Patterson Companies Inc (PDCO) 2005 Q4 法說會逐字稿

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

Welcome to the Patterson Companies, Inc. fourth quarter 2005 earnings conference call.

At this time, all participants' lines are muted.

Following the formal presentation, instructions will be given for the question-and-answer session. (OPERATOR INSTRUCTIONS) As a reminder, this conference is being recorded Thursday, May 26, 2005.

At this time, I would like to turn the presentation over to Peter Frechette, Chairman of the Board.

Go ahead, sir.

Thank you very much, and good morning, and thank you for a participating in our fourth-quarter conference call.

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

At the conclusion of Jim's remarks, all of us 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 this morning's 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 in our annual report on Form 10-K.

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

Before reviewing our full-year and fourth-quarter performance, I want to take a moment to discuss this morning's announcement about Patterson's management transition.

Jim Wiltz, currently the President and Chief Operating Officer, has been named Chief Executive Officer effective May 31, 2005.

As Jim moves into the Chief Executive Officer role, I will continue as an active Chairman of the Board, focusing on a variety of strategic issues as well as shareholder relations.

Jim will retain his position as President, but the Chief Operating Officer post has been eliminated.

This change marks another step in Patterson's management transition process which started in 2003 when Jim was named President and Chief Operating Officer.

Backed by his 36-year career with Patterson, few people understand our business, our sales culture, our markets and our customers as well as Jim.

Jim joined Patterson in 1969 as a dental sales representative, and worked his way up through the management ranks until becoming a Vice President in 1980.

In that capacity, he was an integral part of the management team that implemented our LBO from Beatrice in 1985.

From 1986 to 2003, Jim served as President of our Patterson dental supply unit, and was elected to Patterson's Board of Directors in 2001.

In addition to his knowledge of the dental market, he has played at key role in moving Patterson into the veterinary and rehabilitation supply businesses, and integrating our acquisitions in those markets into Patterson.

His wide-ranging experience makes Jim uniquely qualified to assume his new position, and I have no doubt whatsoever that Patterson will continue to grow and prosper under his seasoned executive leadership.

Turning now to our financial performance, Patterson reported strong results for fiscal 2005.

For the year, which included an additional or 53rd week, consolidated sales increased 23% to 2.4 billion, while earnings rose 23% to 183.7 million, or $1.32 per diluted share.

A substantial portion of these strong results was driven by our dental unit, which performed at an exceptionally high level in fiscal 2005.

For the full year, sales of our Patterson dental business rose 13% to 1.8 billion, with substantially all of this growth internally generated.

Sales of consumable supplies rebounded strongly as the year progressed, reflecting the positive impact of our renewed focused on this aspect of our dental business.

During the second half of fiscal 2005, consumables grew at or above the upper end of our 5 to 7% market growth rate estimate.

Moreover, sales of equipment and related software increased 23% for the year.

Demand for new technology equipment was particularly robust, with sales of CEREC 3D dental restorative system up 39% for the year, while sales of dental radiography systems, including software and hardware, rose 31%.

Dentists are clearly continuing to invest in a wide range of new equipment that can strengthen office productivity and improve clinical outcomes.

As the leading distributor of basic and new technology equipment, Patterson is strongly positioned to continue to capitalize on this investment cycle for some time to come.

Regarding the fourth quarter, we were encouraged by strong revenue growth of our three businesses.

However, fourth-quarter earnings were below planned levels, due to a combination of business-specific factors.

Three things affected the performance of our dental unit.

First, higher-than-anticipated inflation and increased inventories resulted in a higher-than-expected LIFO provision.

As you know, under LIFO, we made an educated forecast early in the fiscal year about inflation for the full year, and then reserve accordingly based on this forecast.

As things turned out, our LIFO index for fiscal 2005 proved insufficient due to the pickup in the overall inflation rate this past year.

The second factor affecting the fourth-quarter results of Patterson dental was additional expenses related to certain field personnel incentive programs.

These additional expenses were incurred due to the above-planned performance of the dental unit for the full year.

Third, fourth-quarter sales of consumable dental supplies were affected by the sale of the Caldwell division's wholesale business during this quarter.

Consumable sales rose 6% in the fourth quarter, but excluding the impact of this transaction, consumable sales increased approximately 7%.

Finally, our Canadian dental operation turned in a relatively weak fourth-quarter performance.

Based on early results thus far in the first quarter of fiscal 2006, we believe that this situation is turning around.

Despite this range of short-term developments, we believe that the fundamentals of the North American dental market remain very positive, as evidenced by our double-digit dental sales growth.

For this reason, we fully expect Patterson Dental to continue to operate at a level consistent with our historical goals.

Turning next to Webster, our veterinary supply business posted a very solid internal growth rate of approximately 12% in the fourth quarter.

This is all the more encouraging when you consider that Webster realized approximately 3 million of ProHeart 6 sales in the fourth quarter of fiscal 2004, but none since this injectable heartworm medication was voluntarily withdrawn from the U.S. market by its manufacturer in September 2004.

The ProHeart situation will continue affecting Webster's sales comparisons for the next two quarters.

Webster's fourth-quarter sales growth was partially offset by the continuation of pricing pressures related to discount strategies of certain competitors.

It is important to understand that this type of pricing environment is nothing new at Patterson.

In the early 1990's, Patterson Dental experienced the same kind of pricing pressure until we succeeded in establishing our full service value-added business on a fully national basis.

Acting to expand Webster's national position as a full service value-added distributor, we believe discount pricing strategies can again be neutral.

Toward this end, Webster has made two acquisitions over the past year and is now internally expanding into the large California veterinary market.

Webster sales representatives are now calling on California accounts and we have begun stocking inventory in the state.

In another positive development, Webster started selling Rimadyl, a companion pet pain relief drug this past April under a new distribution agreement with Pfizer.

We believe this product has a very good potential for Webster.

Finally, AbilityOne's internally generated sales increased approximately 15% in the fourth quarter which marked the strongest showing of the year for our rehabilitation supply unit.

However, AbilityOne's profitability continued to be affected by above-plan operating expenses related to expanded catalog production and mailings and other growth initiatives.

We're currently reevaluating AbilityOne's expense structure with the goal of better aligning future costs with anticipated revenue growth.

All in all, we remain very confident about the future of this business.

As the number one player by a wide margin in a highly fragmented market, AbilityOne is uniquely positioned to capitalize on any number of promising growth opportunities and continue increasing its marketshare.

But while we are not at all satisfied with Patterson's fourth quarter earnings shortfall, we remain very confident in our near and long-term prospects.

We believe we have the right strategies and programs in place to continue capitalizing on growth opportunities in dental, veterinary and the rehabilitation supply markets.

As a result, we're confident about the elements we are in place for making fiscal 2006 another period of record operating results for Patterson.

For the first quarter of fiscal 2006 ending July 30, we're forecasting earnings of $0.31 to $0.33 per diluted share.

This guidance reflects several factors.

Earnings in the first quarter for fiscal 2005 included and extra or 14th week.

Moreover in the year's earlier quarter, Webster's topline included a significant volume of large animal feed lot sales that were inherited from the parent Company of ProVet.

This low-margin business was subsequently eliminated as a part of the overall rationalization of the ProVet operation.

And it is worth repeating that Webster's results in last year's first quarter included approximately 3 million of Pro Heart sales that will be absent in this year's first quarter.

All of these factors will affect our consolidated year-over-year quarter comparison.

For the full year, we're forecasting earnings of 1.54 to 1.58 per diluted share, which is consistent with our historical guidance.

Thank you, and now I would ask Steve Armstrong to review some highlights of our fourth-quarter results.

Thank you, Pete.

Just one further point on the revenue growth for the quarter.

Foreign exchange had a fairly minimal effect, contributing only about a half a percentage point of positive impact on consolidated results.

The gross margin for the year was down 10 basis points and we did not achieve our goal of a 10 basis point improvement.

However, we saw sequential improvement every quarter throughout the year, including a 50 basis point improvement between the third and the fourth quarters.

Numerous factors both positive and negative influenced our consolidated margin throughout the year and I want to address a few specifics.

First, the Dental segment achieved a 20 basis point improvement in its gross margin for the year due primarily to a higher proportion of new technology equipment in its product mix.

Second, we were integrating several acquisitions into the Veterinary and Rehabilitation segments during the year that negatively affected our consolidated gross margin.

Third, as Pete discussed in his remarks, there are pricing pressures in the Veterinary segment.

We're confident these can be overcome, but it will not be a quick fix.

In addition to expanding Webster's market presence, several initiatives that combat low-cost strategies are being implemented.

These include strengthening Webster's value proposition by expanding its product offerings and deploying technology like our Imagine system.

Imagine facilitates the customer's ordering process in addition to strengthening the office operations and productivity.

Turning to the gross margin change in the current quarter on a year-over-year basis, there are two items of particular significance.

First, the LIFO adjustment that Pete mentioned earlier negatively affected our gross margin in this year's fourth quarter.

Second, our margin in the year earlier quarter was positively affected a more favorable than anticipated physical inventory gain.

The net impact of these two items amplified our year-over-year margin comparison.

Looking ahead to fiscal 2006, I would anticipate achieving our historic goal of improving our consolidated gross margin by 10 basis points.

I will now quickly review our operating leverage.

Last year at this time, we said we did not anticipate achieving our goals of improving operating leverage by 40 basis points for the year.

We made this statement due to the substantial amounts of intangible asset amortization related to acquisitions made in late 2004 and at the beginning of 2005, as well as that arising from the AbilityOne acquisition.

We also knew we would be absorbing the cost of these acquisitions throughout the year.

However, we made steady improvements in our operating leverage throughout the year, including a 60 basis point improvement in the fourth quarter.

We will incur less amortization expense in fiscal 2006 and this fact coupled with our historic objective of gaining efficiency from our operating structure makes us believe that we can accomplish our goal of improving the operating expense ratio by 40 basis points during the coming year.

An additional factor affecting our operations was the decision to reduce our outstanding debt through the early retirement of certain floating-rate debt that we had issued as part of the AbilityOne acquisition.

This reduction, which by contract could not occur until late in the fourth quarter, totaled $105 million.

This paydown necessitated the write-off of approximately $500,000 of issuance cost associated with this portion of the debt.

Our free cash flow exceeded $175 million in 2005, which is well above our target of 80 to 85% of earnings.

Fourth-quarter cash flow from operations was more than 16 million, but it was negatively affected by our decision to take advantage of certain inventory purchasing opportunities during the quarter, including the amount of financing contracts we held at year-end by about $10 million and a reduction of trade payables.

The financing contracts increased in proportion with the volume of equipment sales in the quarter and we would expect these contracts to be sold in the first quarter of fiscal 2006.

In conclusion, I would like to provide some insight on our capital spending for next year.

In fiscal 2006, we're currently estimating depreciation and amortization of approximately $23 million with CapEx between 25 and $30 million.

Thank you, and I will now turn it over to Jim Wiltz for a few comments.

Thank you, Steve.

I'm truly honored to be named Patterson's Chief Executive Officer today.

Pete Frechette during his long tenure as Patterson's leader built a regional dental distributor into one of the nation's largest value-added specialty distribution companies serving the dental, veterinary and rehabilitation supply markets.

In so doing, Pete established a business platform that has generated consistently strong sales of earnings growth.

The people-oriented culture that he developed within Patterson and the value-added concept that he established as the hallmark of our business are responsible for the long-term success of this organization.

As his successor, I will strive to build upon Pete's record of achievement and further strengthen our strategic and operational foundation.

Among other things, this means that I will work to further expand our leadership position in the dental market and I will also focus on expanding Patterson's value-added business concept to Webster and AbilityOne.

The considerable potential of these units will be fully unleashed due to their farther adoption of our proven full-service value-added model and I'm committed to making measurable progress on this front.

Again, I think Patterson's Board of Directors and Pete for the conference they've shown in me and I intend to repay their confidence with extended growth and success of this organization.

Thank you, and now I will turn the conference back to the operator who will poll you for any questions that you may have.

(Operator Instructions) Lisa Gill, J.P. Morgan.

Thanks very much and good morning.

Steve, I was wondering -- could you give us a little bit more color around the LIFO provision in the quarter and for the year?

Can you give us a dollar amount just so that when we think about this, we think about it this year versus next year, I would anticipate that you would expect that we would not have that type of number in our model for next year.

And then secondly, I'm wondering if you can talk at all about -- I think you had instituted a share buyback program at one point.

I'm wondering where that stands and what your plans are now?

Sure.

Lisa, without going into a lot of specifics, I would tell you that the LIFO was probably between a half and three-quarters of a point higher than what we anticipated for the year.

It would be at this point probably something that we would look forward to in the fiscal 2006 because to be candid with you, pricing has not changed a lot since the second half of the year.

So we're probably looking at a similar type of number.

The only thing I would tell you is it will be baked into the entire year because now we have further information to refine our estimate, as Pete said.

Okay, so that is included in the guidance then?

Absolutely.

Any thoughts around the share buyback?

The share buyback currently is standing at 6 million shares authorized and we have not used any of it since the Board gave us that authorization in September of 2004.

And so therefore, none of this is built into your guidance as well?

Correct.

Just lastly, can you just give us an update on your thoughts around acquisition outlook for 2006?

Obviously, your guidance today does not include any potential acquisitions, but do you have a lot of opportunities?

Do you feel that the opportunities are not as great as they've been in the past?

Could you just give us some color there?

I think the outlook for this next year is the same it has been in recent history.

We have some discussions underway as we always have had, and so I would not paint it as any more or any less than we have seen over the past few years.

Great, thanks very much.

David Veal, Morgan Stanley.

Hi, thank you, and before I begin, Peter, I would just like to just take a moment to applaud you for a distinguished tenure as CEO.

You've built a great company and have a tremendous amount to be proud of.

Thank you.

I wonder if we can talk about the AbilityOne business for a minute.

The internally generated sales increase there was fantastic I guess relative to what we saw last quarter.

I wonder when you think about 2006, how you think about the organic growth rate there.

And also on the expense line, how should we be thinking about the opportunity for rationalization of that unit?

Did we spend too much on the (indiscernible) catalog?

Were the returns not there?

Was that the growth opportunity that was really missed?

I think two things.

First of all, from the point of view of the expenses of AbilityOne, I think we've had sufficient time now given that the acquisition, et cetera, understand those expenses.

And some of the expenses we're talking about occurred at Medco from the point of view of catalog expenses additional mailings, et cetera.

So I think we are -- we have the expenses headed in the right direction at this point in time.

And I think from the perspective of continuing as it relates to the revenue line, we would continue to set a target there that says we want to grow faster than the market by our traditional kind of 4%.

We see that market growing at 6 to 8%.

So we're looking to grow that business 10% plus in the coming year.

You want to add anything, Jim?

No.

And when we think about the mix, I think one of the issues that had historically troubled that business was getting the mix right between equipment and consumables.

Do you feel like you have managed that transition well?

I think that clearly, the equipment mix had increased and that had an impact on gross margins and we're looking back to get to the consumable business from the point of view of a margin impact.

I think it's fair to say we probably are not there yet, but we will continue to work on it.

Okay, great.

Thank you.

Larry Marsh, Lehman Brothers.

This is Stephen Postal for Larry.

I'm wondering if you could elaborate on your comments regarding inflation in the Dental business.

Was that coming from just -- was that commodity-driven, or was there something else there?

You know, we buy so darned many products, Steven, it's a little hard to say whether it was all commodity-based.

Obviously, there's a hell of a lot of plastic that gets used in this business, so obviously that's going to have to be an impact both in the consumable and the equipment market.

So I don't think we could isolate it down to any one factor, if that's what you're looking for.

It was just across the board, a fairly -- and it wasn't huge.

We're still talking between 2 and 3% here, so it's not out of the ordinary, it was just a little higher than we anticipated (indiscernible).

We've also got the impact in here of Webster and (inaudible).

Oh, sure.

We have two more inventories coming in, so our inventories are obviously up a little too.

But we had anticipated that.

It was really the pricing differential, Steven, that we got blind-sided on a little bit.

Understood.

In that business, two of your biggest competitors there have announced that they will merge.

I believe that actually was last month.

Can you just speak about how you expect that combination to impact the Webster business, how you anticipate that combination affecting your strategy of growing that business to a national platform?

And is it at all possible that you could pick up some share as a result of the two businesses combining together?

The statements we have made on the merger of Butler and Burns (ph) really revolve around two things.

First of all, we don't look at that is having a negative impact on us.

And second of all, we would agree with your statement that we see it as a potential opportunity to pick up some share.

And as you know, the first place we might be able to pick up some share is in the state of California.

Historically in the businesses that we're in because the markets are relatively small, when you have mergers of that size go on, typically there's a fair amount of fallout in the market, which hopefully we will be able to capitalize on.

Do you think you can still be acquisitive into that business?

Yes, I do.

In the context of Rimadyl, how is your sales force picking up that product and do any sales of Rimadyl cannibalize any of your other products?

There would be minimal cannibalization on that product, Steven.

So I guess from a bean counter's perspective, I think we're off to a very nice start with the product, but it's still early.

This is only the second month that we've actually had it in the system.

But hte salespeople are very excited to have it.

It's a very high visibility product and I think Jeff and his group are excited about the opportunity to expand their relationship with Pfizer, which is the more important aspect of this.

If we're successful with Rimadyl, then we have more opportunities with Pfizer.

And have you -- I know the product is (indiscernible), but have you got any feedback from Pfizer suggesting their view of how you're treating that product?

I think it's a little early on that, Steven.

Pfizer management and the Webster management have reviewed the product and had set some goals early on as far as what they thought, how much of that market would switch from Pfizer over to the distribution market.

So I think it's too early to make any judgments on that.

Okay.

There's been a lot of discussion regarding opportunities for digital x-rays.

Some say that it's a very underpenetrated product.

You spoke about the growth rates in fiscal '05.

Just wondering if you could elaborate on those comments, how penetrated you think digital x-ray is and what really is the value proposition of digital x-ray for your customers?

First of all, I read matter of fact just this morning a dental products report that the survey they just completed shows the market at 22% penetrated.

They also showed in the same survey that 18% of the marketplace is ready to buy in the short-term, which in the short-term for them is six months.

So we see the market continuing to be very, very robust.

The model for the dentist, the biggest thing it does for the dentist, it gets them out of the darkroom and processing chemicals, which is one of the biggest nightmares for a dental office.

The payback is somewhat slower than it is on other products, but it does have a payback.

But the biggest advantage is a time saver and getting out of the darkroom.

Thank you very much for the comments.

Robert Willoughby, Banc of America Securities.

Thank you.

Pete, congrats on a job well done, but honestly I've had you sticking around longer than Armstrong.

Can you give any color why Canada was weaker in the latest period?

Is this just kind of a market issue, or was consolidation in that market a factor or what can consolidation in that market mean for you?

I'm thinking about my answer, Robert.

The Canadian market has been, as you know, up and down at best.

Canada, if we look at the whole year, had a very nice year.

The real issue in Canada when we look at it is they had a terrifically stronger prior year's quarter in the CEREC area, et cetera, which affected their equipment sales fairly dramatically on a prior-year comparison.

We expect Canada to continue to move ahead and have another successful year this year and kind of tend to see the fourth quarter as a bit of an abberation, Robert.

Okay, but any consolidation of that market doesn't change your dynamics there?

We don't think so, and I'm assuming what you're talking about is the Arcona (ph) merger or acquisition of?

Yes.

Yes.

We don't see that happening or having any negative impact on us at all, Robert.

Matter of fact, we think there would be some positive fallout.

Again, there's always some custom (indiscernible) in those kind of mergers.

Gotcha.

Also just Steve, dental inventories were higher.

You've indicated the pricing.

Was there a unit issue involved there as well?

Why would that have turned it up?

A couple of things, Bob.

We made some strategic buys if you will in the mid to latter part of the fourth quarter in the consumable area.

In addition, as the volume of the CEREC continues to grow, that gets a little spiky with regard to inventory levels because we're trying to stay ahead of the demand so we can fulfill quickly.

And the manufacturer last year a year ago end of fiscal 2004, we were basically out of sales of stock.

This year, we had some inventory of CEREC.

So it's a combination of those two items, but nothing that I would say is at this point I would tell you to bake into the numbers.

And you did indicate a Coldwell (ph) business was sold in the latest period.

What exactly was that and was it a material number?

Steve can give you a number.

This is Jim.

It is a relatively small piece of business.

What we were doing was selling that wholesale to a couple of other distributors that were really competitors of ours and it was business that we were doing that was unprofitable.

So rather than continue to feed a competitor and an unprofitable piece of business, we sold it off.

It sounds like a good business concept.

It's kind of new for us.

We don't normally sell things, but it just did not fit with our business.

Just from a numbers perspective, Bob, it is under a $10 million business.

It did not have a real significant impact to us.

There really was not much of a gain or loss on it financially, but we just wanted to throw some call on that consumable number and it does because that ends up in the consumable total and it did have a bit of an impact in the quarter.

That's great.

Thank you.

(Operator Instructions).

Derrick Leckow, Barrington Research.

Thank you, good morning.

I had a question on operating margin, Stephen.

You said you were planning for about a 10 basis point improvement from gross margin.

You also said that there would be some help from lower amortization.

That only leaves a little bit more from leverage and I wondered if you could talk to that topic specifically and let me know if you think we're getting to a point here that roughly 13% operating margin that structurally that it would become more difficult to exceed that on a longer-term basis?

Derek, I think your question is better served by having Pete and Jim answer that operating perspective.

I will just tell you that from the financial perspective, we are still making investments in these businesses.

So we will continue to have that pressure on the operating structure.

So we get a little bit of a boost from the amortization going away, but we will have to turn around and reinvest that in some of the businesses.

But I will turn it over to Pete and Jim to talk a little bit about that.

Derek, I think that we still believe and continue to be committed to a 50 basis point improvement in our operating margin per year.

We see that as consistent with our historic objectives of 10 basis points out of gross margin and 40 basis points out of operating leverage.

As Steve says, we will get a little help from amortization this year.

But we also have some nice additional opportunities from the perspective of product mix as well when we talk about high-technology products and those type products that we sell at little better margins.

So we do have that opportunity going forward.

We are comfortable with a 50 basis point improvement if the operating level continues to be achievable (technical difficulty) it is our intention to do that.

Derek, one thing I would add for you is that if you look at what's going on with our distribution consolidation, we've really just begun to consolidate the distribution of Webster into AbilityOne and Patterson under the same roof.

We just completed our first warehouse in South Carolina this past year and we will soon complete one in Kent, Washington.

So over the next couple of years, you'll see that process speed up a bit and we should see some more leverage coming out of that process.

Is that where the majority of the CapEx budget is going to be in the next year?

Yes, sir.

We got delayed a little bit on the facility over in the UK that we talked about last year, so that is in this year as well as some additional spend in the distribution area.

But you're correct, that's where most of it will be.

Just a final question here on the Webster business.

I wonder if this pricing pressure that you're seeing is more regional.

And can you give us a sense for where you -- you're already a pretty full service -- you already had a nice full-service presence in some areas.

Can you compare that to areas where you don't have it, and is the pricing pressure more prevalent in just certain regions of the country?

Derek, we're currently in 35 states with Webster.

The two big holes in terms of our coverage nationally really are in California and that far western part of the country and then the upper Midwest portion of the country, the Ohio, Illinois, Wisconsin, Minnesota hole.

California is clearly the priority for us.

From the point of view of pricing pressures, I think from our perspective, we're probably seeing a greater degree of pricing pressures on the East Coast, but then that is where our market share is the strongest and we would expect that.

I think the other thing that we're enthusiastic about, vis-a-vis the Webster opportunity, is that we are beginning now to get some of our value-added kinds of approaches in place.

We're just at the initial stages of beginning to get into the x-ray business and are now beginning to sell x-rays to veterinarians, et cetera, and we see the opportunity to broaden the product line and move toward a single source of real opportunity to counteract some of that specific product pricing pressure.

One thing I might add, Derek.

One of the things that we see happening when we move into and a new area with Webster, the local regionals seem to react immediately with dropping the price.

But I think we will find that it's not a very good long-term strategy for them.

At least we've found that in our other businesses.

I was just trying to get a sense for whether you're seeing more of that pressure.

It sounds like it's on the East Coast, but that's where you already have a pretty full service operation presently.

And I'm just wondering if you're also, have you guys looked at the comparison versus where you're seeing you're moving into new markets, where are you seeing the greater impact right now?

I don't know that we can quantify it as greater or lesser, but we are seeing an impact.

It is an impact that quite frankly we would expect as we move it in new areas and get competitive.

Jim says the regional guys seem to react with lower prices.

We don't think that's a good strategy for them, given their model.

Jeff Johnson, Robert W. Baird.

I'm filling in for Stu (ph) here.

All of my questions have pretty much been answered, but did have one question hanging out there.

Just want to make sure I understand on the Webster side of the business, the 12% organic growth or comparable basis growth that you're giving, that excludes the 3 million sales from last year's fourth quarter of the Heart Gard products?

Yes, Jeff.

That's how we get to that as we treat it on a comparable basis (indiscernible).

That also includes whatever over the couple of months here of Rimadyl sales that you have included?

Rimadyl would be included in the revenue, yes.

And that is a distribution agreement, not an agency relationship?

That his correct, sir.

That was all I had.

Everything else has been answered.

Larry Marsh, Lehman Brothers.

It's Steven again.

I don't want to belabor this point, but just a follow-up to the LIFO issue.

Steve, you responded that it was a half to three-quarters of a point higher.

I hope this isn't a silly question, but do you mean 0.5 million, or are you talking on a margin basis?

No, if you' measure the inflation, Steven.

Oh, I see.

In terms of 50 basis points or something like that.

Yes, there you go.

Okay.

Also the question on the sales force.

You've increased it sequentially by five sales reps it looked like.

I'm just wondering if you can speak about the opportunities to grow your sales force.

Do you think you can still grow it in the mid-single digits or are we starting to hit the law of large numbers?

We're continuing the goal of growing the sales force at our historic levels and we have added two extra training classes into our schedule up here.

We were doing four a year and we're now doing six a year.

And those classes are averaging 20 to 25 people per class and we will continue that.

Okay.

Steve, for interest expense, I know you noted the write-off of issuance costs.

I think you said $0.5 million.

Even excluding that, interest expense is still above our estimate.

Can you just speak about that and maybe what your average interest rate in the quarter was?

Average rate for the quarter I think was approaching about 4 percentage points.

Mr. Greenspan has been obviously raising the rates and we have some floating-rate debt and we were able to get rid of some of it towards the end of the quarter but really saw no benefit from that, Steven, from an interest rate perspective.

In fact, having to write off the issuance cost exacerbated the rate for the quarter.

And that 4 percentage points I gave you on the current quarter rate would not include the write-off.

The write-off is over and above that.

Understood, okay.

And then the other part of it is, when the rates are going up, you can't -- how do I say this?

You cash management doesn't keep pace.

The rate you can get off your cash management generally does not keep pace with what the LIBOR rates are doing.

So we got squeezed a little bit on that too.

One final question for me.

Can you speak about if you guys have an optimal leverage that you want to keep for the business?

You know, we get that question Stephen and I don't know that there is an optimal level of leverage.

Obviously when we put on the $500 million of debt a little over 1.5 years ago, we felt we brought our (indiscernible) average cost of capital down by almost a full point.

But we're in the situation now where we're generating cash out of the business at a faster pace than we can currently reinvest it.

We knew that was, or we projected that was going to happen, I should say.

We knew what we projected was going to happen.

We'll pay down this current debt.

My current intention is to keep the 150 million of fixed as long as I can.

But again, if we continue to generate the cash faster than we reinvest it, then the debt goes away and then we decide how to get the money back to the shareholders because it is theirs.

Understood.

Thank you very much.

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We'd like to thank everybody for joining us this morning.

And again, I'm very honored to become the CEO of this organization.

Thank you, sir.

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