Patterson Companies Inc (PDCO) 2003 Q4 法說會逐字稿

Good day and welcome to the Patterson Dental fourth quarter earnings conference.

This call is being recorded.

At this time for opening remarks and introductions I would like to turn the call over to the Chairman and Chief Executive Officer, Mr. Peter Frechette.

Please go ahead, sir.

Thank you.

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

With me today is Steve Armstrong, our Executive Vice President and Chief Financial Officer.

Steve will review some highlights of our fourth quarter results following my opening remarks.

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

As you know, Regulation FD prohibits us from providing investors with any earnings guidance unless we release that information simultaneously.

For this reason we've included financial guidance in our earnings release, but it's important to understand that Patterson's actual results may vary from our forecast.

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

Since that information forms a context for what we're saying today, we urge you to review this material.

Turning now to our recent performance, Patterson reported excellent operating results in this year's fourth quarter.

Consolidate sales rose 12% to $447.3 million while net income increased 22% to $33.6 million or 49 cents per diluted share.

These results, which exceeded our previously reported financial guidance for this period were generated by strong performances posted by our dental operations and our Webster Veterinary Supply unit, which reported a fourth quarter sales increase of 20%.

Patterson's fourth quarter performance reflects the vitality of the dental and veterinary supply markets as well as our ability to continue to gain market share.

We continue to believe that the North American dental market is growing at a estimated 7 to 9% annual rate.

This estimate is based on a weighted average that includes double digit growth of the dental equipment and software markets, and a 5 to 7% growth of the consumables market.

In the area of dental equipment, Patterson has positioned itself as the largest distributor of dental equipment by a factor of more than two.

Equally important, Patterson is the exclusive distributor of many major product lines.

For example, we're the exclusive distributor of CEREC 3 dental restorative system, which is affecting a fundamental change in crown, inlay and onlay procedures while also significantly increasing dental office productivity.

Sirona, CEREC's manufacture introduced new 3D software for this equipment that is being extremely well received by dental practitioners.

We're also the exclusive distributor of [SHIK] technology.

[SHIK's] digital radiography sensors which account for a substantial majority of all digital x-ray installations in th U.S.

It's worth noting that [SHIK] recently introduced a wireless sensor that is expected to spur further demand for digital radiography systems.

Patterson also is the only national distributor for some of the world's largest manufacturers of chairs, lighting and cabinets.

This includes ADAC the leading supplier of this equipment in North America.

The strong sales growth of our equipment product lines clearly indicates that Patterson is exceptionally well positioned to meet the expanding need among dentists for equipment that will strengthen office productivity, improve clinical outcomes and enhance the profitability of their practices.

This one of the ways Patterson has differentiated itself from the competition, which is enabling us to continue gaining market share.

We've also differentiated ourselves from the competition by becoming the only company capable of offering single source turnkey digital solutions to dental practitioners.

Dental offices that buy digital radiography equipment and software can have these systems and all work stations networked throughout the entire office.

Our single source digital solution, which encompass installation and training, in addition to post-sales support by local field technicians and the Patterson Technology Center personnel.

We expect this single source concept, along with the roll of the Patterson Technology Center to be an increasingly powerful growth driver for Patterson going forward.

Enhanced technical service is another way that Patterson is differentiating itself from the competition.

During the past year we invested several million dollars in advanced software and communications equipment and in strengthening technical service and support.

The van of every Patterson service technician is now equipped with a GPS system that keeps dispatchers informed about the location of the service tech closest to the customers.

As a result, we will be able to accelerate response times to request for equipment repair services.

Our service technicians are also equipped with hand-held computers to track inventory and improve customer billing.

This system keeps the dispatcher informed in realtime about the parts inventory in the van enabling us to send a technician with the needed parts to the customer.

Taken as a whole, this new initiative, which is now being fully implemented around the country will enhance customer service, improve inventory control and strengthen utilization of our service assets.

Turning to Patterson's organization, we announced in mid-April that Jim Wiltz was promoted to President and Chief Operating Officer of the Patterson Dental Company.

Jim, who is 57, and served as President of our Patterson Dental Supply unit since 1996 assumes the position of President from myself.

While the post of Chief Operating Officer is a newly created executive post, I'm continuing in my prior roles as Chairman and Chief Executive Officer.

Jim, who is also a member of our board of directors has been with Patterson for over 30 years and was part of the management group that led Patterson's buyout from the Beatrice Corporation in 1985.

Scott Kabbes, 42, was named Jim's successor as President of Patterson Dental Supply.

He has served most recently as President of Patterson's Technology Center, which provides the North American dental market with digital technology solutions.

Scott was the founder and President of Eagle Soft, a dental software company that Patterson acquired in 1997.

As a result of these moves we've increased the depth of Patterson's senior management team, which is aimed at ensuring a seamless management transition.

I'd now like to turn to an important organizational initiative at our Webster unit.

Webster, which currently serves veterinarians in 26 eastern and southeastern states has been reorganized into a classic branch office structure, in which sales and customer service are now administered by branch managers.

We did this to move the decision-making process as close to the customer as possible, and to create P&L responsibility at the local level.

This new structure also makes it possible to hire sales representatives outside Webster's traditional regional territory, open a branch office and utilize one of Patterson's existing distribution centers for warehouse and shipping veterinary supplies.

In this regard, Webster's new branch office structure provides a sound organizational basis for Greenfield or Denoble expansion into new geographic markets.

At the same time, Webster is also continuing to evaluate acquisition opportunities as another means for national expansion.

I'll close out my remarks this morning by briefly reviewing our financial guidance.

For the full year 2004, we're forecasting earnings of $2.00 to $2.02 per diluted shares.

Sales for the full year are expected to be 4 percentage points in excess of the 7 to 9% estimated annual growth of the North American market, or 11 to 13%.

For the first quarter of fiscal 2004 ending July 26th, we're forecasting earnings of 42 to 44 cents per diluted share.

Because of the absence of an acquisition as we begin this period, we believe that our first quarter sales growth will be toward the lower end of the 11 to 13% projected increase for the year.

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

I'd now like to turn it over to Steve Armstrong, who will review various aspects of our fourth quarter operating results.

Steve?

Thanks, Pete.

Good morning.

I want to spend just a few minutes on our recent results and give a bit of perspective on what fiscal 2004 might hold in store for us.

Each of our major product groups saw improved revenue performance in the fourth quarter.

In addition, the dental gross margin rate was up 10 basis points for the quarter to 36.3%.

But the consolidated gross margin rate was down in the quarter as the veterinary sales represented a higher percentage of overall revenue in this quarter versus last year's quarter.

As we previously have stated, the gross margin in the veterinary distribution business is about 10 percentage points on average below that in the dental business.

Over time, we see an opportunity to move these gross margin rates closer to those we have historically seen in the dental business.

Our operating margin in the quarter improved by 40 basis points over the prior year.

We believe that we are seeing returns on certain of the infrastructure investments and the acquisitions that we were making or integrating during the fiscal year.

The investments as discussed during our previous quarter quarters' conference calls include our new technical service system, our hardware and networking inititiatives to support digital radiography products and our new customer service order entry system.

The acquisitions included Thompson Dental Company and Distribution Quebec Dentaire.

As Pete mentioned, we continue to invest in our technical service system and our new customer service order entry during, we will invest during fiscal 2004.

While these investments will negatively impact operating results during fiscal 2004, we are optimistic that improved leverage from the acquisitions and returns on our hardware and networking initiative will allow us to return to our targeted annual 50 basis point improvement in operating earnings.

Our operating margin may even expand beyond our annual target in fiscal 2004 as we see the benefits of product mix in our infrastructure investments.

In 2003, our capital expenditures were $12 million.

For fiscal 2004, we will spend in the same range for our routine replenishments and expansions.

We have already begun work on replacing the distribution center in the mid-Atlantic and expect the new facility to be operational late in calendar 2003.

How we finance this facility will depend on market conditions, but in the near term we will incrementally spend approximately 7 to $8 million to build and equip this operation.

Couple of other comments on our cash flow and balance sheet.

The quarterly cash flow from operations was $51 million.

There were basically two factors impacting the operating cash flow and a few lines of our balance sheet that I want to address.

First we reduced our inventories during the quarter as we predicted we would by turning through above normal sundries purchases made on favorable terms during the third quarter.

The veterinary business also reduced its inventories year-over-year as the stocking inventories of Prohard 6 moved through that operation.

Inventories turns for the year were 7.3 times versus 6.5 of last year.

Second, as we discussed at the end of last year, we entered into a new arrangement to sell customer finance contracts to a commercial paper conduit.

Overall we are very pleased with the decision ad certain provisions of this arrangement have caused some growth in our accounts receivable balance since we are required to carry the finance contract longer than under our other agreements.

I'll return to this point in a minute.

We're also financing more as our equipment business has grown.

I want to spend just a couple of minutes on how we assist customers in obtaining financing for their businesses.

An aspect of our overall business strategy is to make it easy for the customer to do business with the Patterson Dental Company.

One of the ways we do this is to provide access to competitive financing options for the customer so they do not spend time shopping for that element of their business needs.

Currently we can direct customers to three forms of financing.

Two are extended by independent financing entities for certain needs such as working capital, term financing, leasing and mortgages.

We also offer an internal program for qualifying equipment purchases.

In the case of the independent entities, we act in essence as a referral agent since any financing that is consummated is closed and serviced by those entities.

Our internal program results in the customer signing a note with Patterson and much like your local auto dealer we sell that paper to a group of banks or to the commercial paper conduit as mentioned above.

We have a combined $250 million of capacity with the banks and the conduit.

We have very exacting credit requirements that must be approved by the banks and the conduit for any finance contract that we would write with the customer.

This includes a current limit of $200,000 on the amount of credit that can be extended.

To give you an indication of the credit quality of this portfolio contracts, bad debt write-offs have been less than 1% of originations over the nearly ten years that we have had this program.

We service this portfolio contracts for the banks and the conduit for which they pay us a small annual fee.

When we sell finance contracts to the banks, we receive 100% of the principal amount of the contracts.

In the case of the conduit we receive 90% of the principal amount and the other 10% being held in a a collateral account by the conduit.

This cash asset is included in the noncurrent other asset classification of our balance sheet and it represents the majority of the change in this balance sheet item during the year.

One other aspect of this arrangement that has caused some confusion is the wholly owned subsidiary we established to sell the finance contracts to the conduit.

This entity, affectionately known as a special purpose entity, but which issues no debt and to which the conduit has no recourse in the case of a bad debt, provides a credit enhancement to the finance contracts by affording extra protection to the conduit under the bankruptcy law.

The last aspect of the arrangement with the conduit has has affected our balance sheet this year is the requirement that we have at least one payment from a customer before a contract is eligible for sale for the conduit.

This has effectively added 30 to 45 days to our inventory of finance contracts to be sold and has accounted for the majority of the increase in our account receivable balance.

As we establish more history with the conduit, we believe that we can reduce or eliminate this requirement and remove this layer from our receivable balance.

The point I want to emphasize is that these finance contracts are not the result of lower credit standards or special finance contract terms and they are being readily turned into cash.

Our DSO, excluding the finance contracts, is at 33 days versus 37 at the end of last year.

Thank you.

Now I'll turn it back to the conference call operator who will poll you for your questions.

Thank you.

The question and answer session will be conducted electronically today.

If you would like to ask a question, simply press the star key followed by the digit one on your touch-tone telephone.

If you're using a speaker phone, please make sure your mute function is turned off to allow your signal to reach our equipment.

Once again, if you would like to ask a question, press star one at this time.

And we'll pause for just a moment.

We'll first hear from Robert Willoughby of Banc of America.

Good morning.

Shawn Harrington in for Robert Willoughby.

My question primarily relates to Canada, you had an excellent experience up north this quarter.

Can you elaborate on what the run rate is there going forward and if there's anything one time in nature that boosted sales this quarter?

Thanks.

Shawn, there was nothing one time that boosted sales there.

I think Canada's increase was really a function of around strong equipment sales et cetera, and there's no reason that should not continue in our view.

Do you think any of the slowdown that you reported from last summer may have somehow pushed forward at all?

Do you think you realized any of those sales?

I think it's difficult for us to really know that.

I think, you know, we've talked about the fact that there is a cyclical nature to equipment sales as a part of our business.

I don't think that's changed.

We continue to believe that dentists are still in that kind of retooling phase that we've talked about before, continuing to be interested in achieving incremental productivity, et cetera.

So there's nothing major there that we would comment on that we haven't talked about in the past, Shawn.

Fair enough.

Thank you very much.

Our next question comes from Glen Santangelo of Smith Barney.

Just two quick questions, if I could.

First, I was curious, when I look at your 12% growth rate you reported in the quarter, if I consider the acquisitions the company did with Thompson and the Canadian dental, how much did they account for in the growth?

And is it fair for me to use a number roughly in the 4ish percent range?

Too high for the quarter, Glen.

Remember we did those acquisitions partway through the quarter of last year.

I would think a more realistic number, Glen, would be 2%.

Two to three.

Two to three?

Okay.

Then secondarily, my question is regarding the vet business.

When you did this deal, I guess it was almost a year and a half ago, you talked about it being a fragmented universe of companies and potentially they are offered some other acquisition opportunities, potentially on the West Coast or the middle of the country to sort of round out the geographical coverage.

What has been your experiences so far as you continue to look along that front?

We continue, Glen, to be interested in expanding that platform as we've talked about.

We are now in the process of finishing up the integration on a complete basis as we indicated to you this morning we've made some changes in the organizational structure.

But as a general rule we don't comment on acquisition activities, as you know.

All right.

Thank you.

As a reminder, if you would like to ask a question, press star one at this time.

And we'll now hear from Suey Wong from Robert W. Baird

Suey Wong, CFA: Thank you.

Also congratulations on a great quarter.

Questions about the equipment.

Pete, can you talk about your mix between basic equipment and also high tech equipment?

Yeah, I can, Suey.

Once again, let me go back and kind of re-emphasize the cyclical nature of this.

Let me talk about the fact we continue to believe that dentists make some priority decisions.

By that when a dentist buys CEREC or buys digital x-ray, he doesn't, unless he's doing an entirely new office, by chairs, units et cetera at the same time in terms of the existing office.

So we do see some changes in the relationship between those two products.

I don't even know -- well, let me say this.

Basic equipment this quarter without CEREC was double digit growth.

Suey Wong, CFA: You said basic equipment was double digits?

Can you give us a rough idea of CEREC and other high tech equipment?

Would it have also been double digits?

Oh yeah.

It would have been double digits.

I think Suey we were surprised pleasantly that the momentum of CEREC continued considering we were coming off that tough comparable of last year in the same quarter.

Suey Wong, CFA: I've got a lot of questions about the projections of industry growth for equipment for the rest of this year.

Could you give us an idea of what you're looking for in terms of equipment growth for the industry and also for Patterson?

Well, you know, if you look at our total equipment this year, it grew 22%, Suey.

I think that coming off a total year like that, we continue to look for double digit growth in the equipment marketplace.

And we would tell you that the equipment marketplace in our view continues to grow double digits.

But we also understand that CEREC and digital x-ray in terms of our view, were maybe stronger than other companies may believe.

And clearly we've got the exclusive on CEREC.

So it's adding a growth component from the point of view, as we look at the market, that it may not be adding for others.

Suey Wong, CFA: Did you think that there's been a long-term change here in the sustainable growth rate in the industry and the equipment?

What I mean by this is that equipment seems to be changing a bit from being a replacement business, as in chairs, dental units, hand pieces, to being -- moving toward high tech, which could supplement the growth.

Yeah, I think Suey, that that's a trend that we've seen over the last maybe -- certainly five years, maybe somewhat longer than that.

And I guess one of the kind of milestones for me might be the inter-oral camera that goes back probably eight to ten years.

And that was kind of a start of as dentists business accelerated, in terms of the dentists' utilization of new technologies, obviously digital x-rays, CEREC, those kinds of things are addition to.

But our belief Suey, is it all goes back to that concept of increased productivity from the dentist's perspective and that's essentially what new technology is doing for them.

I would agree with your statement that, yes, there is a sustainable growth rate there as a result of new technology representing new investment as opposed to simple replacement investment.

Suey Wong, CFA: Thanks, Pete.

And congratulations again.

Thank you.

Our next question comes from Larry Marsh of Lehman Brothers.

Larry Marsh, CFA: Thanks.

Thanks, Pete and Steve.

First of all, maybe for Steve, roughly how much of the equipment purchases were financed during the quarter?

And maybe, if you could elaborate a little bit, are you going to be -- would you ever be in a situation you would have to change the way you report the SPE?

Is it already consolidated or would that have to change under Fin 46?

Let me answer the last question first because that's easy.

We're already consolidate it, Larry.

It's fully consolidated into our financial statements.

As I tried to explain during the prepared remarks, the biggest impact you see on the financial statements from the SPE is down in that other section where that cash collateral account will sit, as long as we're under this arrangement.

Larry Marsh, CFA: Right.

We've sort of layered that in.

As the business grows, we use more of the commercial paper conduit, that will grow, but we don't expect it to see the same type of growth we saw in the current year.

As far as your first question, what we financed in the third quarter -- I'm sorry, the fourth quarter, probably 37.5% of our equipment sales for the quarter.

So as we've stated before, we're seeing an increase in that percentage financed of our total equipment business.

And as our total equipment business grows, the overall volume has been growing at the same time.

Larry Marsh, CFA: Right.

So that's a little bit less than what you showed in the third quarter, and I guess obviously the more you finance the more of a cash flow impact it has over the near term as you have to carry that for at least a month.

Is that right?

Correct.

As I said, as we work with the conduit, convince them of the quality of the paper that they are getting, we think we can probably accelerate that cash flow slightly.

But we did have to-- there's no doubt about it, we layered in about 30 to 45 days into our working capital this year because of that arrangement in our receivable balance.

Larry Marsh, CFA: I see.

So your goal is really to shrink the time between -- shrink the length of time you have to sit on the note before you can sell it to the conduit?

Correct.

Larry Marsh, CFA: Okay.

The second question I just want to make sure I'm clear, Pete, you talk about 11 to 13%, which is consistent with what you said for a good period of time above your definition of market growth.

Do we think of that in context of, is that inclusive of any tuck-in acquisitions for this year, or is that exclusive, or is it kind of a blend?

It's an all-in number, Larry.

Larry Marsh, CFA: Gotcha.

Okay.

So how do we think of what acquisitions could contribute to that?

Or could we get that specific?

Well, the only thing that I would say on that subject has to do with our historic -- and if you look at our historic impact of acquisitions on an average basis, it's been 2, 2 plus percent of revenues.

Larry Marsh, CFA: Gotcha.

Okay.

And then finally, certainly a very strong quarter with Webster.

I mean, you've shown already good margin expansion by the clear revenue acceleration here.

Maybe if you could elaborate a little bit about the structured alteration there, moving more to a branch office phenomenon.

Is that making it easier for them to grow through Greenfielding, rather than through acquisitions?

Is that what we should think of that?

So that the vet business is going to be a combination of both Greenfielding and acquisitions as opposed to just more acquisitions?

Well, let me comment on the organization first, Larry.

What we've essentially done is put a branch manager in charge of a branch which goes back to our whole philosophy about trying to keep decision making as close to the customer as possible.

Historically the sales force in a Webster branch reported to one individual while the operating group in the branch reported to another individual.

We now have put a branch manager on the ground locally who was responsible for both.

We feel that's important because we also get P&L responsibility at that local entity.

And we think that you're absolutely correct that does make it easier for us to Greenfield on the one hand, because we can add sales reps and report them to a branch manager and a local entity who has P&L responsibility.

But additionally it makes it easier for us to do the acquisitions and clearly in our mind was an essential move we needed to make in order to allow tuck-in new branches as acquisitions, if you get my meaning here.

Namely we can make an acquisition now, make it a branch of the Webster organization, integrate it and move on.

So it really serves both options, Larry.

Larry Marsh, CFA: I see.

And it's just taken this year to fully load in the branch manager structure so that now you feel comfortable with it?

We've really gotten two things done.

One is the integration of MIS platforms.

And we're out here shortly beta testing the new customer order entry system, and those kind of things which is the last piece of the MIS piece.

This organizational piece was the second piece.

Larry Marsh, CFA: Okay.

All right.

Very good.

One final question, if I could, you mentioned in your opening remarks that CEREC, I guess Sirona has introduced a 3D software component of CEREC.

Is that viewed as really a new product that would fold into existing market or does this help further expand the market for CEREC products do you think?

This, in our view, helps further expand the market for CEREC products.

It makes the process of doing the restoration substantially easier, because instead of a two dimensional look, I'm now getting a three-dimensional look.

So it really is going to make it a whole lot more convenient for the dentist to utilize the system.

Larry Marsh, CFA: Okay.

So as best you can tell, the manufacturer is rolling this out in appropriate fashion, so you don't run into some of the issues you had with CEREC 3?

We aren't going to have those issues in this rollout in our view, Larry.

I think we're past that.

Hopefully we learned that lesson.

Larry Marsh, CFA: Okay.

Very good, thanks.

As a reminder, if you would like to ask a question, press star one at this time.

We will now here from John Krieger from William Blair.

Hi, good morning.

It's Kevin Cook in for John Krieger.

Understand that acquisitions contributed about 2 percentage points to growth for the quarter.

Just wondering if we could get a little bit more detail on what organic growth in the consumables and dental equipment segments we?

Kevin, I don't know that we've ever given that kind of level of detail in the past.

As Pete has commented in the past, it becomes very mushy when you start talking about what acquisitions, particularly after this length of time.

If you need a surrogate, if you want to use a surrogate, use the 2 to 3% because it doesn't vary much between the equipment and consumable business.

Great.

Then I had a question on your comments about taking market share.

Are you guys taking market share primarily from other national distributors or is it more local mom and pop distributors?

Boy, that's a leading question, Kevin.

I would say to you that from the point of view of my answer to that question, you could look at the growth rates of the two public distributors and draw your own conclusions.

But secondarily, we clearly are taking market share from the other group as we do acquisitions.

So I think it's a combination of the two.

For instance, the Thompson acquisition would have been market share taken from the all other group would be an example of what I'm talking about there, Kevin.

Kevin, the other thing that I was just suggesting to Pete is that what you have to understand is this investment that we made in the capability to provide a turnkey approach to the dentist with regard to digital, which you follow the industry, so you know it's a very important, very highly sought after capability by the practitioner today.

Not all of them have jumped in the pond yet but they seem to be accelerating their interest in the product.

It's a very expensive proposition the way we went at it.

I think it creates a barrier to some of the local and regional guys, whether they have the wherewithal to make that investment and compete in that marketplace.

So are we taking market share from just the nationals and the large regionals or are we taking it from everyone?

I think we're taking it from all aspects of the market.

It's really hard for us to say, well, it's coming out of the locals or it's's coming out of the nationals.

We just don't measure it that way and it's very difficult to get at it.

Sure.

Great.

Thank you very much for the comments.

Once again to ask a question or make a comment, press star one at this time.

We'll pause for just a moment.

We have a follow up from Larry Marsh of Lehman Brothers.

Larry Marsh, CFA: Just one final thing, Pete.

Maybe a little bit of elaboration.

I know Wiltz is not exactly a rookie, but the young kid taking over the President's role, but you're making a pretty strong statement that you're going to remain involved in the company for some period of time.

So when you say you're handing over the President's role, what does that really me?

Well, what it -- now, are you talking about Jim's role or Scott's role as President of the U.S. dental business?

Larry Marsh, CFA: I'm sorry, Jim's role as President of the company.

What it means is that Jim has reporting to him the dental distribution businesses, the Caldwell business, the MIS group here.

So he has all of the customer facing elements associated with our dental business, Larry.

And I think that that is a representative change that does a couple of things for us.

One, it gives us greater management depth with both Jim and Scott involved.

Secondarily, it does move us toward a more seamless transition at whatever time that comes about, because if you're asking me do I have any specific plans at this point in time, the answer is no.

I will be around.

Larry Marsh, CFA: Okay.

Very good.

Thank you.

This concludes our question and answer session for today.

Mr. Frechette, I'll turn the call back over to you for any additional or closing comments.

Thank you very much.

We remain very positive about the prospects for the company and our shareholders in the future, and we appreciate the continuing support.

Thank you.

That does conclude today's teleconference, thank you all for your participation.

You may now disconnect.