expense, you know, we'd expect it to, you know, be maybe a little above what we carried here in Q1 for the rest of the next three quarters as we've kind of re-forecast where we expect rates to go. And so, you know, really, if you look at it versus last year, there'll still be a bit of a headwind here in Q2 and Q3, a little bit less so in Q4.

Okay, that's helpful. And maybe on the longer term side, one of the things that's maybe come out in the last couple of years is that you seem to have a sort of different M&A strategy for the animal health business versus the dental business. Seems like sort of more tuck-ins or more regular cadence of tuck-ins on the animal health side. Can you talk to us a little bit more about sort of maybe why that is, why you're seeing is this availability of assets? Is it just something unique about that business versus some, you know, the dental, which is obviously just had more, you know, core benefits?

Yeah, okay. I think there, you know, first of all, I would start off by saying in terms of our M&A strategy, we're, you know, we're agnostic to some extent between animal health and dental. We're looking for We're looking for the right opportunities that hit our metrics and that, you know, check the box on what we're thinking about in terms of M&A. So, I mean, I would put this particular dynamic and kind of where we've been over the last few years is just, you know, the timing of opportunities that come up and, you know, when we're ready to do something and how they check the box. I don't know that there's anything particularly interesting unique about animal health that would put us into a position where there's some good tuck-in acquisitions versus dental. But we're doing a lot of work. There's a lot of work going into all kinds of potential acquisitions. I know we've been saying this, but we're careful. We want to make sure we make the right investments. And so far, this is what we have. But again, I don't think there's anything unique about animal health and dental. They are different businesses, but we're looking for the right opportunities.

Got it. More for me. How do you think about the private label opportunity? I know you sort of talked about that particular. Is there something you can sort of like quantify there? And I know you said you're adding more products than before, but how do we think about that as like a driver of margins in that business?

Well, I think what you're going to see is private label becoming a more prominent part of our, you know, our program. I mean, and, you know, it's slow. We're not, you know, we're not accelerating at a significantly rapid pace. So, I mean, we move carefully, but definitely there's a strategic objective to make that a bigger part of our business and our sales in both animal health and dental businesses. Got it. Thanks.

Your next question comes from the line of AJ Rice from Credit Suisse. Your line is open.

Thanks. Hi, everybody. Obviously, you had really solid, strong growth in consumables on the dental side, and then your equipment sales down for all the reasons we talked about and need to normalize that. I wonder, though, in the quarter – Does that dynamic, is it enough on the product mix shift you saw to have an impact on the margin? Is that part of why the margins showed the improvements that they did in dental?

Yeah, Ajay. Yeah. You know, it is. I mean, we see typically within our dental business, our consumables margins and our value added services margins, gross margins are higher than our equipment gross margins. Now, they're somewhat interrelated, I'd say, because when we look at equipment, we also think about all the services that we provide with regard to that equipment that actually shows up on our value-added services. So in a quarter where we have slightly lower equipment sales, that quarter we might see a little bit of a mixed benefit. But we know in our model it accrues to mixed benefits going forward when we sell a lot of equipment because we get the value-added service from that relationship.

Okay. The company continues to put in its press release the nod to uncertain macro backdrop and some inflationary pressures. We've talked on the call already about inflation impact or deflation impact in their infection control, and you've said you don't think you're seeing any impact on the equipment sales. Are you just making those statements to sort of keep a cautionary tone on things? Or is there any place that hasn't come up where those two dynamics, uncertain macroeconomic and inflationary pressures are having an impact now that you wouldn't want to call out?

No, I think we are putting that out there as, you know, just sort of a, you know, a caution that, you know, kind of that these forces are out there and We have a lot of ways that we're looking at whether those are impacting our business and looking forward, do we think they're going to, and we're not seeing that. You know, I think, again, I go back to, you know, I've been out in the field. I've been with our top salespeople recently, and I just tell you that the momentum in the business right now, the optimism, the momentum are, you know, are extremely high, and And, you know, they're just not seeing it. So we'll continue to monitor it. I think we want to put that out there just so, you know, I mean, not that people don't, but so people keep that in mind. But it's not showing up.

It sounds like, to an earlier question, when you think about laying out the rest of the year, it doesn't sound like you're making any adjustments, that things get tougher in any particular area. because of these factors later in the year. I just want to confirm that the variation that would be there is more because of the year-to-year comps, et cetera, not so much because you're making an assumption about the macro environment changing. Is that right? Right. Absolutely. All right. Thanks a lot.

And your next question comes from the line of Alan Lutz from Bank of America. Your line is open.

Thanks for taking the questions. I wanted to follow up on Jeff's question from earlier. So over the past six months, equipment sales have been about 8% and that's higher than what it's been over the past eight quarters. And so, you know, as we think about what we've seen so far on interest rates, you've said there's been a marginal impact.

As you think about the guide for the remaining three quarters of the year, is there any expected incremental impact from higher interest rates? And then kind of more thematically and longer term, Is there any way to think about how dentists react if interest rates stay higher for, you know, maybe a few quarters?

Thanks. Well, I would say, you know, first, the concept of any kind of marginal impact on the equipment business given interest rates is something that, you know, we spent a lot of time modeling and it's all really built into our guidance. So, I think it would, you know, Unless there's a fairly dramatic change there, we built some of that into our guidance and that's there. What was the second part of the question?

Just how dentists would historically, how they react if interest rates stay higher for longer. We haven't really seen an environment where rates have been elevated for more than a few quarters. Just curious your perspective there. Thanks.

Yeah. Well, again, you know, what we keep seeing, and it's not just in the numbers, it's really just as we interact with our customers that there's a lot of interest in continual investment in the practice. You know, we'll monitor that. I mean, I think if we start to see something happen there that changes that dynamic, then we'll build that into the expectations. But But again, for right now, that's just, again, there's a lot of interest in investment.

Great, thank you.

And your final question today comes from the line of John Stancil from JP Morgan. Your line is open.

Thank you for taking the question. Wanted to look into production a little bit more. I appreciate you called out the headwind around cattle production. So how did that sequential decline in herd count kind of translate to traffic? And then if you're having conversations with customers, how are you thinking about this? Is this something you see as kind of persistent through the year or more of a kind of a near term? Thanks.

Yeah, so certainly our customers are seeing those lower herd counts on the cattle business, and I'd say our production team is doing a fantastic job managing through that. I think the thing for our business is that we do have a diverse kind of portfolio of customers and species that we serve. We've got a large cattle business, but we also serve the swine markets, the dairy markets. And so as we look at our business, even if one of those markets is relatively down, we see strength like we did in this quarter in the swine market, the dairy markets have come back. So we'll be able to kind of manage through with our portfolio. And, you know, and so there's, you know, a bit of a headwind here in one for a couple of quarters as those herd counts normalize. You know, we're confident we've got, you know, the plan to manage through it.

Great. And then just quickly on working capital, I think you caught out that it was improved in the quarter. Is there anything specifically that you're doing to drive this working capital improvement?

Yeah, no, the team did a good job this quarter. I think we're at a place with our working capital, I'd say, that we're always looking for the right opportunities to make sure we've got the right inventory levels. We're balancing our service levels with not getting too long on certain inventory categories. So I'd say there's opportunities that we look at more kind of opportunistically on the margins. But I just say this quarter, our receivables team is doing a really good job. And I think as we go through the year, we'll continue to find some opportunities to take inventory down a bit, balancing that need to service the demand we see.

Great.

Thank you.

And we have reached the end of our question and answer session. I will now turn the call back over to CEO Don Zervais for some final closing remarks.

Just want to thank everybody for their time today and their interest in Patterson Companies, and we'll talk to you in a quarter. Thank you.

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