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Operator
Good morning, ladies and gentlemen and thank you for standing by.
Welcome to the Patterson Dental third quarter fiscal 2004 earnings conference call.
[OPERATOR INSTRUCTIONS]
I would now like to turn the conference over to Mr. Peter L. Frechette, Chairman and Chief Executive Officer.
Please go ahead, sir.
Peter Frechette - Chairman and CEO
Thank you and good morning.
We appreciate your participation in our third quarter conference call this morning.
Joining me today is Steve Armstrong, our Executive Vice President and Chief Financial Officer, who will review some highlights from our third 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've released 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 forecasts.
Our guidance is subject to a number of risks and uncertainties, which are discussed in detail in our annual report on Form 10-K, and as updated on the Form 8-K filed in September 2003 pertaining to the acquisition of AbilityOne Products.
Since that information forms the context of what we'll be discussing today, we'd urge you to review this material.
Turning now to our recent performance, Patterson reported strong sales and earnings in this year's third quarter.
Consolidated sales rose 24% to $521.2 million, while consolidated earnings increased 33% to 40.1 million or 58 cents per diluted share.
North American dental sales rose 12% in the third quarter compared to 10% year-over-year growth that we reported in this year's second quarter.
Sales of dental consumables grew 6% for the quarter led by U.S. consumables growth of 6.2%.
We believe this improvement in consumables reflects the positive impact of our strengthened market focus on this aspect of our dental operation.
We've made a substantial commitment to our field organization in terms of new sales training, tools and programs.
In addition, we've added approximately 40 new territory sales representatives over the past three quarters.
History clearly demonstrates that our consumable sales growth and market share gains are closely related to increases in our territory sales force.
We expect higher additional territory reps in the fourth quarter.
We also expect to benefit from our revised customer loyalty program, Patterson Plus, which was introduced toward the end of the third quarter.
We believe the former Patterson Plus program was the best of its type in the industry, but we felt it was important to raise the bar even further with a more directed program.
The new program is designed to significantly enhance the value package to participated dentists while improving our overall operating leverage.
We are also continuing to roll out our new technical service system, Clearview, which will be fully operational by the end of the calendar year.
These changes will further differentiate Patterson as the premiere value added distributor in the dental market.
Third quarter growth was paced by another strong performance by our dental equipment operation.
Total equipment sales rose 19% for this period, reflecting strong demand for the Cerec 3-D dental restorative system as well as digital radiography equipment and related software.
Dental practitioners are continuing to adopt new technology equipment that strengthens office productivity, improves clinical outcome and enhances revenues.
Patterson is strongly positioned to capitalize on this trend as North America's largest equipment dealer and leading provider of high-tech equipment.
As some of you probably know, the Serona group, which manufactures the Cerec system, was sold several months ago to a Swedish ventured capital firm and Serona's management.
Since then, we negotiated an extension of our Cerec distribution agreement with Serona through September 2006.
As a result, Patterson will remain the exclusive North American distributor of Cerec systems, including both the chair side and laboratory versions for nearly three more years.
AbilityOne, which was acquired on September 12 and made a full quarter's contribution to our results, posted sales of nearly $53 million and earnings of 5 cents per diluted share.
While AbilityOne's contributions were slightly below our expectations, we don't foresee any fundamental change in this market that would necessitate any modifications to existing strategies.
Since its acquisition in September, we are more convinced than ever of the importance of this transaction to Patterson's future.
Moving on, Webster posted another quarter of solid operating results that were in line with our internal forecast.
Over the past year, Webster sales have benefited from a temporary pharmaceutical distribution agreement and throughout this period, we have been careful to report Webster's sales growth excluding the impact of this arrangement.
As previously reported, this distribution agreement was largely converted to an agency arrangement prior to the start of the third quarter.
This conversion was generally revenue-neutral in the third quarter since there was some carryover inventory that was sold through distribution during this period.
As a result, Webster's 7% revenue growth in the third quarter was consistent with our prior forecast.
Excluding the former distribution agreement, we believe Webster's revenue growth going forward will outpace the 6 to 7% growth rate of the U.S. companion pet veterinary supply market.
I'll close my remarks by briefly reviewing our financial guidance.
For the fourth quarter of fiscal 2004 ending April 24th, we're forecasting earnings of 64 to 66 cents per diluted share, which compares to the 49 cents per share that we reported in last year's fourth quarter.
Our fourth quarter guidance includes an estimated contribution from AbilityOne of 6 to 7 cents per diluted share.
For the 2004 fiscal year, we expect EPS of $2.16 to $2.18.
We remain very optimistic about our fourth quarter outlook based on the vitality of our markets and the effectiveness of the strategies we're using to meet the needs of our customers.
We are well positioned for strong growth and profitability and for continued strength of our market leadership.
Thank you.
I'd like to turn it over to Steve Armstrong now, who will review our third quarter operating results in more detail.
Steve?
Stephen Armstrong - EVP and CFO
Thank you, Pete.
Since this is the first full quarter of reported operations that include AbilityOne, and the impact on our third quarter operating results as fairly dramatic, I will attempt to provide more insight on those effects.
Pete discussed the key revenue contributions for the quarter.
In addition, I would note that foreign currency exchange added approximately 1.5 percentage points to the dental revenue growth for the quarter.
This is very similar to what we have experienced through the first and second quarters of the current year.
In consolidated margins, we saw an improvement of 1.5 percentage points for the quarter.
One full point resulted from the operations of AbilityOne, and the remainder is from the dental operations attributable primarily to mix along with some pricing improvement.
On a consolidated operating expense ratio, we saw improvement of 30 basis points.
This is net of 2.2 million of amortization expense related to identifiable intangibles arising from the preliminary valuation of AbilityOne's assets, which while slightly higher, is generally in line with our expectations.
While we gained leverage in our dental business at the operating expense line, we did so in spite of some substantial investments in our sales organization, our new technical service system and other corporate initiatives that on a combined basis accounted for nearly $2 million of expense in the quarter.
At the operating income line, we saw 1.8-percentage point improvement for the quarter with 80 points of this coming from the consolidation of AbilityOne.
I'd like to take just a minute or so to review the debt financing that we put in place during the quarter.
Even though there have been some public announcements of the program, because it does change the dynamics of our balance sheet.
As most of you know, we used a six-month, $5 million bridge loan to close the AbilityOne acquisition, and that facility was retired during the quarter, and ahead of schedule when we finalized the $650 million package consisting of bank and private debt.
The bank portion of the package totaled $300 million and is comprised of a $100 million five-year amortizing term loan and a 200 million five-year revolving credit facility of which $50 million is currently drawn.
Private debt is a total of $350 million of fixed and floating rate notes with maturities ranging from 3 to 7 years and with one-year no-call provisions.
We had two primary objectives in placing this debt.
One, to lower our overall cost of capital, and two, to provide significant flexibility in financing the growth of the business.
We believe this package and our cash resources accomplish our objectives since our net debt today just over $300 million, of which $150 million is at fixed rates that average just over 3.5%, and the other $150 million carries a floating rate of approximately 2%.
But effectively, we also have another $350 million of capacity in cash and undrawn debt should we need it to continue to invest in the three businesses that make up the company today.
With regard to the fourth quarter operations, we are forecasting interest expense at 2.75% on the outstanding debt balance.
This is lower than the third quarter expense due to a higher interest rate on the bridge loan and a write-off of $800,000 of remaining origination fees on that facility.
Quickly turning to our cash flow for the first nine months of the year, we have generated free cash flow of just under 80% of earnings, as we temporarily invested in our inventories to take advantage of some buying opportunities.
In addition, consistent with the prior year, our inventory of unsold contracts, finance contracts increased by $20 million from the end of the second quarter due to the relative level of the equipment business in the third quarter.
We are targeting a reduction in the net inventory of unsold contracts by $10 million in the fourth quarter, but this will be dependent on the level and timing of our fourth quarter equipment business and at related financing.
It may be into the first quarter of our fiscal 2005 before we can effectively reduce our net inventory of unsold contracts.
But even so, we are confident that our free cash flow for fiscal 2004 should exceed 85% of net earnings.
Thank you, and I'd like to turn it back to the operator, so Pete and I can address your questions.
Just as a logistical note, Pete is in Chicago and I'm here at the General Office in St. Paul, so you may hear us chirping back and forth to figure out who's going to answer your question, just so you know that.
Operator, could you poll for questions, please?
Operator
Thank you, sir.
[OPERATOR INSTRUCTIONS]
Our first question comes from Derek Leckow with Barrington Research.
Derek Leckow - Analyst
Thank you.
Good morning and congratulations on a nice quarter.
Peter Frechette - Chairman and CEO
Thank you Derek.
Derek Leckow - Analyst
Had a question first of all on the inventory.
Could you give us some additional color there where you saw the buying opportunities and where are you carrying higher inventory, which division currently?
Stephen Armstrong - EVP and CFO
Pete, you want that or should I take.
Peter Frechette - Chairman and CEO
Go ahead, Steve.
Stephen Armstrong - EVP and CFO
Derek, really the inventory was primarily in consumables.
As you know, we don't typically stockpile equipment that's usually custom-ordered for the customers' specific needs.
And it really -- there's nothing specific.
It was across a lot of different product categories and manufacturers.
It wasn't isolated to any one.
I would also point out that at the end of the second quarter, we'd worked our inventories down to probably a fairly low level for us for an interim period, and so there was some natural rebuilding that went on in the inventory too.
So it wasn't totally all-buying opportunities, but there were some that we took advantage of.
Derek Leckow - Analyst
And would it mostly be in your North American dental business where you saw this or are you talking about your AbilityOne business?
Stephen Armstrong - EVP and CFO
Actually all three of the businesses, if I recollect correctly, all three of the businesses saw a little bit of inventory growth, but the primary buying opportunities were, yes, in the dental business.
Derek Leckow - Analyst
OK.
Great.
And it probably reflects your outlook on consumables.
They have increased here sequentially.
You're adding additional salespeople to focus on that division, so is that what I'm hearing, Steve?
Stephen Armstrong - EVP and CFO
No, I don't think it was a build for that necessarily, Derek.
This is more just what you see in standard year-end activity.
Derek Leckow - Analyst
OK.
Stephen Armstrong - EVP and CFO
And most of this will turn through in the fourth quarter.
Peter Frechette - Chairman and CEO
Let me just add to what Steve said, Derek, that this is typical at, quote-unquote, calendar year-end from a supplier perspective.
And has been consistent with history.
Derek Leckow - Analyst
OK.
Very well.
Pete, you're at the North American dental show.
I wonder if you could comment for us, any exciting new technology there on the equipment side that you're seeing, and maybe if you could comment a little bit about the trends there.
Obviously we're very pleased to see the trends have been maintained at pretty high growth rates on equipment.
What is your outlook for that going forward?
Peter Frechette - Chairman and CEO
I would love to, Derek, except the show hasn't started yet.
It actually starts Friday morning.
So I haven't heard a peep.
The big news here is that our major equipment supplier, ADAC, is introducing a totally new line of equipment that we are very, very excited about, so they'll be introducing that, quite frankly starting tonight.
So that's the one, I think, significant issue that we can talk about at this point in time that we think is going to have a very positive impact on our business and on the industry.
Derek Leckow - Analyst
And is that an exclusive arrangement with ADAC?
Peter Frechette - Chairman and CEO
No, ADAC sells through us and regional dealers around the country.
Derek Leckow - Analyst
OK.
So in other words, the growth rates that you're seeing, the trend we're seeing here in terms of the investment spending by dental practices seems to be sustainable, at least for the near term.
Peter Frechette - Chairman and CEO
Yes, and let me add a comment here too, that when we talk about dental equipment, we did not see any real year-end equipment buying, that the equipment purchasing was spread across the entire quarter, continued beyond year-end into January at a very similar rate, so we didn't see big interest on the part of the dentist from a tax perspective.
What we continue to believe we see is an interest in the equipment purchasing from the point of view of practice productivity, revenue production, et cetera.
Derek Leckow - Analyst
OK.
Thanks.
Any comments on the guidance for 2005?
I know you haven't talked about that yet, but looks like the average estimate out there is $2.66.
Do you guys have any comment on that?
Peter Frechette - Chairman and CEO
We won't have any comment until we complete the year.
Derek Leckow - Analyst
OK.
Thank you very much.
Appreciate it.
Stephen Armstrong - EVP and CFO
Welcome Derek.
Operator
Our next question comes from Mr. Suey Wong with Robert W. Baird.
Please go ahead with your question.
Suey Wong - Analyst
Great.
Thank you.
The AbilityOne was solid but was a little bit light of my expectations here.
If I remember right last quarter, you did 32 million for half the quarter, and if you double that maybe even include a little more, that we come into the low 60s here or higher.
Could you comment on this?
Was there any seasonality of the business, anything in the market affecting AbilityOne?
Peter Frechette - Chairman and CEO
Suey, the only comment I would make is I'm not sure where your forecast was, but from the point of view of our forecast, they were about $3 million short in terms of our internal forecast, we don't view that as significant in terms of trends, et cetera.
As a result, as we indicated to you, we aren't making any modifications in strategies or our expectations.
Suey Wong - Analyst
Pete, is there much seasonality to this business?
Peter Frechette - Chairman and CEO
Well, Suey, it's important to understand that we don't think there's a lot of seasonality in this business, but it's important to understand, you know, we've had this business for a quarter and a half, so we're kind of learning as well.
I would hesitate to make any comments on seasonality.
Steve, what do you know about it?
Stephen Armstrong - EVP and CFO
No, I think where the vet business tends to add some seasonality because of the winter months, we're not aware of any acceptable type of measurable seasonality in the rehab business.
Suey Wong - Analyst
If I were to model 67% growth going forward, do you think that would be reasonable?
Stephen Armstrong - EVP and CFO
I'm sorry Suey, repeat that.
Suey Wong - Analyst
Sure.
If I were to model 6 or 7% growth for AbilityOne going forward, do you think that will be a reasonable number?
Stephen Armstrong - EVP and CFO
We believe that's in line with what we're seeing in the market and what we expect in the business in the near term here.
Suey Wong - Analyst
Thank you.
Can you comment on the acquisition pipeline both in the rehab market and also in the vet market?
Peter Frechette - Chairman and CEO
Let me just say that conversations continue.
We continue to view all three of our markets as consolidation opportunities, and it's our intention to participate in those opportunities aggressively.
Suey Wong - Analyst
Thanks.
One last question here.
Can you review Canadian performance, the absolute dollars and also sales growth in reported cash and currency?
Peter Frechette - Chairman and CEO
Steve?
Stephen Armstrong - EVP and CFO
Basically, Canada and local currency was flat for the quarter on the consumables and down slightly on the equipment.
This was in the equipment downturn was mostly due to -- you recall last third and fourth quarter, we had a C2 or Cerec 2 trade-in program going with the C3's.
Canada benefited from that.
We're not able to cover that additional volume this year.
And in Canada, I think Canada is doing quite well.
They're obviously going through some changes up there not only in the top management, but we're also imposing some changes from a corporate perspective as we take the opportunity with the management change for a redesign or re-engineer, overused word, but re-examine how we do business in Canada and Pete, you may want to comment little bit further on that.
Peter Frechette - Chairman and CEO
Well, just there is additional integration going on in terms of how we look at and manage Canada going forward and we intend to continue that process.
Suey Wong - Analyst
Thanks.
Do you have the reported number for Canada, both in dollars and growth?
Stephen Armstrong - EVP and CFO
Can we cover that off-line?
I'm not sure I can give it to you real quickly here.
Suey Wong - Analyst
Oh, good.
Thank you.
Stephen Armstrong - EVP and CFO
All right.
Thanks.
Operator
Our next question comes from Larry Marsh with Lehman Brothers.
Please go ahead with your question.
Steven Fass - Analyst
Hi.
This is actually Steven Fass.
Good morning.
Can you guys comment on your view of the dental market, that growth rate?
I know you guys have previously said 7 to 9% or so.
Peter Frechette - Chairman and CEO
From our perspective, we would still be in that 7 to 9% range.
We have historically said that we see the consumable market grow at that kind of 5 to 6 to 7% range, and when you tie the equipment in with the consumable growth rate, we get to that 7 to 9%.
And our target in the marketplace is to continue to grow 4% faster than the market, which puts us into that kind of 11 to 13% range.
Steven Fass - Analyst
Can you discuss the incentive program for software and how that contributed to software growth in the quarter, and just remind us, is this the same program that kind of was in the summer or, you know, kind of what were the changes from the previous program?
Peter Frechette - Chairman and CEO
Well, I don't believe the program has changed -- Steve?
Stephen Armstrong - EVP and CFO
The program, during the summer, we were running one targeted program against practice works early in the year where we would be giving the customer 100% rebate on the software purchase only, but we're back to our basic program where the customer has an opportunity to get a 30% rebate on their purchases assuming they can comply with the other provisions of the program.
That's over a three-year period.
So, 10% a year.
Peter Frechette - Chairman and CEO
Well, the other comment we ought to make too, I think, Steve says that part of what's driving the software sales is the digital radiography program, and we think that's adding significant sales opportunities for us.
Stephen Armstrong - EVP and CFO
Just to review the revenue market, you've got some retrofitting going on as people upgrade programs and so forth, but as Pete said, the primary drives today are clinical decisions with regard to software that's primarily around the digital conversion.
Steven Fass - Analyst
OK.
And then in terms of the EPS contribution for AbilityOne, obviously a little bit less than your internal expectations.
Is that primarily from -- you commented that revenue was slightly below your expectations.
But was that also because of the valuation of the intangibles?
Could you just elaborate on that?
Peter Frechette - Chairman and CEO
Steve?
Stephen Armstrong - EVP and CFO
Actually, Stephen, it was primarily from the revenue short fall that Pete talked about.
If you that I take that down to the high teen, low 20 type of operating earnings, you can see where the bulk of the shortfall would come from.
But the intangible amortization as I stated in my comments was 2.2 million.
We previously forecasted it in the high 1.9 million to 2 million range.
Might have been slightly higher, but it was kind of a combination of the two, but obviously the biggest single contributor was the revenue shortfall that we experienced, from what we thought they might do this quarter.
Steven Fass - Analyst
OK.
Understood.
One final question.
Excluding the sales from the Cerec, what would you kind of gauge growth in the quarter to have been, and how did that compare to, you know, say the past few quarters?
And then if you could just comment on what other pieces of equipment were kind of deriving growth there.
Everyone seems to be talking about digital x-ray.
What else is driving it there?
Peter Frechette - Chairman and CEO
Well, in our comments, we indicated Cerec and Digital Equipment, but we've never broken out specific product lines in terms of growth rate.
We're talking about the total 19% equipment growth rate for the quarter and wouldn't plan to do it now.
Steven Fass - Analyst
Fair enough.
Stephen Armstrong - EVP and CFO
If it's fair to at least put that into perspective, without Cerec, the equipment business is still growing at the market or above it, as far as we see it.
Steven Fass - Analyst
OK.
Fair enough.
Thanks, guys.
Operator
Our next question comes from Robert Willoughby with Banc of America Securities.
Please go ahead with your question.
Sean Harrington - Analyst
Good morning.
Sean Harrington in for Robert Willoughby.
You touched on it with a few of your comments and it's being echoed by some of your vendors and competitors that the digital imaging market is incredibly strong.
Would you characterize this as just broad market adoption or are you still in the early selling phase of that product line?
Peter Frechette - Chairman and CEO
Well, what we would say is that, you know, you essentially have digital radiography at probably a 15 maximum 20% market penetration, so there's a long way to go, and we think it is a broad spectrum adoption.
Digital x-ray provides the dentist an immediate image plus gets them out of the darkroom, etc, etc, and allows them to begin the process of putting the image on the computer, etc.
So we think it's a continuing trend, and we think there's plenty of room to go.
Sean Harrington - Analyst
OK.
And just one book keeping.
Can you give the operating profit by line, by business segment?
Stephen Armstrong - EVP and CFO
Sean, can we do that off line?
Sean Harrington - Analyst
Sure can.
Thanks a lot.
Operator
Our next question comes from Glen Santangelo with Charles Schwab.
Please go ahead with your question.
Deborah Lawson - Analyst
Yes, actually it's Deborah Lawson (ph).
Just wanted to get a little more color around the drivers.
I guess you're not going to provide specific products in dental so you're probably not going to do it in AbilityOne, but can you just give us some sense of what, is it a technology-driven growth there, are there new products coming out?
Just what exactly do you expect to drive the growth rate there, and also could you comment on perhaps the structure of the sales rep in that business and whether or not you're growing those folks and how it sort of -- I know it's a big driver of the growth in the dental business.
Can you give us some commentary on that aspect of your AbilityOne business?
Thanks.
Peter Frechette - Chairman and CEO
Let me just be sure.
We're talking about the AbilityOne business?
Deborah Lawson - Analyst
Yes.
Peter Frechette - Chairman and CEO
Yes, drivers in the market as it relates to AbilityOne, when we kind of talk about the whole occupational and physical therapy issues, are clearly the aging population.
The second issue is obviously the whole physical exercise sports area in terms of additional injuries, some of those kinds of things, so we're back to what we talk about the dental businesses.
Well, in terms of the aging population issue.
Deborah Lawson - Analyst
I understand what the underlying driver of that, but you know are these people using new and you know newfound types of technology that you're able to sell into that market?
I understand what's driving the utilization of the products that you're selling, but what about actual products themselves?
Is there new stuff coming on the market or is everybody using the same old -
Peter Frechette - Chairman and CEO
Deborah Lawson, just Steve will help me with my memory here.
AbilityOne is adding about 1500-plus new products a year, am I correct in that?
Stephen Armstrong - EVP and CFO
That's correct.
Deborah Lawson - Analyst
OK.
Peter Frechette - Chairman and CEO
So there is some new product impact, no question about it.
From a sales rep perspective, when we acquired the company, I think it's, what, 72, 74 sales reps.
Stephen Armstrong - EVP and CFO
In the states.
Peter Frechette - Chairman and CEO
Plan is to double that sales force over the 24 months, so we are growing the sales force, no question about it.
And it's important to remember that AbilityOne only has about 5% market share, so there's a lot of room to grow.
Deborah Lawson - Analyst
OK.
Great.
Thanks a lot.
Operator
[OPERATOR INSTRUCTIONS]
Our next question comes from Alan Mitrani with Copper Beach Capital.
Please go ahead with your question.
Alan Mitrani - Analyst
Thanks.
I want to follow up on those points on AbilityOne.
My understanding of just logically and having known some physical therapists and just -- it seems to me that the summer months or right into the fall months would be better for AbilityOne given the rehab market, and the nature of sports injuries, and things like that.
Is that not or have they seen none of that over the last few years?
Peter Frechette - Chairman and CEO
Steve, we don't see any cyclicality in AbilityOne -
Stephen Armstrong - EVP and CFO
Seasonality.
Alan Mitrani - Analyst
Seasonality.
Stephen Armstrong - EVP and CFO
Seasonality, typically not, Allen.
Obviously, yes, there's more opportunity in the summer months for certain types of injuries, but you also have, you know, skiing and snow boarding and everything during the winter months, but it goes really back to what Pete talked about before in the fact that aging seasonal season is people grow older all the time and that's really what the underlying driver of this business -
Alan Mitrani - Analyst
OK.
And also yes during the year you are going to double the U.S. sales force within the next 12 months?
Peter Frechette - Chairman and CEO
24 months.
Alan Mitrani - Analyst
24 months.
Stephen Armstrong - EVP and CFO
24 to 36 months.
Alan Mitrani - Analyst
OK.
So, and what kind of growth do they see in the U.S. sales force for them over the last couple years?
Is that typical to do that kind of growth?
Peter Frechette - Chairman and CEO
I don't think there's a problem doing that kind of growth, but I can't give you the historic growth rate in the sales force over the past two years.
I don't know whether Steve can or not.
Stephen Armstrong - EVP and CFO
Yes, they have historically, Allen, been over the last five, six years, they've doubled their sales force every three years.
Alan Mitrani - Analyst
Thank you.
Operator
Our next question comes from Larry Marsh with Lehman Brothers.
Please go ahead with your question.
Steven Fass - Analyst
Hi.
It's Steven again.
Can you guys comment on sales rep growth?
I think previously at the analyst meeting, you had suggested perhaps - when I say sales rep growth, I mean in the dental segment -- you had suggested perhaps an addition of a hundred -- I think it's like 45 or so year-to-date.
Is it going to have a - Do you anticipate more sales reps being added in the fourth quarter relative to the third quarter, and how should we think about that for fiscal 2005 also?
Peter Frechette - Chairman and CEO
Well, we've said we intend to grow the sales force, and we indicated to you in our last conference call that we've increased our sales training classes from four to six.
We're up and net towards 40 sales reps at this particular point in time, and would plan to continue to grow that sales force through the fourth quarter.
Steven Fass - Analyst
OK.
Stephen Armstrong - EVP and CFO
That was 40 up - that 40 sales rep growth, Pete, is just on the -
Peter Frechette - Chairman and CEO
Territory reps side.
Stephen Armstrong - EVP and CFO
Just territory reps.
Peter Frechette - Chairman and CEO
Yes.
No, I understand that.
Remember what we said to you in our last conference call, that we've been adding sales reps that are consistent rate of 6% to 7% in terms of the total sales force.
The problem is they've been going into areas other than territory sales reps, where the reps are actually call on the customers.
We now have put a focus back on adding sales reps that are, in fact, calling on customers and have increased that group by 40, would plan to continue to increase it through the fourth quarter.
Steven Fass - Analyst
And then on consumable sales growth, how should we think about that going forward?
Should it continue to, you know, accelerate a bit perhaps towards 7% over the next couple of quarters or more of that you know closer in line to the mid single digits?
Peter Frechette - Chairman and CEO
Well, you know, I think we're seeing it up this quarter.
I think last quarter, we had, what, 4.8%, Steve?
Stephen Armstrong - EVP and CFO
Yes, roughly.
Yes.
Peter Frechette - Chairman and CEO
About 4.8, so we're seeing it up.
I think neither Steve nor I is going to give you an absolute number, but we clearly think the trend is up and would expect as that to continue through the fourth quarter.
Steven Fass - Analyst
Fair enough.
And what would you gauge as kind of the primary driver of seeing you know a bit of improvement there?
Is it the training classes, more focus from the branch manager, the change in the compensation, or, you know, adding more field sales reps?
Peter Frechette - Chairman and CEO
I think adding field sales reps is clearly a plus, and then I would have to say to you all of the other things that you just mentioned in terms of training, new tools, et cetera.
We really have, I think, made some substantial changes, both from the point of training and tools available to the existing sales reps, and we think that's going to have positive impact as well.
Steven Fass - Analyst
And can you just confirm that the change in the compensation, I believe, the branch managers, that was a permanent change?
Peter Frechette - Chairman and CEO
Well, the branch managers incentive program changes every year consistent with our goals I think is the way I had answered that question.
To the extent that we continue to be interested in generating consumable sales, that will be a part of the program.
Steve, you want to make any additional comments on that?
Stephen Armstrong - EVP and CFO
No, I think that's accurate in the sense that it changes as we see the business changing.
Peter Frechette - Chairman and CEO
Yes.
Steven Fass - Analyst
OK.
Thanks for the comments.
Operator
[OPERATOR INSTRUCTIONS]
Our next question comes from Christopher Arndt with Select Equity Group.
Please go ahead with your question.
Christopher Arndt - Analyst
Yes, good morning.
You mentioned that you plan to grow the AbilityOne business at a 6 or 7% rate, but I also heard you mention that you plan to grow the sales force, doubling it in 12 to 36 months.
I just wanted to reconcile those two.
It seems like you're growing the sales force much faster than you expect sales to grow.
Is that right or no?
Peter Frechette - Chairman and CEO
No, I don't think so.
Steve?
Stephen Armstrong - EVP and CFO
No, I think typically you control that very closely, Chris, to make sure that they don't put a salesperson in the field and basically dilute the cost structure.
So, they monitor it, and what we're telling you is historically, they've added to the sales force, grown the business, and they've doubled the sales force every three years.
That's their plan going forward, and they will obviously control that to maintain their operating structure.
Christopher Arndt - Analyst
OK.
And then the second question I wanted to ask was, you mentioned $2 million, I think, of incremental cost in the dental distribution business associated with logistics or additional training.
Can you just expand on that a little bit, and was this, you know, truly kind of a step-up in cost that you did not have in the year-ago quarter?
Peter Frechette - Chairman and CEO
No, I don't think it's a step-up in cost.
It's investments we'd made in programs, and once those investments are completed, there will be some step-up in cost associated with the operating of them.
But we fully expect to get a nice return on all of those programs.
The major one is Clearview our service systems.
Steve, got any other comments you want to make?
Stephen Armstrong - EVP and CFO
I would just add to that or clarify it that the $2 million that we gave you was to indicate that we've made that investment in the quarter.
Obviously as we grow our business, our expense structure has got to grow, but those were really incremental costs that were absorbed in the quarter.
We would not anticipate necessarily identical costs in other quarters, but those were costs that we made or investments as Pete says that we made in the quarter outside of our ordinary operating and run.
Christopher Arndt - Analyst
And when you say investment, this is expensed, right?
Stephen Armstrong - EVP and CFO
That's why they went through operations.
Correct.
Peter Frechette - Chairman and CEO
And let me also say that we have continued to maintain our internal objective of a 50 basis point improvement at the operating margin line and have historically said we want 40 of those basis points to come out of operating leverage and we continue to work toward that.
Christopher Arndt - Analyst
OK.
Congratulations on a very strong quarter.
Peter Frechette - Chairman and CEO
Thank you.
Stephen Armstrong - EVP and CFO
Thank you.
Operator
Our next question comes from Justin Brusel (ph) with Gates Capital Management.
Please go ahead with your question.
Daxil Asesi - Analyst
This is actually Daxil Asesi (ph).
You had told one of the previous callers that you can give them the operating income off-line.
Can we just have it now?
It seems like more than one-person wants it.
Stephen Armstrong - EVP and CFO
I will -- we typically don't break that down.
I'll take that question on an individual basis, so if you care to call me back, I'll try to guide you through that, but we don't give that information publicly.
You'll see it in the 10-Q and everybody will get it at the same time.
Daxil Asesi - Analyst
Everybody will get it at the same time except for the people that call you?
Stephen Armstrong - EVP and CFO
No, I said I didn't give it to anybody specifically.
I said I'll guide them through it.
Daxil Asesi - Analyst
Oh.
OK.
Stephen Armstrong - EVP and CFO
Thanks.
Operator
At this time, there are no additional questions.
Please continue.
Peter Frechette - Chairman and CEO
Appreciate everybody's continued support, and looking forward to discussing our full-year results in April.
Thank you very much for your participation.
Operator
Thank you, sir.
Ladies and gentlemen, this concludes today's Patterson Dental third quarter fiscal 2004 earnings conference call.
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