Patterson Companies, Inc.

Good morning, everyone, and thank you for participating in Patterson Company's fiscal 2024 second 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 line 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, November 29, 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 second quarter of fiscal 2024. The reconciliation tables in our press release are provided to adjust various reported gap measures for the impact of deal amortization and an interest rate swap, along with any related tax effect of these items. We will also discuss free cash flow as defined in our earnings release, which is a non-gap measure, and use the term internal sales to represent net sales adjusted to exclude the impact of foreign currency, contributions from recent acquisitions, and the net impact of an interest rate swap. 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 10 o'clock a.m. Central Time for a period of one week. Now, I'd like to hand the call over to Don Zervais.

Thanks, John, and welcome everyone to Patterson's Fiscal 2024 Second Quarter Conference Call. I will begin my remarks today with highlights of our consolidated results before providing more details on the performance of each of our segments. Our team executed well against the evolving backdrop of macroeconomic uncertainty and other industry factors that had varied impacts on discrete categories within our dental and animal health segments. I'll start with key highlights of strong performance in the quarter. In the dental segment, Patterson's broad and resilient consumables portfolio enabled us to deliver sales growth above market growth amid steady patient demand. And our core equipment category delivered solid year-over-year growth, despite a tough comparison to last year's strong second quarter performance. In animal health, our market-leading production animal business achieved strong sales growth, primarily due to the leading omnichannel presence that Patterson has built to best serve producers. And in both of our business segments, our value-added services categories, including our software offerings, achieved significant growth that outpaced overall sales and sales within the dental and animal health segments offsetting these results we experienced softer than expected demand in two areas of our business macroeconomic conditions impacted our performance in the high-tech dental equipment categories and our companion animal business was impacted by a decline in vet clinic visits and spending ultimately we delivered second quarter adjusted eps of 50 cents We also returned 86 million in capital to shareholders through our dividend and share repurchases. Looking forward, we believe that macroeconomic and industry challenges are likely to persist for the duration of our fiscal year. We therefore have adjusted our fiscal 2024 guidance to reflect our revised expectations for the year. We now expect to deliver adjusted earnings in the range of $2.35 to $2.45 for diluted share. a decline of 4% at the midpoint of our previous range. We remain focused on executing against our proven strategy, which, as a reminder, is designed to achieve four core objectives. First, 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. Despite a more challenging macroeconomic environment during the second quarter, we continued investing across our business in service of our long-term strategic objectives. This includes investments in our distribution capabilities, software offerings, and value-added services to further differentiate Patterson as a partner of choice for our customers. We are focused on managing Patterson for the long term. because we are confident in the strength and resilience of our end markets and in Patterson's ability to perform for our customers and our shareholders. I'd like to touch on some of the targeted investments we made during the second quarter that we expect will drive our efficiency and optimization over the long term. First, we recently completed the expansion of a distribution facility dedicated to our dental business in Canada. We believe the expanded facility in Montreal will enhance our ability to serve customers on the east side of the country and add state-of-the-art features that will drive efficiencies. Second, we successfully completed the implementation of our ERP system in Canada. This is an important milestone in our ERP rollout, connecting our U.S. and Canada operations to provide greater visibility across our North American operations and drive meaningful efficiencies. And finally, Patterson also continued to invest behind our robust suite of software solutions in both our dental and animal health segments. As we've discussed previously, we believe the opportunity for growth within software is meaningful, and we're investing to build upon our strong foundation, add to our capabilities, and address evolving customer preferences. In our fiscal 2024 second quarter, we added technical personnel and other resources to our dental software team. and are pleased with the progress we have made toward an even stronger offering to customer experience. We're building a track record of driving returns from our strategic investments, and we expect that performance to continue. For example, last year, Patterson completed acquisitions of Dairy Tech and RSVP and ACT. Today, those businesses are performing even better than our expectations. The Dairy Tech owned brand is a positive margin contributor in our production animal business. And the RSVP platform for veterinarian staffing is solving today's most critical challenge for our animal health customers. And to meet that demand, we continue to expand RSVP to serve more of Patterson's customers. As we move through the second half of fiscal 24, we plan to continue to balance our investment strategy with cost discipline to calibrate our expenses appropriately within the macroeconomic environment. I am proud of the Patterson team and the way we are navigating a dynamic macroeconomic environment to deliver value for our customers and our shareholders. We continue to believe that the strength of our team, the resiliency of the dental and animal health end markets, and our comprehensive value proposition make Patterson well positioned to drive enhanced growth, profitability, and value creation over the long term. Now I'll provide more detail on the performance of each of our two business segments during the fiscal second quarter. Let's start with dental. In the second quarter, dental segment internal sales declined 0.2% year over year. As I mentioned, our consumables category performed very well in the quarter, with 3% internal sales growth, including the negative deflationary impact of certain infection control product prices. Excluding those infection control products, we saw nearly 5% sales growth. We attribute this strong performance to a few key factors. First, Steady patient traffic for standard dentistry. Second, our long-term consistent commitment to strengthening our relationships with our customers. Third, our broad and resilient dental consumables portfolio, including an expansive suite of private label products, which targets our customer base. And finally, the strong execution by our team. Taken together, these factors enabled Patterson to perform well in the consumables category, and insulated us from macroeconomic headwinds that caused some patients to postpone specialty procedures. On the dental equipment side, internal sales declined 6% year over year. Patterson achieved continued growth in core equipment during the quarter, even on top of last year's strong growth. However, this growth was more than offset by declining sales of high-tech equipment during the quarter. Our digital and CAD CAM businesses faced industry headwinds from the broader economic environment, as well as lengthening upgrade cycles and continued pricing pressure. Moving forward, we are encouraged by the fact that our manufacturing partners have indicated long-term plans to invest and innovate in these important product categories. This is a testament to the continued long-term demand for these types of products. And when there's new innovation, Patterson has a leading capability to sell, finance, install, and service all dental equipment. And finally, dental internal sales in our value-added services category increased approximately 3% over the prior year period. Value-added services represent the entire suite of offerings we provide to our customers that enhance the customer experience, drive loyalty, and help make Patterson an indispensable partner to their practice. Dental value-added services continued to grow at a pace exceeding the rate of the dental segment sales overall. and remain a key strategic focus and significant growth opportunity for Patterson. We are dedicated to continuously deepening Patterson's dental value proposition and positioning ourselves for continued success in a healthy and attractive market that is supported by enduring trends, including an aging population, a drive towards practice modernization, and a heightened awareness of the link between oral health and overall health. We remain confident in our team's ability to effectively navigate ongoing macroeconomic and industry challenges and achieve our long-term goals. Now let's move on to our animal health segment. During the second quarter, Patterson's animal health segment internal sales increased 0.2% year over year. Even in an environment of modest growth, we're seeing evidence that Patterson's deep and broad value proposition across species and multiple channels continues to be a driver of our success. In companion animal, our internal sales declined by low single digits as veterinary clinic business decreased and spending moderated. As I mentioned, we attribute this decrease to moderation in the companion animal industry, hastened by a tough economic climate for consumers navigating inflation and other challenges. However, it's important to put this quarter into broader context of the long-term health of this end market. As we look ahead, we expect this market as a whole to grow in the low single digits over the long term. supported by positive long-term trends in pet parenting. On the production animal side, second quarter internal sales grew by mid-single digits. A strong performance in production reaffirms the strength of our omnichannel presence, highly tailored distribution strategy, and comprehensive offering across animal species. Those strategies, executed by our talented and tenured team, enabled us to continue to win new business and outperform the broader production animal market. Secondarily, our performance also benefited because of the more historical timing of the annual fall run and movement of cattle to feed yards. Across the animal health segment, our value-added services category grew rapidly due to increased demand for our software solutions and equipment services, as well as new programs to drive revenue and operational efficiency in freight. We're also confident that the opportunity for continued growth within software remains significant, We continue to invest in existing solutions to better leverage our strong foundation, add to our capabilities, and address evolving customer preferences. Now I'll turn the call over to Kevin Berry to provide more detail on our financial results.

Thank you, Don, and good morning, everyone. In my prepared remarks this morning, I will cover the financial results for our second quarter of fiscal 24, which ended on October 28, 2023, and then conclude with our outlook for the remainder of the fiscal year. So let's begin by covering the results for our second quarter of fiscal 24. Consolidated reported sales for Patterson Companies in our fiscal 24 second quarter were $1.65 billion, an increase of 1.6% over the second quarter of one year ago. Internal sales, which are adjusted for the effects of currency translation, contributions from recent acquisitions, and the net impact of an interest rate swap, increased 1.0% compared to the same period last year. Gross margin for the second quarter of fiscal 24 was 20.5%, an increase of 30 basis points compared to the prior year period. Beginning with our fiscal 24 second quarter, we have also provided adjusted gross margin, which is a non-GAAP financial measure that adjusts gross margin for the impact of the mark-to-market accounting related to our equipment financing portfolio and the associated interest rate SWOT hedging instruments. We will provide this additional non-GAAP financial measure going forward as it adjusts for the impact of interest rates fluctuations net of the mark-to-market swap adjustment within the P&L. In particular, this adjustment classifies the gain or loss on the interest rate swap from other income expense to net sales to align the swap impact with the impact on customer financing net sales. Remember, the accounting impact of the mark-to-market adjustment impacts our total company gross margin, but not the gross margin within our business segment. And as before, the net impact of interest rate fluctuations between the swap and the equipment financing portfolio has a minimal impact on net income. For the second quarter of fiscal 24, our adjusted gross margin was 20.6% compared to 20.8% in the year-ago period. We provided these comparative numbers for the second quarter and on a year-to-date basis, and we have included reconciliations for the first quarter in today's press release. Importantly, during the second quarter of fiscal 24, Both of our business units posted a year-over-year increase to their respective gross margins compared to the prior year period. The initiatives we have put in place to improve gross margins, working more closely with strategic vendors who reward us for our sales performance, drive improved mix, exercise expense discipline, and leverage our cost structure have translated into improved gross margins for both of our business units. Adjusted operating expenses as percentage of net sales for the second quarter of fiscal 24 were 16.5% and unfavorable by 70 basis points compared to the second quarter of fiscal 23. In the second quarter of fiscal 24, our consolidated adjusted operating margin was 4.2%, a decrease of 80 basis points compared to the second quarter of last year. Note that our adjusted operating margin now includes the impact of the interest rate swap adjustment mentioned previously. In the second half of fiscal 24, we plan to continue to effectively manage our expenses while executing on the margin initiatives that have been yielding results within our business segments and for the company overall. Our adjusted tax rate for the second quarter of fiscal 24 was 25.1%, an increase of 90 basis points compared to the prior year period. Reported net income attributable to Patterson Companies Inc. for the second quarter of fiscal 24 was $40.0 million, or 42 cents per diluted share. This compares to reported net income in the second quarter of last year of $54.1 million, or $0.55 per diluted share. Adjusted net income attributable to Patterson Companies Inc. in the second quarter of fiscal 24 was $47.3 million, or $0.50 per diluted share. This compares to $61.2 million, or $0.63 per diluted share, in the second quarter of fiscal 23. This decrease in adjusted earnings per diluted share for the fiscal second quarter was primarily due to lower sales of dental tie technology equipment and increased operating expenses compared to the prior year period. Now let's turn to our business segments, starting with the dental business. In the second quarter of fiscal 24, internal sales for our dental business decreased 0.2% compared to the second quarter of fiscal 23. Internal sales of dental consumables in the fiscal second quarter increased 2.9% compared to one year ago, despite being impacted by continued price deflation of certain infection control products. Internal sales of non-infection control products increased 4.7% in the second quarter of fiscal 24 compared to the year-ago period. This negative impact from infection control product deflation has steadily moderated over the past year, and we expect the year-over-year deflationary effect to continue moderating and fully normalized at the end of fiscal year 24. In the second quarter of fiscal 24, internal sales of dental equipment decreased 6.3% compared to one year ago. This quarter, core equipment posted positive growth that was more than offset by a decline in the digital X-ray and CAD-CAM product categories compared to the prior year period. We believe the year-over-year decline in these two categories was the result of macroeconomic concerns on some equipment purchasing decisions as well as selling price declines within the imaging categories. Internal sales of value-added services in the second quarter of fiscal 24 increased 3.1% over the prior year period, led by the continued growth of our software business and increased year-over-year contribution from our technical service team. Value-added services, including our software offerings, represent the entire suite of offerings we provide to our customers that help make us an indispensable partner to their practice. And these valuable offerings are also mixed favorable to our P&O. The adjusted operating margin in dental was 9.4% in the second quarter of fiscal 24, which represents an 80 basis point decrease over the prior year period. While gross margins in the dental business for the second quarter of fiscal 24 improved year over year, increased operating expenses related to our SIP implementation and warehouse expansion in Canada, along with investments in our software and technical service business, through the unfavorability and adjusted operating margin on a year-over-year basis. Now let's move to our animal health segment. In the second quarter of fiscal 24, internal sales for our animal health business increased 0.2% compared to the second quarter of fiscal 23. Internal sales for our companion animal business in the second quarter of fiscal 24 decreased 3.6% over the prior year period. Strong sales performance from our NDS business in the UK was more than offset by declines in the U.S. companion animal business. Internal sales for our production animal business in the fiscal second quarter increased 4.1% in the quarter compared to the prior year period. Our production animal team continues to execute well in the market, and our omni-channel approach across several species continues to pay off with sales growth above the overall market. The adjusted operating margin in our animal health segment was 3.6% in the fiscal 24 second quarter, a decrease of 20 basis points from the prior year period. Gross margins in our animal health segment were up in the fiscal 24 second quarter, and an increased operating expenses on a year-over-year basis drove the operating margin decrease compared to the second quarter of fiscal 23. Now let me cover cash flow and balance sheet items. During the first six months of fiscal 24, our free cash flow improved by $28.0 million compared to the same period one year ago. This is primarily due to a decreased level of working capital in the first six months of fiscal 24 compared to the year ago period. Turning now to capital allocation. Our capital spending in the first six months of fiscal 24 was $33.5 million and $6.7 million higher than the first six months of fiscal 23. This increased spending reflects the investments we are making in our distribution capabilities as well as 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 quarter of fiscal 24. We also repurchased approximately $61 million of shares during the second quarter of fiscal 24, thereby returning a total of $85.9 million to shareholders through dividends and share repurchases. Let me conclude with our outlook for the remainder of Fiscal 24. Today we are revising our Fiscal 24 GAAP earnings guidance to a range of $2.04 to $2.14 per diluted share, and our adjusted earnings guidance range to $2.35 to $2.45 per diluted share. We've made these revisions to our GAAP and adjusted earnings per share guidance to account for the macroeconomic environment and uncertainty that we believe will persist for the remainder of our fiscal 24 year. Now I return the call back over to Don for some additional comments.