Patterson Companies Inc (PDCO) 2003 Q2 法說會逐字稿

Good morning, ladies and gentlemen, and thank you for standing by.

Welcome to the Patterson Dental second quarter of fiscal 2004 earnings conference call. (OPERATOR INSTRUCTIONS) As a reminder, this conference is being recorded, Thursday, November 20th, 2003.

I would now like to turn the conference over to Mr. Peter Frechette, Chairman and Chief Executive Officer.

Please go ahead, sir.

Good morning, and thanks for participating in our second quarter conference call.

With me today is Steve Armstrong, our Executive Vice President and CFO, who will be reviewing some highlights from our second quarter results following my opening remarks.

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

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

For this reason, we have included financial guidance in our earnings release, but it is 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 on our annual report on Form 10-K, and as updated in the Form 8-K filed in September 2003 pertaining to the acquisition of AbilityOne Products Corporation.

Since that information forms the context for what we will discuss today, we urge you to review the material.

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

Consolidated sales rose 19 percent to 477.5 million.

Of this total, AbilityOne which was acquired on September 12 contributed sales of approximately $32 million.

Our consolidated second quarter earnings increased 27 percent to 34.9 million, or 51 cents per diluted share, which included a contribution from AbilityOne of approximately 4 cents per share.

AbilityOne's earnings contribution was also in-line with our prior guidance.

North American dental sales rose 2 percent in the second quarter, all of which was internally generated.

Sales of dental consumables grew about 5 percent for the second quarter.

We have rolled out important new sales and marketing programs that are expected to accelerate consumables sales in the coming quarters.

Equally significantly, we added 23 new sales territory representatives during the second quarter.

This is an important initiative because history clearly demonstrates that our consumables sales growth and market share gains are closely related to increases in our territory sales force.

Second quarter growth was paced by another strong performance in our dental equipment operation.

Total equipment sales rose 26 percent in the second quarter reflecting strong demand for the CEREC 3D Dental Restorative System and digital radiography equipment and related software.

The dental market continues the adoption of new technology equipment that strengthens office productivity and improves clinical outcomes.

As the leader in providing high-tech equipment and total digital solutions, we expect to continue to benefit from this trend for some time to come.

Many of you probably saw a press release last week about the sale of the Sirona Group, the manufacturer of the CEREC System to a Swedish venture capital firm and Sirona's management, which now owns 15 percent of the Company.

In recent discussions with Sirona's management we were pleased to hear that the new ownership group has no plans to change or alter Patterson's current relationship as the exclusive North American distributor for the CEREC System.

Moving on, Webster posted another quarter of solid operating results that were in-line with our internal forecast.

Webster's sales for this period benefited from a temporary pharmaceutical distribution agreement that was converted to an agency arrangement during the quarter.

As a result of this conversion, Webster's third quarter revenue growth is expected to be more in-line with overall market growth in the 6 to 7 percent range.

Finally, AbilityOne met our sales and profit expectations in the second quarter.

Since its acquisition over two months ago, we're more convinced than ever of the importance of this transaction.

While on the topic of AbilityOne, I also want to mention that we expect to close permanent financing relations for it -- arrangements for the AbilityOne acquisition later this month.

As you may recall, we initially took out a $500 million bridge facility that was used to finance AbilityOne's $575 million purchase price.

The permanent financing, which will total approximately 650 million, will consist of two components, a private placement that has been fully subscribed, and a revolving line of credit and term loan with a bank group.

We have negotiated very favorable interest rates on each component of this financing package.

After paying down the bridge alone, we will have some borrowing capacity left in the revolving line.

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

For the third quarter of fiscal 2004, ending January 24th, we're forecasting earnings of 57 to 59 cents per diluted share.

This includes an estimated fourth quarter contribution from AbilityOne of 6 to 7 cents per diluted share.

We remain very optimistic about our prospects over the balance of fiscal 2004, based on the vitality of our markets and the effectiveness of our strategies our business units are using to meet the challenging needs of our customers.

In short, Patterson is well positioned for continued growth and profitability and market leadership.

Now I would like to turn the discussion over to Steve Armstrong, who will review some highlights from our second quarter operating results.

Steve.

Thank you, Pete.

Since the first quarter -- this is the first quarter of reported operations that have included AbilityOne.

I will direct must of my remarks to the impact of AbilityOne on our second quarter operating results.

Pete mentioned the revenue contribution, and you will find a detailed breakdown, and the pro forma impact on revenue of this acquisition, in a supplement to the earnings release issued earlier today.

As we have said in the past, we believe AbilityOne's sales growth has upside potential from the standpoint of both internal growth and strategic acquisitions in this highly fragmented market.

Gross margins for the quarter in the dental segment were flat on a year-over-year comparison.

The addition of AbilityOne resulted in a year-over-year improvement of about 40 basis points in our consolidated gross margin.

Excluding AbilityOne, Patterson's consolidated gross margins declined to 34.1 percent, due totally to a shift in Webster's sales mix as a result of the impact of the distribution agreement that Pete mentioned earlier.

While providing substantial growth in revenues, the lower margins on this distribution agreement reduced Webster's gross margins, which in turn affected Patterson's consolidated margin.

The conversion of this distribution agreement to an agency arrangement is expected to result in a sequential improvement in Webster's third quarter gross margins.

Our consolidated expense ratio improved 70 basis points in the second quarter.

Operating expenses in our dental business declined by 50 basis points to 22.4 percent of sales.

Factors contributing to this improvement included continued operating leverage from the infrastructure acquired through last year's Thompson Dental and DQD acquisitions, in addition to the investment in our hardware and networking initiatives.

The veterinary operating expense ratio was 15.1 percent of sales in the second quarter, representing a 1.6 percentage point improvement over the year earlier period.

This improvement resulted primarily from the increased sales volume generated by the pharmaceutical distribution agreement.

AbilityOne's impact on our consolidated expense ratio was negligible for the quarter.

The operating margin of our dental business improved 50 basis points in comparison to last year's second quarter, while the veterinary operating margin declined by about 40 basis points.

As expected, AbilityOne's strong operating metrics also contributed to improvement in our consolidated operating margin for this period, which increased 120 basis points to 11.8 percent from the year earlier quarter.

Now a few words about our cash flow and balance sheet.

We generated $71 million of cash flow from operations in the first half of fiscal 2004 on earnings of $64 million, compared to an operating cash flow of 25 million on earnings of 56 million in the first half of fiscal 2003.

During the second quarter we gave back much of the working capital benefit on cash flow that we saw in this year's first quarter as we pay down dated trade payables and increased income tax deposits.

During the quarter we invested $581 million in acquisitions, of which 500 million was debt financed through a bridge facility, which Pete has discussed.

And this'll be converted to permanent financing later this month.

The changes in our balance sheet from the acquisition of AbilityOne are fairly dramatic, but generally obvious.

There are two assets that resulted from the transaction that caused the significant increase in our other current assets that I want to mention.

One is a physical facility being held for sale, and the second is a tax receivable that results from monetizing stock and stock options surrendered by employees of AbilityOne in the transaction.

Both of these items are expected to be either sold or recovered within the next year.

The remaining details of preliminary purchase accounting will be provided on our Form 10-Q for the second quarter, which we expect to file in about two weeks.

Thank you.

And now I will turn it back to the operator who will poll you for your questions.

(OPERATOR INSTRUCTIONS) Larry Marsh.

Larry Marsh, Lehman Brothers.

I wanted to get a comment from you, Pete, if I could, from what you said in the first quarter around consumables sales.

I know you had suggested that there were several things you were going to put in place to help stimulate growth in that business, additional sales force, other training program training programs.

Could give us an update as to where that stands?

And I know I think you had said that you would start to see some accelerated growth maybe by the fourth quarter.

Is that still your expectation for consumables sales for the rest of this year?

Yes, Larry, just to follow-up on what we said the last quarter, that first of all we were, in fact, going to accelerate our training classes for sales reps from four classes to six classes.

We're in the process of doing that.

As I indicated we added 23 territory sales reps in this quarter.

We have also been holding a series of regional meetings.

We have two more of those meetings to go, and we will complete those in December.

So all of the regions will have been trained, and that training includes some changes in our Patterson Plus system.

It includes some relationship building and training from the point of view of our sales reps and their relationships with their customers, and a number of those sorts of things.

So we're on track with that total program.

And would expect to begin to see improved results in the fourth quarter, yes.

Do you still feel like consumables market, as best you can tell, is growing in that, say, 5 percent range overall?

Yes, what we have said that the consumable market growth rate is, and it is been our fairly consistent approach, been in the 5 percent to 7 percent range.

We would still be in net range, Larry, although we might be closer to the lower end of that range at this point in time.

A follow-up question, if I could.

The Sirona relationship exclusive distributive product in North America, is there a time expiration of that contract?

If so, what is it?

And maybe elaborate on the interaction you had with the new owners?

That contract essentially has a time date on it of September of 2004.

We're in the process are reviewing that contract and discussing an extension, Larry.

And it is our view that we will be able to achieve that from the perspective of the good relationship we have with Sirona.

Sirona’s management has taken, as I indicated to you, a greater ownership position, some 15 percent.

And I think we have worked well with them and clearly the results have been outstanding.

So our view is that we will be moving to extend that contract starting essentially now, and we will get that done long before the September expiration date.

And would you hope to have a multiyear extension or --?

We would love to get -- yes, a multiyear extension.

Derek Leckow.

Barrington Research.

I just had a question on the interest and other expense.

I wonder, Steve, if you could give us a little bit of help with that?

It was quite a bit better than I expected in the quarter.

And as we look at your new financing package coming on in the next month, I understand what that might look like for the next few quarters.

I'm sorry, Derek, I missed the middle part -- the expenses.

Just interest expense, if we can focus on that first.

What are you budgeting in terms of interest expense for the rest of the year?

And will it change materially from what you reported for the first couple of quarters in terms of the interest rate and so forth?

Obviously, interest expense for the quarter was only partially effective, because we didn't take the debt on it until the end of mid-September.

On a full quarter basis, I would refer you back to the 8-K at this particular point as our best estimate of what we would see as sort of a run rate for our interest out of the block.

I can't give you a lot of specifics on the interest elements yet, Derek, only because it is going to be a combination of fixed and floating.

The fixed has been priced, but the floating has not.

So I really can't go on record as to what I think it is going to be.

But I would tell you it is going to be, I think, on a run rate basis very near what we projected for you in that 8-K.

Okay.

I will refer back to that.

Thanks.

That's the best I can do at this point.

And in a month or so we can maybe talk about that?

We will get some information out, because we have to file the documents and so forth.

Okay, thanks.

And then just a question on the gross profit margin, again, with the shift in the sales in the veterinary division, you mentioned that next quarter you are anticipating a sequential improvement in gross profit.

But do you think you'll wind up with a consolidated number that is greater than what you had last year?

For the third quarter I would think we would see some year-over-year margin improvement.

But I want to be careful and forthright here, remember that the third quarter typically is Webster's -- our third fiscal quarter is a fairly weak quarter for Webster.

There is some seasonality in that business and during the cold months they don't sell as much in the northern tier of the country.

So even though the margins will get a little better, it is going to be on a lower sales base.

But we are expecting improvement in our margins going forward into the third quarter.

Sounds good.

And then just on the consumables sales here, Pete, are you anticipating that we will see an improvement, you said by the fourth quarter probably.

But you're at the lower end of the range right now.

Is there anything out there that is holding that back, or do you think that perhaps you're being a little bit conservative in that assumption?

No, I don't thing so.

I think that, as we indicated to you last quarter, our sales force has been growing at the traditional rate of 6 to 7 percent.

But we have been allocating far more of those representatives to the technical product areas, as opposed to the territory area, and we think that is one key.

A couple of other keys I think have been the redo of Patterson Plus, and some of those programs is a part of the process.

But I don't think -- we tend to be a little bit conservative in either case, but certainly no more conservatism here than you would normally expect from us.

Okay.

And was there anything unusual in the equipment side of the business?

Any kind of financing or any kind of special promotions going on outside of the strong sales you are seeing on some of the technical products?

No special promotions of any kind.

Glen Jos Santangelo.

Yes, this is actually Charles Rhyee for Glen Jos Santangelo at SoundView.

If we could just talk about AbilityOne for a second.

In general, can you just maybe go over how you view this market in terms of its size, and how this market -- what is the historic growth rate of the rehab market in general?

And who are some of the major customers of AbilityOne, and also maybe some of the major competitors?

In a very quick overview, we would tell you that the market is about 3. (ph) to 4 billion.

AbilityOne's markets are growing at some 6 to 8 percent.

AbilityOne, about 5 percent to market share is the market leader, which quickly indicates to you it is very fragmented market.

And I'm trying to quickly think of what else we can add, Steve.

They really are no large competitors.

AbilityOne would be the largest competitor by probably a factor of 3 to 4 times.

If you look at some of the -- there is no customer that really represents a major part of revenues.

They're all less than 3 percent.

Are these products going to institutions or clinics or sports teams or something like that?

All of the above.

The answer is all of the above.

And then as a follow-up, last week there was the tentatively proposed Medicare prescription drug and modernization bill, and in it there was some provisions for durable medical equipment where they're going to freeze rates for the next couple of years.

Does AbilityOne have any sort of exposure to Medicare?

And if so, is there any potential impact for the Company?

AbilityOne's exposure to Medicare we would describe as minimal.

Most of what they do is sold to the provider.

The provider provides it to the patient.

And the provider pays AbilityOne, so there is very little kind of governmental involvement in terms of the AbilityOne process at all.

(OPERATOR INSTRUCTIONS) Larry Marsh.

Just a couple of follow-ups.

Canada, up 7 percent.

Give me some progress of the new manager of that division and how the change is going?

And also, what sort of FX benefit did you get in consumables this quarter with Canada?

From the point of view of Canada, Larry, in terms of the new management team, we see ourselves on track.

Canada has been historically a lot more cyclical than we have been here in the U.S.

That cyclicality has primarily been around equipment sales.

And I would tell you that we aren't sitting here telling you that is over.

But we very clearly are moving in the right direction in Canada as it relates to making it more an integral part of our total operations in terms of our North American approach.

Steve can comment on the FX issue.

The FX, Larry, as the press release indicated that 7 percent was in local currencies.

FX had some positive impact, obviously, because of what the Canadian dollar has done against the U.S. dollar, probably 1 percent of the consolidated growth.

Just maybe to go back and elaborate on the financing.

You anticipate announcing or completing that within the next -- you said the next two weeks?

Yes.

We're on schedule to close before the end of the month, Larry.

And knock on wood, if nothing happens, we will close in the next week or so.

And then we will get some public information out to everybody.

I hope that wasn't Pete’s head.

No, that was my head.

It sounds more like mine.

I appreciate the confidence.

I had to give you a little grief.

It sounds like the tone of my head.

If I could talk about the elaboration of why you're borrowing more than you need, is that just because of the opportunity on financing costs, or do you anticipate continuing to be active in the marketplace to identify acquisition opportunities?

I think the answer, Larry, with all candor is, we are always looking at things.

You know that from the time that you followed this business.

What we're trying to do right now is maintain maximum flexibility.

Obviously, the debt markets are very attractive.

We now have, if you will, three businesses to feed with the dental supply business, the veterinary supply business, and now AbilityOne.

We intend to monitor the debt load.

We've got some, we think, very favorable provisions built into it as far as how long we have to carry that debt.

And if our cash flow starts to outperform what we can do as far as reinvesting for the shareholders, then we will pay down the debt and use up some of the cash.

But we've got opportunities that we want, and we want to maintain our flexibility.

Let me just add to that, Larry, kind of reiterate what we said last quarter.

And that is that we're not going to be aggressively out seeking new markets at this point in time, but we are going to be aggressively out seeking acquisitions in the three markets we're not anticipating in.

So I would tell you that the acquisition interest on our part would be further market share opportunities or consolidation opportunities in the dental, rehab and veterinary marketplace.

Is there any priority in terms of which area you would like to focus on most, or is it pretty evenly in line?

No, I think initially we're going to take a broad look.

One of the things that I continue to be very enthusiastic about is the quality of the management teams in each of these three organizations allows us to do it right there at the particular market level.

And I think clearly we're going to be interested in returns, etc., but I think it is going to be a fairly equitable overall view of those three markets and what the opportunities are.

We obviously have opportunities in all of those markets.

Just one point of clarification.

Steve, I guess you're suggesting that your general view of your borrowing costs have already been incorporated in your guidance.

There is no anticipation that the final financing costs would in any way alter what you have communicated in terms of impact?

At this point, we have no reason to believe that our interest costs are going to vary much from what we have already given as far as guidance.

But as I said, some element of it has to do with -- or is going to be priced on floating-rate basis, and so we going to be subject to interest rate fluctuations until we actually get priced and closed.

But if anything, Larry, I think the numbers that you have seen that we have estimated previously are going to be a little on the conservative side from where we think the final pricing, at least out of the box pricing, will be on the debt.

In terms of your prior cash flow and Capex guidance, I assume those remain the same?

Yes, we haven't really changed anything there.

We're still on track.

Some of you that really scour the press may have seen that we have press release put out by the county where we are building the new warehouse down in the mid-Atlantic area.

Some groundbreaking has begun on that facility, and we're still on track to be up and running probably first quarter of next fiscal year.

That is really the only sort of non-mainstream type reinvestment we're making.

Right.

So the timing of that is as you had earlier anticipated?

Yes.

Jeff Johnson, Robert W. Baird.

I have had most my questions answered here, but one last question hanging out there.

On the equipment side, you have had obviously a very nice run over the last good number of quarters here.

We're coming up against a pretty tough comp though next quarter at 37 percent on the equipment side.

How should we think about that as far as modeling goes on the equipment growth next quarter, and then maybe going forward from there?

I guess the first thought off the top of my head, Jeff, is we're not paid to do your job.

Fair enough.

No, as we said, I think in our comments, we expect to continue to benefit from those trends in equipment.

And we would look forward to certainly a very strong year end in terms of the quarter.

And when I say year end, I mean talking about the calendar year end.

Keep in mind that we still have the tax benefit available for the customers, and we don't know what the impact of that will be.

But we would expect a strong equipment quarter in our third quarter.

Fair enough.

And I already pumped you up, Jeff.

Just keep in mind now that we do have a tough comp, so you've got to be judicious in what you're doing out there.

Fair enough.

I appreciated it, Steve.

Robert Willoughby, Bank of America.

Sean Harrington in for Robert.

Can you just elaborate a little more on the working capital movements in the quarter, particularly in addition to what you already said.

AR, I'm assuming the pop there is just completely related to equipment sales?

So on that, and just what you see over the remainder of the year, how should that line item trend?

Actually, Sean, most of what happened in the working capital, the changes you're seeing on the balance sheet have to do with the acquisition.

We had some pluses and minuses working through almost every one of the line items in our, what I will call historic, business.

But as I said during the conference presentation, the formal presentation, the bulk of what went on with regard to the working capital was a pay down of some dated trade payables that we had.

That distribution agreement that Webster was working through had some dated terms that were allowing us to not have to pay those payables which can due in the third quarter, or the second quarter.

And as well as -- you know, as your income continues to grow, unfortunately Uncle Sam continues to take a bigger piece of it.

So our tax deposits had to go up.

So when you really net it all down, that was really the bulk of what happened in the working capital.

And the rest of the balance sheet changes that you see are basically the net of the purchase activity from AbilityOne.

Our day sales, if you really want to measure it, days sales were actually down a day both with and without contracts.

Inventory turns were up to 8 on a trailing four quarter basis.

So I think all balance sheet ratios are really in pretty good shape.

Glen Santangelo, SoundView.

This is Charles Rhyee in again for Glenn.

Just wanted to talk about Webster.

You noted in your press release that you have opened some new sales territories in Washington and Ohio.

When we did this acquisition, I guess a couple years ago now, the talk was to consolidate a fragmented market.

And to date, we really haven't seen that yet.

Should we expect that we're going to be seeing probably just greenfield expansion in the near-term?

And how is sort of this market -- these family-owned companies viewing the market as well in terms to maybe be acquired?

I think what we said last quarter was one of our frustrations is the fact that we've not been able to complete an acquisition here.

And that we have started the greenfield process with the first two spots being in Ohio and the state of Washington.

We obviously are going to continue to work on the acquisition opportunities there.

It is difficult for us to schedule them obviously.

But in the interim, we will be doing the greenfield process.

And my statement would be that short-term that is probably what we will continue to do.

Is there any sort of limiting factor that you see across all these potential acquisitions, or is it just very unique to each one of them that is maybe delaying some activity here?

It is interesting because the veterinary distributors are for the most part "family-owned" businesses.

Those are a little more emotional in terms of letting go of them from the point of view of the family members.

That is not unlike the dental business.

And finally I think we live very stringently with the first commandment which says, thou shall not pay too much.

So I think we will continue to work on it, and I think we will have some success.

But I think it is difficult to schedule.

Derek Leckow, Barrington Research.

I just had a quick follow up on the gross margin trends that you're seeing in dental.

You mentioned that they were flat here in the quarter.

I guess I would like to understand that a little better in terms of the mix shift toward high-tech equipment, which presumably carries a higher margin.

Can you talk about the trends both from the perspective of the consumable products and also from the equipment side?

Derek, this is Steve.

Generally the mix in the dental market for this period was not really that impacted.

There was some good things and some bad things, I guess, as there always are.

Even though we sold a fair amount of the technology, as you'll recall we had the C2 program, trade in program, that was running, that ran through part of the quarter.

So we didn't get the full benefit of the little higher margin that we get off of the CEREC.

Software sales are pretty strong for the quarter with the digital activity.

But again, that is generally not enough to move it a lot.

It really was flat, and we were very comfortable with it being flat, actually.

It could been a lot worse, I guess, from the standpoint of not seeing any activity, but we were very happy in the mid-30s we're at.

We will keep working trying to get our 10 basis points of improvement, and it doesn't come easily, you know.

Yes, right.

I mean as we start to see maybe a slight slowdown in terms of these 20's sort of growth rates in the equipment side, and as consumables presumably will become part of a greater mix on a comparable basis, are you concerned it all about that?

Do you think those are sustainable gross margins there?

Is that 10 basis points going to be tough to get to here in the near-term?

As we have talked in the past, the consumables actually, that is one of the things that is a little bit depressing about our margin for the quarter.

And the depressing impact is that if your equipment business outpaces, at least in our world, outpaces our consumable business we actually had to struggle with the margins a little bit, because you don't have the higher margins overall on your equipment business.

So that tends to hold us back a little bit.

So if we get these consumables growing again, I would be a little bit more bullish on the margin.

But as I said to an earlier question, we still expect margins to improve in the third quarter over last year.

Michael Ganzon (ph), Cobalt Capital.

Two things really, one is I was wondering if you would talk a little bit more about what you saw in this past quarter on the equipment?

You're obviously growing a lot faster than your competitors, and probably a little bit faster than the industry.

You have a great sales force.

I'm just wondering if you can just comment a little more about the trends and what sort of the feedback is from the practicing dentists on this upgrade cycle and new equipment cycle?

And then secondly, if you just talk a little bit about the SG&A, which I know you saw better in the dental business.

You talked about some operating leverage from some acquisitions done last year.

I am wondering when you think that will anniversary?

And what going forward can you do to continue to ramp up that SG&A leverage?

Let me take the first part of the question as there it relates to equipment, and then Steve can deal with the SG&A equipment.

I think that from the point of view of equipment trends, that we continue to see the dentists adopt new technologies that allows them to either increase revenues or productivity.

And clearly that includes not only CEREC and digital x-ray, but basic equipment as well.

It gives them a productivity increase.

We do not expect to say that trend change radically in the short-term.

And as I said to you in my opening comments, we expect to benefit from that trend for some time to come.

Did you see any increase in financing by your dental customers, or pretty much in line with what you have seen for the year to date?

It was almost -- Mike, it was almost flat year-over-year on a quarter comparison as a percentage of the business.

Our financing dollars are up as a percentage of revenue -- it was almost identical as far as the percentage was concerned.

With regard to your SG&A question and on leverage, I kind of goes back to the basic -- some of the goals that we have as a Company, and that if we could -- our growth at plus 4 percent to market and get a our 10 percent improvement in our gross margins.

We look for 40 basis points of improvement in our operating leverage.

It gives us 50 basis points to the operating line, and somewhere between 17 and 20 to the bottom line.

The leverage comes naturally, if you get that revenue growth.

You get a good portion of that leverage, if you're able to keep your expense growth in line with your revenue growth.

And as we have talked in the past, this Company from Pete all the way down to the Chief Financial Officer and lower is very aware of the fact that we have to continue to find smarter and less expensive ways to get our business accomplished.

So it is an ongoing process.

We have numerous programs in place all the time, whether it is at the branch level, the corporate level, in the distribution system.

So it is really hard to say specifically there is one or two projects that are going to drive our leverage.

A big piece of it comes from the revenue growth, the natural aspect of it.

And then one major project we got out there that we're still working on is our technical service system.

We have code-named it ClearView.

And that will be implemented over the next 12 to 18 months, or continue to be implemented.

And that has got the opportunity.

Initially it is going to cause us a little pressure on the margins, but as you saw from this quarter we got 70 basis points of improvement.

So even with that investment, we're still finding ways to move costs out of the system.

AbilityOne's metrics are going to help from a consolidated perspective.

Going forward you're going to see some -- they were in for basically less than a half a quarter this year.

But they are going -- you are going to see some benefit from their metrics also in our consolidated results.

So a lot of things going on, and it is really hard to nail it down to one or two specifics for you.

Louis Gorrigan, Cyprus.

I wanted just a little bit more clarity on the other current assets.

You said that most of the increase sequentially was due to the tax receivable for AbilityOne's stock and stock options that were monetized, and the rest was a building help for sale.

I guess it was up about 20 million sequentially.

Could you breakout that between the two elements?

Could you repeat your name, because we didn't catch it from the operator?

It is Louis Corrigan, with the Cyprus Fund.

Okay, sorry.

Basically those two assets accounted for most of that increase, as well as the normal prepaids and other assets that a company like the AbilityOne would have, whether it is insurance, state taxes or whatever.

But we picked up a facility over in Wisconsin that was the Smith and Nephew corporate headquarters.

It was actually closed after AbilityOne and Smith and Nephew Rehabilitation merged in the spring of 2002.

That property is on the market right now for sale.

It is about a 210,000 square foot facility, so a fairly substantial piece of real estate.

And then the other piece, as you probably understand, when there is stock options and stock involved held by employees you trigger some compensation expense for tax purposes when those are cashed out.

And that is what happened in the AbilityOne acquisition by Patterson.

So there is on the final tax return on the short period for AbilityOne with the change in ownership there will be some deductions on that tax return for that compensation expense.

Would you expect to see the other current assets decline into Q3, is it partly dependent on when you can sell the facility?

No, it will very much will depend on when we sell that facility, and also you will not see us -- those two assets will probably, in high probability, will not be liquidated in the third quarter.

I think it will probably be the end of -- I don't know when the building is going to sell.

We have had people looking at it, but again you just never know when somebody is going to sit down and sign a purchase agreement.

The asset with regard to be receivable recovery will be into our fiscal 2005 before we get recovery on that, because you can't get it until you file the tax returns.

And we've got plenty of work to do before we file the tax returns.

In terms of the other balance sheet items, working capitalwise for the AbilityOne transaction, about how much would you say was added in terms of receivables and inventory from the transaction?

Rather than going down -- I don't want to get into it in this conference call, because you will see it in a couple of weeks, but roughly, not quite 30 million in receivables, 25 to 27 million in inventory.

As we talked about, these are the prepaid.

And then you went into property, and the most of the rest of it went into intangibles.

And we're still working with the evaluation people on how that will split out, so it will be identifiable.

And all others will just fall into the goodwill bucket.

So sort of on a organic basis then our inventory really went down quite a bit sequentially?

Our inventory?

Yes, if you adjust for the acquisition?

Yes, if you take out -- we had some improvement.

We had that distribution inventory at Webster would have been liquidated during the quarter.

So that had an impact.

And basically each of the operating units saw their inventories come down during the quarter.

So it was kind of spread around to everybody.

That's great.

And how much was the distribution revenue for the quarter in Webster?

You know, we have never made that public.

So I really don't want to start.

Was it on the same order as what you booked last quarter?

Yes, roughly.

Boris Luchek (ph), Pennant Capital Management (ph).

I just wanted to ask a question about AbilityOne and understand a little bit more about their SG&A.

It looks like you did a very good job of reducing that relative to what they were doing prior to the acquisition.

Can you just go through the numbers of what they were doing on a run rate basis prior to the acquisition, and what you saw this quarter, and what you did to get there?

Well, we didn't do anything.

It was strictly their management.

It continues to -- they did the Smith and Nephew transaction back, as I said, in the spring of 2002.

And they are still getting some synergies out of the combination of those two businesses.

They continue to grow their business at the top line.

They're able to get better leverage off of their operating structure.

So they will continue that process, just like we do, or have historically done, on the dental side of the business.

So on a quarter-to-quarter basis, how much were they able to reduce it?

It looked like they were running maybe 13 million a quarter or so, prior to the acquisition.

What do you anticipate that on a go forward basis?

We have never gotten down into specific operating costs for each of our operations.

And I don't plan to do that now.

But their operating costs are not going to change substantially, Boris.

Okay.

So you think that where they are now is something that you should see as just a modest decline from here?

Well, they're going to -- as I said, they're going to continue to get leverage off their business.

They're going to have to invest in their infrastructure.

Their plan is -- calls for expanding their sales force.

Their goal is to double their sales force about every three years.

They may accelerate that depending on market conditions.

And so there is going to be growth in their expense structure but as far as a leverage aspect of it, it is probably not going to be -- you are not going to see full percentage points coming out of it.

One more question on the -- I know you had mentioned this earlier.

I might have missed it.

On the interest expense, how should I think about that on a go forward basis?

And on the 500 million you have outstanding, what is the current interest rate?

I'm not sure I am comfortable giving you that number, but you can kind of calculate it.

All in with fees and everything, it is a little less than 4 percent.

The go forward rate, as I said out of the block, we're looking at something around 3.5 to 4 percent.

So the reason it was 1.9 million in the quarter -- I am sorry -- that just seemed a little low?

But it is half a quarter for one thing.

I thought it was -- when did the --?

In September.

Alan Mitrani (ph), Copper Beach Capital.

Can you give us the trends within the quarter?

Did things strengthen towards the end of the quarter, especially in equipment?

Yes, I would tell you that from an equipment perspective we generally strengthen in the quarter, but not significant from the point of view of total volume or anything like that.

We don't see it as a cyclical kind of thing throughout the quarter.

Also, I may have missed it earlier, but you're raising more money than originally you thought.

I guess it seems like maybe because the interest rates are low, and there are opportunities.

Can you sort of rank prioritized your opportunities with the cash that you're looking at potentially acquisition and which sectors?

Well, what we have essentially said is that we're not going to be out looking for new markets.

We're clearly interested in doing acquisitions in the three markets we're now participating in.

And to sit here and tell you that we have ranked prioritized them, or have not, we're going to be looking at opportunities in all of those markets on a broad basis.

And hopefully we will select the opportunities that will give us the greatest return over time.

And lastly, I guess in the past it has been brought up about a dividend.

Can you just reiterate your thoughts there?

The position we have taken vis-a-vis the cash is that we believe we can continue to reinvest that cash in the business to achieve greater returns for our shareholders.

I think the AbilityOne acquisition is an example of that.

And we would continue to maintain that kind of an approach going forward.

And if that approach changes then we would review the other opportunities in terms of dividend, share buy back, etc.

I think what -- I would like to just offer one more comment on the debt and the intention here is that we had been operating this company off of equity capital historically.

The debt markets are very favorable right now.

We had the opportunity to lay in some debt at a very, very nice rate, which lowered our overall rate of cost of capital, which we thought was prudent.

We're basically going to be tied up in debt for no longer than effectively three years, and less than that on a lot of it.

So as I said, if the cash continues to be generated, we can't reinvest it, we'll pay down the debt and go forward.

So it is not -- in the near-term, yes, we're going to have a little cash on our balance sheet and a little debt on our balance sheet, but we will get them down as we see things developed, and do what we think is best for the shareholders.

But the debt markets to raising capital, if you plan to grow your business over the next five years.

It is a great opportunity to take advantage of it if you can.

And so we will just have to see what develops going forward.

There are no further questions at this time.

Please continue.

We again appreciate everybody's continuing support.

And we continue to be very enthusiastic about our opportunities in our marketplaces.

And we look forward to another discussion at the latter part of February.

Thank you so much.

Ladies and gentlemen, this concludes today's Patterson Dental second quarter fiscal 2004 earnings conference.

If you would like to listen to a replay of today's conference, please dial 303-590-3000, followed by access number 559 689.

Once again, if you would like to listen to a replay of today's conference, please dial 303-590-3000, followed by access number 559 689.

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