Patterson Companies - Q2 2022
November 30, 2021
Transcript
Speaker 0
Good morning. My name is Brent, and I will be your conference operator today. At this time, I would like to welcome everyone to The Patterson Companies Fiscal Year 2022 Second Quarter Earnings Call. Call, all lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question and answer Thank you.
It is now my pleasure to turn the call over to Mr. John Wright, Vice President of Investor Relations. Please go ahead.
Speaker 1
Thank you, operator. Good morning, everyone, and thank you for participating in Patterson Companies' fiscal 2022 Second Quarter Conference Call. Joining me today are Patterson President and Chief Executive Officer, Mark Walchirk time, we will be conducting a question and answer session. After a review of the fiscal 2022 Q2 results and outlook by management,
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conference call, we will open the call to your questions.
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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, conference call, we encourage you to review this material. In addition, comments about the markets we serve, including growth rates and market shares
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conference call, our press release are based upon the company's internal
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analysis and estimates. The content of this conference call contains time sensitive information This is accurate only as of the date of the live broadcast, December 1, 2021. Patterson undertakes no obligation to revise or update any forward looking Statements to reflect events or circumstances after the date of this call. Also, a financial slide presentation can be found conference call, we will reference our adjusted results time, we will be conducting a reconciliation of our financial results
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for the Q2 of
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fiscal 2022. The reconciliation table in our press release is provided to adjusted reported GAAP measures, conference call, namely operating income, other income expense net, income before taxes, income tax expense, net income, call, net income attributable to Patterson Companies, Inc. And diluted earnings per share attributable to Patterson Companies, Inc. 4, the impact of gains on investments, time, we will be conducting a few questions. We will be conducting a few questions on the call.
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We will be conducting a few questions
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We will also discuss free cash flow as defined in our earnings release, which is a non GAAP measure,
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time, I will now turn the call over
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to Mr. President and CEO, and I will now turn the call over to Mr. President and CEO, and I will now turn the
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call over to Mr. President and CEO,
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and I will now turn the call over to Mr. President and CEO, and I will now turn the call over to Mr. President and CEO, time, we will be conducting a few more questions on our call to call today's call. We will now begin the call to 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 11 am Central Time for a period of 1 week.
Now, I'd like to hand the call over to Mark Walchirk.
Speaker 3
Thank you, John, and welcome, everyone, to Patterson's fiscal 2022 Q2 conference call. Time, first off, I hope you and your families all had a very happy and safe Thanksgiving holiday. Patterson delivered another strong performance in the Q2 of fiscal 2022,
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call, which ended on October 30, 2021.
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Our top and bottom line results demonstrate that our value proposition continues to resonate time, we are very pleased with our customers and business partners and that our Patterson team continues to show up every day with great passion and focus to deliver on our promise of trusted expertise and Patterson is there to help our customers face business and market challenges, which have certainly become more acute since early 2020. The environment has magnified the importance of Patterson's ability to support our customers with our comprehensive product, technology, software and service offerings. That value proposition, combined with our world class Patterson team, has been the formula for our success. Time, it's reflected in the trust our customers place in us as well as our continued business momentum and strong financial performance. I want to thank our entire Patterson team of more than 7,500 across the organization for their commitment to living our purpose, vision and values every day So with that as our backdrop, time, let me start with some of the highlights of our fiscal 2022 Q2.
First, on a year over year basis, internal sales grew 8%. Time, while internal sales in our Dental segment decreased 2% year over year, our Dental sales exceeded our internal expectations for the quarter time, we posted a 10% increase compared to the pre pandemic period of 2 years ago. Internal sales in our Animal Health segment increased 16% year over year time, we're up 24% compared to the pre pandemic period 2 years ago. Through the 1st 6 months of fiscal 2022, our free cash flow time, we delivered adjusted earnings of $0.58 per diluted share. And finally, given our momentum and confidence in the business, we are raising our adjusted EPS guidance range for fiscal 'twenty two time, we will be conducting a few questions to our shareholders.
With that overview, I'll now dive a bit deeper into the performance drivers in each of our segments during the Q2, starting with Dental. Across our Dental segment, our field sales, service and port, teams continue to deliver value for our customers and business partners and drive strong operational excellence. Now before we get into the specifics, I want to provide some additional context around our results this quarter. The year ago period, the Q2 of fiscal 2021, conference call, we will cover the months of August, September October of calendar 2020. As you may recall, during this time period a year ago, time, the dental market experienced an accelerated recovery as patients gained comfort with the new safety protocols and were returning to the dentist time, even faster than the industry anticipated.
As a result of the rapidly improving market from a year ago, coupled with the great execution by our team, time, Patterson delivered internal sales growth of 12% in the Q2 of fiscal 2021, including strong performance in our consumables category, Given these dynamics in the year ago period, time, we believe it's helpful to refer to some 2 year comparisons back to the pre pandemic period of the Q2 of fiscal 'twenty time,
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we will be conducting a
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brief overview of our Q2
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fiscal 2020 consumables were down less than 1% compared to the prior year, yet increased 17% compared to the pre pandemic period of the Q2 of fiscal 2020. As expected, sales of infection control products declined 13% compared to the prior year as we lapped a period of unprecedented demand in this category time, we have also seen prices moderate considerably compared to 1 year ago. We plan for this impact when forecasting fiscal 2022 As we anticipated, unit volumes and pricing of infection control products to normalize over the course of our fiscal year. However, we believe that sales of infection control products will remain at elevated levels from the pre pandemic timeframe, And we expect steady demand for these products to continue over the long term. Importantly, internal sales of non infection control consumables products time, we increased 3% year over year and sales of non infection control products increased 9% compared to the pre pandemic period of 2 years ago.
Time, we drove increased demand for our private label portfolio of products. We continue adding new products to expand our private label offering, And our sales team is highly engaged and motivated to drive sales growth in this more profitable category. We continue to perform well in our overall consumables category and consumables category, I believe we are growing faster than the market in the product categories in which we compete. On the equipment side, internal sales declined 3% during the quarter of fiscal 2021 compared to the Q2 of last year, but increased 2% when compared to the pre pandemic period of 2 years ago. As a reminder, our equipment performance can vary from quarter to quarter, particularly following or comparing to quarters where Patterson has successfully promoted During the Q2, we attended the DS World program in person, where our team was highly engaged with our customers conference call, we will be conducting a few questions and once again delivered excellent performance.
While a portion of the sales generated at this event were installed in our fiscal 2nd quarter, time, we expect the majority will be recorded in the remainder of this fiscal year. For over 20 years, our teams have worked to help build chairside dentistry category in North America, and we believe our knowledge base, sales experience, support and service time, we have established Patterson as the clear partner of choice for customers who choose to invest in this digital technology. More broadly, time, our dental team does an outstanding job of selling, installing and servicing the latest digital technology for our customers throughout the year as we work with all of our manufacturer partners time, we expect to launch their innovative new technologies. Across the entire equipment market, we believe there is strong demand for new innovation To drive further improvements in productivity and oral healthcare that our dental customers are seeking to offer their patients. And given our large installed base, time, combined with unparalleled customer service and support infrastructure, we believe Patterson is best positioned to execute the continued digitization of dentistry that is taking place.
We are pleased with our equipment results in the quarter, particularly compared to the strong quarter 1 year The demand for core equipment remains strong, and we expect the delays we are currently seeing on product deliveries time, we'll build our backlog and be reflected in our sales volumes over the next several quarters. As we look ahead at the dental market overall, We believe patient traffic has generally returned to pre pandemic levels. We expect dentists will continue investing in the latest equipment, technologies and practice management software time, we are pleased to build and modernize their practices, and we believe the market will return to stable long term growth. These trends time, the momentum in our Dental business give us confidence we can continue capitalizing on these market opportunities. Turning now to our Animal Health segment.
Our Animal Health team continued their positive momentum and delivered a very strong second quarter, achieving fiscal 20222nd quarter internal sales growth of 16% time, we expect year over year and 24% growth compared to the Q2 of fiscal 2020. The overall segment performance was led by internal sales growth in our fiscal 'twenty two to Q2 of 21% year over year in our Companion Animal business and 11% year over year internal sales growth in our Production Animal business. Time, our Animal Health segment also delivered operating margin improvement in the quarter by working closely with our strategic vendor partners, growing equipment sales, time, we are exercising strong expense discipline and also expanding our private label portfolio. In fact, during the fiscal Q2, our own private label brands of Pivotal in the companion space and Aspen in the production market, both continued to perform well within each of their markets. Within our companion animal business, we continue to benefit from the market tailwinds of increased pet adoptions during the pandemic time, we are pleased to report that we are in a position to be able
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to provide value to our
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customers and our customers. We are pleased to announce that we are product and technology offerings, combined with our team's expertise, service, training and support, continues to differentiate Patterson and propel our growth. Time, we believe our results demonstrate that our growth rates are outpacing the market. As we've highlighted previously, the significant growth in demand for pet care has been a strong tailwind for our veterinarian customers over the past 18 months or so, but has also created some challenges. Not only are independent veterinarians responsible for responding to the increased demand from pet owners, they also face challenges in running their own small businesses, time, we have only been amplified by the recent pandemic.
As an indispensable partner, Patterson provides all of the products, time, we have several new services, equipment, training and software tools that vets need to do both aspects of their jobs and meet the needs of their growing customer base. Time, our companion animal customers use our Vet Hero offering to establish a constant connection throughout a pet owner's journey, To offer online appointment booking, to send text reminders in advance of an upcoming appointment, to provide convenient bill pay options and to solicit feedback with reviews. And our commercial relationship with Vetsource allows the veterinarian to offer convenient home delivery of prescriptions and treatment products time, we also provide helpful tools for the veterinarian to run their practice more productively. Our MarketHow forum, enables veterinary practices to access all of their technology solutions in one place for an integrated streamlined experience. Our VetSuccess offering enables a veterinarian to automatically collect data and produce reports for key metrics within their practice.
This management tool works across a number of practice management platforms to compare performance metrics between offices, provide the vet clinic with easy to read reports It helps identify opportunities to improve productivity, profitability and the overall customer experience. Ultimately, our broad range of technology offerings time, e services help our busy companion animal customers save time, operate more efficiently and maintain healthy client relationships So they can focus on delivering the best possible care to the pets. Looking ahead, while the companion animal market growth rate is time, we believe that the increased attention and spending on pets, higher number of clinic visits by pet owners And additional new clinic openings will all serve as growth drivers in the companion animal market going forward. Our focus will remain on supporting The technology and services they need to manage and grow their practices. On the production animal side, as the market continued its recovery in the 2nd quarter, Our production animal team delivered outstanding results.
The challenges that producers faced with processing plant shutdowns during the pandemic And through the demand variability of the market's prolonged recovery have heightened Patterson's ability to be a trusted indispensable partner in such a dynamic environment. In the same way we serve our veterinarians in the companion animal market, Patterson brings the depth and breadth of services and capabilities time, we will be conducting a number of
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key strategic initiatives to producers that span products, equipment, technology,
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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 time, we continue to evolve our go to market strategy in the production animal market time, we are pleased to meet the
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dynamic needs of each specific customer.
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Some customers have a large operation with an on-site veterinarian, time, we partner closely with this veterinarian on their specific treatment plans and delivery solutions to serve their operation. With other customers, we work more closely with the owner operator time, we are pleased to report that we
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are in a position to improve our business as they not only care for their
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animals, but depend on Patterson for operations and accounting software to more profitably manage their business. And finally, we stock retail locations with products where customers can purchase products at their convenience. This omnichannel presence in the production animal market demonstrates our team's true customer focus by ensuring we are serving our customers in the manner they prefer with a broad set of capabilities to meet and exceed their expectations. As we look ahead to the remainder of fiscal 2022, the production market is expected to steadily improve.
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Time, we
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are currently exports across all our production categories, cattle, swine and dairy are running above the 5 year average, reflecting improving global trade. In the swine market, herd sizes have continued to replenish and grow and global demand remains strong. And finally, restaurants and schools have continued to drive demand time, we will maintain our focus on supporting our producer customers as they navigate a dynamic market and help them drive growth in their business. As I mentioned at the start of my comments, we are very pleased with the results of our second quarter and through the first half of fiscal 'twenty two time, we are proud of our progress across both our segments and all three of our end markets and proud of the continued focus and dedication of our entire Patterson team. And with that, I'll now turn the call over to Don to share more details about our fiscal 2022 Q2 performance.
Don?
Speaker 4
Thank you, Mark, and good morning, everyone. In my prepared remarks this morning, I will cover the financial results time, we will be conducting a few questions. Thank you, sir. Our first question comes
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from the line of
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point, we are pleased to report that our business is performing relative to the pre pandemic period time, we will be conducting a few questions on the call for questions. I will now turn the call over to the operator for questions. Thank you, Brent.
Speaker 2
Thank you, Brent. Thank you, Brent. Thank you, Brent. Thank you, Brent.
Speaker 4
Good morning, everyone. Good morning, everyone. Good morning, everyone. Good morning, everyone. Good morning, everyone.
Good morning, everyone. Good morning, everyone. Good morning, everyone. Good morning, everyone. Let's begin by covering the results for our Q2 of fiscal 2022.
Consolidated reported sales for Patterson Companies conference call, our fiscal 2022 Q2 were $1,650,000,000 an increase of 6.2% versus the Q2 1 year ago. Internal sales for our fiscal 2022 Q2 increased 8.3% 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 Q2 of fiscal 2020, internal sales for our fiscal 2022 Q2 increased 18.1%. We believe this improved financial performance in the Q2 of fiscal 2022 is the result of continued momentum and solid sales execution in both of our business segments.
Our Q2 fiscal 2022 adjusted gross margin was 9%. On a year to date basis, through the first half of the year, time, our operating margin is 4.0 percent, down 60 basis points compared to the first half of last year. We expect operating margin expansion in the back half of the year, particularly in the Q4 that will drive margin expansion in both of our business segments quarter, the Q2 of fiscal 2022 was 25.0 percent compared to 23.7% in the same period 1 year ago, time, representing an increase of 130 basis points and a $0.01 headwind compared to the prior year period. Reported net income attributable to Patterson Companies Inc. For the Q2 of fiscal 2022 was 48,300,000 This compares to reported net income in the Q2 of last year of $54,100,000 time, we are pleased to report that we are making progress on our financial results or $0.56 per diluted share.
Adjusted net income attributable to Patterson Companies Inc. In the Q2 of fiscal time, 2022 was $57,100,000 or $0.58 per diluted share. As a reminder, adjusted net income excludes deal amortization and This compares to $61,100,000 or $0.63 per share in the Q2 of fiscal 2021. Now let's turn to our business segments, starting with our dental business. In the Q2 of fiscal 2022, internal sales for our dental business decreased 2.0% compared to the Q2 of fiscal 2021.
As we planned out our fiscal 2022 year, we knew the fiscal second quarter would be a difficult comparison relative to the dental market recovery last year We grew our dental business by 12%. Additionally, we also plan for pricing on certain infection control products to decline on a year over year basis. For some additional context on our dental performance, it is helpful to look back 2 years ago to a comparable period before the impact of the global pandemic. On that basis, dental internal sales for the Q2 of fiscal 2022 are up 9.8% compared to the Q2 of fiscal 2020. Internal sales of dental consumables declined 0.8% in the 2nd quarter compared to 1 year ago.
As we have discussed, The consumables category is undergoing a transition in the current environment as pricing on certain infection control products is considerably lower compared to the prior year. In our fiscal 2022 Q2, sales of our infection control products decreased by 13% year over year. When excluding the sales impact from infection control products, our consumables sales grew 3% year over year. Let's also take a look at our dental consumables performance compared to the pre pandemic period of the Q2 of fiscal 2020. On that basis, internal sales of dental consumables in the Q2 of fiscal 2022 have increased 16.7% time, we expect to be able to continue
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to be in the Q2 of fiscal 2020. And if
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you exclude the impact of infection control products, our non interest rate is 9% Internal sales of dental equipment and software decreased 3.0% compared to 1 year ago. Time, our performance in the equipment category in the quarter was impacted by the known supply chain challenges in the core equipment category. However, sales of CADCAM products increased double digits in the Q2 of fiscal 2022. As we have noted previously, the equipment category growth can vary by quarter, and it is worth noting that our average quarterly year over year growth for our equipment business over the past 8 quarters is 7%. This notable performance is directly related to the work our dental team has done to establish Patterson as the partner of choice for equipment and technology for dental customers.
Adjusted operating margins in dental were 9.4% in the fiscal Q2 and down from the Q2 of last year time, we had a number of temporary spending reductions related to COVID-nineteen. Again, we remain committed to driving operating margin improvement time, we are pleased to report that we are in
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our dental business for fiscal 2022. Now let's move on
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to our Animal Health segment. In In the Q2 of fiscal 2022, internal sales for Animal Health Business increased 16.2% compared to the Q2 of fiscal 2021. Internal sales for our Companion Animal business increased 20.8% compared to the Q2 of last year, time, the internal sales in our production animal business grew 11.3% in the 2nd quarter compared to the prior year. Time, for some additional context on this performance, we'll look back 2 years ago to the comparable period before the impact of the global pandemic. Animal Health internal sales for the Q2 of fiscal 2022 increased 24.3% compared to the Q2 of fiscal 2020.
Time, internal sales for our Companion Animal business in the Q2 of fiscal 2022 increased 35.1% Over the fiscal Q2 of 2020 and for our Production Animal business, 2nd quarter fiscal 2022 internal sales increased 13.6% time, we
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will be conducting
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a call over the Q2
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of fiscal 2020. Our Animal Health sales performance has been strong through the impact of the global pandemic, And these results demonstrate the high level of commitment and execution of our entire Animal Health team as they serve our Animal Health customers. Adjusted operating margins in our Animal Health segment were 3.4% in the fiscal 2nd quarter, an increase of 50 basis points from the prior year. Time, 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 time, production animal customers and our team focused on expense discipline and also delivered improved product mix with stronger sales of product, time, we will be conducting a few minutes to discuss
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our financial results. Moving on
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to free cash flow and capital allocation. Through the 1st 6 months of fiscal 2022, our free cash flow is $31,300,000 an increase of $59,600,000 Please note that our free cash flow for the Q2 of fiscal 2022 included the $36,000,000 payment point $2.6 per diluted share and returned $25,300,000 to our shareholders. Through the 1st 6 months of fiscal 22, we have paid out $50,400,000 in dividends. Our Board continues to view our dividend as an important component of our capital allocation strategy Let me conclude with some comments on our outlook for fiscal 2022. Today, we are updating our GAAP earnings guidance from our prior guidance range of $1.64 to $1.74 per diluted share time, we are updating our adjusted earnings guidance from our prior guidance range of $1.95 to 2.05 dollars per diluted share to an adjusted earnings guidance range time, we are pleased with our performance to date and the continued momentum and trends we are seeing in our business and our respective end markets.
For modeling purposes, Given the comparisons to the prior year, you can assume that our EPS in the remaining two quarters of fiscal 2022 year will be more heavily weighted to the Q4. Let me also add that our guidance assumes North American and international market conditions remain consistent with current market conditions And that there are no material adverse developments associated with the pandemic. And now I will turn the call back over to Mark for some additional comments.
Speaker 3
Thanks, Don. As we look ahead to the second half of our fiscal year and beyond, I wanted to highlight several key points call, we will now begin to give us confidence about our strengthening position in each of our end markets and in Patterson's long term value creation potential. First, we have the right strategy in place to capitalize on positive end market fundamentals with the ability to day nimble and manage through potential changes in market dynamics should they occur. 2nd, we have the right set of comprehensive products, services and technology time, we have over 7,500 passionate, dedicated and focused team members who wake up every day energized to deliver on our promise of trusted expertise time, we are pleased to report that we are in the position of our shareholders and our capital allocation strategy remains focused on returning cash to shareholders through our attractive dividend time, we will be conducting a few questions on our financial results and identifying strategic investments that will help accelerate our performance and create enhanced returns for our shareholders. That concludes our prepared remarks.
And now Don and I will be glad to take your questions. Operator, please open the line.
Speaker 0
We'll pause for just a moment to compile our Q and A roster. Your first question comes from Nathan Rich with Goldman Sachs. Your line is open.
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Hi, good morning. Thanks for the questions. Mark, maybe starting with the Companion Animal business, I think it accelerated even on a 2 year basis and I know you had kind of pointed to maybe trends moderated as you face tougher comparisons. But just curious kind of what's driving the strength that you're currently seeing in any kind of specific product categories that you would highlight there?
Speaker 3
Yes, Nathan, thanks. We're really pleased with the performance of our Companion Animal business. The team is doing a great job. And as you noted, we've continued to see, I think, multiple quarters here, a very strong growth. And As we indicated, really, I think a couple of key reasons.
First, obviously, the strong market tailwinds that we're taking full advantage of, more pets in the system, More pet parents like myself are paying more attention to our pets, going to veterinarian clinics more often. And we're also seeing a higher spend per visit. So you have those really positive, I think, macro trends that are taking place. And then you couple that with, Yes, I just think the great work and execution of our team, really being there from the start of the pandemic, helping our customers manage through some challenging periods, really supporting them with products, with technology, with services, with education to help our companion animal customers Deal with the dynamics going on in the market and really help them manage their practices in a very productive manner. So I think the combination of those two factors has really been time, some of the fuel behind our strong performance in this area, and we think the team is well positioned to continue to grow.
Like we said, we don't expect these levels of growth going on continually. We do think, obviously, the growth rates will moderate. But certainly, we're really pleased with our performance here and the fact that we believe our growth is definitely outpacing the market growth at this point.
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Great. Thanks. And if I can maybe jump over to Dental. Don, I think you highlighted the 2 year growth in Dental of about 10
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How should we
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think about that as we think about 3Q trends? I think if that kind of 10% 2 year growth held that would imply revenues of around $690,000,000 for the segment. Is that in the right ballpark? I know there's maybe some Moving pieces on the equipment side, so we'd just be curious to get your thoughts on kind of cadence for the segment in 3Q.
Speaker 4
Yes. Obviously, Nathan, we're having we don't normally give guidance like that. But I would say that time, maybe thinking about the way you just kind of characterize that is probably relatively in the ballpark.
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Okay. Fair enough. Thank you.
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Your next question comes from the line of Michael Ernie with Bank of America, your line is open.
Speaker 6
Good morning and congratulations on the strong quarter. I want to dive a little bit into the operational side. Clearly, you're dealing with a lot of macro uncertainties, positives and negatives. As you think about your ability to essentially flex spending this flex cost, how much does that go into the typical cadence of the quarter? And especially with the potential pending uncertainty of the omicron variant, what will that mean in terms of how you think forward
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time, I'd say, first of all, Michael, thank you. I'd say, I'll make a comment or 2 this, Mark, and Don can chime in as well. I think as we've indicated, we are seeing some pressure on the cost front, in particular, in the areas of transportation and labor, I think we've referenced that now for a couple of the last quarters. Our team is really doing a great job mitigating those cost pressures and really as we see our top line continue to grow, we're getting good leverage around our expense base there. In terms of Omicron, I think, look, it's certainly too early to determine what impact, if any, time, the new variant will have on end market demand.
Let's be to be clear at this point, we certainly don't anticipate time, it will result in any type of broad industry shutdown that we experienced early last year. And I'd certainly also note that we're in a much better position as an industry And I think society as a whole that we to be prepared for these pandemic changes as they go forward. But the reality is no one really knows what the future will hold regarding the pandemic, and we're going to continue to monitor it closely. But certainly, we don't see We don't anticipate a significant impact from an end market demand standpoint.
Speaker 4
Yes. I would just add that the cost Pressures are really baked into the guidance and the thoughts that we've outlined today. I think in terms of the variant, to Mark's point, we don't expect a significant impact, but our guidance really isn't based on point in the past, I think that would change
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the dynamics.
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Got it. And I guess, When you think about the dental business as a whole and coming out of the New York Dental Show and with conferences slowly but surely starting back up, time, how do you think about any changes that you'd expect to see relative to the broader sales cycle? Now that we're almost 2 years into COVID, have time, your customers taking a different approach in terms of how they want to buy? Do they need that consultative approach that they had historically going forward? And how do you think that factors into
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Well, I think that consultative approach, Michael, is frankly now more important than ever. And I think we really proved that, our team really through the course of the pandemic, obviously, the dental industry facing an unprecedented challenge As a result of the pandemic, and I think that consultative approach that our field teams, field sales and service and support teams time, we believe the industry is generally back pre pandemic levels, really across the board, again, to the point earlier, if there are changes to the pandemic, That could affect that, but we're not anticipating that at this point. Our customers are continuing to show a lot of confidence in their practices. They're investing in equipment and technology. We talked a little bit about some of the supply chain challenges that we're seeing on the core equipment side.
Well, one of the key elements of that is just the strong demand That our customers are driving, again, due to, I think, the confidence in their practices and the confidence in the long term growth prospects for the industry. So I really think back to the my early comments that, that consultative approach is more important than ever. I think our customers appreciate point, we have a very comprehensive set of product buys, and I think that's a key element to our success, both the momentum that we've been building and going forward.
Speaker 7
Thank you.
Speaker 3
Thank you.
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Your next question comes from the line of Jeff Johnson with Baird, your line is open.
Speaker 8
Thank you. Good morning, guys.
Speaker 1
Can you hear me okay?
Speaker 3
Yes. Yes. Yes. Hey, Jeff.
Speaker 7
All right.
Speaker 8
Hey, guys. How are you? So Mark, you've made some changes here in Dental Leadership. Eric is taking on more of a strategic role. I think you've been pretty point, we are on some recent calls, you may be increasing your focus on potential M and A.
2 things I'd like to understand on that. 1, with where cash flow dynamics have been, What capacity would you have right now? Just kind of put us in the ballpark just so we could think about that. And then I think more importantly, strategically, Are you thinking about scale in your current verticals? Could you vertically integrate from a manufacturing perspective?
Is there a potential third leg to the school? Again, I don't expect you to name your targets, but just kind of how are you thinking conceptually about where that M and A could go? Sorry. Thanks.
Speaker 3
Yes, Jeff, thank you. And Don can talk to the capacity question here in a second. Let me maybe cover the broader topic here. And certainly, we continue to focus on opportunities to accelerate our growth and profitability through accretive M and A. And You mentioned some of the leadership changes we've made.
I'm really pleased with the work the team has been doing over the past 6 to 9 months to identify potential opportunities and really to rebuild that muscle at Prior to our recent acquisition of Miller Vet, it had been a number of years since Patterson had done any type of significant M and A, so we have the opportunity to put our balance sheet to work. We intend to do so, but really only if the opportunities meet Our strategic rationale meet our financial hurdles and really that we find opportunities that would be a good fit culturally within Patterson. And again, really, the intent here is to drive greater value for our customers, strengthen our value proposition, Build and expand our presence in margin accretive product and service areas, potential to build scale in the core business. So this process takes some time and continues to be a key focus for our executive team. And we'll certainly be very selective about Some of these types of investments looking forward, and it's a key focus for us.
Speaker 4
Yes. And Jeff, in terms of capacity, I think for the right transaction In the right circumstances, we'd certainly be willing north of 4, between 4 and 5 times temporarily. Given our cash flow dynamics, I think we would be comfortable with that and comfortable with the ability to pay that down relatively quickly, so we have quite a bit of capacity. I think that shouldn't be a constraint in terms of the things that Mark just outlined.
Speaker 8
Yes. Post the rehab divest in the AHI deal, you were kind of sitting around 4%, today you slipped below 20% this past quarter. OpEx control has obviously been very strong here and more than offset that. Time, I guess, when do we how do we think about titrating that? 1, do gross margins mainly for mix or are there other issues there?
Does that continue to trend lower? And when does OpEx start to rise back up as you maybe attend some of these meetings, do more training, things like that? Just kind of help time, how to think about maybe the interplay between gross margin and OpEx spend over the next 4 to 6 to 8 quarters? Thanks.
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Yes. Well, I
Speaker 4
think the gross margin issue is really a segment mix issue entirely. I think I had to outline Shin that in the Dental business, our gross margin in the quarter was flat quarter over quarter and in the Animal Health segment was up time, we're really just experiencing the segment mix impact. We expect that to be a bit of a headwind we continue to battle, but time, we also think that we have good opportunity on the expense side. I think you saw in the quarter 15.3 percent of our We expect that to go up slightly as things kind of come back online in certain ways. But I think overall, time, we think we have the expense controls to really keep mitigating that margin, the gross margin impact.
Speaker 8
Got it. Thanks guys. I appreciate the
Speaker 7
color. Thanks Jeff.
Speaker 0
Your next, Schindler. Your line is open.
Speaker 9
Hey guys, thanks for taking
Speaker 7
the questions. Congrats on the nice quarter here. Mark, I wanted to start asking on some of the pricing dynamics out there, a bit of a time, we've some price increases are already been pushed through as we've all seen, but many manufacturers take these price increases at the turn of the year, we're just a month out from flipping to 'twenty two. So it would be just great if you could talk about what you're hearing from your dental and animal health manufacturing partners with respect to planned price increases going forward, how much higher than normal are these price increases? And have you experienced any pushback from your definition?
Certainly, we are time, as you noted, some higher levels of cost inflation from some of our manufacturers,
Speaker 3
some so far in the kind of calendar Q4 And certainly as we move into 2022, really across both business segments, we typically see average cost increases in the 2% to 3% range, and we are seeing Some of those manufacturer cost increases moderately dental than in the Animal Health segment, but we are seeing some increased levels in the Animal Health segment as well. Our pricing our customer pricing methodology is built to really help ensure that these market pricing methodology is in place. Time, I will say, at the same time, we're working closely with our manufacturers to really work to mitigate the impact of these inflationary trends and to try to point, the joint approach from both manufacturers and us to try to minimize the ultimate impact to the customer. So certainly, something that we continue to watch closely. Time, our teams are working our pricing methodology is really built to help ensure that these cost increases do get passed on to the market.
Speaker 7
Great. That's helpful. Thanks, Mark. And then on the next question, I know we don't have gross margin guidance, but I guess following up a bit on Jeff's question, is there anything we should have in mind that would shift these segment gross margins higher or lower when we think forward over the quarter, as we start thinking about fiscal 'twenty three as well?
Speaker 3
No. I think the way that we've
Speaker 4
kind of the cadence of margin here So far this year is really as we expected. I don't have anything specific I'd highlight for you as a significant or one time type
Speaker 3
Yes, the only thing that I would add is just a continued focus across both of our businesses really to try to drive and improve our mix. So whether that's through private label products, software and technology, equipment, for example, in particular in the animal health space, Those would be some key elements to helping to improve our mix and really selling and further penetrating our time, improving customer revenue numbers with some of our higher margin products. So that's a key focus for us as well.
Speaker 7
All right. Thanks so much guys. Congrats again. Thank you. Thank you.
Speaker 0
Your next question comes from the line of Jon Block with Stifel, your line is open.
Speaker 9
Thanks, guys. Good morning. Mark, maybe I'll just start with consolidation. There's ongoing talk of rate of dental consolidation coming out of the pandemic among the DSOs, are you seeing that has it occurred In Companion Animal as well, maybe just talk to what that does or doesn't mean for Patterson based on your positioning within those corporate accounts? And then I've got a follow-up.
Speaker 3
Okay. Sure. Yes, John, thanks. First of all, in the dental space, the DSO segment has been growing time, we're rapidly here for the last several years, and we're certainly seeing that continue. I think as we've shared, we've made significant investments over the last several years time, we'll build out our team and our capabilities to support the DSO and really the regional DSO or our DSO segment as well.
And time, we're pleased with the continued focus of our team there and frankly, the business performance that we're seeing. And Obviously, that's going to be an important growth vehicle for us going forward. And I think also we've mentioned, We're really focused on working with those groups and those customers, both at the regional and national level, that really see the value proposition that Patterson can to their operation and making sure that we're partnering with the right DSOs and our DSOs, where we can jointly certainly benefit from that. So definitely a focus from us. We're not seeing necessarily an acceleration, to your question.
But I think the growth of the companion animal segment, in particular, we are seeing some strong growth there. Like we have in dental, we built out our strategic accounts team in the companion animal segment. We are time, winning in that space, we're showing up more frequently maybe than we had in the past. And we certainly think that we know that that's an element that's helping to fuel time, some of our growth in the companion segment as well. So very important portions of the business in both dental and time, we're certainly focused on continuing to grow there and making sure we grow with the right customers.
Speaker 7
Got it.
Speaker 9
Very helpful. And Don, I'm going to push you on gross margins a little bit. A lot of helpful color on the GMs down 80 bps year over year, The financing, I get it. But last quarter, you thought it was going to be up gross margin throughout the balance of the year, the remainder of the year was down And I don't think it's all mixed because you said actually Dental was better than your internal goals for fiscal 2Q. Getting away from year over year and leaning on mix, if we just isolate last quarter, you thought it was going to be up.
What happened, call it, sequentially, if that makes sense, that occurred that made gross margins to decline 60 bps Q over Q. Were there any time, are there other pressure points to call out other than mix? Thanks.
Speaker 4
Well, it was down as I mentioned in the script, it was down 80 basis points point, we're going
Speaker 7
to be looking at the numbers
Speaker 3
and 60 basis points of
Speaker 4
that is just pure mix. I think that in that context, the Animal Health performance was better than we expected, better than our internal forecast. Dental was probably slightly lower in some areas. And so That had an impact. The other 20 basis points of the 80 basis points is really the effect of rising interest rates on our equipment financing portfolio, and we're required to mark that to market.
That goes into the margin as a negative. The However, it's fully hedged. And so below the line, you saw the offsetting impact of that. And there's really a zero impact on EPS, but we do get that cost in our gross margin that's then offset down below the That was a 20 basis point impact.
Speaker 2
Yes.
Speaker 7
Okay. I think I got all that.
Speaker 9
Fair enough. I'll follow-up offline. Thanks guys.
Speaker 3
Thanks John.
Speaker 0
Your next question comes from the line of John Kreger with William Blair. Your line is open.
Speaker 10
Hey guys. Don, I wanted to follow-up on your comment. I think a couple of times that growth would be a little bit more weighted towards the fiscal Q4. Can you just expand upon why that would be? I would think with the dental optimism that we might see a surge of equipment time,
Speaker 4
I think what we're talking about is really the more just the EPS impacts. And that's really less about sales and some more about the cadence of expenses and some of the timing of other elements of our Margin, I was really so I was talking about that in the context of guidance and how to model the back half on an EPS basis.
Speaker 10
Okay, great. Thank you. That's helpful. And maybe just as a follow-up to that, can you talk about supply chain issues causing any stock outs and delayed equipment, I think you said some core equipment categories have been challenged within dental. Can you talk about when that might improve?
And are you seeing that impacting any other categories?
Speaker 3
Yes, John, thanks. This is Mark. As we indicated in the prepared remarks, we are seeing extended lead times from our manufacturers, in particular, in the core equipment category, I think this is an industry issue that is widely known. And I think there's a number of factors that are impacting that, Certainly supply chain elements, but really very strong demand from our customers. So we're really pleased with the backlog that we have.
But as I indicated, we are experiencing longer lead times than normal in this category in particular, and that certainly affected our overall equipment results But again, the good news here is our customers are investing in their practices. We have a strong funnel. And we certainly believe this is a near term issue, and we work we're constantly working with our manufacturer time, we're going to continue to monitor our customers and to work with our customers to let them know the status of their orders. But we do anticipate this issue to continue over the next quarter or so and really, then moderate and really get back to normal, probably mid next early to mid next year.
Speaker 10
Great, thanks. And maybe Mark one last quick one. The 11% livestock growth was really impressive. Can you talk about is that just an easy comparison? Or is there something else going on that's allowing you to do so much better than what I'd consider to be a longer term market trend in the low single digits there?
Thanks.
Speaker 3
Yes, thanks. I mean, I think bottom line, we saw a time, really nice recovery in some of the market trends and again, coupled, I think, with the great execution and focus of our team in the Production Animal business. And I think really that's been a formula for success for us, not just in production, but really across the business overall. And so again, Our production animal team, they have been there every day with our customers in this space since the pandemic started and supporting our customers, Managing through some very challenging periods and now that demand for dairy and protein products is really Coming up and really driving some of those good tailwinds, again, our team is there to support our customers. And I think, again, our growth here It's outpacing the market.
So we did have a tougher comp than Q1. But we're really pleased With the results of our production animal business in Q2 and really through the first half, and the team is doing a great job in executing And taking care of our customers and really bringing the value that our customers expect.
Speaker 10
Great. Thank you.
Speaker 0
There are no further questions at this time. I will now turn the call over to Mr. Mark Walchirk for closing remarks.
Speaker 3
Well, great. Well, thanks, everyone. Really appreciate all your time today and your continued interest in Patterson. Wishing all of you and your families a very happy and healthy holiday, and look
Speaker 0
Ladies and gentlemen, thank you for your participation. This concludes today's conference call. You may now disconnect.