Patterson Companies Inc (PDCO) 2020 Q3 法說會逐字稿

Ladies and gentlemen, thank you for standing by, and welcome to Patterson Companies Fiscal 2020 Third Quarter Conference Call.

(Operator Instructions) Please be advised that today's conference is being recorded.

(Operator Instructions)

I would now like to hand the conference over to your speaker today, John Wright, VP of Investor Relations.

Thank you.

Please go ahead, sir.

Thank you, operator, and good morning, everyone.

Thank you for participating in Patterson Companies Fiscal 2020 Third Quarter Earnings Conference Call.

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

After a review of the fiscal 2020 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 27, 2020.

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 of fiscal 2020.

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

and diluted earnings per share attributable to Patterson Companies, Inc.

for the impact of deal amortization, integration and business restructuring expenses, legal expenses, accelerated debt-related costs and an investment gain, along with the related tax effects of these items.

We will also discuss free cash flow as defined in our earnings release, which is a non-GAAP measure, and the impact of foreign currency.

In particular, we will 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 1 week.

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

Thank you, John, and welcome, everyone, to Patterson's fiscal 2020 third quarter conference call.

We are very pleased with our strong performance and execution in the third quarter and the momentum we are building across Patterson heading into the end of our fiscal year.

Our focused and disciplined approach to improve execution and strengthen our value proposition delivered both improved top line growth and margin expansion in the quarter.

Let me begin with a summary of several key highlights.

First, Patterson grew internal sales year-over-year by 4.3%.

We also expanded our operating margins by 40 basis points, generating a consolidated adjusted operating margin of 4.3%.

In our Dental segment, revenues grew across all 3 categories, resulting in internal sales growth of 8%, and our Animal Health segment sales grew 1.3%.

Our strong top line growth and margin improvement delivered adjusted earnings per share of $0.47 in the quarter.

And as a result of our improved financial results, we are raising our fiscal 2020 adjusted earnings guidance range from the prior range of $1.36 to $1.46 per diluted share to $1.50 to $1.55 per diluted share.

With those highlights in mind, let me now dive into the quarter in more detail.

Patterson's year-over-year internal sales growth of 4.3% in the quarter is the result of our continued customer focus, our strong value proposition, high rates of customer satisfaction in both of our segments and benefits from the investments we've been making in our field sales and service teams.

The 40 basis point improvement in adjusted operating margin we delivered in the third quarter was driven by a number of factors, including our continued focus on operational excellence, improved product and segment mix, disciplined expense management and working with our manufacturing partners drive additional value through strategic sourcing.

From a mix perspective, our margin benefited from continued growth in our private label portfolio and strong performance from our higher-margin Dental segment, including our consumables and value-added services categories.

Additionally, our customer financing offering, which is reported as revenue in our corporate segment, but primarily driven by technology equipment sales in our Dental segment, also contributed to our improved margin performance in the quarter.

This strong combination of revenue growth and margin expansion during the quarter resulted in adjusted earnings per diluted share of $0.47, representing a 24% increase over the prior year.

We've made great progress to accelerate our performance throughout fiscal 2020 as part of our 3-year plan to deliver improved results and enhanced value for our shareholders.

Now I'll turn to each of our segments, starting with our Dental business.

Our Dental segment internal sales increased 8% over the prior year period, driven by continued double-digit growth in equipment sales, strong growth in our value-added services category and, notably, a return to growth in our consumables segment.

Our dental consumables category delivered positive growth of 2% in the quarter.

This is an important milestone for our Dental business as this marks the first quarter of positive consumables growth since early fiscal 2017.

Our consistently improving sales trend in consumables is the result of the long-term investments we've been making to build our sales organization and to provide tools to help enhance their productivity and execution.

Our strong quarterly performance in this important category is very encouraging as we remain focused on delivering our value proposition to our broad customer base of independent dental practices, regional and national DSOs.

Our equipment category delivered another very strong quarter, with internal sales growing 16%, led by double-digit increases in the CAD/CAM and digital categories.

Our performance in these categories was driven by Patterson's ability to take strategic advantage of manufacturer innovation and new product introductions, which we effectively promoted and executed.

As we've communicated previously, the timing of new product introductions, promotional programs and other factors can certainly impact our equipment business from quarter-to-quarter.

However, our results clearly illustrate that Patterson is the partner of choice for dental practices when new innovation is introduced to the market.

Our dental customers are confident that Patterson is the right partner to support them for the entire life cycle of the technology and equipment they purchase for their unique practice needs.

From product selection and financing, to installation, software integration and training and support, our comprehensive value proposition helps our customers achieve the return on investment they expect for the complete life cycle of their equipment and technology investments.

In addition, increased demand for our labor, repair services and technical support helped generate nearly 9% growth in our value-added services category, further illustrating how our equipment sales drive higher-margin recurring revenues for our Dental business.

Our experienced and responsive local service technicians teamed up with the national support from our Patterson Technology Center provide the comprehensive technology and support ecosystem for our dental customers, and we believe this is a true advantage for Patterson and essential to delivering our value proposition to our customers.

We are also pleased with the progress of our team's efforts to pursue relationships with DSO customers where Patterson serves as a comprehensive and strategic partner to help enable their growth and success.

During the third quarter, we signed and expanded multiyear agreement with Pacific Dental Services, one of the premier DSOs in the country.

We partnered with Pacific Dental for many years in the technology category, and we are privileged now and look forward to supporting their organization with a comprehensive offering that includes dental supplies, technology, equipment and related products and services.

While our expanded relationship with Pacific did not have any significant impact on our financial performance in the third quarter, we look forward to growing this relationship going forward.

I want to congratulate our dental team for the strong quarter and the growth they delivered across all 3 categories of our Dental business, consumables, equipment and value-added services, as the investments in our field sales and service organizations continue to generate returns and as we capitalize on the introduction of new innovation to the market.

We remain confident that Patterson serves a stable dental end market with positive underlying fundamentals, and we believe we are well positioned to accelerate our performance as customers continue to see and experience the tangible benefit of Patterson's differentiated value proposition.

Turning now to Animal Health.

In the third quarter, our Animal Health business generated internal sales growth of 1.3%, with continued growth in our companion business and improving trends in our production business despite some ongoing challenges in the beef and dairy end markets.

Patterson delivered top line growth in the third quarter that we believe is generally in line with the performance of the broader global market.

The continued positive trend in our companion animal business is a function of our ability to deliver a compelling value proposition, focused on supporting veterinarians as they work to build a stronger connection with pet owners, particularly as market dynamics and consumer preferences continue to evolve.

Our field sales teams cultivate deep relationships with our veterinarian customers who consider Patterson to be their trusted partner to help them grow their unique practice.

Not only does Patterson provide a broad array of products and prescription medications, our comprehensive offerings also include the technologies and services that today's veterinarians need to meet the changing demands of their pet owner customers.

For example, we support veterinary practices with products that help them build branded mobile apps for their practice to more proactively communicate with pet owners.

We also facilitate home delivery of prescriptions through our partnership with Vetsource and their ScriptRight platform for electronic prescriptions.

Additionally, our NaVetor cloud-based practice management software allows veterinarians to effectively manage an individual or group practice and integrate these new tools and technologies.

These examples demonstrate how Patterson is at the forefront of helping veterinary practices evolve with today's pet owners and drive continued success for their practice.

These technology offerings are accretive to our margins and serve to differentiate Patterson as a long-term business partner for our veterinary customers.

As pet ownership and spending on a macro level continues to grow, we believe our team's focus to help veterinarians build lasting trusted relationships with their customers and to provide exceptional care to their pets will further drive demand for our companion animal products and services.

In the production animal business, our teams executed well in the swine market to drive improved performance while also managing through some continued softness in the beef and dairy end markets.

Our strength in the growing swine market is due to our customized value proposition, deep customer relationships, unique offerings and optimized supply chain.

We believe we can drive strong sales performance as the global demand for pork continues to grow.

While changing consumer preferences are likely to continue impacting demand for dairy products, we have seen signs of some improvement in the beef cattle market, and our value proposition in the overall food animal space positions us well to capitalize as markets improve.

One aspect of our Animal Health business that is increasingly important to our customers is disease prevention to help protect the health of their herds.

Patterson Animal Health has the infrastructure, the expertise and the capabilities to provide highly customized delivery models to assist our production animal customers in their focus to address and alleviate biosecurity concerns, which, again, makes us a valued business partner.

Before I turn the call over to Don, I wanted to briefly touch on the coronavirus issue, which is obviously a troubling and still evolving development across the globe.

While we have seen some increased demand for certain infection control and protective products, these trends did not have a significant financial impact on our business in the third quarter.

More importantly, we are committed to providing our customers with the critical products they need and working closely with our manufacturing partners and local authorities to ensure we are effectively meeting the needs of our customers and their communities during this period.

In summary, both of our businesses contributed to our strong quarter.

We are confident that we operate in stable end markets and that our value proposition continues to deliver growth in revenue and profitability.

Our third quarter results demonstrate that we are on track to deliver our fiscal 2020 goal of accelerated financial performance while delivering enhanced value for our customers and improved returns for our shareholders.

And with that, I'll turn the call now over to Don for a deeper dive into our financial results.

Thank you, Mark, and good morning, everyone.

Consolidated reported sales for Patterson Companies in our fiscal 2020 third quarter were $1.46 billion, an increase of 4.3% versus the third quarter a year ago.

Internal sales, which are adjusted for the effects of currency translation and changes in product selling relationships, also increased 4.3% compared to the same period last year.

Our third quarter adjusted gross margin was 21.4%, which was flat versus the third quarter of fiscal 2019.

Adjusted operating expenses as a percentage of net sales for the third quarter were 17.1% and favorable by 40 basis points on a year-over-year basis, primarily related to continued disciplined expense management and the impact of leveraging our operating expenses over higher sales volume.

We continue to carefully manage our operating expenses within each of our business segments and at the corporate level while also balancing the need for investments to sustain and grow the business for the long term.

In the third quarter, our consolidated adjusted operating margin was 4.3%, which represents a 40 basis point improvement over the same period in the prior year.

Our consolidated adjusted operating margin has continued to improve, and this margin momentum is primarily the result of Patterson's efforts to drive operational improvements and expense discipline and the added impact of segment mix and leveraging higher sales volume.

We are encouraged by the continued progression of our adjusted operating margin over the last 7 quarters.

Reported net income attributable to Patterson Companies, Inc.

for the third quarter of fiscal 2020 was $23.2 million or $0.24 per diluted share.

This compares to $31.2 million and $0.33 per diluted share in the comparable period 1 year ago.

Adjusted net income attributable to Patterson Companies, Inc., which excludes deal amortization costs, integration and business restructuring expenses, legal reserve expenses, accelerated debt-related costs and discrete tax matters, totaled $44.5 million or $0.47 per diluted share.

This compares to $35.6 million or $0.38 in the quarter -- third quarter of 2019.

This represents a $0.09 or 24% increase over the third quarter of 2019.

This increase primarily reflects the sales performance in our Dental segment across all 3 categories, consumables, equipment and value-added services, and the continued improvement of our adjusted operating profit margin.

Now let's turn to our business segments.

In our Dental business, internal sales increased 8.0% compared to the third quarter of fiscal 2019.

On that same basis, Patterson sales of consumable dental supplies were up 1.8% and just over 2% in the U.S. market.

This represents the first time we've delivered positive internal sales growth of consumable dental supplies since the first quarter of fiscal 2017.

Internal sales of equipment in the quarter increased 16% versus the same period a year ago, led by double-digit percentage increases in the CAD/CAM and digital categories.

As we have previously stated, the equipment market can fluctuate from quarter-to-quarter based on the timing of manufacturer-run promotions, the release schedules for new products and technology and other factors.

We continue to capitalize on the strength of our complete life cycle full-service model and as the partner of choice for dental practices whenever new innovation is introduced.

Adjusted operating margins in Dental were 8.9% in the third quarter, a 50 basis point decline compared to the prior year.

This operating margin decrease was the result of the product mix impact of higher equipment sales and the write-off of certain aged equipment inventory, partially offset by improved year-over-year gross margin in our consumables business and the positive margin impact of increasing private label products.

There's one other important item I want to highlight here, and that is the equipment financing we offer to our customers as a value-added service, which is an important part of how we help them manage the entire life cycle of their significant equipment purchases.

Historically, the revenue and profit from this value-added offering is reported within our corporate segment.

This quarter, financing as a value-added service would have contributed 40 basis points of additional operating margin to the Dental business over what financing contributed in the third quarter of last year.

Now let's move on to the Animal Health business.

Internal sales for our Animal Health business increased 1.3% compared to the same period a year ago.

As Mark mentioned in his remarks, we delivered continued revenue growth in our companion animal business and believe the trends in our production business are improving despite challenges in the beef and dairy end markets.

Adjusted operating margins in our Animal Health segment were 2.8% in the third quarter, a slight decrease of 10 basis points compared to the third quarter of the prior year.

If you look at our Animal Health operating margins on a historical basis, you'll find our third quarter operating margins can be impacted by the seasonality of this business across both the companion animal and production animal categories of our Animal Health segment.

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

We have continued taking actions to improve our overall working capital, increase Patterson's cash flow and strengthen our balance sheet, and we are pleased to see the impact on our results.

During the first 9 months of fiscal 2020, we have used $169 million in cash from operating activities.

We have also collected deferred purchase price receivables of $359 million, which is included in the Investing Activities section of the cash flow statement.

To fully appreciate our free cash flow, the total of these 2 amounts is $190 million.

Free cash flow, which we have explained and calculated in the table within our press release, has decreased $52 million during the first 9 months of fiscal 2020 compared to the first 9 months of the prior year.

The year-over-year decrease is primarily due to the timing of cash conversion related to the financing of much higher level of equipment sales along with a slightly higher level of inventory.

During the third quarter, we took steps to optimize our debt structure by entering into agreements to purchase and cancel $379 million of private placement debt.

To fund this debt retirement, we used funds from our revolving line of credit and a new committed term loan under our existing credit agreement.

Turning to capital allocation.

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

In the third quarter of fiscal 2020, we returned $25 million to our shareholders in the form of dividends.

And on a year-to-year date basis, we have returned $75.5 million back to our shareholders as dividend payments.

Our Board continues to view our dividend as an important component of returning value to our shareholders.

And the current dividend yield provides a meaningful baseline return to shareholders as we continue focusing on our plans to drive improved performance in the business.

Let me conclude with some comments on our fiscal 2020 guidance.

Given our improved performance through the first 9 months of fiscal 2020, we now expect GAAP earnings to be in the range of $0.49 to $0.54 per diluted share.

For our fiscal 2020 adjusted EPS, we are again raising our adjusted earnings guidance range to $1.50 to $1.55 per diluted share compared to the prior range of $1.36 to $1.46 per diluted share.

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

Thanks, Don.

Let me now briefly wrap up with a few closing comments before opening the call up to your questions.

First, we are very encouraged with our performance through the first 3 quarters of fiscal 2020, and we are focused on continuing our momentum through the remainder of our fiscal year.

As you recall, fiscal 2020 is the second year of our 3-year plan, with a clear focus on accelerating our financial performance after stabilizing the core business in fiscal 2019.

Looking ahead to fiscal 2021, we expect to focus on expanding our capabilities to continue to position Patterson for long-term success.

At a high level, this may include further investments in our core business while exploring opportunities to enter new categories, grow deeper in some of our targeted customer segments, invest in new services and partnerships and consider value accretive M&A.

Before we conclude, I want to thank the entire Patterson team for their hard work and dedication and for their passion and focus on delivering value to our customers and business partners.

I'm confident that we have the right team and the right strategy to continue executing our 3-year plan to drive enhanced value to our customers, business partners and shareholders.

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

Operator?

(Operator Instructions) Your first question is from the line of Erin Wright from Crédit Suisse.

Great.

On the dental consumables front, can you break down some of the components of what was driving the latest improvement?

How much of it was market share gains versus underlying market improvement?

And I'm curious were you seeing any sort of change in behavior amongst your independent dental practice cohort at all in terms of pricing versus volume dynamics?

That would be great.

Yes.

Erin, thanks.

This is Mark.

I think the -- our consumables results in the quarter are really a reflection of consistent focus that we've had on a number of key things and investments that we've been making over the last couple of years.

And as I mentioned, really building out our field sales organization, driving operational excellence that results in improved customer satisfaction, I think, certainly, consistent with the overall value proposition that our dental customers see from Patterson and certainly, investments that we've made in some of the productivity tools, and I think all those things are starting to pay off.

We certainly, as I indicated, see a stable market in the Dental segment.

We do see positive fundamentals.

We're focused on supporting our customers across really all 3 key segments, private practice, regional and national DSOs.

And so I don't think there's one thing in particular that really generated the 2% growth in consumables.

I think it's the result of investments that we've made and a real keen focus that we've had on this trend.

Yes.

Erin, this is Don.

I just want to add one thing to gross margins in our consumables business were up slightly year-over-year.

So that was a notable item in the quarter.

And then one other thing that's been talked about on the consumable side, the Pacific Dental contract really had no significant impact to the quarter, less than $0.5 million of revenue in the quarter that we just concluded.

Okay, that's helpful.

And then on the Animal Health side, can you speak to the companion animal business?

Do you think you're taking share on that front?

And how much is incorporated into your guidance in terms of the consolidation of Elanco's distributor relationships?

And should that bear pending their transaction actually benefit you as well?

Have there been any sort of meaningful changes in terms of your vendor relationships that's incorporated into guidance at this point?

Yes, thanks.

Look, I'm really pleased with the results of our companion business.

We're growing -- excuse me, right in line with the market.

I think our teams are very focused on continuing to build out our value proposition there and really being a real trusted business partner for our veterinarian customers.

We still see, obviously, the vet as really the crucial part of the pet ownership ecosystem.

And certainly, enabling our veterinary customers with technology tools to help them continue to enhance the relationship with their customers, the pet parents, if you will.

We really view that as a key part of our value proposition.

And I think that's showing up, certainly, in the results of our companion business.

I wouldn't really comment directly on specific manufacturer relationships.

We engage actively, obviously, with the manufacturers across the Animal Health segment, great relationships there, continue to talk about how we can jointly bring value to our customers, to our veterinary customers and really support that channel and that market.

And certainly, as the manufacturers continue to grow and bring new innovation to market, and look for solutions from a supply chain efficiency standpoint, we think we're very well positioned to take advantage of that going forward.

Your next question comes from the line of Jeff Johnson from Baird.

Can you hear me okay?

Yes.

Thanks, Jeff.

Great.

Congratulations on the quarter.

So a couple dental questions and then one vet question.

On the Dental side, would be interested to hear kind of your outlook for the private label part of the business here over the next few years?

I think if we look at some of your peers, the percentage may be in the low double digits as a percentage of consumables.

Where is yours today or ballpark where is yours today?

Where do you think it could go?

And then on the DSO side, a similar question.

We peg your kind of share at this point of the mid- and large DSOs maybe around 20%, maybe a little north of 20%.

Where do you think that could go over the next several years?

Would just be interested on both those topics.

Yes.

Jeff, thanks.

I would characterize both of those areas as places, frankly, that we have maybe historically been a bit underpenetrated.

And as we've spoken on these calls over the last number of quarters, 2 areas that we are investing in, and we expect to improve our penetration.

So specifically around private label, we continue to grow our private label business faster than our overall consumables business.

We continue to see that, that creates a lot of value for our customers that are, obviously, looking at different ways and want to make sure they have a comprehensive and complete product selection in their practices.

We also have opportunities to introduce and launch new private label products.

So not only can we improve penetration with our existing portfolio but also expand our portfolio, which we would expect would drive growth over time.

And I think the same would be the case in the DSO market where, again, historically, I think Patterson was underpenetrated there.

We've made it clear about investing in that space over the last couple of years.

We're very focused on finding the DSOs, both regionally and nationally, that fit well with our value proposition and see the value across kind of the entire portfolio of products and services and support that Patterson can provide.

And certainly, obviously, Pacific Dental is a great example of that.

But we're also focused on the regional DSO space.

And again, similar to my comments on private label, we'd expect that to be an opportunity for growth for us and penetration going forward.

All right, great.

And then just on the vet side of the business, we've obviously had a -- seen a history on the production side of cyclicality in the past.

To your point, I think in your prepared remarks, there are some secular things going on though in some parts of the market, especially dairy, but maybe even beef depending on outlook for protein consumption.

But between that and in companion animal, it seems like there's some secular changes going on as well.

I'd love to hear kind of -- I don't know if you'd put a 3- to 5-year view out there or a long-range view.

Just where do you think the Animal Health business combined production and companion can grow over the next several years?

Is it low single digits?

Can it get back to mid-single digits?

Just conceptually, how should we be thinking about that?

Yes, thanks.

Look, I think you outlined a number of factors that are going on within our Animal Health business overall and certainly within each of the 2 segments.

We're seeing good, strong growth in the swine category.

We actually believe we're continuing to take share there.

We've seen some challenges, frankly, in the beef cattle and dairy markets.

I think beef is maybe showing some positive signs.

I think dairy certainly is going to be -- continue to be challenged.

And so we think that in the feed animal space, low to mid-single-digit growth over the long term, certainly driven -- supported and driven by long-term global demand for protein.

And I would say in companion animal, similar numbers kind of low to mid-, long-term market growth.

Certainly, just the underlying fundamentals in the companion animal segment, pet ownership, those we expect to drive that type of growth.

And certainly, just to reinforce, I think the veterinarian is really at the center of providing care to pets.

And we believe that as manufacturers continue to drive innovation and as pet ownership continues to increase, that, again, the fundamentals of the companion market are strong and, as I mentioned, growing in that low to mid-single-digit rate long term.

Your next question comes from the line of John Kreger from William Blair.

Mark, just following up on Jeff's question, can you give us maybe in broad strokes, what production versus companion did on the Animal Health side for you this quarter?

Would down a couple of percentage points be about right for production?

Yes.

I think, certainly, obviously, overall growth about 1.3%, certainly higher than that in companion and a bit lower than that in production.

So I think those numbers you reflected are pretty accurate.

Great.

And then flipping over to Dental, you mentioned sort of thinking about the business in 3 buckets, privates, regionals and national DSOs.

Can you give us a sense about how those 3 categories are growing?

Are you seeing pretty consistent growth across all 3?

Or are there any outliers?

So I think all 3 categories, certainly, we support, and we're very focused on building out our value proposition and supporting and investing in all 3 categories.

Certainly, I think the DSO market, if you combine the regional and nationals, are growing faster than the private practice market.

We did see what I would suggest would be healthy results from our private practice customer segment in the third quarter.

And certainly, that was a big part of the results that we're able to deliver around our consumables growth in the quarter.

So certainly, there's some elements within the different segments of the customer base, and certainly, DSOs, I think, are growing faster than private practice, but we're continuing to invest in all 3 portions.

I would also say in private practice, as you look at our equipment results which we really haven't spoken too much yet, really pleased with another very strong quarter there.

And I think the investments that private practices are making in building out their practices with equipment and technology, that suggests to me a confidence that our private practice customers have around the long-term prospects for growth in their practices.

And we obviously had another very strong quarter there.

And certainly, that gives us some confidence in the private practice component of our business going forward.

Very helpful.

Just one last one, Don.

As Pacific fully rolls into the next quarter, can you give us a sense about how many basis points in growth lift you would expect from that relationship?

Yes, we're not -- appreciate the question, John.

We're not going to get into that level of detail.

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

Mark, you mentioned you hadn't spent too much time here on equipment.

So maybe I'll start there.

As you think about some of the recent introductions that have come to market, it seems like there's been a lot of price bifurcation in terms of what's being offered in various different -- in all likelihood lower price points than some of the typical equipment.

I guess, as you get feedback from the market from the customer base, especially when these lower price points still come with equivalent or better innovation, are your customers looking to spend less to get more and willing to spend more on the total if the per product spend is less?

I'm not talking about the cheaper products, but more because there's a less of an investment being made, they're more willing to actually buy more equipment.

Well, I think, Michael, it's an interesting question.

I mean, I think, there's a lot of dynamics in play, and I don't know that you could probably characterize the entire customer base in one bucket or another.

Look, I think, the fundamentals here are really important.

As manufacturers continue to bring innovation to the market and continue to launch new products that help our Dental customers improve productivity, improve patient care, drive growth in their practices, this is a really good formula for us.

And as we've spoken about, we believe we really have a competitive advantage here.

And we're really pleased with our results, not only this quarter, but frankly, over the last several quarters.

And I think if you look on a trailing 12-month basis, our overall dental equipment is up about 11%.

So this innovation is great for our customers.

It's great for Patterson.

We obviously sell the products to them, but we also provide a wide range of services and support that, I think, are truly valued in the marketplace.

So again, while there are different price points for different types of products, whatever the category may be, I think the fundamental area here that we're encouraged by is the investments that our customers are making in their practices, and I think in many cases partnering with Patterson to help execute that.

And then just one more question.

You talked about some of the sales force efficiency, maybe, Mark, as you think back on -- since you joined the company, what are the additional tools -- what are the additional components that a salesperson today versus salesperson at that point has to go to market with -- to make him or her more effective.

Yes, I think a couple of elements, in particular, as we spoke, obviously, a major ERP implementation that the company went through several years ago.

And certainly, one of the benefits of that is really a comprehensive CRM type system for our field sales organizations that I think really do a couple of things.

Number one, it just helps improve the analytics at a territory level that help our reps better manage their territories.

I think, secondly, we are building out and have implemented kind of a lead generation tool, which our reps are using to help them really, again, understand in a deeper, more analytical way what's going on in each of their -- with each of their customers and identifying opportunities for growth and enhancement and helping to serve up opportunities that, that customer would view as beneficial to their practice.

So I think it's a combination of several things that have really driven some of the results that we've seen.

Number one, we've obviously invested in more feet on the street.

We're training those folks aggressively, and we're seeing improvements in their productivity.

We obviously have a very tenured and experienced core group of dental sales reps really across the company that have fantastic relationships with their customers.

We've seen great gains in our customer satisfaction and Net Promoter Scores, driven through the great service that we're providing.

And again, specific to your question, adding some productivity tools to help with analytics, lead generation, et cetera, that's been a good formula for us so far.

Your next question comes from the line of Glen Santangelo from Guggenheim.

Mark, I just want to follow-up on the equipment side.

I mean, obviously, a much better result than I think all of us were expecting.

And I think in the prepared remarks you highlighted CAD/CAM and other digital categories.

But could you maybe give us a sense for how strong the growth was in high-tech versus basic so we can maybe think about overall end market demand and growth for this category in general -- for equipment in general?

Yes.

Thanks, Glen.

Certainly, the primary driver of our equipment growth in the quarter came from, really, the higher -- the technology-related products, although our "core equipment business" performed well also I think as our customers are thinking about the investments that they're making in their practice.

Look, our customers obviously don't have unlimited funds.

So as they're thinking about where they put their investment, we're seeing them certainly look at the technology advancements that are being introduced into the marketplace as great places for them to invest in and really get a good return for -- in their practice.

So I wouldn't suggest that we're seeing any kind of slowdown in the core equipment area.

We are really pleased with our results there.

We expect that to continue.

But to your question, certainly, the technology components, in particular, CAD/CAM were the main drivers of our equipment results in the quarter.

Maybe I just ask a follow-up on the margins.

You highlighted a number of things in your prepared remarks, including product mix, strategic sourcing, some of the things you did on the cost side.

Can you help us think about the contribution of these different drivers to help us better assess the sustainability of that margin trend as we look to 4Q and into next year?

Yes, I don't think we're going to break it down in the smaller pieces, Glen, as I'm sure you can understand.

But what I would say is, we're obviously focused on margin.

That's an important element of our performance for sure.

We're also focused on growth, and we're able to, obviously, drive growth and margin improvement in the quarter.

And we're focused on various elements that are going to drive margin improvement over time.

So continue to focus on operational excellence, continue to be disciplined about our cost structure, continue to focus on ways to improve not only our kind of segment mix but our product mix.

Certainly, a growing consumables business or a portion of our business drives favorable margins overall.

So all of these elements are areas of focus, and we expect to continue to focus on margin.

Yes.

And Glen, maybe I'll just add.

I think if you look back over our 7 previous quarters here, you can just kind of see the cadence of the margin and that may give you a little bit of a hint on the sustainability.

I think this is really broad-based.

It's not one item.

It's not sort of onetime events.

Really, this is really all of it put in the hopper and you're seeing the results here over kind of a 7-quarter period.

Your next question comes from the line of Kevin Caliendo from UBS.

I just want to get into the Dental margin a little bit.

You mentioned it was down 50 bps year-over-year, 40 basis points of that was caused by the shift of the equipment financing to VAS.

So that means it was still down 10 basis points yet the consumables gross margins were higher.

Is the decline in margins is simply a mix issue that equipment operating margins are just lower in general and grew faster?

Or can you talk a little bit more specifically about the operating margins within consumables and equipment, the trend?

Yes, this is Don.

So just one thing to clear up.

The equipment financing margins are still in the corporate segment.

So that may have not been worded just quite right, but just so we're clear on that.

So there was a 50 basis point decline in Dental margins.

But I wanted to highlight that the consumer margins were up.

The other piece is really, yes, just the mix of the equipment, and then we did have some -- we did write-off some equipment in the quarter and not overly significant some older equipment in our portfolio that offset that.

That's helpful.

And just as a quick follow-up.

We appreciate the coronavirus update and the impact in 3Q.

But have you seen any impact on demand in Dental globally in your fiscal fourth quarter at all?

I mean we're all focused on China, but the Chinese government has called out Dental is the one sort of service that is the most likely to pass the virus.

And so I was just wondering if you're seeing any slowdown in demand into February and the like globally?

Yes, Kevin, we have not, at this point, seen any slowdown in demand in our Dental segment as a result of the coronavirus.

Obviously, we're watching it closely.

And we're working with our customers and manufacturer partners and local authorities, as I mentioned, to just ensure access from a supply chain standpoint.

But to your question, no, we've not seen any specific implications to demand at this point.

I guess, one really quick follow-up to that.

On the supply chain, how much of your equipment supply, any of raw materials, anything comes from China?

Well, certainly, really, primarily in the consumables area, private label -- some of the private label products that we purchase are manufactured there.

Certainly, you've got some general merchandise sundries products that are manufactured in China.

But to my knowledge, I'm not exactly sure.

But from an equipment raw material standpoint, I don't believe so.

Your next question comes from the line of Nathan Rich from Goldman Sachs.

Mark, just starting at a high level, you're kind of approaching the final year of our 3-year strategic plan.

You've obviously highlighted the improvement you've seen in Dental, the improvement you're starting to see with operating margins.

I guess as we look forward from here, how do you see the initiatives that you put in place kind of coming together as we think about the trajectory of the business a little bit longer term?

Yes, Nathan, thanks.

Certainly, as we've spoken to this 3-year plan, year 1 really trying to stabilize on the core business; year 2 about accelerating our performance and I think we're well in place to achieve the year 1 and year 2 goals; and certainly, year 3, thinking about how we continue to build on that momentum and expand.

And so as I think about FY '21 and beyond at this point, probably a few key things.

One, we're certainly going to continue to invest in our core business to build on the momentum that we're starting to establish and really continue to build out our value proposition that supports our customers and the things that we've spoken of, top line growth, margin, margin focus, cost, et cetera.

Secondly, certainly, we're making really good strides.

We haven't talked about kind of our value-added services category.

That grew, I think, approximately 9% and in the quarter.

So those are margin accretive areas, such as software, tech service.

Those are certainly areas that we'll continue to invest in.

They generate, again, margin accretion for us, but also great service and recurring revenues, a great service for our customers.

And certainly, as our balance sheet continues to improve, I think, third, to identify appropriate and accretive M&A and business development opportunities that would drive growth, build on and expand upon our value proposition and, again, continue to enhance the value bringing to our customers.

So you're not really going to get into any further specifics around what that would be.

But certainly, we're looking at a variety of opportunities.

We'll certainly be very thoughtful about how we may put additional capital work -- capital to work while certainly supporting our existing capital allocation approach.

So we're thinking -- obviously, right now, we're focused and head down to finish the year strong.

But certainly, we're thinking about FY '21 and beyond.

And hopefully, Nathan, that gives you a little color on the types of things that we'd be thinking about.

Mark, appreciate that.

And just a quick follow-up on the Dental equipment business.

With the strong placements on the high-tech and digital side, can you remind us what the kind of historical relationship that you guys have seen between equipment places -- placements in categories like CAD/CAM and consumables revenue?

Do you typically see sort of a tail or a benefit on the consumable side after you place a piece of equipment?

Well, I think it would be hard to directly correlate the 2 necessarily.

I think the way that we think about it certainly is, we're bringing value to our customers, we're helping them make really important investment decisions, we're helping support them, we're helping ensure productivity and that they get the return on their investments that we certainly have additional products and services that I think put us in a great position to further penetrate with those customers.

So again, we're very focused on that comprehensive approach.

We're very focused on being a trusted business partner.

And we certainly believe that as we continue to bring value to our customers across the equipment and technology category, that's very positive for us in terms of our consumables and value-added services categories as well, both of which are margin accretive to the equipment category.

Your next question comes from the line of Elizabeth Anderson from Evercore ISI.

Congrats on a good quarter.

I only have one question.

I mean I know that you guys are obviously going after the DSO business and more DSO business and looking for attractive partners there, but I just wanted to know, like, in terms of your current book of DSO business for this -- the rest of fiscal '20 and into '21, are you guys having any sort of renewals on the like horizon that we should be generally aware of?

Or is that something that's sort of not pushed out beyond there?

Yes, Elizabeth, thanks.

We don't specifically talk about renewal time lines with key customers.

Certainly, as you've indicated, we're very focused on continuing to invest in and build out our capabilities to support the DSO market.

We're pleased with our improved performance there, and we're pleased with the teams that we have in place and the investments that we're making in this area, and we're also pleased with the value that we believe these DSO customers see in Patterson.

And certainly, obviously, there's an ongoing process in these relationships.

And again, we're very focused on bringing value so that when relationships do come up for renewal, we're in a great position to continue to build on and extend and expand our relationships with our key customers.

Okay.

Perfect.

That's very helpful.

And the other question I had in terms of -- I know some manufacturers have changed some of their loyalty programs in recent months, and it could -- and I just wanted to see sort of if you guys had seen an impact that you could attribute to there because you could see it working very positively as some of them are key partners of yours or sort of neutral to negative.

So I just wanted to get a better sense of what you're seeing from there?

Yes, thanks.

We certainly see that as a positive.

In fact, as customers continue to build on their relationships with Patterson or with some of our key manufacturing partners and really increase their share of wallet with Patterson or with some of our key partners, I think that bodes well for everyone throughout the supply chain.

We also are very focused on continuing to invest in and grow our loyalty programs.

We're making great progress there.

We relaunched it back in early last year -- excuse me, and we're seeing some great growth of our loyalty programs.

And we don't view those as competitive in any way with our manufacturers.

So we see that as a positive, and we look forward to continuing to work closely with our key manufacturing partners to drive growth for both of our products.

Your next question comes from the line of Jon Block from Stifel.

Great.

Nice quarter, guys.

Nice broad-based quarter.

So congrats.

I guess, Don, the first one is just how the segment results or margins were relative to the company's expectations?

And I guess where I'm going with that is, I was sort of surprised to see the OP margin compression by segment despite solid internal growth.

So maybe if you can just comment on how that played out versus your expectations?

Well, I think if you look at the -- I mean it was pretty close to our expectations.

I think the Dental margin, as I mentioned, we did have some equipment write-down for some older equipment.

So that was not necessarily in our internal expectation.

But I think beyond that, if you look at the way the Animal Health margins performed and then the rest of kind of the Dental segment, that was right in line with what we thought.

Okay.

Maybe as a follow-up, maybe to ask it differently, I'm just curious EBIT dollars, if you would, for Dental and Animal Health were flat year-over-year, correct, and sort of the $9 million-ish increase in EBIT at the non-GAAP level, essentially, all came from less of a loss in corporate.

Is that correct?

Yes, that's accurate.

And if you look at that, you could break that into really into 2 pieces.

I think it's kind of half the equipment financing impact of higher equipment sales.

And so, if you will, that really probably -- you could attribute to the Dental segment and then the other half of that is really a reduction in in our corporate expenses, just given all the programs that we have in place to continue to work on that as part of our P&L.

That's great color.

That's very helpful.

And then maybe just a broad-based second question would be, can you just give us the weightings of how it breaks out within your Dental equipment?

Is it 50-50-ish?

Or what is it, I guess, for call it, traditional equipment versus high-tech?

And lastly, is there an updated number to think about tax rate for the year?

I think the initial, Don, was 25% to 27%?

Are we closer to 25% with 1 quarter to go?

With regard to the equipment, really won't -- wouldn't want to break that out more specifically.

So thanks for the question, but just not going to get into that level of detail.

And I would say on the second question, yes, if you want to start positioning yourself more toward the 25% number, that's probably most accurate.

Your final question comes from the line of Steven Valiquette from Barclays.

One of my primary questions on the dental consumables strength was asked a couple of minutes ago.

But just to state it a little bit differently, I guess, I was curious, is there any visibility you have on how much of the dental consumables growth in fiscal 3Q is directly related to the underlying patient volume growth within your customers versus perhaps a bolus of consumable sales that may have been tied to inventory build related to new equipment placements?

Whether it's currently your blocks related to chair-side CAD/CAM placements or just other dynamics like that, that might be over and above the underlying patient volume growth?

No, Steven, I wouldn't suggest that it was related to the second element there.

I think we're -- as I mentioned, we're certainly seeing a steady and stable dental market with positive, certainly, long-term fundamentals.

And I wouldn't characterize our consumables results in the quarter with regard to inventory builds by customers or specific products that they would have purchased in advance or as part of an equipment investment.

So I think it's a direct result of the things that we've been talking about, building out our field sales organization, continuing to drive improvements in the customer experience and just solid execution across our teams.

Okay.

And just quickly, this is also touched on a little bit, but just to tackle a little more directly.

One of your largest dental distribution competitors did talk about some soft end market demand related to independent practitioners, in particular, mean, it definitely seems like you we're not witnessing that same trend based on your reported results.

But I'm just curious if you're able to comment on that topic since this industry observation was cited by at least one of your larger competitors?

Look, we're certainly not going to comment on specific elements that are -- others in the market would suggest.

But I think as we've indicated throughout the call, we're pleased with the 2% growth in our consumables business in the quarter and, in fact, what was slightly above 2% in our U.S. consumables business.

And certainly indicated, we're in a competitive market, and we believe the dental market is stable and steady with positive fundamentals, and we're focused on our business and continuing to execute and bring value to our customers.

That concludes today's Q&A.

I turn the call back to the presenters for any closing comments.

Just wanted to thank everyone for your time this morning.

And certainly, we look forward to hosting you on our fourth quarter fiscal 2020 earnings call in June.

Thanks very much for your time.

That concludes today's conference call.

Thank you, everyone, for joining.

You may now disconnect.