Patterson Companies Inc (PDCO) 2019 Q2 法說會逐字稿

Good morning.

My name is Denise, and I'll be your conference operator today.

At this time, I'd like to welcome everyone to the Patterson Companies Second Quarter Fiscal 2019 Conference Call.

(Operator Instructions) Thank you.

Mr. John Wright, VP of Investor Relations, you may begin your conference.

Thank you, operator.

Good morning, everyone, and thank you for participating in Patterson Companies Fiscal 2019 Second Quarter Earnings Conference Call.

Joining me today are Patterson President and Chief Executive Officer, Mark Walchirk; and Chief Financial Officer, Don Zurbay.

After a review of the fiscal 2019 second quarter by management, we will open up the call to your questions.

Before we begin, let me remind you that certain comments made during this conference call are forward looking in nature and subject to certain risks and uncertainties.

These factors, which could cause actual results to materially differ from those indicated in such forward-looking statements, are discussed in detail in our Form 10-K and 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, December 6, 2018.

Patterson undertakes no obligation to revise or update any forward-looking statements to reflect events or circumstances after the date of this call.

Also, a financial slide presentation can be found in the Investor Relations section of our website at pattersoncompanies.com.

Please note that in this morning's conference call, we will reference our adjusted results for the second quarter and first 6 months of both fiscal 2018 and fiscal 2019.

The reconciliation table in our press release is provided to adjust reported GAAP measures, namely operating income, income before taxes, income tax expense, net income, net income attributable to Patterson Companies Inc.

and diluted earnings per share attributed to Patterson Companies Inc., or the impact of deal amortization, integration and business restructuring expenses and legal reserve costs, along with the related tax effects of these items.

We will also discuss free cash flow, which is a non-GAAP measure, and the impact of foreign currency.

In particular, we use the term internal sales to represent net sales adjusted to exclude foreign currency impact and changes in product selling relationships.

The reconciliation of our reported and adjusted results can be found in this morning's press release.

This call is being recorded and will be available for replay starting today at noon, Central time, for a period of one week.

Now I'd like to turn the call over to Mark Walchirk.

Thank you, John.

And first, let me start by thanking all of you for your patience and flexibility in joining us for our second quarter call a week after we originally anticipated.

As we announced last week, we needed more time to work through a technical accounting treatment update related to the appreciation of shares associated with joint venture investments.

And with that work now complete and our full second quarter results now reported, I want to provide you with a summary of our second quarter results and an update on the progress against our key initiatives.

But before we turn to the quarter, I'd like to take a brief look back at our progress over the past year.

It has been just over one year since I officially joined Patterson as CEO.

It has certainly been a dynamic year, and I can tell you, I am more energized and committed than ever to helping lead our company into the future.

And while we certainly have much work ahead to deliver more consistent performance, I am pleased with what our team has been able to accomplish in a short period of time.

We've installed new processes and procedures, including a specific focus on key performance metrics, that are improving our core day-to-day business execution.

We are stabilizing our field organizations, performing extensive work to enhance our customer value proposition and align the organization around a focused set of initiatives.

We have also continued to build upon our experienced and tenured team with new talent and a fresh perspective, and evolved our company culture with a focus on driving improved collaboration, accountability and a focus on execution.

Taken together, we are building a strong foundation for future success, and we are beginning to see the early impact of our actions in our results.

We are encouraged by some early signs of improved performance, but we recognize that our transformation will take time, and we continue to believe that fiscal 2019 is a transition year for our business.

That said, our results during the quarter and through the first 6 months of the year give us confidence that we are taking the right steps to build a stronger Patterson that is well positioned to deliver long-term value.

Turning now to the second quarter.

Our results met our expectations and demonstrate the effect of beginning to execute against our key initiatives.

Internal sales increased 1.8% in the quarter, which marked our second consecutive quarter of year-over-year revenue growth, as our top line is starting to benefit from the actions we're taking to improve the customer experience, stabilize our field sales organization and enhance sales execution.

Our operating margins improved sequentially from the fiscal 2019 first quarter.

We are pleased with these improved results, and we are committed to continuing to take additional steps to stabilize our margins and improve our profitability in the face of what we expect will continue to be a competitive environment in both our Dental and Animal Health segments.

Based on our performance to date and our outlook for the back half of the year, we are reaffirming our fiscal 2019 guidance.

Turning briefly now to our results across our 2 segments.

Within our Animal Health segment, we delivered another solid quarter with internal sales increasing 4.5% compared to the same period a year ago.

These growth rates are at or above what we believe to be the underlying market for both the companion animal and production animal segments.

In the Dental segment, overall internal sales declined 1.8% versus the second quarter of fiscal 2018.

In our consumables business, we continue to see improving revenue trends.

And in our equipment business, while overall sales were essentially flat, we are pleased with the growth we generated in the digital and CAD/CAM categories as our technology equipment grew approximately 15% in revenues on substantially higher unit volume in the second quarter.

As we have discussed over the past year, we are sharply focused on executing 5 broad initiatives.

First, improving the customer experience; second, enhancing sales execution; third, stabilizing our margins; fourth, driving improved cash flow; and fifth, continuing to build the overall talent at Patterson.

Let me discuss the progress we are making with respect to each of these initiatives.

Starting with our focus on improving the customer experience.

As we said last quarter, we believe the most significant customer issues we have faced have been addressed and are largely behind us.

We continue to invest in our digital experience to make it easier and more effective for our customers to do business with Patterson.

Overall, we continue to meet or exceed our key customer experience goals, including fill rates, order quality and customer satisfaction.

As part of our focus on the customer experience, we've been regularly measuring customer satisfaction and Net Promoter Score, and we have seen steady improvement over the past year.

With respect to improving sales execution, we continued to invest in building out our sales force across both our Dental and Animal Health segments.

During the second quarter, we met our goals for onboarding new sales representatives and have trained and equipped them with useful productivity tools, including our powerful new CRM system.

We believe the investments we are making in this area to add to our sales force and to use technology to help make our reps more productive will help enable our field organization to serve our customers more effectively.

Our third initiative is centered around stabilizing our margins, which is primarily focused on 3 core areas: an increased focus on higher-margin private-label products, strategic sourcing and cost savings.

Our focus on expanding and growing our private-label portfolio is progressing well.

As we have discussed previously, we have established specific private-label growth goals for each of our businesses and aligned management and the sales team around increasing the penetration of our existing private-label portfolio.

As a result, our private-label category grew more than 7% company-wide in the second quarter compared to last year.

This included strong year-over-year growth in our Animal Health private-label products and also, notably, year-over-year revenue growth in our Dental private-label products.

During the first half of fiscal 2019, we added close to 100 new SKUs to our private-label portfolio, and we continue to see more opportunities for additional SKU introductions going forward.

Expanding our private-label offering aligns with the needs of our customers and enables us to capture improved margins, which is a key element of our overall plan to stabilize our margins over time.

In addition, we implemented a disciplined strategic sourcing program that we believe is scalable and will allow us to accelerate progress in this important area.

This will be a multi-year initiative, but we are already seeing progress.

For example, we recently completed a comprehensive portfolio review of our Dental private-label portfolio, which included a formal RFP process.

This strategic review resulted in vendor and SKU consolidation and improved acquisition costs.

We will continue to pursue additional opportunities to drive our strategic sourcing initiatives across the company.

We also remain sharply focused on carefully analyzing our cost structure and making adjustments to balance our expenses with the needs and opportunities of the business.

And we are taking steps to help ensure these -- the appropriate balance in this area.

With respect to our fourth initiative, improving working capital and cash flow, our efforts have driven meaningful improvements as our inventory, accounts payable and accounts receivable balances were all favorable on a sequential basis compared to Q1 of fiscal 2019 and also improved on a year-over-year basis from 2Q of fiscal 2018.

Our teams are squarely focused on improving working capital, and we are holding our leaders accountable for these improvements.

Don will provide some additional color on our performance in this area during his remarks.

Turning now to our final key initiative, continuing to build and enhance the overall talent at Patterson.

Earlier this week, we announced the appointment of Tony Pellegrin as Vice President of Business Development.

This is a newly created role for Patterson, which is designed to enable us to explore additional opportunities for strategic growth in an efficient and focused manner.

Tony brings over 25 years of corporate development experience, and we are excited to have him on board.

In addition, we are making good progress on the search for a new President of our Dental business, and we expect to complete this process in the coming weeks.

While it is clear that we still have a lot of work ahead, we remain focused on these key initiatives to improve our core business execution.

And as we discussed today, we are beginning to see our efforts pay off.

Our team is aligned on our goals, working collaboratively across functions and holding each other accountable, and we are encouraged by our progress.

Before I turn it over to Don, I also want to provide a brief update on the long-term strategy process we've been undertaking.

We continue to believe that we are in strong and stable end markets.

And certainly, we actively monitor these markets, the trends impacting them and the competitive environment and product and service lines in which we operate to identify continuous opportunities for improvement.

Across both our Animal Health and Dental businesses, we recognize that delivering a broad range of products, technologies and value-added services are the key factors for our customers of all sizes and types.

Our customers value the variety of products and technologies we offer as well as our ability to tailor a set of solutions most relevant to their needs.

You should expect our go-forward strategy to build upon our strong value proposition, which remains critical to our long-term success and is grounded in a wide range of products, technology and services that our customers rely on and the exceptional relationships we have with them.

At a high level, we will be focusing on several key areas.

First, we will continue to strengthen our core and focus on delivering even better execution and a greater customer experience.

Second, we will accelerate our investment in high-value areas of our current business.

And finally, we will continue to invest into other adjacencies that help create superior customer value and expand our growth opportunities.

Overall, we have a great foundation in each of our businesses, and we look forward to building on these strengths to become even more valuable to our customers and to deliver improved performance to our shareholders.

And with that, I'll turn it over to Don for a deeper dive into the quarter's results.

Thank you, Mark, and good morning, everyone.

First, I will walk through the financial highlights for the entire company.

Next, I'll focus a bit on each of our 2 segments.

And finally, I will cover a few balance sheet and cash flow items.

Before I get into the results, I want to make a brief comment on the recent rescheduling of our earnings call.

As we announced last week, we needed more time to evaluate the impact on nonoperating income related to the appreciation of shares associated with investments in joint ventures in light of recent accounting pronouncements.

This update in accounting treatment does not relate to our normal business operations or the accounting for those operations, nor does it have any impact on our historical results.

The second quarter results we are announcing today accurately account for our joint venture investments in compliance with the new accounting pronouncements.

As you'll see from my remarks, I will generally be focusing more on the sequential view of the business instead of the typical year-over-year comparisons.

We believe it is helpful to highlight the progress we are making in the business as we continue to focus on the business improvement initiatives that Mark has already described in some detail.

Now let me walk through the financials for the second quarter of fiscal 2019.

Consolidated reported sales for Patterson Companies in the fiscal 2019 second quarter were $1.4 billion, an increase of 1.4% versus the second quarter a year ago.

Internal sales, which are adjusted for the effect of currency translation and changes in product selling relationships, increased 1.8%.

This represents our second consecutive quarter of positive year-over-year revenue growth.

We believe this reflects the impact of our initiatives to bring growth back to the top line.

Our second quarter consolidated gross margin was 21.0%, down slightly by 20 basis points on a sequential basis from what we achieved in Q1 of fiscal 2019.

Operating expenses for the second quarter were 60 basis points lower than they were in the first quarter, reflecting initiatives to manage expenses in the quarter.

We will continue to carefully manage our operating expenses for the remainder of the year, while also balancing the need to invest in certain areas of our business to achieve our objectives to grow and improve the business.

Also included in our operating expenses in the second quarter were increased legal expenses related to our various outstanding legal matters.

The timing of these expenses is difficult to forecast, and we estimate that they impacted our earnings per share in the quarter by $0.03 in excess of what we originally forecast.

In the second quarter, our consolidated operating margin was 3.6%, reflecting a 40 basis point sequential improvement from the operating margin in the first quarter of fiscal 2019.

Our adjusted effective tax rate was 23.9% for the quarter, down from a rate of 34.6% in the second quarter of fiscal 2018 and reflecting the impact of the new tax legislation.

On the bottom line, the GAAP net income attributable to Patterson Companies Inc.

for the second quarter was $28.9 million or $0.31 per diluted share.

Adjusted net income attributable to Patterson Companies Inc., which excludes deal amortization costs, totaled $36.3 million for the second quarter of fiscal 2019, and adjusted earnings per diluted share was $0.39 in the quarter.

Now let's turn to our segments.

Internal sales for our Animal Health business increased 4.5% compared to the same period a year ago.

In both the companion animal and production animal businesses, our top line growth rate is at or above what we believe is the current rate of growth in the market.

Both categories delivered improved operating margin from the first quarter and solid performance across all species in our portfolio.

Operating margins in our Animal Health segment were 3.6% in Q2, a 40 basis point sequential improvement over the operating margins in Animal Health in the first quarter of 2019.

Now let's move on to the Dental business.

In our Dental business, internal sales declined 1.8% versus the second quarter of fiscal 2018.

On that same basis, Patterson sales of consumable dental supplies decreased 2.2% during the 2019 second quarter compared to a year ago, and total equipment sales were essentially flat versus last year.

Dental consumable sales, however, continued to improve sequentially as we experienced improved stabilization and productivity in our field sales force.

And as Mark already highlighted, technology equipment grew 15% in dollars, and we saw substantially higher unit volume as we continued the transition of selling a broader portfolio of equipment from a number of new vendors.

Operating margins in Dental were 8.4% in the quarter and reflect a 110 basis point improvement from our operating margins in the first quarter.

Now let's look at several cash flow and balance sheet items.

Through the first 6 months of fiscal 2019, we have generated approximately $200 million in cash from operating activities.

We collected our deferred purchase price receivables of $166 million on a year-to-date basis, which is included in the investing activities section of the cash flow statement.

To fully appreciate our improved cash flow, the combined total of these 2 items equals $366 million, which allowed us to reduce debt in the first 6 months of fiscal 2019 by $196 million and also have an additional $103 million of cash on our balance sheet.

As a reminder, we put our new trade AR facility in place during the first quarter as a way to efficiently access working capital and use the proceeds to pay down higher interest debt.

In addition to the proceeds from our AR facility, our year-to-date improvement in cash flow is also the result of our continued focus to decrease our net working capital, and I'm pleased to report that our net working capital numbers are favorable sequentially compared to the first quarter of this fiscal year as well as compared to the same period 1 year ago.

We believe there is more potential here for improvement in working capital, and we will remain diligent in our focus and efforts to continue this trend and free up additional cash to put to work in the business or return to shareholders.

Turning to capital allocation.

We continued to execute on our strategy to return cash to our shareholders.

Through the first 6 months of fiscal 2019, we returned $50 million to our shareholders in the form of dividends.

Let me conclude with some comments on our fiscal 2019 outlook and guidance.

For fiscal 2019, we are reaffirming our guidance and expect GAAP earnings to be in the range of $0.84 to $0.94 per diluted share and our non-GAAP adjusted earnings to be in the range of $1.40 to $1.50 per diluted share.

Our adjusted earnings guidance excludes the after-tax impact of deal amortization expenses and legal settlement reserve, which together totaled $51.8 million or approximately $0.56 per diluted share.

For modeling purposes, let me walk through a few items to help you model how we plan to finish the remainder of fiscal 2019 to land in a range of $1.40 to $1.50.

We have assumed a modest revenue growth rate improvement from our first half year-over-year revenue growth rate as we move through the remainder of the year.

For gross margin, we expect some margin contribution from our strategic sourcing and private-label initiatives in the second half of the year.

With regard to operating expenses, we have made certain adjustments to our original plan as we prepared our most recent forecast.

We are currently modeling operating expenses as a percent of sales to moderate slightly for the remainder of the year from our first half level.

While we plan to make the necessary investments to drive improved performance and still have conviction those investments are correct and showing some early progress, we know we need to balance these necessary investments with a cost structure that aligns with the profit contribution of the business.

As Mark outlined, we will continue to carefully analyze our cost structure and make additional adjustments to our expenses as needed to ensure they are aligned with the needs and opportunities in the business.

Because this process is ongoing, any further adjustments we make in our expenses are not reflected in our EPS guidance.

For our tax rate, we still expect our adjusted effective tax rate for 2019 to be in the range of 25% to 27%.

Our share count is forecasted to be in the range of 93 million to 94 million shares.

And now I will turn the call back over to Mark.

Thanks, Don.

Before we wrap up and open it up for questions, I want to reiterate that while we are certainly encouraged with our progress, we have much work ahead, and we remain focused on driving our core business execution and operating with a sense of urgency to deliver on our commitments to our customers, employees and shareholders.

And with that, we'll open up the lines, so Don and I can take your questions.

Operator?

(Operator Instructions) Your first question comes from Erin Wright with Crédit Suisse.

Can you comment a little bit on your guidance and what it implies on an operational basis, particularly in the Dental segment in the coming quarters?

I guess, was the latest quarterly experience below or ahead of your expectations?

And what are some of those factors that are contributing to the second half profit ramp?

Erin, it's Don.

I think -- I'm not sure I heard your entire question.

But I would say that our Dental margins, which improved slightly, operating margin sequentially, which is really, in our mind, how we need to look at this as we're kind of moving through this process, were really in line with our expectations.

And as we move through the remainder of the year here, I think that -- we think that there's some room for modest improvement in that operating margin in the back half of the year as some of the initiatives we have in place to help that, strategic sourcing and our private label, to name a few, help us.

So I think we're looking for some modest improvement to continue as we get into Q3 and Q4.

And again, I'm not sure I fully heard your question and if that responds to it, but that's some color for you.

Okay.

Yes, that's helpful.

And I guess my second question is more so on the dynamics across dental equipment, breaking out high-tech equipment as well as basic equipment.

I think you said high-tech was up 15%, but what was that basic equipment underlying growth trend?

And can you kind of comment on the underlying demand trends as well as the traction you're seeing from some of your new vendor relationships?

Yes, Erin.

Thanks.

This is Mark.

I mean, I think we're certainly pleased with the fact that I think we've transitioned through, over the past 12 to 15 months, the really change in our relationship, especially in the technology area, where we're obviously offering a much more broader portfolio of products.

I think some of that work and that execution was evidenced in our technology equipment results in the quarter.

Certainly, it's a competitive market, as it has always been.

We're pleased with our revenue growth as well as our unit volume growth on a wide range of technology products.

And we're pleased with the transition that the organization has made to really offer a much broader range of products and, frankly, ensure that we are working closely with our customers to help them with the right technology and equipment that meets their needs in terms of how they choose to practice.

So we're pleased with the continued progress that we've made there.

We certainly continue to believe strongly in chairside dentistry.

But obviously as a full-service provider, we feel it's important to offer a broad portfolio of products, and I'm pleased with the execution of our field teams in this area.

Your next question comes from Jeff Johnson with Baird.

Maybe a question, starting with Mark, and then Don, a question for you as well.

But Mark, just following up on your equipment comments there.

I guess, I'd be interested, you talked about unit growth in the technology side far outweighing or far outpacing the dollar growth.

Are you seeing a transition to lower-priced products from other vendors or lower prices within the same vendors?

Meaning, are we seeing price points on like-for-like or apples-for-apples products coming down?

Or is it just a transition from more expensive products from one vendor to maybe less expensive products from other vendors?

Yes, Jeff.

It's a good question.

I wouldn't say it's one specific factor.

I think probably a combination of factors, certainly some promotional activity in the marketplace.

Certainly -- we obviously engage in a competitive market.

I think, as we're selling, obviously, a broader portfolio now, we're selling additional products.

There's both dollar and unit volume growth there with those products.

So I think there's a combination of things that are taking place in the technology and equipment sector right now, and we feel that we're competing well there.

And we believe that we have a very strong value proposition for our customers there, not only in helping them decide on which type of technology products best fit with how they want to practice, but frankly, helping them with the support after the sale and our tech service organization, we provide a comprehensive solution there.

So we believe that we continue to be well positioned there.

And now having a broader portfolio of products, certainly, that are at different price points is something that you're seeing play out in the numbers that we've shared.

Would you provide any color at all on [DI] versus full in-office systems?

Or anything that helps us understand one or both sides of that business?

No, I wouldn't want to get into anything more specific than I think we've shared at this point.

Fair enough.

And then, Don, just to follow-up on the accounting changes that you talked about.

Was there any actual impact on the fiscal second quarter P&L?

And was that a GAAP or a non-GAAP?

I'm just trying to see, with the delay in the earnings call by the week, was there actually something in the P&L that was in there?

And should we exclude that or include it from GAAP to non-GAAP adjustments?

So yes, there was an impact that was, I'd call it, around $4 million gain in other income expense that you can see that did impact the quarter.

We've not excluded that from a non-GAAP perspective as it relates really to kind of the ongoing underlying dynamics of the JV that we're invested in.

I would highlight, just in the interest of puts and takes, I mean, I think the way we're looking at this is, as you think about the quarter and guidance for the year and how does this all impacts that, I mean, that positive impact is there.

We also -- and I think we highlighted in our prepared remarks here, we did have a significantly higher interest expense quarter than we had forecasted or anticipated.

That cost us about $0.03 that you'd also have to think about.

And those 2 really, I would say, largely offset.

So that's why as we look kind of forward, we would say the impact on guidance of what happened this quarter, there are a few puts and takes, but it's really relatively in line with where we expected it to be, and that's part of the reason we're maintaining our guidance range.

Your next question comes from Brandon Couillard with Jefferies.

Mark, if -- I'd be curious if you could sort of elaborate a little bit on sort of where you think Tony can add the most value as the new Head of Business Development, and perhaps what some of his priorities will be, whether you'd be looking at perhaps some international opportunities or other -- or building out your sort of specialty portfolio, where he'll be concentrated.

Yes.

Thanks, Brandon, for the question.

Certainly, it's an important investment we've made as we talk about continuing to build our talent at Patterson.

Certainly, as we think about how we execute on our strategy, having more of a formal business development and corporate development function is an important part of that.

And so we're not centering in specifically in one specific area at this point, although obviously, we've got some early areas that we're going to ask Tony to focus on.

But I think they would certainly be in support of helping us execute on some of the strategic priorities that we have.

So whether that's, as we shared, talking a little bit about investing in some of the high-value areas, technology to support our customers, technical support, business solutions.

Certainly, as we think about how do we move into some adjacencies that are certainly within the purview of the businesses that we're in, how do we expand in some of the areas around private label, for example, where there are some new product or service lines that we can begin to engage and invest in and certainly, how we think about build or buy types of decisions there.

So I would say his early perspective will be pretty wide.

We'll obviously want him to narrow that sooner rather than later.

But certainly, as we think about business development, corporate development opportunities, they would be directly in support of helping us drive some of the strategic direction priorities that we have.

And then one for Don.

Appreciate your comments on the gross margin trend sequentially.

But could you help us bridge the year-over-year change?

And were there any dental equipment charges in the period or any other inventory charges that you've kind of absorbed in some of the previous quarters?

No, we really didn't have that dynamic in any material way this quarter, I think.

And I don't -- we're -- again, as I mentioned, we're really trying to stay focused on our sequential view.

I think the 180 basis point decline in our gross margin would be -- I don't have the precise basis point reconciliation in front of me, but I would say that it's really largely similar to last year, absent the inventory charges.

I mean, we had a -- there's a segment mix impact.

There's an impact from less equipment financing, and there's an impact with both the Dental gross margin and a very much more minor impact on the Animal Health side that are all contributing to that 180 basis point move.

Your next question comes from John Kreger with William Blair.

Mark, just kind of referencing back to your early comments about you made a lot of progress but still more to do.

At this point, are you comfortable that fiscal '20 can be a growth year for Patterson?

Or too soon to say that?

Well, I think, obviously, we -- short answer, I think, too soon to say that.

Certainly, we're not in a position where we're going to provide any guidance around fiscal '20 at this point.

But I would come back to kind of a key theme that I'd like to certainly convey is, I feel we're certainly making progress.

I think we see some of that progress in our performance, but we certainly have much more progress that we need to continue to make.

And we're really heads-down focused on continuing to drive against this improved core business execution, continuing to drive against the 5 priorities, kind of operating priorities that we outlined, really starting to build out kind of where we take our strategy as a company, and frankly, trying to create and start to build upon some momentum.

So again, to answer your question more directly, we're certainly not in a position to provide FY '20 guidance at this point.

But we're encouraged by the progress we're making, and we have a lot of work to do.

Okay.

And a follow-up.

Can you give us an update on how the corporate account business is going across the Dental and Animal Health businesses?

Just curious if that's growing faster or slower than overall and if that's proving to be a margin tailwind or headwind.

Yes.

Thanks, John.

Good question.

Certainly, this is an area that I've had an opportunity to engage in somewhat in our team, and certainly, this is an area where we continue to build out our team and invest in resources to support kind of corporate accounts, if you will, national accounts, DSOs, obviously, as they're referred to in the dental space.

And this is an area where we believe there's opportunity for us to grow.

Certainly, we want to be very strategic in working with those types of corporate accounts that are a good match for us in terms of the types of value-add solutions that we bring to the table.

Certainly, those customers have high expectations.

And I would say, I think as we've shared previously, the margin profile of a large corporate account is lower than the margin profile of a smaller private-practice customer.

But it's also important that we think about our cost structure in working with those types of corporate accounts.

So that's -- it's an important area of focus for us.

We're pleased with the progress that we made there.

But I would tell you, consistent with kind of the earlier comments to Brandon's question, we still have a lot of work to do to strengthen ourselves in that area.

Your next question comes from Jon Block with Stifel.

Two, I think.

One for Mark, one for Don.

Mark, the dental consumable, the improvement in the rate of growth, maybe if you can touch on how much is market, if any, versus internal improvements with some of the initiatives that you guys have put in place recently.

And do you expect that dental consumable number, sort of the growth rate decline closer to whatever is considered market as we enter fiscal '20?

And then I've got one for Don.

Yes.

Thanks, Jon.

So I do -- we have shown some consistent sequential improvement in that area.

We're not growing at the market.

We believe the market is a low single-digit growth rate, call it 1% to 2%.

We believe the market is stable and still good end markets in this area.

But we are making progress.

And I think one specific example of that, we actually grew our private-label consumables business in the quarter on a year-over-year basis.

So it was slight growth, but certainly, we think that that's a leading indicator of the fact that we are continuing to make some progress there.

I think another important indicator and a big driver in this area is just the continued efforts the team is driving to continue to stabilize our field sales organization.

We are continuing to invest there.

We're continuing to onboard new reps.

We're continuing to provide them with useful productivity tools to help make them more productive and more efficient and help bring greater value to our customers.

So again, I would say consistent with kind of the themes that we've been conveying, making progress.

Pleased with the progress we're making, a big focus there certainly, and a lot of work to do.

In terms of when we would anticipate growing in that -- in the consumables business, again, I don't think we're going to get into specific FY '20 guidance at this point.

But we're pleased with some of the momentum that we're seeing in that area.

Got it.

Very helpful.

And then, Don, let me maybe ask a 2-parter just around guidance and clarity.

So the $4 million impact, the gain in other income, I just want to be clear, was that or is that a onetime event specific to fiscal 2Q?

Or is there any tail to that?

And then relative to the last guidance, it seems -- and this is me speaking, but it seems like gross margin might have a bit more pressure.

The year-over-year internal revenue growth took a slight, slight step back in fiscal 2Q relative to 1Q.

So it sounded like to me that you're making up the difference in OpEx, tightening the belt, but then I thought you also said that any reduction in OpEx is not in the guidance.

So sorry for the long-winded one, but maybe if you could just help clarify that.

Yes.

So relative to the $4 million gain, that's really -- we're viewing that as a onetime event here in the quarter.

We don't expect there to be significant continuing impacts in Q3 and 4. And then on the guidance, I guess the operating expenses, what I was referring to there is that we have made some -- we did make some changes.

We're kind of in the early stages, we're still working through it.

We did make some changes in our OpEx that impacted the quarter and will for the rest of the year, favorably.

But there's -- this is an ongoing process.

And so my point was that as we move forward, there may be and probably will be additional operating expense initiatives and things that we do in the back half that really aren't fully identified yet, and as a result, we have not baked into the guidance, we've not factored into the EPS guidance for the year.

Your next question comes from Nathan Rich with Goldman Sachs.

Don, maybe just following up on that last one.

Should we think of gross margins as improving off of the 21% level that we saw this quarter as we look forward over the balance of the year?

And then could you remind us of where private-label penetration is today?

And what type of margin delta you see there as you convert more sales through private label?

Well, so -- yes, we -- I think our expectation would be some very modest gross margin improvement from the first half to the second half, just given some of the initiatives we're involved in.

On the private-label side, we're probably not going to give you exact quantification.

I would tell you that the gross margin profile on that is substantially higher than the rest of our business.

Private label is still not a significant factor overall as we expect it to be, but it does have a much higher margin profile.

Okay, that's helpful.

And then Mark, just going back to your comments about exploring new growth opportunities.

Could you talk about your view on M&A at this point?

And would you consider doing an acquisition if it kind of helped execute on those strategies that you're going after?

Yes, certainly.

Short answer is yes.

I think, as I mentioned earlier, the way we think about M&A is what -- how can M&A help support driving the strategic priorities that we have.

So as we think about continuing to invest in high-value areas, as we think about how do we continue to become more valuable to our customers, that would be an area that we would pursue some M&A potentially in as well as how we think about entering into some adjacencies or some new products or service lines that we're not currently in or that we have a lower position in and how do we think about M&A opportunities, business development opportunities to do that, how we think about supporting technology and innovation.

So these are all elements that we would certainly be -- would be part of the work that we'd be doing from a corporate development standpoint, and again, I would say in support of driving our strategy.

We certainly believe as we continue to, I think, solidify and stabilize and strengthen our balance sheet that we have an opportunity to deploy capital to help drive some of the growth initiatives.

And certainly, Don, chime in here.

Yes.

And I will just weigh in.

I think we tried to highlight some of the good aspects of our cash flow in the quarter, and we expect to -- there's still room for improvement there, there's still room for additional benefit as we look at our cash flow.

And so that, to me, is all a part of how do we set ourselves up to do exactly what you're describing.

Your next question comes from Steve Beuchaw with Morgan Stanley.

The first one is for Don.

I wonder if you could help us get a sense for how cash flow trends from here?

A couple of things that might be helpful would be, can you talk about how much more improvement you would anticipate in working capital, particularly what you think might be a logical DSO target from here?

And could you give us any sense of the size of the impact of the factoring program so far, how much of a benefit that's been?

Appreciating that it's not exclusively -- or maybe mainly not in operating cash flow.

Right.

That impact is about $160 million, so that's the -- that's maybe the first thing.

On your second question, I think we mentioned this last quarter, we are really -- I don't mean to not be helpful, but I think we're really not in a position where we want to give cash flow guidance, including DSO or DIOH-type targets.

I think what I can tell you is that, again, there's opportunity here, particularly as it relates to our inventory, to continue to improve that number.

And so I feel like this is an area that you might characterize as we're just getting started.

So -- but again, I don't want to really get into giving specific guidance on it.

And that $160 million, should we see more of that in the back half?

I think what you should view that as is, as we accelerated the receivable collection, that was worth $160 million.

So that was kind of the onetime impact of moving up the receivables into the program.

And now from here, the receivables kind of behave as they always have.

It's just that you're getting them sooner, if you will.

So I think the $160 million is more of a onetime thing here in the quarter.

Okay.

And then just a couple of real quick ones for Mark.

One is, can you talk about or compare the growth rates in the quarter within Animal Health between companion animal and production animal?

And then quickly, can you give us any sense for an expectation on timing for conclusion of the process, resolution of the process with the FTC?

Yes.

Thank you.

So I think we're not going to break out the specific growth rates of companion versus production.

We're pleased with the performance in that business in the quarter, and we're pleased with the growth rates, as we indicated, we believe are at or above the market there.

So we're pleased with the rates there, but we're not breaking them out specifically.

I think in terms of the FTC, as I think we've indicated in the past, the trial is ongoing.

We expect it to wrap up in January, with potentially a decision likely in the summer of 2019.

We continue to vigorously defend ourselves in the case.

And just as a reminder, the complaint only seeks injunctive relief, and no monetary damages or fines are sought.

So we're continuing to be part of, obviously, the ongoing trial.

That's really the status of it.

And this is Don.

Let me just -- the breakout of -- I recognize that we've done that in the past, but the breakout of production and companion animal, we're really trying to get ourselves conformed to the way that we report Dental, which is just as a single segment.

We have 2 presidents of these divisions, and we want to really try to get ourselves back to here's how we do this on a consistent basis, and we put that together the same way for both businesses.

Your next question comes from Ross Muken with Evercore ISI.

Maybe just sticking on the animal business.

Any impacts or implications from some of the manufacturer consolidation that's happened and some of the new sort of spins, split-offs or separated companies in terms of contracting?

And any change in sort of bias between agency and other in terms of those types of relationships?

Thanks, Ross.

So I don't think really any new news to report there.

Certainly, our team within the Animal Health business, and certainly myself as well, we engage with the executive teams at these manufacturers, and we're working closely with them to continue to bring value to our joint customers and working together to define ways that we can bring value to each other.

So I guess, nothing really more specific to share other than that at this point.

And maybe just quickly for Don.

Now that you've been in this sort of seat for a bit on, just on the balance sheet, you already, obviously -- you have the AR factoring that gave you some relief, and now you want to sort of ramp up M&A.

I guess, how should we think about where you'd be willing to take leverage given the dividend?

And just sort of thoughts on how we should think about sort of the evolution of that M&A effort, given the individual you just sort of added?

Yes.

Well, we -- I think we've said before, we try to target 3.0 as an appropriate debt-to-EBITDA ratio, at least as the way our banks measure it.

I think for the right deal, we're certainly willing to push the envelope somewhat aggressively.

And of course, it all gets into what kind of EBITDA the target's bringing back and ROIC, et cetera.

But if it's the right deal and it advances the strategy, we're in a position, I think, where we can put some significant resources to bear and we're willing to push the envelope for a period of time and then ramp it back down to those levels.

Your next question comes from David Larsen with Leerink Partners.

Can you talk about the sales force on the Dental side?

Like, how many reps have you added?

How many do you have now?

How far along are you in that process?

And then do you have any comments or thoughts around the productivity of those new hires?

Yes, David.

Thanks for the question.

We don't provide specifics in terms of the number of reps that we have or the number that we onboard during the course of a quarter.

I think what we have indicated is that we're building our field sales force in our Dental segment.

We are right on track with the onboarding of new reps during the quarter and through the year.

We continue to see improved stabilization in terms of our Dental field sales organization.

I've had an opportunity during the quarter to travel with several of our folks, and I'm really pleased with the progress we're making there, and frankly, the progress that we're making on helping to deliver some productivity tools and make some investments in helping improve the productivity of our reps, make them more efficient and ultimately more valuable to their customers.

Those relationships our reps have with our customers are incredibly important.

They're a critical asset, certainly, that we have.

And we're pleased with the progress that we've made over the past 6 to 12 months in terms of stabilizing the field sales organization, investing in the field sales organization.

And certainly, I think, starting to see some early signs of the impacts there, as we indicated, in terms of some continue -- improved trends in our consumables and certainly a focus on private label, just as a couple of examples.

So again, not to provide specific numbers, but we're right on track there and pleased with the progress we're making.

When do you think you will be -- like, have the number of reps that you want?

Like, will it be by the end of fiscal '19, maybe mid fiscal '20?

I'm just trying to get a sense for how far along we are in the process without being too specific.

Are we like 80% there, 90% there?

Any high-level thoughts?

I'm not sure, David, there's -- I don't think there's a magic number.

I think the market will continue to evolve, our customers will continue to evolve, and I think we'll continue to evolve our sales organization to make sure that we're positioned well with our customers and with the marketplace and the evolution there.

So I don't think there is a magic number or a magic date at which we're where we want to be.

I would expect we'll continue to invest in our field sales organization and make sure we've got the appropriate number to serve our customers.

Okay.

And then just one more quick one.

I think I heard that the benefit in -- like, there was a benefit to other income that was offset by higher interest expense.

But according to my model, it looks like on a sequential basis, other income improved by about $4.7 million and interest expense had a favorable trend of about $1.8 million sequentially.

So I'm just -- I'm having a tough time seeing in my model how the one benefit from, I guess, the delay in the reporting offset the higher interest cost.

Yes.

This is Don.

The higher benefit from the JV accounting, what I mentioned was it actually offset higher legal costs, which would be up in our operating expenses.

The interest expense was down slightly just because of our strong cash flow and paying down debt.

But I was just pointing out that if you're highlighting a few items, the thing to think about is that the $4 million gain that's in other income expense is one item.

But something to also consider as you're looking at the quarter and as you're thinking about maintaining our guidance for the year was higher legal expenses, which had -- which were about $0.03 higher on an EPS basis than what we had anticipated.

Your next question comes from Kevin Ellich with Craig-Hallum.

This is Ryan Kimbrel on for Kevin Ellich.

I know you guys said that your legal expense was affected by an EPS $0.03 in excess of what you originally expected.

Do you think or do you expect the outsized legal expense to persist?

Or is it mostly contained in the second quarter?

And then I've got one more.

Well, we certainly have legal expenses that are persisting.

We don't necessarily think they'll persist at the level they were at.

And I would also add, the point here really is, as we look at the back half, we think we've forecasted them appropriately and so they're built -- anything like that would be built into the guidance that we've given.

Okay, great.

And could you guys provide a little more color on what you continue to see in terms of competitive pricing pressure?

Dental operating margin obviously declined year-over-year but improved sequentially.

I know you said in the press release that you continue to expect pricing pressure to persist for the time being, but did those competitive headwinds subside a little bit compared to last quarter?

Should we look at last quarter as a bottom of sorts?

Or was this quarter's sequential increase in operating margin more of a transitory event?

Well, I think, Ryan, certainly we are in a competitive environment, as we always have been.

And certainly, we shared last quarter some competitive pricing pressure, which we expect to continue.

But I'd say we did see some stabilization, I think, in the quarter.

And we're obviously very focused on ensuring our customers are thinking about Patterson in the context of our total value proposition.

So that's kind of where we sit at this point.

And I think we have time just for one more question.

Okay.

And your last question comes from Steven Valiquette with Barclays.

Just with the discussion around the sequential improvement in the operating margins.

Just kind of curious, looking back to my model really over the past 3 or 4 years or so, there has always been a pretty notable improvement in operating margins from fiscal 1Q to fiscal 2Q.

I was just wondering if there's anything mechanical about the business, where the fiscal 2Q margins are always going to be higher than fiscal 1Q.

And then a follow up just on the same thing, is really that, again, if margins are improving in the fiscal second quarter, it always has not translated into better results in the back half of each fiscal year.

So I'm just wondering, is there any extra color on why that might be more sustainable for this fiscal year versus prior fiscal years?

Yes.

Well, I think part of that -- part of what you're seeing there probably also just relates simply to there's an increase in sales, so there's a little more leveraging that can take place from Q1 to Q2.

But we're also encouraged by the trends in the business.

I mean, from our chair, we're -- and just maybe -- it doesn't maybe jump out in certain numbers here, but we're feeling encouraged about the progress of the business and the improvement in a variety of areas.

And so as we look to the second half, we are really sort of anticipating that these kind of things continue as we get into Q3 and Q4.

And those should translate to somewhat better operating profit margin in the back half.

And I'll turn the call back over to Mark Walchirk for final comments.

Yes.

Thank you, and thanks, everyone, for joining us today.

We look forward to providing another update for you on our third quarter fiscal 2019 earnings call.

Thanks very much.

This concludes today's conference call.

You may now disconnect.