Patterson Companies Inc

NASDAQ:PDCO

Earnings Call Transcript 2022-Q3

[Operator]

00:04 Good morning. My name is Rob and I will be your conference operator today. At this time, I would like to welcome everyone to the Patterson Companies Third Quarter Fiscal Year 2022 Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers’ remarks, there will be a question-and-answer session. [Operator Instructions] 00:35 Thank you. John Wright, Vice President, Investor Relations, you may begin your conference.

[John Wright, Vice President, IR]

00:45 Thank you, operator. Good morning, everyone and thank you for participating in Patterson Companies fiscal 2022 third quarter conference call. Joining me today are Patterson’s President and Chief Executive Officer, Mark Walchirk; and Patterson’s Chief Financial Officer, Don Zurbay. After a review of the fiscal 2022 third quarter results and outlook by management, we will open the call to your questions. 01:09 Before we begin, let me remind you that certain comments made during this conference call are forward-looking in nature and subject to certain risks and uncertainties. These factors, which could cause actual results to materially differ from those indicated in such forward-looking statements are discussed in detail in our Form 10-K and our other filings with the Securities and Exchange Commission. We encourage you to review this material. 01:35 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, 2022. Patterson undertakes no obligation to revise or update any forward-looking statements to reflect events or circumstances after the date of this call. Also, a financial slide presentation can be found in the Investor Relations section of our website at pattersoncompanies.com. 02:13 Please note that in this morning’s conference call, we will reference our adjusted results for the third quarter of fiscal 2022. The reconciliation table in our press release is provided to adjust reported GAAP measures, namely operating income, other income expense net, income before taxes, income tax expense, net income, net income attributable to Patterson Companies, Inc. and diluted earnings per share attributable to Patterson Companies, Inc. for the impact of gains on investments, inventory donation charges, deal amortization, legal reserves and integration and business restructuring expenses, along with the related tax effects of these items. 02:57 We will also discuss free cash flow as defined in our earnings release, which is a non-GAAP measure and use the term internal sales to represent net sales adjusted to exclude the impact of foreign currency, changes in product selling relationships, contributions from recent acquisitions and the extra week of selling results in the first quarter of fiscal 2022. These non-GAAP measures are not intended to be a substitute for our GAAP results. This call is being recorded and will be available for replay starting today at 11:00 a.m. Central Time for a period of one week. 03:31 Now, I’d like to hand the call over to Mark Walchirk.

[Mark Walchirk, President & CEO]

03:36 Thank you, John and welcome everyone to Patterson's fiscal 2022 third quarter earnings call. Before we begin our discussion, I want to first acknowledge the devastating situation in Ukraine and while we do not have any specific operations in Ukraine or Russia, our thoughts are certainly with Ukrainian people and everyone affected by this tragic war. And I know we are all very hopeful for a fast and peaceful resolution. 04:02 I'll turn now to our discussion of our third quarter. Patterson continued to deliver strong performance. This time in our fiscal third quarter, which ended on January 29, 2022. I'm very proud of the way our team continues to execute against the backdrop of a dynamic end market environment and during this quarter, in particular, given the acute disruption caused by the Omicron variant in the last several weeks of the quarter. 04:29 Even in light of the Omicron impact in the quarter, our team remained focused on delivering value to our customers, highlighted by a number of key factors including delivering solid top line growth, and gross margin expansion across our total overall business, driving gross margin and adjusted operating margin improvement in both our Dental and Animal Health business segments, and achieving adjusted earnings per share for the quarter of $0.55 and year-to-date adjusted earnings per diluted share of $1.56. 05:00 Given our year-to-date performance and our confidence in the business going forward, we are again raising our adjusted EPS guidance expectations for fiscal 2022 from $2.00 to $2.10 per diluted share to $2.08 to $2.13 per diluted share. The midpoint of our updated adjusted EPS guidance range now represents a 10% year-over-year improvement over the prior fiscal year. 05:29 With that overview, I'll now dive a bit deeper into the performance drivers in each of our segments during the fiscal third quarter, starting first with our Dental business. During the third quarter, our Dental segment achieved gross margin expansion of 120 basis points and adjusted operating margin improvement of 70 basis points compared to the prior year period. These results were primarily driven by favorable contributions from vendor rebates, driven by our continued revenue performance, improved product mix with stronger sales of our higher margin products including private label products, software and value-added services, and overall, strong execution across the business even in light of the disruption from the Omicron variant and the ongoing industry wide supply chain challenges in the core equipment category. 06:17 With respect to our top line performance, internal sales in our Dental segment increased slightly compared to the prior year. Internal sales of Consumables declined about 2% year-over-year. Several factors contributed to our Consumable’s performance during the quarter, so I'd like to provide some additional context. First, we continue to see the moderation of pricing and demand for the infection control category, which we anticipated within our fiscal 2022 forecast and guidance. Excluding infection control products, our third quarter Consumables internal sales grew nearly 4%. 06:53 Second, our Consumables performance during the quarter reflected the impact from the Omicron variant which was particularly acute during the last few weeks of January and the final month of our fiscal third quarter. We estimate that the Omicron variant negatively impacted our overall Consumables growth by about 2% during the quarter. Importantly, we anticipate the most notable impact from the Omicron variant is reflected in our fiscal third quarter results. 07:21 And finally, our Consumables growth rate in the third quarter is stacked on top of our strong performance during the year-ago period, when we reported internal sales growth for Consumables of nearly 14%. On a year-to-date basis, internal sales of our consumables category through the first-nine months of fiscal 2022 increased by more than 8% compared to the same period in fiscal ’21. 07:45 Turning now to our equipment results. Equipment internal sales increased nearly 2% year-over-year, driven by double-digit growth of CAD/CAM and digital technology products partially offset by a double-digit decline in sales of core equipment products, due to the supply chain challenges that have been felt throughout the industry. In my recent discussions with our key manufacturers, they expect these specific core equipment challenges to persist in the near term, that may not be fully resolved until sometime in the second half of the 2022 calendar year. However, we remain very encouraged by the strong demand our team continues to generate for these products with our customers. 08:25 In light of these ongoing challenges in the core equipment category, our dental equipment growth in the quarter is a testament to Patterson's value proposition, our leadership in the equipment category and excellent execution by the entire Dental team. Internal sales of value-added services increased approximately 4% compared to the prior year period, driven by higher sales of our higher margin software and service offerings. 08:51 One of the key drivers of our value proposition with our Dental customers continues to be our software and business solutions portfolio. We offer a leading suite of practice management software which serves as the nerve center of a modern dental practice. Patterson's portfolio of software solutions, which we call Revolve provides a comprehensive suite of services and tools to help our Dental customers drive success for their practice, including practice management, patient engagement, revenue cycle management, practice analytics and security and compliance. 09:25 Our Fuse cloud-based practice management platform is designed to unlock the growth potential of multi-location practices and connects everything they need to run both their clinical practice and their business, across every location, every schedule and every patient. These multi-location customers use our software to create more efficiencies and to scale their business for faster growth by eliminating redundant tasks and consolidating data and analytics into meaningful reporting to ultimately help streamline their front office workflow, improve staff efficiency and increased profitability. 10:01 Patterson Dental also provides most comprehensive software and technology support in the industry. Our Patterson Technology Center is staffed with over 400 experts trained to work with dental practices to maximize their practice technology and software. And with our field-based technology advisors, we differentiate our support further by offering both in practice and virtual on boarding and training services to meet their individualized customer service and training needs. Our software solutions are key focus area for us as we continue to devote additional resources to grow this segment to support our customers and improve our mix. 10:40 Across the entire dental equipment and software market, we believe there is strong demand for continued innovation in the marketplace. I recently had the opportunity to engage directly with many of our manufacturer partners and a number of customers at the Chicago Midwinter Dental Meeting. Our customers are optimistic about the future of their practices and the innovation and support available to them as they in turn seek to modernize their practices and offer enhanced clinical care to their patients. 11:08 I was also encouraged in my discussions at the conference by the heightened awareness and momentum in the industry to help the general public better understand the connection between oral health and overall health and more specifically our oral health can help identify other health-related issues. Going to the dentist is not only important for patient's oral health, but also for patients’ overall health care. Collectively, these trends continue to drive positive long-term fundamentals for the entire dental industry. 11:38 Looking ahead, we expect the dental market will return to its historical growth pattern as we move beyond the pandemic. We remain confident in Patterson’s strong position in the market, the depth and experience of our team and our ability to drive continued momentum from these positive market fundamentals. 11:57 To wrap up my comments on the Dental segment, I'd like to congratulate our entire Dental team for their fiscal third quarter performance and strong execution, especially in light of the Omnicom (ph) disruption and supply chain challenges. 12:10 Turning now to our Animal Health segment. Our Animal Health team continued their positive momentum and delivered a very strong third quarter. On the top line, our Animal Health segment delivered internal sales growth of more than 8%, driven by the sixth straight quarter of double-digit growth in the Companion Animal segment and continued strong growth in our Production Animal segment. 12:35 In addition to the strong top line performance, our animal health team achieved gross margin expansion of 50 basis points and adjusted operating margin improvement of 10 basis points in the quarter, highlighted by several key factors. First, our continued focus to improve product mix by driving sales of our higher margin categories of equipment and value-added services, and growing our private label portfolio at an even higher growth rate than our overall Animal Health business. 13:02 Second, our working closely with our strategic vendor partners, including driving share to those products and vendor partners who choose to reward Patterson's deep customer relationships an extensive value proposition. And third, through the ongoing and strong overall execution across the business. Our Animal Health performance reflects the compelling advantage of Patterson's Animal Health platform, which provides products and value-added solutions for all three of the industry's key channels veterinarian, retail and producer. 13:35 The animal health market continues to evolve and our customers are seeking access to the products and solutions from a variety of sources. The depth of our offering and breadth across all channels was one of the primary drivers of continued success in the animal health market. Our Companion Animal business continues to benefit from the considerable increase in pet ownership that has occurred in the past two years. According to statistics from pet adoption organizations nearly 1 million pets were adopted during 2021 in the U.S. alone, continuing a trend that began during the onset of the pandemic. 14:15 In addition, pet owners have become more attentive, devoting considerable time, thought and money toward caring for their pets. Recent industry research underscores that the overwhelming majority of today's pet owners believe their pet is truly part of the family and they are committed to their pet’s medical care even during challenging economic times. Overall, these attitudes towards pet ownership are driving continued strong traffic at vet clinics and higher spend per visit and this gives us confidence in the long-term growth and durability of the Companion Animal market. 14:49 Beyond these positive market fundamentals, Patterson's comprehensive product and technology offerings combined with our team's expertise, service, training and support continues to differentiate Patterson and propel our growth resulting in growth rates to continue to outpace the overall market. While the Companion Animal market growth rate is expected to moderate over the coming quarters, Patterson’s ecosystem of products and services sets us up well to continue driving long-term growth in this market. Given the larger population of pet owners and the increased attention and spending on pets, we expect the markets normalized long-term growth rate will be higher than pre-pandemic levels. 15:29 On the Production Animal side, our team delivered another excellent quarter, reflecting the strength of both the overall production animal markets continued recovery and Patterson's value proposition for producers, particularly in a dynamic environment. Patterson brings a depth and breadth of services and capabilities to producers that span products, equipment, technology, services and trusted expertise. Producers reward us with their business as become an integral part of their team, helping them manage a sustainable and profitable operation and contributing to the health and safety of their animals. 16:05 We found that deep partnerships with our producer customers are in particular built on having an omnichannel presence in the production animal market. Consistent with our overall Animal health approach, Patterson's go-to-market strategy has solutions for large operations with onsite veterinarians, smaller owner operators along with a strong presence in the retail channel to be serving our customers in the manner they prefer with a broad set of capabilities to meet and exceed their expectations. 16:33 We're pleased with the pace of market recovery across all species and as we look ahead, the production market is expected to steadily improve. Exports across all our Production categories, cattle, swine and dairy are running above the five-year average and processing plant capacity as largely returned to pre-pandemic levels. This recovery is encouraging and we anticipate continued improvement going forward. So let me also congratulate our entire Animal Health team for their strong execution and results in the fiscal third quarter. 17:06 As I wrap up my initial comments on our fiscal third quarter, I'm pleased with our performance across both business units and confident in our business momentum and competitive position to drive growth and margin expansion going forward. 17:20 And with that, I'll turn the call over to Don to share more details about our fiscal 2022 third quarter performance. Don?

[Don Zurbay, CFO]

17:28 Thank you, Mark and good morning, everyone. In my prepared remarks this morning, I will cover the financial results for the third quarter of fiscal 2022, which ended on January 29, 2022 and revised outlook for the remainder of the year. Consistent with the past several quarters due to the comparison dynamics to the market recovery from COVID-19 prior fiscal year. I'll also refer to how our business is performing relative to the pre-pandemic period of the third quarter fiscal 2020. We believe these additional data points are helpful way to understand our business performance and illustrate how we have managed through the pandemic within each of our markets. 18:08 Let's begin by covering the consolidated results for our third quarter of fiscal 2022. Consolidated reported sales for Patterson Companies in our fiscal 2022 third quarter were $1.6 billion, an increase of 2.9% versus the third quarter one year ago. Internal sales for our fiscal 2022 third quarter increased 4.3% compared to the prior year. As a reminder, internal sales are adjusted for the effects of currency translation, changes in product selling relationships and contributions from recent acquisitions. 18:45 Compared to the pre-pandemic third quarter of fiscal 2020, internal sales for our fiscal 2022 third quarter increased 11.5%. We believe our financial performance in the third quarter of fiscal 2022 is the result of continued business momentum and solid sales execution in both of our business segments, even as we dealt with some lingering effects of the global pandemic that Mark just described. 19:10 Our third quarter fiscal 2022, gross margin was 21.1%, up 20 basis points compared to the prior year and up 130 basis points sequentially from the second quarter. Our gross margin expanded on a year-over-year basis, despite a 20 basis point headwind related to the impact of marking our equipment portfolio to market value. 19:30 As we have discussed in the past, this impact on our gross margin is mitigated by a hedging instrument reflected in our interest and other expense line item in the P&L, which eliminates the impact to our bottom line. Importantly, we achieved gross margin expansion in each of our business segments on a year-over-year basis as a result of our focus on product mix and our ability to pass on the inflationary cost increases that we received from our manufacturer partners. 20:02 Adjusted operating expenses as a percentage of net sales for the third quarter of fiscal 2022 were 16.7%, an increase of 40 basis points compared to the fiscal third quarter one year ago. On a year-to-date basis, our operating expenses as a percentage of net sales were 30 basis points lower than the prior year. 20:25 In the fiscal 2022 third quarter, our consolidated adjusted operating margin was 4.4% and down 20 basis points compared to the third quarter of last year. Excluding the impact on our gross margin of marking our equipment portfolio to market value as previously mentioned, our consolidated adjusted operating margin was flat with last year. 20:48 As we have previously mentioned, we continue to focus on driving operating margin improvement through our efforts on expense discipline, mix management within our segments and ongoing expense leveraging as we continue growing the topline. As a result of these efforts, our operating margin in both of our business segments improved during the third quarter of fiscal 2022 versus the prior year. 21:11 Our adjusted tax rate for the third quarter of fiscal 2022 was 24.7% compared to 20.2% in the same period one year ago, representing a $0.03 per diluted share headwind compared to the prior year period. Reported net income attributable to Patterson Companies Inc. for the third quarter of fiscal 2022 was $57.0 million or $0.58 per diluted share. This compares to reported net income in the third quarter of last year of $48.8 million or $0.50 per diluted share. 21:46 Adjusted net income attributable to Patterson Companies Inc in the third quarter of fiscal 2022 was $54.2 million or $0.55 per diluted share. As a reminder, adjusted net income excludes deal amortization and gains on investments. This compares to $55.8 million or $0.58 per share in the third quarter of fiscal 2021. 22:12 Now let's turn to our business segments, starting with our Dental business. In the third quarter of fiscal 2022, internal sales for our Dental business increased 0.1% compared to the third quarter of fiscal 2021. On a year-to-date basis, our Dental business is up 6.8% versus the same nine-month period in the prior fiscal year. Internal sales of dental consumables decreased 1.8% in our fiscal 2022 third quarter compared to the prior year. 22:45 As we stated at the beginning of our fiscal year, we expected the revenue contribution of certain infection control products to decline on a year-over-year basis. To that point, during the third quarter, sales of certain infection control products decreased by approximately 20% compared to the third quarter of the prior fiscal year. When excluding the sales impact from infection control products, our consumable sales grew 3.6% year-over-year. 23:12 As Mark previously mentioned, we estimate that the impact of the Omicron COVID-19 variants, negatively impacted our consumables in the third quarter by approximately 2%. While it's difficult to isolate the impact of any one variable in the timing of the Omicron variant affected each geography differently, we did observe the most noticable slowdown in our daily consumable sales from the last week in December through the entire month of January due to patient appointment cancellations and office staff shortages. 23:44 As additional context, if you compare our third quarter dental consumables performance, so the pre-pandemic period of the third quarter of fiscal 2020, internal sales increased to 11.5%. During our fiscal 2020 third quarter, internal sales of dental equipment and software increased 1.6% compared to one year ago. While sales of CAD/CAM and digital technology products were strong in the quarter, our core equipment category continues to be impacted by the known supply challenges related to these products. 24:20 As we've noted previously, the equipment category growth can vary by quarter. It is worth noting that even with these continued supply chain challenges during the first nine months of fiscal 2022, sales of dental equipment increased 5.3% versus the same period in the prior fiscal year. Additionally, our average quarterly year-over-year growth for our equipment business over the past eight quarters is 5.2%. This performance continues to illustrate the strength of our value proposition for Patterson as the partner of choice when it comes to the selling, financing, training and servicing of equipment for our Dental customers. 25:02 Adjusted operating margins in dental were 10.1% in the fiscal third quarter and up 70 basis points from the third quarter of last year, driven by improved gross margin and continued expense discipline. Again, we remain committed to driving operating margin improvement in our Dental business for fiscal 2022. 25:21 Now let's move on to our Animal Health segment. In the third quarter of fiscal 2022, internal sales for our Animal Health business increased 8.2% compared to the third quarter of fiscal 2021. Internal sales for our Companion Animal business increased 12.4% compared to the third quarter of last year. While internal sales in our Production Animal business grew 3.6% in the third quarter compared to the prior year. 25:49 For some additional context on this performance, let's go back two years ago to the comparable period before the impact of the global pandemic. Animal health internal sales for the third quarter of fiscal 2022 increased 19.0% compared to the third quarter of fiscal 2020. Adjusted operating margins in our Animal Health segment were 3.4% in the fiscal third quarter, an increase of 10 basis points from the prior year. 26:16 Our Animal Health team continues to successfully drive higher sales growth with vendor partners to reward us for our value-added approach to both our companion and production animal customers. Additionally, our team also delivered improved product mix with stronger sales of private label products, equipment and software. 26:36 Moving on to free cash flow and capital allocation, through the first-nine months of fiscal 2022, our free cash flow is $57.7 million, an increase of $49.2 million over the first nine months of the prior year. Please note that our free cash flow for the first-nine months of the fiscal 2022 includes $36 million to settle our shareholder litigation in the second quarter. While our year-to-date free cash flow is running ahead of the same period last year, in the fiscal third quarter, we did choose to take advantage of some strategic purchases before we enter the new calendar year. 27:10 During the third quarter of fiscal 2022, we declared a quarterly cash dividend of $0.26 per diluted share and returned $25.3 million to our shareholders. Through the first-nine months of fiscal 2022, we have paid out $75.7 million in dividends. Our Board continues to view our dividend as an important component of our capital allocation strategy to return cash to our shareholders. 27:37 Let me conclude with some comments on the remainder of our fiscal 2022. Today, we are raising our GAAP earnings guidance from our prior GAAP guidance range of $1.69 to $1.79 per diluted share to a new GAAP guidance range of $1.86 to $1.91 per diluted share. We are also updating our adjusted earnings guidance from our prior guidance range of $2 to $2.10 per diluted share to a new adjusted earnings guidance range for fiscal 2022 of $2.08 to $2.13 per diluted share. 28:16 Now I will turn the call back to Mark for some additional comments.

[Mark Walchirk, President & CEO]

28:21 Now before we move on to Q&A, I want to again acknowledge and thank our employees for their continued dedication, focus and execution of our strategy. Particularly over the last few years, as our business and end markets continue to face various obstacles and challenges. This mindset helps Patterson live out our purpose, vision and values every day in this foundational to our success, employee engagement and performance. 28:47 I'm proud that Patterson Dental was recently recognized as the best overall Dental supply company by Verywell Health, based on our exceptional customer support. We also achieved a significant improvement on the Human Rights Campaign Foundation's Corporate Equality Index which measures corporate policies related to workplace equity. And finally, Patterson recently joined the Forbes list of America's Best Large Employers. This recognition is a testimony to the focus and passion of our entire Patterson team to serve our customers, our industries and our communities. 29:22 So to wrap up, as we head into Q4, we're optimistic about the momentum in our business and our ability to continue the successful execution of our strategy. We are well positioned to capitalize on the positive fundamentals in our end markets as we strive to be an indispensable partner for our customers. And we continue to look for opportunities to make thoughtful investments to drive top line growth, margin improvement and value creation for our shareholders. 29:49 And with that, Don and I look forward to taking your questions.

[Operator]

29:53 [Operator Instructions] And your first question comes from the line of Michael Cherny from Bank of America. Your line is open.

[Michael Cherny, Bank of America]

30:10 Good morning and thanks so much for taking the call. I would love to dive a little bit more into the margin progression over the course of the quarter. Clearly, given macro factors the margins stood out in terms of upside you generated relative to, at least our expectations. As you think now and maybe Mark and Don for a look back as well, since you joined the company, where do you think you are in terms of the broad-based margin progression and how should we think about the next leg of upside, especially as volume dynamics return towards normalized levels?

[Don Zurbay, CFO]

30:43 Yeah. Thanks, Michael. Good question. I think, I would characterize us as really kind of in the middle innings of this process. We've made good progress, it's not always linear, but I think if you look over time, we've made progress, particularly, if you look at each business unit separately but more, more opportunity to come, we think that for both of our business units there is opportunity to continue to expand the margin and we really look forward to that as we move forward.

[Mark Walchirk, President & CEO]

31:19 Yeah, Michael. This is Mark. Thanks for the question. We spoke a fair amount about mix in our prepared remarks and maybe just to again highlight the importance of this really across both of our businesses and really a key element is how we continue to drive the margin expansion over time and this will continue to be a strong focus for us and the key areas that we've spoken to like private label, equipment and technology, software and support services, all of these areas and others will -- we will continue to invest in, align our goals around, track and monitor with KPIs. And importantly, incent our field sales and management teams to drive faster growth in these margin accretive areas. So obviously, margin improvement is a critical focus across the company and it's something that we'll continue to be very focused on, not going forward.

[Michael Cherny, Bank of America]

32:10 Thanks. And then just one more quick one and I don't think I heard this, I apologize if it's repeated, do you -- could you give any commentary around February exit rates and where things stand as we sit today?

[Mark Walchirk, President & CEO]

32:22 Well, we're not commenting specifically on February, but certainly, we saw what we kind of think there is a bit of a bell curve with -- that related to the Omicron variant, we started to see some impacts in late December, early January and then I think really the most acute period for us within the last several weeks of January and fortunately, not only from a business standpoint, obviously, but from a public health standpoint it seems like the Omicron variant has gone away as fast as it came in. So, we were pleased with the return to the pre-Omicron levels, I would say and in certainly, we've built any potential impacts from that into our fourth quarter guidance.

[Michael Cherny, Bank of America]

33:09 Great. Thanks so much.

[Mark Walchirk, President & CEO]

33:12 Thank you.

[Operator]

33:13 Your next question comes from the line of Erin Wright from Morgan Stanley. Your line is open.

[Erin Wright, Morgan Stanley]

33:20 Great. Thanks. And [indiscernible] can you speak to what exactly you're experiencing in terms of supply chain challenges and can you quantify how big of an impact that was there will be over the next kind of several quarters and what sort of visibility you have on the dynamic as well as the key areas of focus, or areas of impact? You mentioned strong CAD/CAM, but I guess provide some level of detail where you're seeing the headwinds there? Thanks.

[Mark Walchirk, President & CEO]

33:46 Yeah. Sure, Erin. Thanks for the question. We've spoken I think for a number of quarters regarding the core equipment category in Dental in some of the ongoing supply chain challenges there. And I think as we indicated, we do expect to see those persist here through the first half and into the second half of the year. I was at the Chicago Midwinter Meeting last week had an opportunity to speak with a number of our manufacturers on this topic and they're certainly facing challenges, not so much now from a labor standpoint, but primarily now with the availability of certain component parts and I don't think Omicron certainly didn't help the situation in December and January and again just due to the -- I think ongoing supply chain challenges that we expect these delays to continue on core equipment. 34:36 I would however, say, the good news is that the demand for these products continues to remain strong, very strong in fact, and so the issue is not simply the supply chain, but there is also an issue of increased demand. Our customers are continuing to invest in their practices, which is a great sign and how they view the marketplace going forward. And the comfort that they have in their businesses and their practices going forward. So, while certainly an unfortunate delay in getting the orders produced and install for our customers the pipeline and backlog is very promising. We continue to stay very close to our manufacturers. We certainly are starting to see some supply chain impacts and some of the technology products and again we're staying very close to our manufacturers to continue to manage through that. And again, I would say we're just generally dealing with some significant supply chain issues around certain parts, but the good news for us and what keeps us very encouraged here is the backlog and pipeline remains very strong. And we're just pushing some of these orders perhaps out a little further than we had originally expected.

[Erin Wright, Morgan Stanley]

35:45 Okay. Great. And then on Animal Health, you mentioned some positive dynamics across Companion Animal with double-digit growth. But you are also mentioning some normalization and trends are you starting to see that now and where do you think that long-term growth profile for Animal Health shapes out for you? And can you speak to also the opportunity for drivers of future margin expansion across that particular segment? Thanks.

[Mark Walchirk, President & CEO]

36:09 Yeah. Sure. Thank you. I think we've been saying for a number of quarters that we didn't expect that 20% plus growth in the Companion Animal segment for forever obviously, we have seen that start to moderate, but we also have delivered now I think six straight quarters of double-digit top line growth there. So, our teams are doing a fantastic job in the field and we're working closely with our -- the strategic relationships we have with certain key manufacturers there. Our comprehensive value prop, I think is resonating with our customers and obviously there are certainly some strong market tailwinds in that segment. Our teams are taking full advantage of those tailwinds and executing well and we believe delivering growth that is clearly outpacing the market. 36:56 In terms of the go forward, we certainly believe there has been a step change in the kind of the fundamentals of the companion animal market and certainly, once we would kind of get fully past the COVID dynamic. We certainly believe that that market will grow at a faster rate growth post-pandemic then it was pre-pandemic. And so, we're really, really encouraged by that. And our team, as I said is doing a great job of taking advantage of those tailwinds. In terms of your question around margin enhancement, look, I think it also gets back to this discussion earlier Michael's question around mix, we continue to focus our teams across both of our businesses and mix and in the animal health space many similar opportunities around private label, equipment, technology, software and services and our teams are really focused on driving mix improvements to expand margins over time. So, we think there is certainly opportunity and good runway there as well.

[Don Zurbay, CFO]

37:55 And this is Don. Let me just -- the only thing, I'd add to Mark's comments is also just really the leveraging impact of continued sales execution and continued sales volume increases.

[Erin Wright, Morgan Stanley]

38:10 Okay. Great. Thank you.

[Operator]

38:13 Your next question comes from the line of Jeff Johnson from Baird. Your line is open.

[Jeff Johnson, Baird]

38:22 Thank you. Good morning, guys. Maybe a question on pricing in the non-margin, so Mark started with you on pricing, I think it's fairly accepted now that pricing probably up 2% to 3% in consumables this year at least most places outside of the largest DSOs. What's going on in pricing in the Animal Health segment? We’re just not as familiar there haven't heard as much about pricing there, are you getting pricing power there? And even on dental equipment, we've heard kind of mixed thing. So outside of Dental consumables, just how should we think about the pricing environment over the next 12 months? Thanks.

[Mark Walchirk, President & CEO]

38:53 Yeah, Jeff. Thank you. Certainly, I think as we indicated and Don indicated, the cost increased activity from both really dental and animal health came in generally as we anticipated. And then the range that we expected that we spoke of, I think last quarter, we did see some higher levels of normal cost inflation in late 2021 and into calendar ‘22 across both segments, probably a bit more in Dental then perhaps Animal Health. So, Animal Health was just maybe just a tick above average and Dental maybe a couple of ticks above average there. And I would say primarily, we did see it more so in the consumables categories. Although, we have seen some in the equipment category as well and I think per my earlier comments, the fact that obviously we're continuing to see strong demand in that area. I think the manufacturers obviously have a number of inflationary pressures that they're dealing with and obviously, they make their decisions around the pricing in the marketplace and the product recommended product price. So, we have a very strong methodology and process to pass on cost increases our teams did a great job executing on that. So, we feel real good about where we stand. We certainly are staying close to our manufacturers and as things continue to evolve from a supply chain and inflationary standpoint, there are other cost increases that perhaps will occur over the course of the year obviously, will be ready for those. And we'll take the same, the same process that we did at the first of the year. So, feel real good about where we stand at this point and obviously, we're staying very close to it. And I would say, at the same time working closely with our manufacturers to try to identify opportunities to mitigate or to minimize those cost increases that ultimately do get passed on to our customers.

[Jeff Johnson, Baird]

40:44 All right. That's helpful. Thank you. And Don, maybe just on the margin side, you guys have touched a couple of times on this call about the segment improvements the 10 basis points in Animal Health, 70 basis points in Dental. And I think that's more or less been true over the last several quarters as well that the segments have been flat to up at least as a general trend, but even this quarter, if we exclude those mark to market impacts the company wide margin flat in year-over-year, which would imply the corporate or the unallocated kind of pulled down those segment improvements. And I would think the unallocated to the corporate would be kind of the more in your control kind of part of the expense line. So just what's going on the corporate side, and how should we think about that outside of just the segment margin going forward? Thanks.

[Don Zurbay, CFO]

41:32 Yeah. Jeff, I think it's really less about the corporate segment and just more also about segment mix, in terms of the way that the sales have progressed this year. So, if you look at it going forward, we think that kind of headwind, if you will to the overall operating margins versus the segment operating margins will moderate and not be quite as big a drag on us, but I think it has more to do with that in the mass. The corporate segment -- in the corporate segment, generally, other than some of the elements we've talked about with the interest rate hedging hasn't really been a big change -- there's not really big fluctuations or variances there, they are really doing anything significant to our margin.

[Jeff Johnson, Baird]

42:23 Okay. That’s helpful. Thank you.

[Operator]

42:25 And your next question comes from the line of Jason Bednar from Piper Sandler. Your line is open.

[Jason Bednar, Piper Sandler]

42:33 Hey. Good morning. Thanks for taking the questions. Mark or Don, I'm going to come back on the margin side because those gross margin improvements in Dental and Animal Health were really strong. But there’s clearly some commodities (ph) here on a year-over-year basis with comps and rebates and things like that. So maybe could -- is there a way you could unpack for us just maybe how much this quarter -- the strength we saw this quarter was a normalization of some of those things and things like those rebates maybe product mix versus what is a reflection of things you're doing such as improving sourcing, managing expenses, taking price actions, et cetera?

[Don Zurbay, CFO]

43:12 Yeah. I think, it's a really a little of all of it. We probably wouldn't break the pieces out. I think for us both sides are contributing and the things we're doing internally to help the margin is really what I look at it on the go-forward basis.

[Mark Walchirk, President & CEO]

43:36 Yeah. And I would just add, Jason, thanks. I think it's a combination of factors and just good strong execution across the business, both from a gross margin and operating margin standpoint. So many of the things that you mentioned sourcing, mix, pricing, continuing to manage our expenses, getting leverage on the increased top line. Those are all factors that are contributing, both to our gross margin and operating margin performance, and it has been, it is and it will continue to be a very strong focus for us going forward.

[Jason Bednar, Piper Sandler]

44:09 All right. That's helpful. And then maybe as a follow up, a lot of us have been asking the last few quarters about your M&A interest and you've included the appetite certainly there. Could you help us with maybe where you're at in the stage of evaluating targets? Is there anything right now that's keeping transactions for getting across the finish line, whether it'd be evaluation, strategic fit, cultural fit, just anything on those lines would be helpful? Thank you.

[Mark Walchirk, President & CEO]

44:39 Yeah, Jason. Thanks. I mean we have noted our improved financial performance and obviously the strength of our balance sheet has certainly put us in a position to make those types of strategic investments. We continue to actively pursue these opportunities and really gets to exactly what you said when we find the right ones that fit strategically for us financially culturally, we will certainly move forward and we have and continue to evaluate a number of opportunities, but as we've also noted we're not simply going to do a deal, do a deal just for the sake of doing a deal. And so, we have a disciplined approach around that, but it's certainly, I wouldn't want to suggest it's no longer a focus, it's absolutely a focus for us and we'll continue to evaluate opportunities and to your question about getting them across the goal line to this point, we just haven't found the right, the right ones that against it those various elements. 45:33 I'll also tell you, we're making internal investments to also help drive growth and profitability. Investments in our fulfillment center operations to improve productivity, investments in our technology platforms to drive greater value for our customers. And certainly, investments in our sales and service teams to continue to really drive our value proposition in the marketplace. So, we're going to continue to look for ways to drive inorganic growth through investments, we're going to continue to invest internally for organic growth and margin expansion. And its a -- will remain an important focus for us going forward.

[Jason Bednar, Piper Sandler]

46:13 All right. Appreciate the color. Thank you.

[Mark Walchirk, President & CEO]

46:17 Thank you.

[Operator]

46:18 Your next question comes from the line of Kevin Caliendo from UBS. Your line is open.

[Kevin Caliendo, UBS]

46:27 Great. Thanks. Yesterday, [indiscernible] hinted that they may take a larger price increase than they normally do and take it earlier in the year. And can you just walk us through how that might impact you if they were to say pick up 5% increase in consumables and or equipment in May, like what happens to you build up inventories ahead of that and how does that -- would that impact the way you think about fiscal ’23?

[Mark Walchirk, President & CEO]

46:58 Yes, Kim. Thanks. I'd say in general not to comment specifically on one manufacturer. But certainly, we do see cost increase activity that happens throughout the course of the year, typically it does happen in Q4 or Q1, but it doesn't mean that manufacturers don't take price increases throughout the course of the year and as we've indicated, we have a tight formal process that we use to manage through that those situations. There is opportunities to -- as Don indicated, make strategic purchases will do so if that makes sense. And then as we've spoken our pricing methodology with our customers, both on the dental and animal health sides of the business really allow us to pass on those manufacturer cost increases to our customers and our teams, this is not a new phenomenon for us, our teams have done this consistently over the years and we have a formal process to do that and they executed it again very well this year. So, if we were to see further price increase activity then we will implement the same process. To this point we're not anticipating that in our Q4 and to the extent that there is any elements of that for next year, we'll speak to it next quarter.

[Kevin Caliendo, UBS]

48:21 That’s helpful. And just one quick follow-up. The chip shortages and the impact on that. Can you just quantify in any way, like how meaningful it is or any -- you have any visibility on when that might start to clear up and how if it's been impacting, you didn't really call it out specifically here, and I'm just wondering, if you could or if it's not material enough to call out and when you think if it is material when it might clear up?

[Mark Walchirk, President & CEO]

48:53 Yeah. I think Kevin as we indicated we spoke, I spoke a little bit to kind of certain component parts and it's certainly would be in particular the chip shortage were not as close to it as our manufacturers would be directly, but we're obviously staying very close to them as they are working through some of the challenges associated with the chips and component parts. My discussions last week as a matter of fact with a number of manufacturers were specific on this topic and it is a very challenging supply chain situation for a number of our manufacturers right now. As I indicated, and I think we believe that the core equipment category challenges will probably persist into the early second half of the year. And we are starting to see some, I would say modest challenges with regard to some of the higher technology products. But as I indicated earlier, we built that at this point into our Q4 and I would just again underscore a large part of the challenges from a supply chain standpoint in the timing of getting products to our customers and installed is because the demand is very strong across the entire equipment category. And so that continues to give us confidence in our customers, investing in their practices and obviously, we feel very good about our competitive position as it relates to equipment and technology and our ability to work with our customers there. So hard to give you a specific date or time line. Frankly, I think it is perhaps a bit of a moving target at this point and obviously things are evolving across the supply chain that could affect that over time. But at this point, I think what we shared is what we know at this point and we're obviously staying very closely -- close to our manufacturers as that situation may evolve.

[Kevin Caliendo, UBS]

50:42 Thank you so much.

[Mark Walchirk, President & CEO]

50:44 Yeah. Thank you.

[Operator]

50:47 Your next question comes from the line of Nathan Rich from Goldman Sachs. Your line is open.

[Nathan Rich, Goldman Sachs]

50:52 Hi. Good morning. Thanks for the questions. Don, maybe one for you on the guidance for the fourth quarter, it looks like a similar level of EPS relative to what you reported in the third quarter. I guess, is there any detail you could kind of give us between revenue and margins, given some of the supply headwinds that you talked about in Dental equipment and also kind of the recent outperformance on margins, maybe just how are you kind of thinking about that at a high level?

[Don Zurbay, CFO]

51:22 Yeah. I think if you look back at last year's Q4, there were some LIFO challenges and a few other things that we had called out. So, we expect, if you look on a year-over-year basis for the gross margin to be up fairly significantly. And then, on the operating margin, same thing for the same reason. So, I think if you more – if you look at it on a year-over-year basis, that's where you'll see some pretty significant margin improvement in the actual fourth quarter compared to last year. And then, -- yeah. I guess that’s what I would say on that.

[Nathan Rich, Goldman Sachs]

52:04 Okay. And I guess maybe just following up on sort of top line and I guess is there any way to kind of talk about the magnitude of the slowdown that you saw in January relative to maybe what the business did in November and December, kind of, I guess particularly for the Dental consumables business and I guess with those kind of November, December race would be more appropriate as we think about going forward, both fourth quarter and beyond?

[Mark Walchirk, President & CEO]

52:36 Well, I think with regard to the impact in January and in our fiscal third quarter, but again I think most acute in the last several weeks of January, I think we indicated Delta had perhaps, about a 2% impact in our consumables for the quarter and we saw some lingering effects, what we're really pleased by Nathan is the, the rate of patient demand, office visits, appointments really back on track here after certainly some impact in the month of January. So, in terms of our consumables, we expect it to be, to be back on track here obviously, pending no other further COVID related impacts and really that period from late December through at the end of January we think is, for the most part behind us at this point.

[Nathan Rich, Goldman Sachs]

53:32 Makes sense. Thanks for the comments.

[Mark Walchirk, President & CEO]

53:36 Yeah. Thank you.

[Operator]

53:38 Your next question comes from the line of Jon Block from Stifel. Your line is open.

[Jon Block, Stifel]

53:43 Yeah. Hi. Good morning. First question I want to actually follow up a little bit on some that's been asked, but Don, just looking at the guidance, you're no longer expecting fiscal ‘22 to have sort of that 4Q EPS back-end weighted component. I think the guide now implies, sort of flat Q-over-Q EPS and just would love your thoughts, is it just sort of a conservative nature, why no longer do expected to step up into fiscal 4Q considering based on what you guys said you might get some Omicron delayed visits that hopefully surface in that February or March timeframe from the delays that you called out or that we all saw in December and January?

[Don Zurbay, CFO]

54:27 Yeah. I think we're just trying to strike a balance with that and some of them being a little bit cautious on some of the elements that we've talked about. So, and this year had a much different cadence than last year. So, while we expect some increase Q3 or Q4, it's really not the same dynamic that we've had in the past, just given some of the timing dynamics we've seen.

[Jon Block, Stifel]

54:56 Okay. Got it. And then more maybe for you, I know M&A was also asked earlier, but maybe just talk to us about M&A versus partnerships versus share repos or even increasing the dividend. When I look at a partnership, or what I call partnerships are, there seems to be a lot of clear aligners that have hit the market that I think would really benefit from a broader reach into GP's even some DTC companies that seem to be refocusing on the professional channel there was or fit that was somewhat announced recently. We don't -- I don't think they have the broad reach and the breadth that you guys have. So just would love your thoughts on how you guys evaluate the M&A, the purchase versus, hey, we want to leverage our sales force versus putting capital to work in a different way via share repo? Thanks.

[Mark Walchirk, President & CEO]

55:45 Yeah, John. Thanks, good question. I'd say, those are all part of the calculus that we consider in terms of ultimately driving growth and shareholder value over time. So opportunities to make obviously outright acquisitions we've spoken on some of the things that we would prioritize their areas that would strengthen our value proposition, build and expand our presence in margin accretive product, software service areas, looking to build scale in our core business just several examples, or maybe the types of areas that would be a good fits for us, but also the idea of how we can partner with manufacturers or new companies that are entering the space that have products or services that could really take advantage of the scale and reach that Patterson has across both our Dental and Animal Health businesses. So that is also an area that we are focused on and consider and have ongoing discussions around. 56:48 And then the third piece in terms of other ways to return cash to shareholders, I think as Don indicated and I’ll pass it to him here in a second. We certainly remain committed to our dividend, and in general, looking for ways that we can invest in the business, invest in organic growth, invest in inorganic growth partnerships and also additional ways that we can return cash to our shareholders over time. So, Don not sure if you have anything to add there.

[Don Zurbay, CFO]

57:17 No. I think that was pretty comprehensive.

[Jon Block, Stifel]

57:22 Perfect. Thanks, guys.

[Mark Walchirk, President & CEO]

57:24 Thanks, John.

[Operator]

57:26 And your last question comes from the line of John Kreger from William Blair. Your line is open.

[John Kreger, William Blair]

57:33 Hi. Thanks very much. Mark just to clarify the dental equipment supply chain issues. So, from your perspective, should we assume that maybe it gets a little bit worse as it sounds like maybe it's creeping into some of the higher tech categories?

[Mark Walchirk, President & CEO]

57:50 Well, John, I think certainly the Omicron situation in January, in particular didn't help primarily around the core equipment category. And so, we have indicated, we felt like it will go through the first half and probably into the second half certainly calendar Q3 on the core equipment side. We did here earlier this week and we are seeing some, I would say, moderate impacts with regard to some of the imaging CAD/CAM more of the high-tech digital products. What I would say is the backlog continues to be strong and we have opportunities to continue to install products that were quarter here over the past weeks and months. So hard to say at this point of it's getting worse. We're staying very close to it. It does literally change I think day by day for our manufacturer partners based on the accessibility to certain component parts in particular chips, so hard to -- really hard to predict at this point in terms of a timeframe. 58:45 The thing that gives us good confidence even to the extent that I was -- some of these orders may be pushed out a bit, is the fact that demand remained strong, really across the entire equipment category. I know, I probably said that a few times, but I really want to continue to underscore that. Our customers are continuing to invest in their practices that gives us high confidence in the long-term growth opportunities in this segment. And while we're in the midst of working through some supply chain challenges. I think if you think about the long-term prospects for equipment and technology in the Dental segment. It's very strong. We're very optimistic about that. And we're very focused on continuing to drive growth in that area and our team does a fantastic job. 59:44 And the last thing, I would say is, sometimes it also depends on the manufacturer. So, manufacturers have had less, less issues than others. We sell a very broad product line of core and digital dentistry technology products and so we'll continue to manage through that on behalf of our customers and work closely with our manufacturers to get those products that are shipped and installed as soon as possible.

[John Kreger, William Blair]

60:11 Sounds good. Thanks. Maybe one other one. I know you guys have put a lot of effort into making your sort of corporate account offering more competitive across both Animal Health and Dental. Can you just give us an update on how that's going? Any kind of key jump ball opportunities or renewals situations in the coming year, that we should be thinking else?

[Mark Walchirk, President & CEO]

60:31 Yeah. Nothing that I would call out in particular around specific customers or specific opportunities in the months ahead. It really is -- we've said across both our businesses, I mean Dental space [indiscernible] DSOs. The animal health space with corporate accounts. Our teams are doing very well there. We continue to invest and our teams and the resources, the support functions to support customers in the DSO. Our DSO and corporate account space. We are doing very well in those spaces that growing certainly based on the strong execution of our team. So, nothing has changed in that area. In terms of our focus on it, our ability to continue to execute the investments that we have made and will continue to make to drive growth in that category and also to make sure that we continue to work with those corporate accounts, those are DSOs those DSOs that really see the value proposition that Patterson can offer and find really good partnerships, strategic relationships and partnerships that can be built on mutual success for the long term and we're excited about our continued progress there.

[John Kreger, William Blair]

61:45 Great. Thanks so much.

[Mark Walchirk, President & CEO]

61:48 Yeah. Thank you.

[Operator]

61:50 This concludes our question-and-answer -- I apologize, this concludes our question-and-answer session. I will turn the call back over to Mark Walchirk, CEO for some closing comments.

[Mark Walchirk, President & CEO]

62:03 Yeah. Thank you very much and thank you everyone for your time today and continued interest in Patterson Companies and we look forward to speaking to you again next quarter. Thanks very much.

[Operator]

62:13 This concludes today's conference call. Thank you for your participation. You may now disconnect.