Patterson Companies Inc (PDCO) 2019 Q3 法說會逐字稿

Good morning.

My name is Jacqueline.

I will be your conference operator today.

At this time, I would like to welcome everyone to the Patterson Companies Third Quarter Fiscal 2019 Conference Call.

(Operator Instructions)

I would now like to turn the call over to John Wright, VP of Investor Relations at Patterson.

Mr. Wright, please go ahead.

Thank you, operator.

Good morning, everyone, and thank you for participating in Patterson Companies' Fiscal 2019 Third 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 third 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 our other filings with the Securities and Exchange Commission.

We encourage you to review this material.

In addition, comments about the markets we serve, including growth rates and market shares, are based upon the company's internal analysis and estimates.

The content of this conference call contains time-sensitive information that is accurate only as of the date of the live broadcast, February 28, 2019.

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 third quarter and the first 9 months of both fiscal 2018 and fiscal 2019.

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

and diluted earnings per share attributed to Patterson Companies Inc.

for the impact of deal amortization, integration and business restructuring expenses, legal reserve costs and discrete tax matters, along with the related tax effects of these items.

We will 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.

A 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 1 week.

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

Thank you, John.

Welcome, and good morning, everyone, to Patterson's Fiscal 2019 Third Quarter Earnings Call.

Today, I will provide a summary of our third quarter results, an update on our progress against our key initiatives and some context and perspective on our strategic priorities going forward.

We were pleased with our performance and continued progress in the third quarter.

Our results reflect our sharp focus on execution across our 5 key initiatives, which are driving improved top line growth and profitability.

We delivered the third consecutive quarter of year-over-year revenue growth, which we attribute to the actions we have taken to improve the customer experience, stabilize our field sales organizations and enhance sales execution.

It's also worth noting that we achieved these strong top line results with 1 less selling day in the quarter compared to the year-ago period.

We also generated the second consecutive quarter of sequential operating margin improvement, demonstrating the positive impact of our ongoing focus to improve our strategic sourcing, grow our private-label portfolio, manage our cost effectively and drive enhanced performance in our higher-margin value-added services.

All of these areas also present further opportunity for us to stabilize and grow our margins over time.

Based on our year-to-date performance, we have narrowed our adjusted EPS within the existing range to $1.40 to $1.45.

Turning briefly now to the results across our 2 business segments.

We were pleased with the performance of our Dental segment in the quarter, which realized internal sales growth of approximately 1% compared to the same period last year, marking the first quarter of year-over-year revenue growth in more than 2 years.

The revenue trends in our dental consumables category continued to improve, which we believe reflects our strong focus on improving execution to stabilize our Dental business and the continued investments we are making in our field sales and operations teams.

Our dental private-label portfolio is also progressing well.

We are seeing increased customer demand in this area and believe we have a lot of runway to increase private-label penetration with our existing customers as well as introduce new products to expand the portfolio.

In the dental equipment category, we delivered nearly 6% revenue growth for the quarter, which was driven by double-digit growth in both the CAD/CAM and core equipment categories.

Increased equipment and technology purchases suggest that our customers are investing in their practices and are confident in their future growth prospects.

This area will continue to be a key differentiator for Patterson.

And we believe we are well positioned to take advantage of this growth.

Our third quarter internal sales growth demonstrates that our team's hard work is starting to pay off, and we are committed to driving continued improvement in our Dental business going forward.

I will provide more color on our Dental segment performance in a moment.

Turning now to Animal Health.

We achieved another solid quarter in this segment.

Internal sales grew nearly 3% compared to the year-ago period.

We believe we continued to gain market share in the quarter based on our estimates for the underlying markets in both companion and production.

We have taken a number of steps that position us well to compete in the exciting and evolving Animal Health segment.

And we fundamentally believe in the strength of our value proposition and our capabilities.

We have and will continue to capitalize on the significant market opportunity in Animal Health through the delivery of a full and comprehensive suite of solutions that allow veterinarians to offer all methods of serving their customers, including home delivery, with tools that drive greater levels of compliance.

We are constantly adding new capabilities to strengthen our Animal Health value proposition to meet the evolving needs of all types of veterinarians and help enhance their relationships with customers.

As I have shared on a number of our previous quarterly calls, we remain focused on executing our 5 key initiatives, which we believe are contributing to our improved performance.

As a quick reminder, they include improving the customer experience, enhancing sales execution, stabilizing our margins, driving improved cash flow and finally, building the overall talent at Patterson.

Let me touch on a few of these initiatives in more depth.

Our improved dental equipment and technology sales during the third quarter is evidence of our efforts to continue to enhance sales execution.

Equipment is a key area where Patterson has and continues to distinguish itself in the market.

Given our expertise in selling the latest high-quality technology, Patterson customers know that when they purchase these products from us, they will receive exceptional support and service long after the purchase is complete.

Our ability to serve our customers' needs throughout the lifecycle of their equipment is a key element of Patterson's value proposition.

And we believe it helps drive customer retention and loyalty.

Dental equipment and technology sales also have a positive effect on our overall performance by supporting other higher-margin aspects of our business, including equipment financing and our comprehensive technical service and support infrastructure, all of which also performed well in the third quarter.

We recently attended the Chicago Midwinter Dental Show and are excited about the upcoming International Dental Show in Germany in March, where we have a great opportunity to interact with our manufacturing partners to learn about new technology innovation in the Dental segment.

We're particularly excited this year, given our ability to compete across the market with a broad and complete portfolio of high-tech products from different manufacturers at various price points.

When new innovation is introduced, we believe Patterson is exceptionally well positioned, given our differentiated expertise in selling and servicing the latest technological equipment.

We also made notable progress in stabilizing our margins during the third quarter.

Private label is up double digits in Animal Health from strong growth in the companion market.

And in our Dental segment, our private-label business performed better than our overall consumables segment.

We are gaining momentum in this area, and we continue to launch new products to build out our private-label portfolio.

We also remain focused on additional margin levers, including strategic sourcing and managing our cost structure while also balancing our expenses with the need to continue to invest in the business.

As we announced last month, following a thorough search, we appointed Eric Shirley as President of our Dental segment effective February 4. Eric was the clear choice to lead our Dental business into the future, given his significant industry leadership experience and his strong track record of performance.

We are excited to have him onboard and believe his appointment is further evidence of our efforts to continue to build the overall talent and leadership at Patterson.

Finally, I want to provide a little context on how we're thinking about the business going forward.

As we've discussed, our efforts throughout fiscal '19 have primarily been focused on stabilizing our core business.

And we are confident that the continued progress we have made across our Dental and Animal Health segments will position us well for the future.

While we recognize the continued importance of near-term performance, we're also thinking ahead about how we can expand and grow the business longer term.

As we look forward, our strategic objectives are centered on 3 key areas: continuing to stabilize the core business, accelerating our performance via continued execution on our key initiatives and pursuing opportunities to expand our product and service offerings via both organic and inorganic business development efforts.

These key strategic objectives are all centered around our relentless focus on our customers and continuing to increase our value to them.

First and foremost, we will remain focused on execution to drive growth, working capital and margin improvement to continue the progress we have made during fiscal 2019.

Next, we plan to invest further and accelerate growth in our software and technical service platforms, which represent accretive margin opportunities.

We will also invest in modernizing our dot-com platform to ensure it is easy for our customers to do business with Patterson.

And finally, as we think about growing the business for the future, we'll be thoughtful about potential M&A opportunities that help support and drive our strategic initiatives.

I want to emphasize that we believe we have a compelling value proposition.

And continuing to invest in that value proposition is critical to our ongoing success.

We operate in healthy, growing and stable market segments with attractive underlying fundamentals and positive margin profiles.

As a leader within both of these segments, we know our customers are looking for a trusted partner to help them achieve their business goals.

And as the needs of our customers have evolved, so has Patterson.

We provide our customers with a comprehensive portfolio of products, services and technology solutions to help them be more productive and efficient, all executed by our local field sales, operations and support teams.

Our teams are aligned and focused on continuing to be a trusted business partner to our customers.

And with that, I'll turn it over to Don for a deeper dive into our third quarter 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 business segments.

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

On today's call, I will focus both on the sequential view of the business in addition to the typical year-over-year comparisons to highlight the progress we are making in the business as we continue to focus on the business improvement initiatives that Mark has already reviewed in some detail.

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

Consolidated reported sales for Patterson Companies in the third quarter of fiscal 2019 were $1.4 billion, an increase of 1.6% versus the third quarter a year ago.

Internal sales, which are adjusted for the effects of currency translation and changes in product selling relationships, increased 2.5%.

It is also worth noting that the third quarter of fiscal 2019 contained 1 less selling day than the same period 1 year ago.

This was our third consecutive quarter of positive year-over-year revenue growth.

And we experienced a 70 basis point improvement in our year-over-year sales growth rate than what was reported in the second quarter.

We believe these results reflect the continued positive impact of the initiatives Mark discussed to bring growth back to the top line.

Our third quarter consolidated gross margin was 21.4%, an improvement of 40 basis points on a sequential basis from what we achieved in Q2 of fiscal 2019.

Operating expenses for the third quarter were consistent with the second quarter of fiscal 2019, reflecting initiatives to proactively manage expenses in the quarter.

We continue to carefully manage our operating expenses while also balancing the need for certain investments to improve and grow the business for the long term.

In the third quarter, our consolidated operating margin was 3.9%, reflecting a 30 basis point sequential improvement from the operating margin in the second quarter fiscal 2019, which continues the trend of improving operating margin during fiscal 2019.

Our adjusted effective tax rate was 24.5% for the quarter, up from a rate of 21% in the third quarter of fiscal 2018, when the new tax legislation was enacted.

It is worth noting that the year-over-year comparison in tax rates translated into a slight headwind in the third quarter of $0.02 of EPS.

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

for the third quarter was $31.2 million or $0.33 per diluted share.

Adjusted net income attributable to Patterson Companies Inc., which excludes deal amortization costs and discrete tax matters, totaled $35.6 million for the third quarter of fiscal 2019 and adjusted earnings per diluted share was $0.38 in the quarter.

Now let's turn to our operating segments.

Internal sales for our Animal Health business increased 2.8% 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.

Operating margins in our Animal Health segment were 2.9% in Q3, a 70 basis point sequential decline over the operating margins in Animal Health in the second quarter of 2019.

The sequential decline in operating margins is consistent with the prior year and primarily reflects the impact of lower sales volume due to the seasonality of this business.

In our Dental business, internal sales increased 0.9% versus the third quarter of fiscal 2018.

On that same basis, our third quarter fiscal 2019 sales of consumable dental supplies decreased 1.9% during the 2019 third quarter compared to a year ago.

However, our total equipment sales increased 5.6% versus last year.

Although dental consumable sales declined during the quarter, they continued to improve sequentially as we experienced improved stabilization and productivity in our field sales force.

Additionally, keep in mind that the impact of 1 less selling day in the third quarter would have only added to the improved sequential performance.

As Mark already highlighted, we posted solid performance for both core equipment and CAD/CAM equipment, which were up double digits compared to the same period 1 year ago.

Operating margins in Dental were 9.4% in the quarter and reflect 100 basis point improvement from our operating margins in the second quarter.

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

Through the first 9 months of fiscal 2019, we have generated approximately $76 million in cash from operating activities.

We collected deferred purchase price receivables of $309 million on a year-to-date basis, which is included in the investing activity section of the cash flow statement.

This amount includes both the trade AR facility that we established in the first quarter and our existing equipment financing facility.

To fully appreciate our improved cash flow, the combined total of these 2 items equals $385 million, which allowed us to reduce debt in the first 9 months of fiscal 2019 by $231 million and also have an additional $54 million of cash on our balance sheet compared to the beginning of the fiscal year.

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 am pleased to report that our net working capital numbers have improved by $68 million during the first 3 quarters of fiscal 2019.

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 9 months of fiscal 2019, we have returned $75 million to our shareholders in the form of dividends.

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

For fiscal 2019, we expect to deliver on the range we outlined during our first quarter and are confident in our fourth quarter expectations.

We are narrowing our guidance range and expect GAAP earnings to be in the range of $0.89 to $0.94 per diluted share and our non-GAAP adjusted earnings to be in the range of $1.40 to $1.45 per diluted share.

Our adjusted earnings guidance excludes the after-tax impact of deal amortization expenses, legal settlement costs and a tax benefit related to the 2017 Tax Act, which together totaled $47.6 million or approximately $0.51 per diluted share.

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

Thank you, Don.

Now before we wrap up and take your questions, I want to say how pleased I am with our team's focus and execution as we approach the end of fiscal 2019.

While we still have much work ahead, we are on track with our expectations, and we are confident in achieving our forecast for the fourth quarter.

We have spent a lot of time and energy on stabilizing our core business to build a stronger growth platform for Patterson.

Our improved performance in the third quarter is a testament of our team's hard work.

And I'm grateful for their dedication and commitment to help driving our key initiatives and help support our customers' success.

And with that, we will open the line, so Don and I can take your questions.

Operator?

(Operator Instructions) Your first question comes from John Kreger from William Blair.

Can you maybe just get a little bit more specific on how the companion animal part of the business did versus the production?

I know you said both did better than the market.

But can you give us the growth rates for those 2 pieces?

Yes, John, thanks for the question.

I think as we showed you last quarter, we're really not going to break those into pieces.

But we want to continue to just report that segment the same way we do our Dental segment and show consumables equipment and other.

Yes.

And just to add, John.

Thanks for the question, this is Mark.

Certainly, we do to believe that we continue to grow slightly ahead of the market across both of our companion and production segments.

We did see a little bit of softness in production during the quarter, I think, as a result of several factors, certainly some seasonality, some end market softness, I think particularly in dairy, which I think has been a tough end market for some time, also given the fact that there was 1 less selling day and our production comp from the same period last year was on a pretty significant growth quarter.

So we're pleased with the performance of our Animal Health business both across companion and production, but as I mentioned, maybe a bit of seasonality softness in the production segment.

Great.

And then one other follow-up on Animal Health, I think you mentioned in your remarks one kind of service offering is home delivery.

Are you seeing a greater uptick of that offering?

And how does that flow through and impact your business?

Yes, thank you.

So certainly, there's a lot of evolution going on in the companion animal space.

I mean, we're very -- we continue to be very focused on supporting our vet clinics and hospitals and really enabling them to take advantage of the changes that are going on and the evolution going on in the marketplace.

We partner with an offering called ScriptRight, which is a home delivery platform, which is actually installed in over 20,000 vet clinics and hospitals across the country.

So we believe squarely in the focus of the vet hospitals.

Obviously though, the market continues to evolve, and we want to make sure that we're providing the tools and resources and technology to support our vet hospitals and the vet clinics, take advantage of those -- of the continued evolution and the shifts in demand that take place across the market.

So we feel certainly good about how we're positioned there.

We feel very good about the resources that we provide to the vets to take advantage of some of those evolving trends.

Your next question comes from Erin Wright from Crédit Suisse.

On the Dental segment consumables, can you parse out the different components here of growth, whether it relates to the private label, the 1x -- the 1 less selling day as well as what you're seeing in terms of underlying demand trends across general consumables as well?

And then if you could speak to that quarterly progression you saw throughout the quarter in terms of underlying Dental demand trends, that would be great.

Yes, Erin, thanks.

It's Mark.

I'll maybe start and then turn it over to Don maybe to -- I don't know that we're going to get into the actual specifics of each of these different elements.

But certainly, I think a couple things that I would comment with regard to the dental consumables, I think there's perhaps a bit of end market softness over the last several months.

But certainly, our revenue trends in the consumables continue to improve on a sequential basis, obviously would have been stronger given the fact that we did have 1 less selling day.

So I think that's important to note as well.

And certainly, we're very pleased with the growth in our dental equipment category, which I think also would suggest confidence in the overall demand for dental services in the market.

So again, maybe a bit of end market softness from a consumable standpoint, but we think generally demand is positive.

And certainly, maybe any additional color that Don would add.

Yes, just a couple of things, Erin.

Our private label grew faster than our overall consumables growth.

So that continues to be a dynamic.

On the extra selling day, we're not going to quantify it mostly because we don't have an exact detailed calculation that would show that kind of dynamic.

I think obviously if you do the simple math on that, it could be worth as much as 1.7% of growth.

We don't think it was worth that.

But there's some number there, it did have an impact, particularly around the consumables business probably more for both Animal Health and Dental versus the equipment business.

Okay, great.

And then what are some of the key components or drivers that should contribute to any meaningful ramp implied in the fourth quarter with the guidance?

And just what's driving that ramp?

And where are you seeing the biggest step-up in the fourth quarter?

And what are the embedded profit assumptions?

So yes, thanks.

So I think if you take a look at the Dental side, we think there's going to be continued improvement in our consumables.

So that trend continues.

I think what we saw is some of the usual Animal Health seasonality that comes into play in Q3, same dynamic last year that contributed to lower revenue in Q2 sequentially.

And sequentially, there has always been a bit of a margin downstroke on Animal Health, given that dynamic.

We expect that obviously to moderate in Q4.

So there should be some margin improvement as well.

Otherwise, we really think Q4 is going to be roughly with those dynamics, but beyond that, just kind of a continuation of a lot of the things we saw in Q3.

Your next question comes from Jeff Johnson from Baird.

Can you hear me okay?

Yes.

Mark and Don, just a couple of questions here.

Let me, I guess, focus on the equipment side, on the dental equipment side, if I could.

First, on the imaging side, we've seen some price points come down.

It seems like $80,000 is kind of the new price point for some high-end 2D, 3D imaging systems.

It seems like that is stimulating some good demand.

Can you maybe point to how that new price point that some seem to be zeroing in on is driving demand?

And did that help that equipment number in the quarter?

Yes, Jeff, thanks.

I think there's a lot of things going on in the equipment market right now.

Obviously, you have some changes to ASP.

You have some different price points.

You have new product introductions that are taking place.

And so really, this is a very exciting time, I think, as it relates to dental technology and the innovation that continues to come to market.

And frankly, we're really excited about that.

And we believe that Patterson is positioned incredibly well to take advantage of the evolving market, to take advantage of new innovation and also to take advantage of different price points for the different categories of products.

And I think that's a good example of the decision that was made to really broaden our portfolio of products and really to ensure that Patterson has the opportunity to offer that broad portfolio of products, also a broad portfolio of products at various price points into the marketplace.

And so we believe that evidence of that is in our results in the quarter, double-digit growth across both CAD/CAM and our core equipment categories.

And certainly, given some of the price points and some of the promotional activity that took place in the quarter, our unit growth is actually certainly higher than our revenue growth.

So we're really pleased with our performance there.

And certainly, again not only do we think we're very, very strong at selling these high-tech products, but also really the add-on effect of the other services that we provide well after the sale, whether it's our technology services, our technological and software support via our Patterson Technology Center.

We have a comprehensive support and service infrastructure that we think it really is a differentiator for us.

So we're excited about continued innovation in the dental equipment and technology area.

And we expect to take good advantage of that going forward.

All right, great.

And maybe a follow-up, just on that same theme.

On the digital impression side, we're starting to see maybe some 3Shape and Planmeca that shake out kind of $25,000 to $30,000.

Obviously, Dentsply is going to go with a high-end premium price with their new Primescan.

Just what are you hearing in the field?

Where is dentist's mindset on kind of high-end premium versus kind of other price points for DI?

Just how do you think that evolution of DI uptake occurs over the next couple of years?

And then just a very quick softball for you.

You've been getting some good new hires here at the company.

What's the internal morale like over the past years?

So it seems like it's on the uptick.

We think Eric is a home run add for you guys running the Dental business, so would just love kind of internally to hear how morale is trending at the company, too.

Yes, thank you.

Let me start with your first question.

Without getting into any specifics on specific manufacturers, I mean, I think the main message that I would send here is pretty consistent with the earlier answer.

Look, we're really pleased with the fact that we are offering a broad and full comprehensive portfolio of technology products in the dental space.

And that portfolio includes products at various price points.

And I think what that does is really open up our ability to sell these products and also our add-on services across the entire marketplace.

So I think like any large market, there's going to be customers that want to purchase kind of in more of the good, better, best categories.

We believe that there are markets within each of those categories.

And we're seeing our Dental customers invest in their practices to improve productivity, to bring new technology to improve the clinical outcomes of their patients.

And so we expect continued growth in that area.

And we expect it across all categories in terms of the level of investment that our customers will make.

So we're excited about that going forward.

I think certainly your second question as it relates to kind of morale within the organization, we're really pleased with the improvements in morale.

We've got a fantastic culture here at Patterson, a fantastic team, a very dedicated, loyal, focused employees.

I think we're adding some good additions in leadership to the team and I think that are very complementary.

So we're excited to have Eric onboard.

Thank you for your nice comments there.

He's already in his, I think, third or fourth week and diving in with certainly with both feet.

And we're really excited about the continued improvement that we've seen.

I was just at the Chicago Midwinter Show last week, engaging with our customers, manufacturers and notably our field sales teams that were in attendance as well.

And I feel really good about where things are in terms of the morale within the organization and certainly looking forward to continuing to enhance that over time and continuing to build on the great culture that we have here at Patterson.

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

So just wanted to, Mark, wondering if you could expand maybe upon what organic and inorganic opportunities you're seeing in, I guess, vetting in the market right now to drive additional growth over time.

Especially in Dental, is there anything specifically like which markets or categories you're most interested in?

Yes.

Thanks, Kevin.

I mean, I think as I mentioned during the prepared remarks, really kind of focused on really 3 core, I guess, strategic pillars.

And certainly, continuing to stabilize our core businesses is job one.

And I think we are making good progress.

I think our results would suggest that.

But certainly, we still have runway in the areas that we've been focused on, like sales execution, sourcing in private label, working capital, et cetera.

And that will certainly continue to be front and center as we move into FY '20.

Secondly, as we look to accelerate performance in FY '20 and beyond, really thinking about how we invest and continue to focus on some of the higher-margin products and services, things like software, technology service and support, private label.

These are elements within our value proposition today that are actually performing well but that we can continue to invest into to improve our performance.

And I think they will help drive growth and also represent accretive margin opportunities and also very importantly, help build out our value proposition and help support our customers' focus on success, things like business services, consulting, training and education, et cetera.

And then really the third area, to get specifically to your question, is how we think about expanding into new growth areas, market adjacencies, both from an organic and inorganic standpoint.

And while I'm not going to get into specifics necessarily, certainly there's good opportunities for Patterson to pursue that are really right in line with both our Dental and Animal Health platforms, allow for some expansion into frankly broader areas of the value chain, looking at areas that will drive growth that represent accretive margin opportunities, expansion into market adjacencies within the Dental and Animal Health space, building scale within our existing platform, again building out additional products and services to support our value proposition.

So those would be some of the areas that we're very focused on as we think about inorganic opportunities going forward.

Okay, that's helpful.

And then I guess, just wanted to go back maybe Don can talk a little bit more about some of the moving parts that we're seeing on the cash flow statement and working capital.

And I guess, where do you expect to end the year in terms of free cash flow?

Well, I think that if you look at the cash flow we've generated during the year and kind of walk through the quarters, it was $221 million in the first quarter, $145 million in the second and $19 million in the third, which really mostly in the third quarter had to do with inventory being up $53 million, which is -- that has to a lot to do with the seasonality of our business and was kind of an expected ramp on the inventory.

That's a piece of this equation that you can expect to come down in the fourth quarter.

So I think that there's going to be some opportunity to continue to improve that free cash flow or the cash flow from operations as we get through the fourth quarter.

So I probably won't give you exact guidance.

I think we had mentioned that on the last call.

But you could consider the Q3 number plus some benefit as we get that inventory balance back down as maybe a bit of a proxy for what might happen.

Your next question comes from Jon Block from Stifel.

Don, first one might be for you.

It seems that the guidance implies that your year-over-year op margins are up in fiscal 4Q '19 for the first time in, I think, years quite honestly and by a decent amount, maybe around 40 or 50 bps year-over-year.

I'm guessing you don't want to give specific fiscal '20 guidance.

But at a high level, can we assume that, that trend of year-over-year op margin expansion again should start again in 4Q '19 continues for fiscal '20?

Yes.

I don't want to get really into the fiscal '20 guidance yet.

And I'm not trying to be not helpful, but I don't want to do that.

I think what I can tell you is, yes, you're right.

So we've had good progress on our operating margins, 3.2% in Q1, 3.6%, 3.9%.

And we expect some of the dynamics, as I mentioned, in Q3 really to continue into Q4 with potentially some improvement there on some things.

So that does end up pushing us to a position where the Q4 op profit is year-over-year actually does go positive.

I think we like our trends during the year.

I think we like our trends as we move into fiscal '20.

But beyond that, I'm probably not going to quantify too much.

Okay, got it.

And Mark, just to shift gears and over to you for a moment, and you talked about maybe the Dental end markets getting more choppy the past couple of months, notably on the consumable side.

Do you want to go ahead and pontificate for us what might be causing that?

Do you think that -- do you sort of chalk that up to just normal volatility of the end markets?

Or is there anything specific that you can point to that may have led to some of those weakening trends that you alluded to over the past couple of months?

Yes, thanks, Jon.

I certainly won't attempt to pontificate.

But I don't know if there's any specific kind of underlying dynamic that I would point to.

As I said, I think we saw some end market softness on the consumables.

I think hard to put a specific pinpoint on 1 or 2 things.

I think the thing that -- the area that frankly gives us some positive perspective with regard to the underlying trends, however, is the investment that we're seeing our practices make in equipment.

And that to me represents their view that their practices are going to continue to grow over time.

So I think that's an important indicator, at least from our perspective, of the confidence that the market has in that the practices are investing in growth and investing in their practices.

Also still as we think about our position in the market and the things that we've been focused on over the last year really is to continue to focus on execution and continue to get back to consistent growth in our Dental business.

And just to again highlight, we delivered nearly 1% growth, which is the first time in over 2 years that our Dental business grew on a year-over-year basis, all with -- also within the situation, where there was 1 less selling day.

So we still have a lot of work to do to continue to stabilize and get back to consistent growth in Dental.

But we're pleased with the progress we're making.

We're pleased with the execution the team is delivering on.

We're pleased with the continued positive trends we're seeing in consumables and obviously the positive trends we're seeing on the equipment side.

So to answer your question directly, I wouldn't pinpoint anything in particular.

But we're very focused on execution.

We're very focused on continuing to grow our Dental business going forward.

Your next question comes from Nathan Rich from Goldman Sachs.

Mark, maybe starting with you, just wanted to go back to a comment you made in the prepared remarks against the progress you've made kind of going after some of the strategic initiatives you've identified this year.

It sounds like you're planning to invest on the software and support side to drive growth.

So I just wondered if you could maybe give us a little bit more color on what those investments look like and how that will kind of come together and hopefully drive the top line kind of as we look forward.

Yes, thank you, Nathan.

So I mean, as I think about our kind of technology and software and support infrastructure, this is a really key part of our value proposition.

Certainly, we have a very strong installed base of customers, of practices using our software and e-services.

We continue to actually grow that installed base.

We continue to invest in the future software products and services for the marketplace.

We continue to focus on how we can bring value not only to the private practice space but also the DSO space in terms of the infrastructure that we have.

Two areas in particular that we continue to believe strongly and will continue to invest in our tech service, which really is our team across North America that goes out and provides equipment and maintenance support for our customers.

This is a great part of our operation and something that we think again distinguishes us in the marketplace.

Also our comprehensive technology and software support infrastructure at our Patterson Technology Center, where we literally have hundreds of people who are -- their full-time job every day is to support our customers and to help them ensure the productivity and efficiency of their practices and the effective use of the software tools that we provide as well as the technology of products that we sell.

So this is an important part of our value proposition.

There are certainly investments that we're making in continuing to build out that infrastructure and continuing to bring that value to our customers.

So we think there's just some good runway there.

Great, that makes sense.

And Don, maybe a follow-up for you.

I think you had mentioned Dental EBIT margins were up about 100 basis points sequentially.

Any more detail you could provide on kind of what drove the sequential step-up?

And do you think you can kind of continue to build on that as we look at performance in the Dental segment in 4Q?

Yes, I think there's been a couple things really.

We had good -- we're kind of managing our operating expenses in an effective manner.

We had good consistency on our margin sequentially.

And I think that we like the dynamics.

I think, moving forward, that was a big step-up.

You may not see that exact kind of move sequentially each quarter.

But we think we're moving in the right direction on a lot of different things that are helping that margin improve.

Your next question comes from Michael Cherny from Bank of America.

This is Allen Lutz in for Mike.

Does the end market softness in dental consumables need to change at all for you to meet the 4Q guide?

Or is that fully embedded in the numbers?

No, that's -- it doesn't need to change.

That's fully embedded in our numbers.

I mean, again we kind of understand what's happening in the market.

But we're focused on our own program.

And even with some softness this quarter, we really liked our execution and the trends here in our consumable business.

And the continued improvement, we expect that to continue.

Great.

And you talked about double-digit growth in CAD/CAM in the quarter.

So now that Primescan has launched, do you expect any contribution in the fourth quarter?

And then how do you expect that to ramp over time?

Well, Allen, this is Mark.

I'm certainly not going to comment on specific contribution from a specific product.

But we're certainly excited about the Primescan launch.

We certainly have been working closely with our partners at Dentsply Sirona around that.

Good response from our customers.

And we expect good growth in that product category as well as many of the product categories across the dental technology space.

And so as I mentioned earlier, we believe that this is an area that really differentiates Patterson in the market.

We've broadened our portfolio over the last 12 months.

I think our teams are really excited about being able to offer a broad portfolio of products to our customers and really make sure that we can match up the customers' need for equipment and technology with our ability to provide that solution to them.

So we're excited about launches like Primescan.

We're excited about additional technology launches and innovation that we expect.

And we certainly believe that as new innovation gets introduced in the Dental segment, we're very well positioned to take advantage of that.

Your next question comes from David Larsen from SVB Leerink.

This is Westley on for Dave.

I just had one quick question regarding the corporate line item for revenues, up to $9.5 million this quarter.

It's about 40% up from last quarter and just under 300% up year-over-year.

I guess, kind of what's driving that growth both sequentially and year-over-year?

And how is that something that we can expect to move going forward?

Yes, that does move around a little bit.

I think that the main thing was really just strong equipment sales and the financing that went along with those.

There is an impact on the -- as we look at the yield curve, that did also have a positive impact to the quarter.

So it was really both things going in the right direction.

Your next question comes from Michael Minchak from JPMorgan.

So first, on dental equipment, you saw a nice rebound in growth this quarter.

Was there anything that was unique that drove that growth or anything that was maybe pulled ahead?

Obviously, you've cycled the change in the manufacturer relationship.

I guess, can you talk about traction you're seeing on newer relationships?

And then I guess, historically we've typically seen some positive impact from tax incentives on equipment purchases at the end of the calendar year.

Is that something that you saw as a challenge this past quarter?

Yes, Michael, thanks.

I mean, I think we've spoken a fair amount about equipment.

And I think it's a really comprehensive -- a variety of things that are helping drive the performance there.

We certainly don't believe that we pulled sales in.

There was some nice promotional activity in the marketplace that was positive.

We continue to drive our unit sales.

We continue to sell products that we haven't historically sold.

We continue to sell these new products to new customers.

We have a much broader portfolio of products.

It's been over a year now since we changed the relationship with -- from an exclusivity standpoint.

And so our teams are just better prepared to execute.

And our team is doing a great job in the field.

And I think not only like I've been saying are we really strong at selling the dental core and high-tech equipment, but I think our customers recognize the aftersales support that we provide from a maintenance standpoint, from a tech service standpoint, from a technical support standpoint.

And I think these are all things that are contributing to some positive results that we saw in our equipment business.

And as I'd mentioned earlier, we're excited about continued innovation in this space.

And we think that positions us well.

Got it.

And then maybe just a follow-up question on the margins.

So fiscal '18 notwithstanding, if I look historically, you've typically seen some sequential operating margin expansion from 2Q to 3Q.

So I guess, I'm trying to understand, how much of the sequential improvement you saw this quarter is related to that typical seasonal improvement versus sort of the specific initiatives you're taking to drive improved financial performance?

Is there any way to sort of parse that out?

There's probably elements of both.

I don't have a breakdown that I could parse that out any more -- in any more detail.

I think the thing to understand is that a lot of that has to do with our internal programs.

There was margin improvement, even though in the Animal Health space, there was again some margin degradation just due to seasonality.

So we're king of overcoming that.

And again, good trend, we like the trend and expect some of the dynamics here that are in place with that to continue as we move into the fourth quarter and next year.

And just to add quickly, I mean, certainly this is a really important focus for us and for our teams.

And as we think about the key initiatives that we've been focused on, so we're seeing private label, our cost structure, et cetera, all obviously designed to continue to stabilize our margins.

I also think we continue to see further stabilization from our ERP implementation.

And we still have work to do to continue to drive that.

But I think that's helped from a stabilization standpoint as well.

Yes, I mean, if I might add, a lot of the initiatives are in the cost area, where we've been -- we haven't done anything large enough to make a big announcement.

But there's been a lot of analysis of the cost structure and decisions made on the investments that we need going forward to drive the business versus where we think we can opportunistically reduce cost as we move into fourth quarter.

Our next question comes from Sarah James from Piper Jaffray.

One of your peers had a successful animal health spinoff recently and acknowledge that was a little bit different of a mix than your Animal Health business.

But how do you think about getting credit for or unlocking the value for investors via your Animal Health assets?

Yes, Sarah, thanks.

Well, as I mentioned, certainly we're pleased with our Animal Health performance.

We believe we have strong positions across both companion and production and believe that we continue to improve our position in those markets.

And it's a market with good underlying fundamentals.

As we mentioned, we continue to believe that we -- we continue to gain share in the quarter and certainly remain very focused on driving value in this business.

That said, our board, we regularly evaluate options and alternatives that are in the best interest of our shareholders, customers and employees.

And we'll certainly continue to do that going forward.

Got it.

And can you talk a little bit about the robustness of the technology and value-added M&A pipeline?

Are you finding the type of assets that you strategically want to add being available in the market?

Or is this more of a situation where they're not available and you need to build out these capabilities yourself?

Yes, I think it's a combination.

I think as we kind of canvas the market and as we think about centering in on some of our key strategic initiatives, we would look at ways to support those initiatives, both organically and inorganically.

So I think there are assets in the marketplace that could potentially be attractive to us.

I think we, as mentioned earlier, continue to focus on our execution and continue to stabilize the business, continue to stabilize our balance sheet to put us in a position where we can take advantage of some M&A opportunities that would support those strategies.

So we're looking across many of the things that I mentioned earlier and really ensuring that they drive focus on growth, margin accretion, get us into some different market adjacencies, perhaps build scale but certainly all supportive and well within kind of the parameters of our Dental and Animal Health platforms.

And your last question comes from Steven Valiquette from Barclays.

Great.

So just a quick question here around the operating margins on the Animal Health side.

You did mention that we're seeing the normal seasonality on the...

Steven, I think we lost you.

Can you hear us?

(Operator Instructions)

Okay.

Yes, sorry, I'm not sure what happened there.

I'm on a landline.

But just following up on the operating margin on the Animal Health.

It seems like the year-over-year trends are getting a little bit worse as the year goes on.

I know previously, you've talked about maybe missing some manufacturing rebates from time to time in that business.

I'm not sure if that maybe happened in the fiscal third quarter, maybe that gives you confidence on the rebound in the fiscal fourth quarter.

But just looking for more color around the operating margin trends in Animal Health.

Yes, that, we did not have any dynamics like that.

I would characterize the Animal Health operating margin decline as really again normal seasonality with revenue coming down and kind of a deleveraging impact of that.

And then there were a few smaller one-time items in the quarter that were negative that weighed on it a bit.

We do expect as we get into Q4 that there will be some improvement and that will bounce back.

There are no further questions at this time.

I'll turn the call back over to the presenters.

Yes, thanks so much.

And thanks, everyone, for joining us today.

We look forward to providing another update on our fourth quarter fiscal 2019 earnings call in late June.

Thanks very much.

This concludes today's conference call.

You may now disconnect.