Patterson Companies Inc (PDCO) 2003 Q3 法說會逐字稿

Thank you.

Good morning and thank you for participating in our third quarter conference call.

Joining me today are Steve Armstrong our Executive Vice President and Chief Financial Officer.

Steve will reviewing our third quarter results following my opening remarks.

At the conclusion of Steve's remarks, we will be happy to take any of your questions.

Regulation FD prohibits us from providing any earnings guidance unless we release that information simultaneously.

For this reason, we have included financial guidance and our earnings rose, but it is important to understand that Patterson's actual results may vary from our forecast.

Our guidance is summary to a number of risks and uncertainties which are discussed in detail in our annual report on form 10K.

Since the information that forms the context of what we will be saying today, we urge to review that material.

Turning now to our recent operating results, the third quarter was another period of strong sales and earnings growth for Patterson.

Total sales were up 18% while quarter earnings increased 19%.

North American Bell sales grew 19% and we are continuing to gain market share.

Our Webster Veterinary Supply unit is also growing faster than the U.S. companion veterinary supply market.

With that much said, I'll briefly review some of the highlights of our third quarter performance.

North American sales of consumable Bell products 11% in the third quarter.

Our third quarter sales analysis indicates that consumable sales for this period were affected by the mid-week timing of the Christmas and New Year's holidays.

The sales growth rate for fiscal January, which included both of these holidays, was 3-4% points below the average of the first two months of the quarter.

This is a seasonal factor and does not affect our estimate the North American dental market continues to grow at 7-9% annual.

Bell Equipment sales rose 37% in the third quarter which follows sales gains of 16% in the second quarter and 22% in the first quarter.

Our third quarter equipment business was strong across the board.

The demand for the CEREC3 Dental Restorative System remains robust reflecting the steadily degree of clinical exceptance among practitioners.

We believe the CEREC System continues to gain acceptance as a proven means for enhancing dental office productivity and profitability.

Sales of digital radiography systems also continue to run at a high rate during the third the quarter.

Digital radiography systems are now part of our dental office networking and hardware program which was fully rolled out on a national basis during the third quarter.

Under this program, dental offices would buy our digital x-ray equipment and software, can have these systems, an all work stations network throughout the entire office.

Fully supported by local Patterson personnel, this networking initiative is the newest component of our single source technology solution for dental offices.

We are confident in saying that no other company is capable of providing this type of total digital solution which encompasses a full range of product, seamless installation and training and complete wholesale support by skilled field technicians and Patterson Technology Center personnel.

We expect the single source concept to be an increasingly powerful driver for Patterson going forward and in the third quarter [INAUDIBLE] the hardware component of this initiative, were more than double the second level.

Finally, I want to point out the basic dental equipment also posted strong growth in the third quarter.

Discussing digital technology and new generation equipment is often easy to overlook the ongoing demand for such basic equipment as chairs, units, lights and cabinetry all of which increased 20% in the third quarter.

The willingness of the growing number of dentist to invest in capital equipment of all types, and thus prepare for the future is a very positive sign for the dental market in our opinion.

The next aspect of the Patterson third quarter results that I would like to discuss is our software business which rebounded strongly from its second quarter performance.

The third quarter software units were 180% over the second quarter level.

The majority of this growth posted by our clinical software that is used to optimize the productivity potential of digital radiography systems.

The corrective sales actions that we implemented earlier this year are starting to generate the desired results and we expect this progress to continue in the fourth quarter.

Our Canadian dental operation reported the strongly improved third quarter.

As you may recall, our Canadian operation posted below planned second quarter results due primarily to softness in certain regional equipment markets.

In our second quarter conference call, we said the absence of widespread market weakness made us believe that our Canadian dental operation should perform better during the second half.

Even when the positive impact of the DQD acquisition is excluded, our Canadian operation records strong consumables and equipment sales in the third quarter.

I also want to emphasize that the Webster Veterinary Supply is continuing to perform at a high level.

Webster's third quarter sales were up 8%, which is a very good growth rate for Webster's seasonally weakest part of the year.

The spring months of the fourth quarter mark the start of Webster's seasonally strongest period which extends through our first quarter.

Turning now to our fourth quarter financial guidance, we are forecasting sales growth of 10 - 12%.

Two primary factors will be affecting our anticipated fourth quarter sales growth.

First, the Thompson Bell acquisition will anniversary on April 2.

Second, because CEREK sales were exceptionally strong in last years fourth quarter, we believe it's prudent to remain somewhat cautious in forecasting CEREK sales this early in the quarter.

Based on our anticipated growth rate, we are forecasting fourth quarter earnings of 47-48 cents per diluted share.

Net income at this level would result of full year earnings of $1.68 to $1.69 per diluted share, which excludes a one-time non cash benefit of 5 cents per diluted share resulting from the adoption of an accounting change for good will in the first quarter of fiscal 2003.

Our businesses are gaining market share and the strategies are in place to help insure successful future for this organization and our shareholders.

Now I would like to turn it over to Steve who will review various aspects of our third quarter operating results with you, Steve.

Thanks, Pete.

Rather than repeating a lot of facts and figures that you already have in the earnings release, I thought I would spend a few minutes and add some color to some of the third quarter developements.

First, in the area of equipment and software sales, in addition to strong performance by our CEREK line and our basic equipment categories, our equipment operation also benefited from the continuation of strong demand for radiography systems in the third quarter.

Sales of this new generation equipment increased 87% year-over-year reflecting the growing recognition of a benefit and cost effectiveness of this technology.

Now, I would like to briefly discuss our [INAUDIBLE] in operating margins where we did not see improvement and we [INAUDIBLE] to target.

A significant and equipment and software sales increase in the third quarter led to a shift in our revenue mix.

This resulted in equipment accounting for a higher percentage of total revenues and equipment generally contributes slightly lower gross operating margins than the the consumable business.

Our operating margin was also impacted by our continuing investment in Patterson's infrastructure.

These investments, as discussed during our second quarter conference call, include our new technical service system, our hardware and networking initiative to support radiography products and our new customer service order entry system.

We are committed to each of these efforts to full advantage of promising market opportunities and to further our customer service.

We also saw some pressure on operating leverage from the continued integration of the former Thompson Dental operation, the timing of certain advertising programs and expenses related to health and liability insurance.

A couple of comments on our cash flow and balance sheet.

The quarterly cash flow from operations was $9 million.

There were basically two factors impacting that operating cash flow.

The first is bitter sweet.

Our financing activity was up almost 220% due to the strong equipment performance that Pete discussed.

Since most of this financing activity occurred in the last two months of the quarter, we could not sell these contracts by quarter end because the installment contracts had not matured sufficiently to be sold to the commercial paper conduit.

This paper will be sold in the fourth quarter.

A deal excluding the contract of the 32 days versus 36 at the end of the second quarter.

Our operating cash flow was also affected by our decisions to take advantage of vendor opportunities during the quarter.

As a result of these opportunities, we purchased additional months of consumable inventory that increased by our levels by about 17 million for these consumable inventories.

This was partially offset by our reduction in our equipment inventory between the second and third quarters of approximately $8 million.

We believe this additional consumable inventory will work it's way through our system by the end of the fiscal year.

In spite of this addition, our inventory turns improved at 6.9 times at the end of the quarter.

Our total cash flow for the period also reflects a repurchase of 330,000 shares of stock or about $13 million.

There remains 1.1 million shares under our current repurchase authorization.

With those comments, I will turn it back to the operator to poll you for your questions.

Thank you.

Thank you.

The question and answer session will be conducted electronically.

If you would like ask a question, please do so by pressing the star key followed by the digit 1 on your touch tone telephone.

If you are using a speaker phone, we ask you that make sure your mute function is turned off to make sure your signal to reach our equipment.

Once again, it is star 1 if you would like ask a question.

We will pause for just a moment.

We'll take our first question from Glenn San Tangelo with Salomon Smith Barney.

Hi, how are you Peter.

I just have a couple quick questions.

On this consumables number, I'm trying to get a sense of what that number might have looked like if you backed out Thompson Dental.

I'm just not sure how much of that growth was organic versus acquired.

And you sort of cited that Christmas being on the middle of the week might have had an impact.

Is it a big difference if Christmas falls on a Wednesday versus a Tuesday as it did in prior year?

Does that have a meaningful impact on sales?

Let me answer the question in two parts.

The first part, is as it relates to summary number might have looked like without Thompson.

The issue for us Glenn, is that once we integrate those sales territories, and with the Thompson rep and with the Patterson representative go through accounts and the Patterson rep ends with some accounts, the Thompson rep ends up with some accounts and there's no consistent basis .

Once that's done, we really can't done give you an answer to the first part of your question.

Okay.

The second part of the question says, is there a difference when Christmas and New Year's falls on a Wednesday versus a Tuesday.

In our view, we have made a rule around here there will be no more Christmases and New Year's on Wednesday.

Yeah, we do think that when it falls in the middle of the week like that, there's probably an extra day involved in terms of time off, non-production, that sort of thing on the part of the dental office.

So we do think there's an impact there, but I don't want to create for anybody that this is the first time we've ever had a Christmas and a New Year's holiday.

We've obviously had it before and as we said, it's simply a seasonal factor and we don't see it affecting our estimate of growth rate in the market place.

Just one more question, if I might, on the equipment side, was there any, what do you think led to that huge spike in the equipment sales?

Was there any discounting of the products involved.

I mean, are we comparing apples to apples.

It just seems like it's just such a large spike which, I guess, is obviously good for you guys.

Yeah, I think Glenn, there are 3 or 4 things.

We've talked about in the past with you this concept that we have of a kind of a retooling going on in the equipment market place as it relates to the dental office and the fact that the dentist is busier.

Recognizes that new basic equipment like chairs, lights, units, et cetera not only enhances their productivity but is a benefit from the point of new patient comfort, et cetera.

The second thing that I think we would tell you is that there was an additional tax benefit at year end and we would think that some customers took advantage of that.

Clearly, we are seeing the continuing and growing acceptance of CEREK and digital x-ray as a part of that growth rate and a continuing strong market overall and we think, effective sales programs.

Now, to answer your question directly, we did not have any major continuing discount programs in the third quarter.

We did, and do have, a trade in program for CEREK in terms of customers that want to trade up to the new model.

Okay, thanks for the comments.

Appreciate it.

We'll take our next question from Larry Marsh will Lehman Brothers.

Yes, Pete and Steve.

A question on the equipment as well.

Roughly how much of that business was financed in some way?

Can you provide some perspective there and would attribute that mix to, that percentage to product mix?

And then, Steve, remind us how long does the installment sale have to age before you can sell it off to the conduit, to the commercial paper conduit, which would show an improvement in your cash flow statement?

And then also, was there any increase tax benefit from dentists buying equipment this year versus 2001 that you can speak of?

How about if we talk about the last one first just to follow up on Pete's comments.

There was an additional bonus depreciation for the small business owner, well actually for any business this year.

See, you had the section 179 deduction which is a $25,000 automatic expensing of capital transaction and then you had the bonus depreciation which, if I recall correctly, is like a 30% write-off in the first year over and above the $25,000.

Just sort of put that into perspective, it allows a purchaser of a CEREK, for example, to write off close to 40-50% of the cost of that equipment in the first year.

So, for the small business person, we think it has a very positive aspect in some of their buying decisions.

With regard to the financing activity, the volume was extremely heavy in line with the equipment purchases obviously, we financed 45-50% of the purchases during the quarter.

The answer to your details as far as when we can sell a contract, we basically sell once a quarter, we sell on the 15th or the midweek of the third month of the quarter and the conduit has the rules that say that you have to have at least one payment in the contract before you sell.

So effectively, if you back off today's, if you're looking at we have to, we're relegated to about a 50 - 60 day inventory that we we just have to prove to the conduit we don't have to stick with this 30 day penalty and hopefully we can get better cash flow out of it.

But it's going to take some negotiation on our part and some time to just prove to the conduit that we have the type of quality of paper that would deserve better terms under the arrangement.

So we're managing it from a couple of fronts not only using our facilities smarter and trying to turn the paper faster as far as getting it out in the field, but also then we'll have to negotiate under the contract to try to improve our flow here a little bit.

Right, so is it fairly, Steve, it could create some [INAUDIBLE] on an equivalent basis of cash flow as you have identified.

Yeah it will Larry, I think in all candor we have been struggling with it since the first quarter really, and we're learning from this.

It's going to take a little bit of time to get our practices honed but at the same time we're a little bit [INAUDIBLE] to the flow of the transactions out in the field as those contracts come back on as a customer base.

Right.

Were there any promotions or financing from the manufacturer of note in the quarter along with the year end incentives that you can speak of, or was there none of note?

No, I mean last year it was fairly well publicized that there was a manufacturer's rebate during the third and the fourth quarter for the Cirak.

That program was not running this year.

The product is picking up the momentum in the market where either the manufacturers or ourselves felt that was necessary.

As Pete said, the CEREK2s have been available for trade ins.

There's a program running there.

That's a convenience to the customer, probably stimulating some transactions.

It's not broad based.

Okay.

Great, thanks.

We'll next hear from Derrick Latow with Barrington Research.

I have a question regarding the amount of cash you will be generating in the next few quarters.

Obviously, as you sell the equipment contracts and reduce your inventory.

Does this change anything as it relates to your share of purchase opportunity or your dividend policy or anything along those lines?

I would just, with regard to the dividend policy, we review that policy with our board almost every meeting that we have as Bush's proposals take shape, we'll see what that will do for us and what kind of effect that will have.

We will obviously be -- you guys keep bidding my stock price, I'll be very aggressive with my stock repurchase program, but we'll continue to use that and obviously, we're about half the authorization from where we began.

We'll probably talk to the board about whether we want to refresh that in the not too distant future.

We're continually looking for acquisition opportunities and we want to preserve some of that cash for the expansion of the two businesses too.

Any specific updates you can give us on the acquisition front?

No specific updates other than we continue to be involved in the acquisition.

Okay.

What's your -- what would you estimate your current capacity utilization is and would you have to do anything to your capital expenditure budget for next year for 2004?

I think, as we've indicated in the past, we are clearly looking at distribution in terms of the east coast.

We probably have some things to do in Canada over the next 12-24 months kind of thing, but beyond that, we feel we're in good shape, and at this particular point in time, you know, these are things that we're planning ahead.

We aren't feeling any major constraints at this point in time.

I would add a little color to that from the stand point that our propensity has been to buy distribution centers if we expand or replace -- we're currently in a replacement mode.

I don't think we'll be expanding our distribution system.

But we'll look at the market conditions and decide whether we would want to lease or buy.

I have said publicly before our current plans would estimate that we would be spending some amount of money in our distribution center.

It would take us, even if we lease a facility, it's about $4,000 to $5,000 of interior capital goods to bring an operation up to our standards.

If we buy, you're probably looking at an investment per warehouse between $8 and $12 million depending on the location.

We're not going to do that in one year.

I'm still sticking to my guns that the capital expenditures would be in the $13 million to $15 million range this year and could be higher going into fiscal 2004.

But we'll keep you posted as we make decisions in that area.

Thank you very much and congratulations.

Thanks.

If you would like to ask a question press star one at this time.

We'll hear from Valerie Braun with Robert Baird.

I have a quick question.

Did you have a year over year growth rate for your software.

The year over year, the software group, including the services, the statements, maintenance contract was down slightly 6-1/2%.

Okay.

The software element itself, just the unit sales was down 32% as Pete said, it was still soft over last year.

That's 32%?

Down, correct.

Can you talk about -- I know your software sales are included in the equipment number that you gave of 37% increase.

Can you talk about a percentage of sales there?

What percent of the equipment sales, the software and then maybe can you give us a break down as far as basic equipment versus the higher analogy of digital equipment?

We never give specifics.

We gave you the soft sales side group.

I can do that for you.

Software sales during the period were $2.6 million.

The other services, electronic services and maintenance contracts were was slightly under $5 million.

Do you think the decrease in the software business again impact the gross margin.

You talked about the mix as far as higher equipment sales impacting gross margin.

Would software -- wouldn't that be a higher version product?

It is, Val.

If you do the math and compare it to last year, you're within a few hundred thousand of the total between the two.

Actually the software business was probably not having much of an impact on the margins.

It's more the equipment.

More the mix of the equipment than the consumeables.

One more question.

I know you were asked about your acquisition outlook.

Do you see both the dental and the markets being fairly fragmented still as far as the opportunities and priorities with the expansion, do you see you expanding more veterinary or dental?

Do you have commentary on that.

We would continue to see both markets as fragmented.

Both markets represent opportunities for us.

From our perspective in terms of acquisitions, we would look to dental acquisitions or veterinary acquisitions with the same sense of urgency.

Quite frankly, we wouldn't place a priority one over the other at this particular point in time.

We would be more than willing to do both.

One last question.

You mentioned that you believe the North American Dental market is growing 7 to 9%.

Will that be consistent?

That's the number we talked about in the past.

That's the number that's still consistent with our estimate.

Thank you.

We'll next hear from Robert Willoughby with Credit Suisse First Boston.

Good morning, Shawn Harrington in for Robert Willoughby.

Just on the accounts receivable.

That's been ticking up a little in the last couple of quarters.

I'm sure the inability to sell some of that financing contributed to that.

What are some of the other factors there and what's your outlook for the next few quarters.

By the time you take the contract out of our AR, it's been coming down on a day sales basis.

We're into the low 30s now.

Most of the growth you're seeing there is all due to contracts but the rest of our trades are holding very nicely.

We got a little bit of a bump as Webster came in because they typically had a little bit higher day sales than the dental business has said.

That's pretty much factored in.

You're not seeing an increase because of that.

This should be a pretty good move as that comes down as you sell those off?

I have to caution you there, Shawn.

This goes back to what Larry talked about.

Depending on the timing of these contracts and the volume of the equipment business, we could just be seeing a replenishment in the near term because of selling the contracts we generated in this quarter which we fully anticipate to do.

Depending on the level of financing in the fourth quarter we could be replacing those.

Okay.

I would then go back to the management issues, and that is being smarter, being faster and turning this paper.

We'll probably have to negotiate with the conduit to see if we cancel the paper to them on a faster basis also.

Okay.

Just on the equipment growth for the next quarter obviously, you -- do you think you might have pulled -- I am sure you pulled sales from this quarter into the next quarter is that a fair statement.

I don't think we forced sales from future sales.

We're being straightforward in terms of the contributions we talked about as it relates to ser oak.

Thanks.

Okay.

Thanks.

It is star one if you'd like to ask a question.

And we'll next here from Curtis Brockleman from Salomon Smith Barney.

I have one more question on the equipment sales.

When will you know in the quarter how sales are going as far as trend wise.

How will you notify the investment community?

Historically we've never done anything like that I think my answer to you is when the quarterly results are in, we'll announce it unless something were to be significant or material as it relates to our estimated revenue increase.

Thanks.

Nice quarter.

Thank you.

We'll take a follow-up from Derrick Latow with Barrington Research.

I just wanted to talk about the consumable trends as it relates to the aesthetics products, the whitening products and things like that.

Are you seeing any change that may or may not be economy related in the market place?

I'm not sure I understand the question, Derrick when you say not economically related.

Related to perhaps some of the more discretionary types of dental products that you might be selling through your dental offices.

Are you saying is the economy beginning to have an impact on discretionary services offered by the dentists?

Yes.

We aren't seeing anything like that at this point in time.

I think from our point of view, the dentists remain busy.

We aren't in even way getting a broad spectrum as it relates to the impact of the economy and the dental market place at this point in time.

So, are those products still selling at rates that are higher than the average industry growth rate?

Yes, they are.

Okay.

Thank you.

We'll take a follow-up from Valerie Braun with Robert Baird.

Just quickly.

On fiscal 2004, I can't remember if you guys have given out formal guidance or not or if it's just a matter of your overall goals.

I think you have said goals occurring 4% to 5% higher than market.

Do you have any formal guidance for '04?

Can you give us a general goals at least?

Our historical pattern, valley, has been to give fiscal four guidance as part of the fourth quarter earnings release.

I think we'll stick to that.

In general terms, yes, we'd steer you back to our general goal of trying to grow 4% points faster than the markets top line and should give us a -- an 18% to 20% growth in the bottom line, assuming we get our 50 basis points out of our operating margin.

All right.

Thanks, very much.

You're welcome.

We will take our final question today from Matt Weatherby with M A Weatherby.

Actually Mr. Weatherby disconnected.

I'll turn it over to you for closing remarks.

Thank you.

We thank you for the continuing support and look forward to a strong year end finish and we'll chat with you at the end of the fourth quarter.

Thank you very much.

That does conclude today's conference.

We thank you for today's participation and have a great day.