Patterson Companies - Q3 2023
March 2, 2023
Transcript
Speaker 0
Ladies and gentlemen, good morning. My name is Abby, and I will be your conference operator today. At this time, I would like to welcome everyone to the Patterson Companies Incorporated Third Quarter Fiscal 2023 Earnings Conference Call. Today's conference is being recorded and all lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question and answer session.
Star key followed by the number 1 on your telephone keypad. Thank you. And I will now turn the conference over to John Wright, Vice President of Investor Relations. You may begin.
Speaker 1
Thank you, operator. Good morning, everyone, and thank you for participating in Patterson Companies' fiscal 2023 Q3 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 the fiscal 2023 Q3 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 ks and our other filings with the Securities and Exchange Commission. We encourage you to review this material. In addition, Comments about the markets we serve, including growth rates and market shares, are based upon the company's internal analysis and estimates. The content of this conference call contains time sensitive information that is accurate only as of the date of the live broadcast, March 2, 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 Q3 of fiscal 2023. The reconciliation table in our press release is provided to adjust reported GAAP measures, namely operating income, loss, 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. 4, the impact of deal amortization, integration and business restructuring expenses, legal reserves, inventory donation charges and gains on investments along with the related tax effects of these items. We will also discuss free cash flow as defined in our earnings release, which is a non GAAP measure and use the term internal sales to represent net sales adjusted to exclude the impact of foreign currency, contributions from recent acquisitions and the extra week of selling results in the Q1 of fiscal 2022.
These non GAAP measures are not intended to be a substitute for our GAAP results. This call is being recorded and will be available for replay starting at 10 am Central Time for a period of 1 week. Now, I'd like to hand the call over to Don Zerbein.
Speaker 2
Thanks, John, and good morning, everyone. Thank you for joining us to discuss our Q3 fiscal 2023 results. We appreciate your interest in Patterson Companies. We had a very good Q3 reflecting the successful execution of our strategy to create value for both our customers and our shareholders. Overall, for our fiscal Q3, We delivered internal sales growth of 2% year over year as a modest decline in our Dental segment was more than offset by growth in our Animal Health segment.
We achieved adjusted operating margin expansion for the overall business and within both our Dental and Animal Health segments, demonstrating our ongoing strategic focus on operational excellence, improved mix and disciplined expense management. And ultimately, we generated adjusted earnings of $0.62 per diluted share, an increase of 13% over last year's Q3. As a result of our progress through the 1st three quarters and our expectations for the final months of our fiscal year, We remain on track to achieve the internal sales growth and adjusted operating margin expansion goals we outlined at the beginning of the year. And we narrowed our fiscal 2023 adjusted earnings guidance to $2.25 to $2.30 per diluted share. Our continued strong performance reflects the Resolute commitment to our proven strategy and its key areas of focus.
In the Q3, we continued to deepen the value proposition we offer our customers. This included completing 2 strategic acquisitions in the Animal Health segment that enhance our offerings, investing in a cutting edge highly sustainable warehouse facility in the U. K. To expand our presence in that region, Rolling out improvements to our dental customer loyalty program, Patterson Advantage and strengthening our supply chain through onshoring collaborations with our manufacturing partners. This ongoing work to deepen the value we provide dental and animal health customers differentiates Patterson and makes us an indispensable partner, not just a distributor.
We also made progress enhancing our margin performance with a focus on operational excellence, improved mix and thoughtful planning with our strategic manufacturer partners. This is evident in our operating margin expansion within each of our two segments in enterprise wide. And finally, we remain committed to managing the organization with a keen focus on cost discipline. We continue to focus on running a rigorous process for this discipline and return on our investments. Before I move on to a more detailed discussion of our segment performance, I want to highlight 2 important leadership appointments we made in the Q3.
First, Kevin Berry was named our Chief Financial Officer. Kevin's career demonstrates a successful track record of creating more efficient cost structures, driving cash flow and generating value for shareholders. Kevin has been an integral member of the finance organization of Patterson for several years, and I'm confident in the direction of the finance organization under his leadership. Kevin is aligned on maintaining Patterson's balanced capital allocation approach to drive long term value creation. 2nd, we created the new role of Chief Operating Officer to enhance our accountability and focus on leveraging the value of our total enterprise to drive efficiency and improve performance.
Our Dental and Animal Health segments cater to different end users that share key characteristics across their operations and end markets. I believe there is considerable opportunity to drive increased synergy to build upon the competitive advantages we have across those markets. No one is better suited to lead this initiative than Kevin Pullman, most recently President of Patterson Animal Health. Kevin is a proven operator with a strong track record of performance improvement and serving customers. In this new role, Kevin has been working to identify opportunities to improve operations and optimize performance.
We have also established a Patterson operating leadership team comprised of key leaders in both segments to further strengthen alignment and adoption of best practices across the organization. The business The comprised Patterson's Animal Health segment will be overseen by their existing leaders George Enriquez, President of Companion Animal and Steve Cunningham, President of Production Animal. Tim Rogen will continue to lead the dental segment as its President. Patterson has a deep bench of highly capable executive leaders who are instrumental in developing and implementing Patterson's strategy. I believe these enhancements to the executive leadership team best position Patterson to achieve our goals to drive long term shareholder value.
Now let's turn to our segment performance starting with Dental. Our 3rd quarter Dental segment internal sales decreased about 4 year over year, primarily driven by a decline in digital and CADCAM technology products and deflationary impacts Infection Control Consumables category. Nonetheless, outstanding execution by our teams enabled our Dental segment to maintain double digit operating margins and deliver year over year operating margin expansion. We remain focused on advancing and strengthening key margin enhancement initiatives. In consumables, our internal sales in the 3rd quarter declined both single digits year over year due to the persistent deflationary impact of certain infection control products.
However, excluding infection control products, our consumables category grew approximately 5 in the fiscal Q3. We provide a broad range of infection control products and demand for these offerings remains strong in comparison to pre COVID levels as dentists have adapted to meet a higher standard of care. As we have previously discussed, improvements in the global supply chain for certain infection control products Have resulted in considerable pricing declines from the pandemic highs for certain products in this category. While we believe pricing has largely stabilized, The comparison to elevated pricing is expected to continue throughout fiscal 2024. Our noninfection control portfolio continues to perform well as our broad offering, including private label products, appeals to customers across the dental market from independent private practices to regional and national DSOs.
The combined power of our offering and our tenured knowledgeable sales force enabled Patterson to outperform the market in this category. We're proud of our standout culture and talented team and we'll continue to invest in this area to deliver sustained organic growth. In our equipment category, 3rd quarter internal sales declined in the high single digits year over year, driven by client in digital and CADCAM Technology Products. Equipment sales can fluctuate quarter to quarter largely due to a variety of external factors that influence the timing of sales, including the timing of new innovation, promotional programs and upgrade cycles, as well as product quality and availability. In our 2023 Q3, we lapped the execution of a major upgrade program in the CADCAM category, which had a notable impact on the year over year comparison.
What's important to recognize are the longer term trends. The growing use of digital technology enables dentists to offer an improved patient experience with a higher level of oral healthcare. That improved experience drives demand for innovation among both dentists and patients and supports a long runway of growth over time. When there's new technology in the marketplace, Patterson is best positioned to sell, finance, install and service that technology for the complete lifecycle of those investments. Our long term results support that.
Over the last 8 quarters, our average year over year growth in dental equipment is over 13%. This substantial growth reflects the value proposition Patterson offers our customers in the dental equipment category and our market leading capability to deliver and support new technology innovation from our manufacturer partners for dental customers. Importantly, we drove double digit growth in core equipment in the 3rd quarter, as we continue to execute on and sustain a backlog of core equipment orders. Performance in this category demonstrates that dentists are making equipment investments to keep their practices fresh and running well. During the Q3, our dental value added services category delivered solid mid single digit growth, driven by broader adoption of our desktop and cloud based practice management software solutions, the foundation of a modern dental practice and demand for our field technical service offering, which we have enhanced with new productivity tools.
Looking ahead, The dental business is poised to benefit from resilient secular tailwinds, including an aging population, demand for practice modernization and a growing appreciation for oral health as a key link to overall health. Given these underlying fundamentals and the market stability they create, We are confident in our ability to achieve our goals in fiscal 2023 and beyond. Let's now turn to the Animal Health segment. During the Q3 of fiscal 'twenty three, our internal sales increased 5% year over year, as our teams delivered growth that we believe outperformed the market in both production and companion animal. We continue to benefit from the depth of our offering and omni channel presence It spans a wide range of animal species and offers comprehensive solutions for diverse customers.
We also demonstrated successful margin performance with initiatives including effective cost management, improved product mix, including growth in our value added services segment and partnership with strategic manufacturing partners that reward us for the value we provide. In companion, our internal sales in the 3rd quarter increased by over 7%. This performance is particularly impressive considering the double digit sales growth in the prior year period. Our sustained growth is a testament to the strong execution of our plan, including excellent performance from our experienced internal and external sales teams, operational discipline and our value add consultative approach. Our differentiated approach creates deep relationships with our preferred manufacturing partners and customers, and we're seeing the results of those efforts.
We've also benefited from the strong growth in our private label portfolio within the companion category. Our expanding private label portfolio includes a collection of owned brands with strong equity in the market. We are continuing to invest in this important category. As I mentioned before, during the quarter, we closed division of RSVP and ACT, which stands for Relief Services for Veterinary Practitioners and Animal Care Technologies. This transaction provides innovative solutions to veterinary practices through data extraction and conversion, staffing and video based training services.
The early days of our integration have reinforced the opportunity to deepen our value proposition, expand our companion animal capabilities and address critical customer needs. We remain confident in the resiliency and growth of the companion animal market. We believe pet parents are increasingly dedicated to the health of their pets and making necessary investments when it comes to the longevity of those pets. On the production animal side, 3rd quarter internal sales increased by 1% year over year, which we believe outpaces the market based on industry data. This continued outperformance is attributable to the outstanding execution of our team, a differentiated model of hands on service, delivery options and a comprehensive product and services portfolio.
I'm particularly proud of our internal sales growth considering the industry wide headwinds in the production animal market, including pricing pressure on Draxen, a broadly used product that now faces generic competition as well as drought conditions that have impacted the beef herd. Despite these external challenges, we continue to drive growth and invest in our future. We successfully closed our acquisition of Dairy Tech, which expands our portfolio of owned brands. Dairy Tech provides pasteurizing equipment and single use bags to safely produce, store and feed colostrum, a necessary nutrient for newborn calves. This is a critical capability for our cattle producer customers and we are excited to efficiently and effectively support the health of the producers' herds.
This acquisition expands our value added platform in the production animal business and aligns well with several trends that we have been observing in the market, including producers looking for more efficient ways to manage costs and improved profitability, a continued market emphasis on biosecurity and herd health and strong global demand for protein and dairy. Across the Animal Health segment, our value added services category delivered significant growth during the quarter. The strong performance can be largely attributed to our suite of software solutions, which is an important focus area for us going forward, as well as our equipment service offering. Similar to our dental segment, our equipment service offering is a differentiator for Patterson Enables us to support the full lifecycle of equipment for our customers. As we look ahead, we believe our Animal Health position for continued success amid a dynamic end market.
Now, I'll turn the call over to Kevin Barry to provide more detail on our financial performance.
Speaker 3
Thank you, Don, and good morning, everyone. In my prepared remarks this morning, I will cover the financial results for our Q3 of fiscal 2023, which ended on January 28, 2023, and then conclude with our outlook for the remainder of the fiscal year. So let's begin by covering the results
Speaker 2
for our Q3 of fiscal 2023.
Speaker 3
Consolidated reported sales for Patterson Companies in our fiscal 2023 Q3 were $1,600,000,000 an increase of 0.3% versus the Q3 1 year ago. Internal sales, which are adjusted for the effects Currency translation and contributions from recent acquisitions increased 1.8% compared to the same period last year. Our Q3 fiscal 2023 gross margin was 21.4%, an increase of 30 basis points compared to the prior year. Our gross margin was positively impacted by 10 basis points this quarter by the mark to market accounting adjustment on our equipment financing portfolio. As we have mentioned in prior earnings calls, any positive or negative impact related to this mark to market accounting adjustment is nearly offset by our corresponding hedging instrument, which is reflected in the interest and other expense line on our P and L.
So the net result has a minimal impact on our adjusted earnings per share. This dynamic also occurred in the 3rd fiscal quarter of last year when the negative impact of the mark to market accounting calculation was 20 basis points. Normalizing for the 10 basis points of positive impact this quarter and the 20 basis points of negative impact in the year ago period, Our gross margin rate is flat compared to prior year. 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 Q3, each of our business units posted a year over year increase to their respective gross margins in the prior year period.
Across the company, we continue to focus on gross margin expansion initiatives such as pricing and cost execution and driving an improved mix with the higher growth of Margin Accretive Product Categories. Adjusted operating expenses as a percentage of net sales for the Q3 of fiscal 2023 were 16.1% and favorable by 60 basis points compared to 1 year ago. In the fiscal 2023 Q3, our consolidated adjusted operating margin was 5.3%, an increase of 90 basis points compared to the Q3 of last year. Again, when normalizing for the accounting impact of the mark to market adjustment in both periods related to gross margin, Our consolidated adjusted operating margin in the fiscal Q3 expanded by 60 basis points over the prior year. We remain focused on driving operating margin expansion through our efforts to improve gross margin with pricing and cost execution, working more closely with strategic vendors who reward us for sales performance, driving improved mix, as well as exercising expense discipline and leveraging our cost structure as we grow the top line.
With these collective efforts, we intend to deliver adjusted operating margin expansion in both of our business segments and for the total business in fiscal 2023. Our adjusted tax rate for the Q3 of fiscal 2023 was 22.5%, a decrease of 220 basis points compared to the prior year. For the full year, we expect our tax rate to be in line with the prior year. Reported net income attributable to Patterson Companies Inc. For the Q3 of fiscal 2023 was $53,900,000 or $0.55 per diluted share.
This compares to reported net income in the Q3 of last year of $57,000,000 or $0.58 per diluted share. The year over year decrease is related to the investment gain we recorded in the Q3 of last year. Adjusted net income attributable to Patterson Companies Inc. In the Q3 of fiscal 2023 was $61,100,000 or $0.62 per diluted share. This compares to $54,200,000 or $0.55 per diluted share in the Q3 of fiscal 2022.
This 13% increase in adjusted earnings per diluted share for the fiscal Q3 is primarily due to the operating margin expansion in both of our business segments. Now let's turn to our business segments, starting with the dental business. In the Q3 of fiscal 2023, internal sales for our dental business decreased 3.8% compared to the Q3 of fiscal 2022. Internal sales of Dental consumables declined 1.5% compared to 1 year ago. As Don mentioned earlier, we continue to experience the deflationary impact of infection control products compared to the prior year.
Internal sales of non infection control products increased 4.6% in the fiscal Q3 compared to the year ago period. We expect the year over year deflationary impact of infection control products to continue for the remainder of fiscal 2023 and throughout fiscal 2024. Internal sales of dental equipment and software decreased 9.7% compared to 1 year ago. In core equipment, our double digit sales increase in the quarter reflects our ongoing efforts to effectively manage the supply chain in this category to deliver and install the equipment our dental customers have ordered to update their practices or open new dental offices. However, sales of technology products declined in the quarter, primarily due to the comparison to a CADCAM upgrade program in the prior year period.
Internal sales of value added services in the Q3 of fiscal 2023 increased 4.5% over the prior year period, led by the solid year over year performance of our technical service team and continued growth of our software business. Value added services represent the entire suite of offerings we provide to our customers that help make us an indispensable partner to their practice and these available offerings are also mixed favorable to our P and L. Adjusted operating margins in dental were 10.2% in the fiscal third quarter and a 10 basis point improvement over the prior year period. This operating margin performance reflects the efforts of our dental team to improve gross margins Effective pricing and mix management and continued expense discipline to deliver operating margin expansion for fiscal 2023. Now let's move on to our Animal Health segment.
In the Q3 of fiscal 2023, internal sales for our Animal Health business increased 4.6% compared to the Q3 of fiscal 2022. Internal sales for our companion animal business increased 7.4% versus the Q3 1 year ago. Internal sales for our production animal business increased 1.4% in the quarter compared to the prior year. The entire production animal market has been affected by a deflationary impact of a key branded product that recently came off patent And as Don mentioned is now experiencing generic competition. Excluding this deflationary impact, internal sales for the production animal increased by 2.4%.
Industry data would indicate that our sales teams in both Companion Animal and production continue to outperform the overall market during the fiscal Q3. Adjusted operating margins in our Animal Health segment were 4.2% in the fiscal Q3, an increase of 80 basis points from the prior year. Our animal health team continues to drive business with strategic manufacturing partners who value our ability to deliver sales, while also exercising expense discipline as they seek to expand operating margin for fiscal 2023. Now let me cover cash flow and balance sheet items. During the 1st 9 months of fiscal 2023, our free cash flow declined by $70,400,000 compared to the same period 1 year ago.
This was primarily due to an increased level of working capital in the 1st 9 months of fiscal 2023, driven by strategic inventory purchases and timing of accounts payable. Turning now to capital allocation. We continue to execute on our strategy to return cash to our shareholders. In the Q3 of fiscal 'twenty three, we declared a quarterly cash dividend of $0.26 per diluted share, which was then paid at the beginning of the Q4 of fiscal 'twenty three. On a year to date basis in fiscal 2023, Patterson has returned $91,000,000 to shareholders through dividends and share repurchases.
Let me conclude with our outlook for the remainder of fiscal 2023. Today, we are narrowing our fiscal 2023 GAAP earnings guidance range to $1.96 to $2.01 per diluted share and our adjusted earnings guidance range to $2.25 $2.30 per diluted share. We intend to deliver internal sales growth and adjusted operating margin expansion for fiscal 2023 for the total business and within both of our business segments, and we remain committed to achieving our goals for the fiscal year. And now, I will turn this call back over to Don for some additional comments.
Speaker 2
Thanks, Kevin. Before we open it up for Q and A, I want to thank the entire Patterson team. Our people differentiate Patterson, driving our results and our long term success. I'm excited by the momentum we are carrying into final stretch of fiscal 2023. We are well positioned to achieve our financial and operational goals and to continue to deliver for all of our stakeholders.
That concludes our prepared remarks. Kevin and I will be glad to take questions. Operator, please open the line.
Speaker 0
Thank you. And we will pause for just a moment to compile the Q and A roster. We will take our first question from Jason Bednar with Piper Sandler. Your line is open.
Speaker 4
Hey, good morning. Thanks for taking the questions. I wanted to touch on some of the larger deltas or surprises in the quarter. Maybe starting first with margins, this is Pretty impressive here with company wide and particularly within animal health. You've been on a multiyear journey here with margin improvement that Probably doesn't get enough attention or credit, but maybe can you elaborate further on the source and sustainability of the margin improvement?
Appreciate the color that you gave, but just any additional, Again, details you can provide there, especially as we look forward to fiscal 2024.
Speaker 2
Yes. Jason, thanks for the comment and for the appreciation of our margin. I think, Like we said, I think we feel like we have sustainable programs in place. We outlined some of them In their prepared remarks and I'll see if Kevin Barry has anything he wants to add to that. But this is really, like you said, a multi period journey.
The things that we've put in place we think are sustainable that they're long term. We've said before, we're aiming to continue that trend and not going to get too specific on guidance, but I I think if you look back over the last couple of years, year over year, you've seen the operating margins improve 20 to 30 basis points on average, which we think is reasonable and sustainable. So, all good from our end. I really applaud the team, the teams, particularly as you mentioned in animal health, in a lower margin business. They've done a great job with increasing those margins and maybe I'll ask Kevin Barry if there's anything else he'd like to add on Specifics in terms of some of the examples we have.
Speaker 3
Yes. Again, I appreciate the question. Both business units, like you said, have expanded their op margins this quarter to take a good trend. And it's really been a holistic approach for both. Don and I mentioned a couple of examples of how we're approaching, our pricing and costing initiatives, how we're managing the mix within Both businesses have a big impact on our margins and driving those higher margin higher value product lines and service lines that we have.
And then the other one I'd highlight is we've done some very good work on our operations side and looking at our logistics network and distribution network and how efficient are we being getting those products and services to our customers. And we've had some good wins there With our businesses partner, with our logistics team here in Patterson. So again, it's a very holistic approach, which Again, as we think is a muscle we keep building here and that's going to keep paying off in the future.
Speaker 2
Yes. Jason, maybe I'd add as well that You saw the announcement or I mentioned today on the call that we've added a Chief Operating Officer position Patterson and Kevin Pullman is in that position. I think that This is he is in a position to address an underserved part of this margin story, which is really Getting after, some of the synergies that we've looked at, we've worked on, but maybe not with the focus we're going to have In terms of things across the enterprise, so both business units have done a great job with their margin improvement, but And there's more there, but I think one of the untapped pieces of this is really how do you look at the company Holistically, there's a lot of opportunity there.
Speaker 4
Okay. That's really helpful. Thanks, Don. And yes, definitely still some room there to run on margins. Maybe in core dental consumables, mid single digit growth there is pretty darn solid.
But I'll actually ask on infection control. I appreciate the comments here, the early comments on deflationary pressures continuing for the next several quarters. Do you want to take it a step further on quantifying what impact this might have? Does it get less bad or less of a headwind or Stay at its current rate or the delta relative to the core business. And then should we be contemplating any shift in Company profitability or decremental margins as a result of these ongoing pressures.
Speaker 2
Yes. So just so we're Clear, Jason, on
Speaker 5
kind of
Speaker 2
how this plays out. We're expecting the deflationary pressure in the sense that the pricing Keeps coming down. It's largely where we think it's going to be. I think there's probably a little bit more to come here In our Q4, where we think it bottoms out, if you will. I think the point Is that on a year over year basis then just because it's been coming down all of this fiscal year, when you look into next fiscal year, It's going to be a headwind when you think about it on a year over year comparison basis.
So that's what we're kind of looking at. We're not Probably going to give commentary on the impact on this call. I would say that as we Look toward the Q4 call and our guidance for next fiscal year. This will definitely be a topic And we'll probably give some good color on the call next quarter in terms of how the year over year impact on Our earnings looks. Okay, fair enough.
Thanks so much guys.
Speaker 0
And we will take our next question from Michael Cherny with Bank of America. Your line is open.
Speaker 6
Good morning and thanks for taking the question. So this might be a tough one to ask, but I know you talked about some of the deflationary dynamics on infection control heading into fiscal 2024. Are there any other things we should be thinking about that would skew towards the abnormal in terms of what you'd expect for the run rate baseline into 2024, especially just given where we are in the year. Is there any way to interpret how to think about Both the 3Q numbers and the 4Q implied guidance in terms of the appropriate jumping off point for your fiscal 2024 trajectory.
Speaker 2
I want to try to be helpful, Michael, here, but we're going to really stay away, I think, from too much commentary on this call again. I think The discipline here we're going to maintain of giving guidance on next call and putting a lot of color around that. I mean, the deflationary impact is something we've talked about. I think that's a fair point. Interest rate environment obviously is hard to call for all of us.
So that's another, I'd say, wildcard in the mix. But otherwise, We like the momentum in our businesses. I think you saw it this quarter absent the dental equipment. The dental equipment issue this quarter really has more to do with timing and upgrade cycles and technology cycles than it does anything else. And again, I've said this before, The looking at equipment sales performance in a 3 month increments is really a difficult proposition.
You want to look at it over Longer periods of time, but we expect in spite of macroeconomic headwinds, we're expecting that to hold up well. We have good momentum in core equipment and a timing issue in the other categories. But Otherwise, really business as usual.
Speaker 3
Michael, maybe the one thing I'd add as you think about the jumping off point here is, as we reiterated guidance today. We are also reiterating that we still expect and project that we're going to grow our internal sales The company this year and we're going to deliver the operating margin expansion for the individual business units and overall company. So as you're thinking about how do you think about the rest of this year, I think those are important considerations to kind of put your model together.
Speaker 6
I appreciate you humoring me on a question that I know is hard to answer at this point in time. But maybe just to pick, a little bit, Don, on a comment you made related to the equipment side, The dynamics of interest rates, have you seen any changes in your order book either in terms of any potential delays or cancellations and or From a leading indicators perspective, mix in terms of the type of products, type of equipment that people are looking for beyond what you've already placed and sold?
Speaker 2
No, we haven't. And in fact, I'd tell you and of course, this has some element of timing in it as well, but Deposits on hand for our equipment and for pending equipment installations are robust and they're up from last quarter and where they've been. Got it. Thank you.
Speaker 0
We'll take our next question from Erin Wright with Morgan Stanley. Your line is open.
Speaker 7
Great. Thanks for taking my question. So first on Animal Health, what are you seeing in terms of price realization given The level of price increases at the pharma manufacturer level, particularly in companion animals, so that's excluding obviously some of the price dynamics that we're seeing on the production animal And are there any changes in buy sell versus agency relationships embedded in your guidance at this point that we should be aware of as we think about calendar 2023.
Speaker 2
In terms of the companion animal market, we're really not seeing anything too significant in terms of pricing there. It's really been kind of business as usual. Traffic is moderate is kind of steadily moderating. I think What we're seeing is that the spend per visit right now, the traffic is down slightly, but the spend per visit is up. But in terms of pricing itself, really not anything there.
On the buy sell, we don't expect anything too significant In the upcoming year, I'll let Kevin Barry chime in if he wants on this topic. Yes.
Speaker 3
We're not projecting anything changing right now.
Speaker 7
Okay. That's helpful. And then on the dental side, what are you seeing now in terms of the monthly demand trends across kind of the quarter and how we should be thinking about that. I know we are lapping Omicron and other dynamics, But how are you thinking about just underlying demand across dental, excluding some of the variables across the equipment side?
Speaker 2
Yes. Well, we saw I mean, patient traffic is we would characterize it as generally stable. But we did see an increase in traffic throughout the quarter. So If you look if you really broke it down monthly, which we typically don't give this kind of guidance, but I would tell you That monthly traffic improved as the quarter went on.
Speaker 0
Great. Thank you. We will take our next question from Jeff Johnson with Baird. Your line is open.
Speaker 8
Thank you. Good morning, guys. Maybe I'll follow-up on that last point there. I think our checks and some of our survey work have clearly shown kind of that January and even February rebound on the dental demand side. We're kind of hearing it more from a mix standpoint and a little bit price more so than patient volumes.
I just love any color you can provide around what kind of pricing dynamic you're seeing right now and kind of those improvements you're pointing to throughout the quarter that sync pretty well with what we're seeing. I know you don't give too much color. I'm not asking you to Had different product lines, but hygiene and preventative was the improvement there, was it in some of the higher end, resto and other kind of consumable products that would go more mix Just trying to understand what's kind of driving maybe some of that improved spend we heard about in January February so far in the dental world? Thanks.
Speaker 2
Yes. Hey, Jeff. Appreciate the question. Yes, try to be as helpful as possible. I think It was kind of steady improvement, particularly notable, I guess, in January.
I don't have a breakdown right here of exactly how that looked in terms of traffic, pricing, etcetera. I think it was a mix of both, really. And so generally, I'd call it kind of a mix and I think that we're not probably going to be able to break it down too much further than that on this call.
Speaker 8
All right. That's fair. Let me push you, I guess, on one other point you made on equipment and a lot of it being timing and all that. Historically, I know Section 179 and that doesn't have as much pull anymore as those write offs have been pretty stable now for the last few years, but are those write limits. But typically, I think in the 5 years prior to this year going through 2Q to 3Q in your You get about a 20% sequential lift in equipment dollars and you got basically none this quarter.
20 Points feels like it's more than timing and I understand the technology timing stuff you're talking about, but basic equipment improving also was against some Supply constraints last year in the quarter. So there was some push and pull on both those fronts. So I mean just what's your outlook for equipment maybe over the next 6 to 12 months with inflation and interest rates where they are in that, just what's your look of the lay of the land on equipment? Thanks.
Speaker 2
Yes. Well, I think we've said for a while that we over time, we think the equipment Business for us is a mid single digit growth piece of the portfolio. Obviously, over the last 8 quarters, we've averaged 13% growth in that category. So, but I would revert back to what we think is slightly above market, which is the 5% and Yes, we expect that to happen. I think when you look at this quarter, and I'd say timing, but I also would tell We had a difficult comp.
Again, I don't the upgrade cycle in CADCAM This is a was a significant factor. And so, again, looking at it in isolation, I think It's difficult, but I would kind of revert you back to that mid single digit growth as a good proxy for the long term kind of health of that business.
Speaker 8
Yes. Got it. Thank you.
Speaker 0
And we will take our next question from Brandon Vazquez with William Blair, your line is open.
Speaker 9
Hi, everyone. Thanks for taking the question. I wanted to try to Talk a little bit about kind of forward expectations again, but I appreciate we won't get any hard numbers here for a little bit. So maybe there's a lot of kind of moving pieces, whether they're macro or company specific. Can you just kind of walk through expectations for some of those dynamics, right?
There's generic headwinds in animal, there's CADCAM Kind of upgrade cycle anniversarying in this quarter. So how do some of those things impact the business in the P and L over call it the next 12 quarters?
Speaker 2
12th quarters? Again, yes, I mean, Why it would be helpful here. I think, obviously, that's a long timeframe for us and for giving guidance, but we're also not going to Talk too much about next year. I think the way I would think about it, I think you've hit on 2 aspects of the That are going to impact next year. But the thing I'm looking at right now that I think is important is just Patient traffic has been stable, in spite of what's happening in the overall macroeconomic markets.
We're really encouraged by that in all the businesses. The margin improvement, which we expect to continue. Again, if you dig through and look at what's driving that, It's largely things that are we believe are sustainable, that are going to be helpful next year and into the future. And so stable markets, encouraging stable markets, margin improvement, There are there's the issue that you brought up, but otherwise, I think we're in a good spot here as we move into next quarter.
Speaker 9
Thanks, Rob. And maybe for next question, you had mentioned you made an acquisition of a warehouse, I think that was for the animal health side in the U. K. Maybe just expand on any other additional plans to expand internationally, maybe even in dental, If any of that is on the books for upcoming year. Thanks.
Speaker 2
No, Go ahead, Kevin.
Speaker 3
Yes. I think what you're referring to, we're doing an internal capital project on our warehouse operations in our U. K. MBS business. It wasn't an acquisition, but it's a so it's an internal investment we're making.
It's a really good investment to help the operations of that business in That services the veterinary market over there. It wasn't an acquisition. It was an internal capital spend.
Speaker 9
Okay. And then any future plans to continue investing in international? Is it Expectations that that becomes a bigger part of the business over the coming years?
Speaker 2
Yes, I think we We'll look at opportunities to continue to bolster and improve the operations we have Internationally, yes, we wouldn't comment on any plans beyond that.
Speaker 9
Okay. Thanks.
Speaker 0
And we will take our next question from Jon Block with Stifel. Your line is open.
Speaker 5
Thanks, guys. Good morning. Maybe I'll just follow-up on a couple of other things. But I'll focus on a 4.6% internal Dental consumables ex PPE. So a good number was often, call it a real comp, I think a 3.6 comp.
So And then I step up from a couple of prior quarters. Don, do you want to just maybe elaborate on it a little bit? Can you talk to Is that sustainable? Should we be thinking about this 3% to 5% range again ex PPE as the normal? And then maybe just Close the loop on some other questions.
The past couple of quarters, I think there's been almost like a 600 basis point delta between your internal dental consumables And that's specific to the number ex PPE. And when we think about fiscal 2024, what I'm getting is when you take into the jump off Taking in terms of the jump off point on pricing, it's still a headwind in fiscal 'twenty four, but that 600 basis point delta, call it, titans in fiscal 2024. And maybe if you can address that and then I've got a follow-up. Thanks.
Speaker 2
Yes, I think that's a fair way to look at it in terms of the delta. The big impact here is as the pricing has come down so significantly Throughout the year and then as you get into next year, it's a little bit more of a year over year comparison issue. Again, I think we're excited about our consumables growth. I mean, that's moved around a little bit, but I think Over the last couple of years that's improved each quarter and we're really executing well with our dental customers. I think when you look at the portfolio outside of PPE, we've done a good job of putting that together.
And Again, sorry to not try to be helpful here, but I think you can look at kind of maybe Our growth rates here in the last year, ex PPE and that's probably a decent proxy for how we're Executing in the market and what we think could happen, moving forward.
Speaker 5
Okay, perfect. Thanks for that. And then just second question, Shook gears a little bit. Some of the initiatives are in dental specialties have been quiet In my opinion, so just thoughts on that page picking up. I mean, you've got Angel Online, we believe coming to the U.
S. Shortly and Maybe they go direct ortho, but I would think they want to partner in the really fragmented GP segment. Smautorex talked about Trying to do white label or private label. So it seems like there's a couple of opportunities, we call it capital light opportunities To get involved in faster growth areas of dental specialties, notably clear liners, maybe just your thoughts, Don, when you look forward with the organization, Being a player in that segment going forward in fiscal 2024 and beyond. Thanks guys.
Speaker 2
Yes. Well, we're really focused and we've said this, and we're starting to do some smaller acquisitions, but we've been really focused on a number of Different opportunities for our M and A strategy and capital allocation. Obviously, those are attractive markets. And so they're not they're on our radar, and we continue to look at the opportunities to See if they fit our criteria, fit our strategy and if there's something that is going to be good for Patterson, That's definitely something we'll be looking at and more to come on M and A. Fair enough.
Thanks guys.
Speaker 0
We will take our next question from Nathan Rich with Goldman Sachs. Your line is open.
Speaker 10
Hey, good morning. Thanks for
Speaker 11
the questions. Just wanted to go back to the Dental equipment performance in 3Q. I guess, is there any more detail you could provide on kind of the magnitude of that cycling that upgrade program from the prior year? And I guess I asked because you faced another tough comparison in equipment in 4Q that I think was also kind of driven by double digit growth in CADCAM and digital last year. So do we see this sort of near term softness continue through the balance of this year before maybe getting back to growth in fiscal 2024.
Speaker 2
Well, obviously, any of that's built into the guidance we gave, but maybe I'll see if Kevin's got Some thoughts on what he wants to share relative to that.
Speaker 3
Yes. I think what I'd say is, We did see declines in those technology categories this quarter. Like Don had Mentioned it was somewhat promotional related to the prior period. But we are also seeing good growth in our core equipment year over year. And so I think as you look at our total equipment category, it's obviously the technology piece is a good chunk of it, but we've got Some really solid momentum on our core equipment that kind of continues to help offset certainly help offset some of the softness in this quarter.
So I think that's maybe the additional color I'd give on how we're thinking about that category. And again, like Don said, that's obviously built into our forecast for
Speaker 11
Okay. And then maybe Kevin, if I could just ask a follow-up on the free cash flow performance. Obviously negative year to date. You talked about the working capital and build, I think mainly related to inventory. Do we see some of that reverse in 4Q?
And can you maybe help us think about what a more maybe normalized run rate for free cash flow is going forward?
Speaker 3
Yes. So we do have some seasonality in our free cash flow where we typically see Inventories coming out of Q3 is a bit higher and then we typically draw down in Q4 and have April cash flow in Q4 and we expect that to happen again this year. I think what happened in Q3 is, we Had some opportunities to strategically buy in some inventory and ensure some service levels and we did that And we didn't see as much of an increase in our accounts payable to offset that. So there's some timing of when the bills got paid that Impacted us here in Q3 that we'll also expect some line to bet here in Q4.
Speaker 2
Yes, I mean over time
Speaker 3
I think what I'd say is that I think we have opportunity to I think our balance sheet is in a pretty good place and I think we can leverage Get some leverage on our cash flow as we grow the top line. Our teams have done a good job internally, particularly on the inventory side, looking at How do we get better at forecasting? How do we make sure we've got the right products in the right locations to optimize inventory levels and the costs we spend moving products around. And so over time, I would think that we've got the opportunity to be able to grow our top line faster than we need to for our inventories.
Speaker 10
Okay, great. Thank you.
Speaker 0
We will take our final question from Kevin Caliendo with UBS. Your line is open.
Speaker 10
Thanks for sneaking me in. Speaking of inventory, one of your primary manufacturing suppliers talked about putting inventory into the channel in 1Q, Just in their 1Q, the March quarter. Just wondering how that, if it in any way has impacted you guys?
Speaker 2
No, I think There's a lot of timing involved in how the equipment moves, but really not in terms of that hasn't impacted us in terms of our ability to install equipment and really our sales cycle, etcetera.
Speaker 5
Okay.
Speaker 10
So it's not necessarily meaningful or it doesn't explain any of the sort of results that we've seen or expectations that we have for next quarter? No. No. Okay, helpful. What are you guys expecting In terms of manufacturer price increases for 2023, obviously, last year for calendar 2023, last year, obviously, there were a lot more price Maybe more acute price increases than you normally see.
Are you expecting the next cycle to be more normal or do you Still expect elevated price increases from manufacturers.
Speaker 3
I think what I'd say is, obviously, Our portfolio is pretty broad. We deal with a lot of manufacturers at different places in the pricing cycle. But I think as a general comment, We'd expect a slight slowing from certainly what you saw sort of immediately post pandemic going forward. But as we look internally, we see there's a pretty big mix. And as we've been talking about this call, there are some products that as the supply chains have normalized or Competition comes in that prices go the other way.
So but in general, I think if you're just talking about price advances from the manufacturers, it's I'd expect it still to be positive, but not quite at the rate we saw in the past year or 2.
Speaker 5
Got it.
Speaker 10
And I apologize if I missed this, but can you just Can you talk about the impact from the completed M and A on expectations for your fiscal 2023? Was there any Incremental impact to the top line or to earnings from the deal you completed?
Speaker 3
Yes. We got Some revenue benefit here in Q3. I think that's in the tables in our press release, you can see that. From an EPS standpoint, it's relatively de minimis here in this fiscal year. It's part of our guidance.
But here in Q3, with those deals, we got about a month, 1.5 months of impact from them.
Speaker 10
Great. Well, listen, thanks guys. Thanks for getting me in. Appreciate it.
Speaker 2
Thanks. You bet. That's all the questions for today. I really appreciate everybody's time. Thanks for your time and your interest in Patterson Companies and we'll talk to you next quarter.
Speaker 0
Ladies and gentlemen, this concludes today's conference call, and we thank you for your participation. You may now disconnect.