Patterson Companies Inc (PDCO) 2006 Q2 法說會逐字稿

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  • Operator

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

  • Welcome to the Patterson Companies earnings second quarter 2006 conference call. (OPERATOR INSTRUCTIONS).

  • As a reminder, this conference is being recorded Wednesday, November 23, 2005.

  • I would now like to turn the comforts over to Peter Frechette, Chairman.

  • Peter Frechette - Chairman

  • Thank you and good morning.

  • We appreciate your participation in our second quarter fiscal 2006 conference call.

  • Jim Wiltz, who was obviously scheduled to be on the call, has had an unexpected personal matter, so I will be filling in for Jim.

  • Also joining me today is Steve Armstrong, our Executive Vice President and Chief Financial Officer, and we will be pleased to take your questions at the conclusion of our remarks.

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

  • For this reason, we've included financial guidance in this morning's earnings release which is consistent with the guidance that we released on November 18th.

  • It's important to understand that Patterson's actual results may vary from our forecast.

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

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

  • Turning now to our second-quarter results, consolidated sales rose 11% to 641.7 million.

  • Excluding the impact of two acquisitions made during the past year, internally-generated sales increased approximately 7%.

  • Net income increased 5% to 44.7 million, or $0.32 per diluted share.

  • As I will discuss in a few minutes, several components of our business performed in line with our expectations in the second quarter, but on balance, we're not satisfied with Patterson's results for this period.

  • Our second-quarter earnings shortfall was attributed primarily to weaker-than-forecasted sales growth of basic dental equipment, including chairs, lights, dental units and cabinetry.

  • Stated simply, we've been strongly focusing on our high-technology equipment lines for the past several quarters, and the resulting sales of CEREC and digital radiography systems have been very solid.

  • Unfortunately, this emphasis on high-tech equipment was accompanied by an unintended lack of focus on basic dental equipment, which largely explains our current position in this area.

  • We are now implementing some corrective actions, but as we stated in this morning's release, these measures are not expected to have a significant near-term impact on the growth rate of basic dental equipment sales.

  • I also want to emphasize that the dental equipment market remains an excellent long-term opportunity for Patterson.

  • We believe dentists will continue to modernize their practices with new equipment that strengthens productivity and provides offices with a state-of-the-art appearance.

  • As the leading distributor of dental equipment by a considerable margin, no other company is better positioned than Patterson to meet these needs, which is why we are optimistic about the long-term prospects of the equipment business.

  • Although to a much lesser extent, our second-quarter results were also affected by a below-plan performance at our Patterson Medical unit, resulting from both weaker-than-forecasted sales growth and a shift in products mix that adversely affected margins.

  • As we reported in a Form 10 8-K filing during the second quarter, we have named David Sproat as the new President of Patterson Medical as a step toward improving the performance of this business.

  • Over the next several months, David and his staff will reassess the operations and programs of this unit with the objective of driving stronger and more consistent performance from this business.

  • We see substantial long-term opportunities in the global rehabilitation market and continue to believe that Patterson Medical represents a solid growth path platform for capitalizing on this opportunity.

  • As I said at the beginning of my remarks, several aspects of our business performed in line with expectations in the second quarter.

  • The first is consumable dental supplies.

  • Excluding the impact of the recent Accu-Bite acquisition and the sale of the wholesale business in the front office supply division, which occurred in the third quarter of last year, consumable sales were up 9% in the second quarter.

  • The second positive factor was sales of high-technology equipment, where both CEREC and digital radiography sales continued to grow in double-digits.

  • And third, we are encouraged by the performance of our Webster Veterinary unit, whose sales rose 14% after excluding the contribution from the October 2004 acquisition of Milburn Distributions.

  • Webster is benefiting from the expansion of its geographic marketplace through acquisitions and internal expansion, in addition to a new pharmaceutical distribution agreement with Pfizer.

  • We believe that Webster is now on a solid growth footing.

  • Turning now to the financial guidance contained in this morning's release, we are forecasting earnings of $0.38 to $0.40 per diluted share for the third quarter of fiscal 2006 ending January 28, 2006.

  • We've also reduced our previously issued full-year earnings guidance to $1.44 to $1.46 per diluted share from the guidance of $1.54 to $1.58 that was issued at the beginning of fiscal 2006.

  • The third-quarter and revised full-year guidance reflect the fact that the corrective actions we are implementing in the area of basic dental equipment are not expected to have significant near-term impact.

  • We are fully committed to working through the situation and returning Patterson to its historic course of revenue and profitability.

  • Despite our near-term challenges, we believe that Patterson's business foundation remains strong and our dental veterinary rehabilitation units can further strengthen their positions of industry leadership.

  • As a result, we remain confident about Patterson's long-term prospects.

  • Thank you.

  • Now I would like to turn the program over to Steve Armstrong who will review some highlights from our second-quarter results.

  • Steve Armstrong - EVP and CFO

  • Thanks, Pete.

  • Although our revenues for the second quarter have already been discussed, I want to make one additional point -- namely, the revenue shortfall in basic dental equipment had a more severe impact on our consolidated operating profit than it might first appear.

  • The total sales contribution from Accu-Bite, which was acquired partway through the quarter, and which was not included in our previously issued second-quarter guidance, did mitigate some of the revenue shortfall.

  • But, as we indicated in prior statements about the anticipated impact of Accu-Bite, there was no operating profit generated from this revenue.

  • In effect, while Accu-Bite helped cushion the dental equipment sales shortfall, we essentially exchanged high-margin operating profit dollars for no-margin dollars.

  • Proceeding down the income statement, our consolidated gross margin declined by 120 basis points, 34.2% to 35.4% in the second quarter of fiscal 2005.

  • Several factors contributed to this margin decline.

  • The gross margin of our dental business declined as a result of consolidating Accu-Bite's business, which has lower margins than Patterson Dental's norm.

  • We'd expect this impact to start dissipating as Accu-Bite is further integrated into our dental operation over the next couple of quarters.

  • Dental margins also were affected by a shift during the quarter in the interest rate curve used to mark to market our finance contract portfolio.

  • The second-quarter shift was almost double what we had experienced in other recent quarters, and it reduced our contract gains on a comparable basis.

  • Finally, our consolidated gross margin also reflects the relative change in the mix between the three business units in the current quarter compared to the prior year.

  • During the second quarter, the growth of the veterinary business caused it to account for a larger percentage of total operations, and because of its historic lower gross margins in comparison to the other two businesses, Patterson's consolidated gross margin was thus reduced.

  • The decline in our consolidated gross margin was partially offset by a 50 basis point improvement in our consolidated operating expense ratio.

  • This improvement resulted primarily from the lower level of intangible amortization at Patterson Medical and better operating leverage at our veterinary unit.

  • The dental expense ratio, which was flat year-over-year, was adversely affected by the Accu-Bite business.

  • But again, this impact should dissipate as Accu-Bite is integrated into our dental business.

  • In view of our reduced sales and earnings guidance for the full year, we are also challenging each of our business units to reduce discretionary spending for the remainder of fiscal 2006.

  • On a consolidated basis, our second-quarter operating margin declined by 70 basis points to 11.4%.

  • This decline was attributable primarily to the shortfall in dental equipment sales, to a lesser extent by the revenue shortfall in gross margin impact at Patterson Medical, and to the consolidation of the Accu-Bite business, whose ratios were dilutive in the quarter.

  • Turning now to our second-quarter cash flow, operations yielded approximately $40 million compared to 60 million in last year's second quarter.

  • Our cash flow for the period was affected by a temporary buildup of about $30 million of finance contracts that will be sold in the third quarter.

  • We had been negotiating with our commercial paper conduit to modify one of the qualifiers in the contract purchase agreement, and we reached a successful conclusion, but not until after the regular sale date for this quarter.

  • Capital expenditures totaled $11 million in this year's second quarter.

  • This amount includes investments in new share distribution -- new share distribution center in Lancaster Pennsylvania, as well as a new distribution facility for Patterson Medical's UK operation.

  • Our days sales outstanding increased slightly to 48 days in the second quarter, from 46 at April 30th.

  • The inventory turns declined to 7.4 times versus 7.9 for fiscal 2005.

  • Both of these comparisons were again affected by the Accu-Bite acquisition.

  • Thank you.

  • I will turn it back to the operator to see if there's any questions.

  • Operator?

  • Operator

  • (OPERATOR INSTRUCTIONS).

  • Larry Marsh, Lehman Brothers.

  • Larry Marsh - Analyst

  • Thanks and good morning, Pete and Steve.

  • I hope Jim is okay.

  • I just wanted to elaborate on maybe two things.

  • First of all, talk a little bit about the management change at AbilityOne.

  • Obviously, you disclosed David now running that division as of late September.

  • Two things.

  • What will his priorities be in coming into this business and what precipitated the change to replace Ed?

  • And then, who is running the sales effort now in dental, now that David is over at AbilityOne?

  • Peter Frechette - Chairman

  • Two things.

  • The change at our medical unit was precipitated, obviously, by what we felt was a need to improve results, primarily dedicated at the revenue line.

  • And we think David brings a lot of that talent with him.

  • And the second question was what, Larry?

  • Steve Armstrong - EVP and CFO

  • I'll take it, Pete.

  • Larry, the succession up at dental -- Scott Anderson, who was Vice President of Marketing, has moved into the Vice President of Sales position.

  • Scott has been with the organization in multiple roles over the years, both here at the corporate office and out at a branch level.

  • And then, John Bettencourt, who has been our branch manager at our main facility, will be moving here to the corporate office first of December to take over the Vice President of Marketing position.

  • And John, again, has had a tenure here as the National Director of Equipment Sales (multiple speakers).

  • So he's very familiar with the equipment business.

  • Larry Marsh - Analyst

  • So if I hear you correctly, David's first priority is to try to accelerate revenue growth?

  • Peter Frechette - Chairman

  • David's first priority -- obviously, he's going to need to assess the business, and so that's going to take him a little time.

  • But the first priority absolutely is to begin to deal with the question of revenue growth.

  • Do you want to add anything to that, Steve?

  • Steve Armstrong - EVP and CFO

  • No.

  • Larry Marsh - Analyst

  • And just to be clear, Ed is still with the company but no longer running it?

  • Peter Frechette - Chairman

  • Correct.

  • Ed is really in a consultant capacity at this point in time.

  • Larry Marsh - Analyst

  • Second question, maybe Steve, if you could elaborate on -- you mentioned changing some of your interest rate assumptions, which reduced your contract gains in the quarter.

  • Could you elaborate on that and what impact that might have had?

  • Steve Armstrong - EVP and CFO

  • I'll try. (multiple speakers) taking up all the time here.

  • Each quarter, as you know from history, we sell off a number of contracts to two different facilities.

  • When we do that, the gain that we calculate off of those contracts, you really have to forecast it out, and you try to use some published curve -- we use a LIBOR curve, a 16-month LIBOR curve to do that.

  • And the mechanical process that you go through is you basically mark your contracts to market every quarter.

  • So, whatever you have sold in the past, you have to re-mark it or mark to market and reprice them.

  • So, you're constantly taking this flow of interest rates and bringing it back to current market rates.

  • And that calculation, the curve that we use took an abnormal -- it kind of flattened out in the first quarter, Larry.

  • And then by the time we got to our second quarter, it sort of normalized again, and the longer end of that curve shifted up.

  • So, we ended up picking up almost a 50 basis point adjustment in the quarter, where in prior quarters we've been seeing more of a 25 basis point change, more in line with what the market (technical difficulty) open market committee has been doing with base rates.

  • So, it's kind of a double whammy in the sense we got hit.

  • Obviously, the portfolio continues to grow until we (indiscernible) the quarter and had a larger impact.

  • Larry Marsh - Analyst

  • Are you quantifying the impact, and would you anticipate this to be recurring or more just this quarter?

  • Steve Armstrong - EVP and CFO

  • Interest rates we have very little to do with here, very little impact on them.

  • So, I can't predict it won't happen again.

  • I would think it would be highly unlikely.

  • But those of you that work in the interest rate markets know these (technical difficulty) doing some goofy things at different points as far as how that curve moves up and down.

  • But we're not expecting it.

  • I wouldn't predict it again.

  • I think it was an isolated situation in this quarter.

  • Larry Marsh - Analyst

  • Okay.

  • Final question.

  • I know Jim last quarter talked about that A-dec 40th anniversary promotion, and I guess you're communicating it hasn't been that successful, perhaps some of their efforts, and also alluded to a financing promotion that you launched this last quarter.

  • Could you elaborate on that and how you feel it's done so far?

  • Peter Frechette - Chairman

  • Maybe what we ought to do here, Larry, is just kind of touch on the total equipment approach, and then talk about the two specifics you raised.

  • Let me back up for a minute, because I think it's important we all understand that our emphasis needs to be on total equipment.

  • Clearly, we had a core equipment shortfall, but we need to emphasize total equipment and we need to increase the emphasis on core equipment, which we simply define as chairs, units and lights.

  • In addition to the items you're talking about, what we're putting in place is a prospective program for our 900 territory reps.

  • Part of that program is fairly simply go back and deal with customers, about what their needs are, etcetera, and work to meet those needs -- put our equipment shortfall in the quarter in perspective for you in a very simple way.

  • If every sales rep had sold one more chair, for example, in the quarter, we wouldn't have had the shortfall.

  • So, we do very well, quite frankly, with big orders.

  • We are really talking about going back with our 900 territory reps, emphasizing customer needs and working through the territory rep.

  • The second piece is we are going to add some additional equipment reps.

  • And I think it is important to probably back up a minute and understand that equipment orders aren't instantaneous in the sense that we don't get an equipment order today and ship it tomorrow kind of thing.

  • And you've heard us say in our guidance that we expect the impact or the increased success with the program to be a little bit further down the road, because customers do not order equipment today and ship it tomorrow.

  • It generally takes three to six months for those orders to flow through to us, so once they're achieved and invoiced into the customer.

  • And with that, Steve, I'll let you talk about the program that Larry raised, and then we will see what other questions we have on the subject.

  • Steve Armstrong - EVP and CFO

  • Let me take the financing program.

  • Larry, you know we've run financing programs almost every year for the last three or four years in conjunction with our year-end equipment program, which has been a staple for this company.

  • We do it every year.

  • Not anything really unique there.

  • We've tweaked it a little bit this year to adjust for current interest rates, but that was the only change really to the financing portion of the program.

  • With regard to the A-dec program, you're correct; that program was not as successful, I don't think, as Patterson or A-dec had hoped it would be.

  • That doesn't mean it didn't have some successes, but it probably wasn't as robust as people intended it.

  • But that's -- you try things and you live with the results.

  • That's about as much as I can say about the program.

  • I think it was -- people felt it was a very successful program, but not as successful as it might have been.

  • Operator

  • Robert Willoughby, Banc of America Securities.

  • Robert Willoughby - Analyst

  • Pete or Steve, you have addressed it somewhat, but can you speak more to the corrective actions specifically that you are doing?

  • It sounds good, but it doesn't sound like anything I'm bringing to the bank here near term.

  • Adding sales reps was one solution.

  • But are you doing things with incentive compensation and the IT systems internally?

  • Peter Frechette - Chairman

  • I think initially what we are really doing is emphasizing territory reps with customers in terms of a prospecting program, Bob, bringing on some additional equipment reps as a part of that process.

  • We've got our year-end program going, which we have traditionally had.

  • So, I'm not sitting here at all telling you that that's a new or different kind of program.

  • But the real emphasis, I think, goes back to first of all ensuring that we sell a lot of equipment we are interested in, continuing to emphasize the total equipment line, but we do have to increase the emphasis on core equipment.

  • And our intention is to do that with the prospecting program and the interface with the customer at the local level.

  • Steve, you want to add anything else to that?

  • Steve Armstrong - EVP and CFO

  • I would just tell you there's no intentions to go and revamp any compensation programs or anything like that that hit the table.

  • You can always tweak them, but that doesn't seem to be the basic issue right now.

  • Robert Willoughby - Analyst

  • From the management information systems standpoint, you have a decentralized structure, I guess.

  • Are you guys getting the data that you need as quickly as you need it?

  • It sounds like this hit you late in the game; maybe you should have known something about it earlier.

  • Peter Frechette - Chairman

  • I think -- we continued to emphasize the high-tech equipment.

  • We're doing very well with that.

  • I think it's fair to say that that probably covered up some send (ph), Bob.

  • Those numbers have now gotten large enough that we don't cover that anymore, and so we need to go back and go after the basic core equipment kind of stuff.

  • But yes, I think we've got all of the information we need relative to revenues, etcetera, to go after this problem.

  • Robert Willoughby - Analyst

  • In terms of the dental consumables, that was a surprising number.

  • What drove the pickup there in sales of those products?

  • Steve Armstrong - EVP and CFO

  • Hard work.

  • Peter Frechette - Chairman

  • Yes.

  • We had the chat with you, I think, three or four quarters ago (multiple speakers) consumable emphasis, etcetera.

  • And I think you're seeing some impact of that, no question about it.

  • So, yes, we are pleased with the consumable dental growth, obviously.

  • Robert Willoughby - Analyst

  • Just a question on the veterinary business.

  • It was a good organic number there.

  • How much of that was kind of pushing out in California?

  • How much was just doing better in existing locations?

  • Can you give us any color, breakdown on that growth maybe?

  • Peter Frechette - Chairman

  • I can't off the top of my head, other than the fact it was a nice organic growth number.

  • Steve, I don't know whether you can regionalize it or not.

  • Steve Armstrong - EVP and CFO

  • We mentioned the Rimadyl.

  • I would just try to put that in perspective.

  • That was not a major part of it, so I don't want anybody to overemphasize Rimadyl.

  • That is an attractive product for us, but it's not driving the bulk of the sales.

  • I can't, Bob -- if you put a salesperson in an existing market versus putting them in a new market, you hope for the same result.

  • So, I'm not sure I can categorize it for you.

  • We don't keep track of it that way.

  • It would strictly be qualitative (indiscernible)

  • Operator

  • Suey Wong, Robert W. Baird.

  • Suey Wong - Analyst

  • I'd just like to talk about basic equipment a bit more.

  • I'm wondering if maybe you guys are a victim of your own success.

  • You've had so many years here of strong equipment numbers, both digital and high-tech, and also basic equipment.

  • But clearly (indiscernible) hasn't been a big plus for basic equipment over the last few years.

  • And what I'm hearing on a grass-roots level is that it may be hard to sell in basic equipment.

  • My core question is if we pulled forward some equipment volumes here.

  • Peter Frechette - Chairman

  • I'm sorry, Suey, I missed part of your question.

  • You broke up a little bit.

  • Suey Wong - Analyst

  • Pete, I'm asking about the basic equipment.

  • I'm just wondering if you guys are the victim of your own success here, because you've had so many years of strong basic equipment numbers.

  • What I'm hearing on a grass-roots level is that it's getting harder to sell in basic equipment, chairs, lights, cabinets, the units, etcetera.

  • So, I'm thinking that equipment volumes have been pulled forward.

  • Peter Frechette - Chairman

  • By pulled forward you're talking about we've taken future sales into current quarters type thing?

  • Suey Wong - Analyst

  • Yes.

  • Peter Frechette - Chairman

  • I don't think we have a sense of that, Suey.

  • I think our sense at this point in time really has been a lack of emphasis as we have kind of focused on the high-tech equipment, which kind of has happened -- the high-tech equipment is going very well.

  • Fairly easy for a territory sales representative to take those orders in lieu of or working on core equipment, which I think probably is currently maybe a more difficult sell now.

  • But I think our opportunity remains strong, and I think it's a matter of going back and increasing the emphasis on the core equipment.

  • And we need to be careful here.

  • You know, to some extent, as a lot of you have heard me say, it's kind of like (indiscernible) in the fireplace; watch one and the other goes out.

  • We need to watch both.

  • And I think our intention is to do that through this increased emphasis program and adding some additional equipment reps.

  • But we don't have a strong sense that the market has gotten tougher, etcetera, etcetera.

  • Steve, I don't know what comments you might want to add.

  • Steve Armstrong - EVP and CFO

  • I think the general feeling in the organization, and reading the tea leaves and various aspects of the market are that the equipment business is still a great opportunity, and Patterson wants to be certain that it gets it share of it.

  • So, yes, it might be a little harder work than it was a year ago or two years ago, but the opportunity is still there to grow the business.

  • And I think management firmly believes that.

  • Suey Wong - Analyst

  • Continuing on with basic equipment, are you seeing anything on the competitive front with regards to changes in pricing, any kind of special competitor programs that are impacting your business?

  • Peter Frechette - Chairman

  • I don't think there are any that I am aware of on a significant basis.

  • Steve?

  • Steve Armstrong - EVP and CFO

  • No.

  • Suey Wong - Analyst

  • One last question.

  • Could you talk about the pricing environment in vet?

  • In the past there's been some pricing pressures, and I just want to get an update there.

  • Steve Armstrong - EVP and CFO

  • I'll jump in.

  • Suey, I don't think they've gone away.

  • They're still there, but margins have eroded a little bit over time.

  • But they're probably -- we're not seeing the erosion that we saw over the last six, eight quarters.

  • It seems to have stabilized, but I think part of that is the way we've addressed it, as well as the fact that the market is -- I'll call the competitive situation a little bit more stable today than it's been over the last year and a half, since there's been some consolidation and some new competitors stepping into the marketplace more aggressively.

  • I'm not sure -- it's not gone away, but I just don't think it's having as much of an impact.

  • Stabilized, I guess, is the word I would use.

  • Operator

  • (OPERATOR INSTRUCTIONS).

  • Susan Lovering, Morningstar.

  • Susan Lovering - Analyst

  • I'd just like to confirm that you mentioned inventory turns are down over last year because of the Accu-Bite acquisition.

  • Was any of that due to buildup of basic equipment products?

  • And overall, what's your outlook on managing inventory going forward?

  • Steve Armstrong - EVP and CFO

  • The answer to that is the biggest portion of that is trying to absorb that Accu-Bite inventory that came in partway through the quarter.

  • That will be pretty much through the system by the end of the third and definitely into the fourth quarter.

  • We had a change in our inventory levels, but not in basic equipment; it was more in the CEREC equipment, because we really had a back-order situation a year ago at this time.

  • So, we've got a better stock of CEREC today, a more comfortable stock of CEREC today.

  • The rest of the inventory levels are pretty stable, so there wasn't any dramatic change one way or the other.

  • Operator

  • Steven Postal, Lehman Brothers.

  • Steven Postal - Analyst

  • You talked about the mix of products in the medical business contributing to the lower gross margin.

  • I'm just wondering if you could elaborate on what type of mix shift (technical difficulty)

  • Peter Frechette - Chairman

  • Essentially it boils down to equipment increasing as a percent of total versus consumables.

  • Fair statement, Steve?

  • Steve Armstrong - EVP and CFO

  • Correct.

  • Peter Frechette - Chairman

  • It's greater equipment sales.

  • Steve Armstrong - EVP and CFO

  • Before you run off and look at that chart we put in the back of the press release and say equipment didn't change, there was a combination of equipment.

  • We put the larger equipment in the equipment line (indiscernible) some smaller equipment that goes in the consumable line, stuff that sells for less than 4 or $500.

  • So, it's a combination of those products.

  • It wasn't substantial, Steven, but it did contribute.

  • And we're just trying to be as forthright as we can here in regard to what happened (multiple speakers) the quarter.

  • Steven Postal - Analyst

  • So fair to say smaller equipment that had gross margins growing faster than the other part of the business?

  • Steve Armstrong - EVP and CFO

  • That's correct.

  • Steven Postal - Analyst

  • And back to the dental equipment area, I know that Sine (ph) I believe earlier in the year disclosed that they're distributing some digital equipment from Serona, obviously non-CEREC.

  • Can you just talk about whether you thought that had any impact on your equipment business?

  • Peter Frechette - Chairman

  • I think our reaction to that is we aren't aware of any direct impact on our business of that.

  • Steve?

  • Steve Armstrong - EVP and CFO

  • I assume you're referring to the digital pans (ph) and so forth, Steven?

  • Steven Postal - Analyst

  • That's right.

  • Steve Armstrong - EVP and CFO

  • You know, I talked to our equipment and marketing -- our sales and marketing people about whether there could be an impact from that.

  • And generally those types of purchases, when you sell them into your customer base where you've got the common relationship, it's not a competitive situation where you have bids going out.

  • So, I don't -- I'm with Pete.

  • I don't think that has -- and our salespeople would tell you that doesn't have a significant impact on our business.

  • Steven Postal - Analyst

  • Fair enough.

  • Capital spending -- Steve, I think you previously said your guidance was 35 million in CapEx in fiscal '06.

  • Is that still a good number to use?

  • Steve Armstrong - EVP and CFO

  • You know, we looked at that and we almost commented on it, but there were so many other things to talk about we didn't.

  • We're probably going to go through that $35 million number this year for two reasons.

  • We had a delay on the overseas building that we're putting in for medical over in the UK, so that moved into this year.

  • And then the Lancaster facility has been accelerated.

  • So, give me until third quarter and I will give you a revision on that.

  • But we're probably at this point looking closer to (technical difficulty) million;

  • I'll push it to 40 million at this point, for the year.

  • Steven Postal - Analyst

  • Anything unusual with LIFO accounting in the quarter?

  • Steve Armstrong - EVP and CFO

  • No.

  • We're watching it very closely, obviously, as we're seeing some price increasing coming through from energy costs and so forth.

  • But we didn't change anything in the quarter.

  • We got a little surprise in the fourth quarter of last year so we're gearing very attentive to what's going on this year with regard to the inflation rates.

  • Steven Postal - Analyst

  • Final question from me.

  • The share repurchase authorization that you have -- care to comment on if you would plan on using some of that, what's on your authorization?

  • Steve Armstrong - EVP and CFO

  • I think I'd go back to my standard answer.

  • We have it available.

  • There's 6 million shares out there.

  • Obviously, the first priority for us is to put our cash back into the business.

  • If we can't do that, we'll try to get it back to the shareholders.

  • And probably we'd do it through some kind of a share repurchase at this particular point.

  • And that's as far as I'm going to comment today.

  • Operator

  • Charles Reed (ph), Credit Suisse First Boston.

  • Charles Reed - Analyst

  • Just a couple of questions, stepping back about the equipment market.

  • Within your customer base, do you guys -- can you give us a sense on maybe what percentage of them currently own a piece of your core equipment products, like shares, cabinets and such like that?

  • And also, what is the general lifecycle on some of these products?

  • What's the replacement cycle?

  • Do they last five years, 10 years?

  • And finally maybe if you can give us a sense on the relative margin contribution.

  • Are these base equipment just -- even though they might be lower price points, but just much higher margins than your CEREC product, like the higher-end digital x-ray CEREC products?

  • And maybe also, in a sense on between your businesses if you can just remind us again where the highest margins are -- I mean, probably obviously with equipment being the highest.

  • Is that higher than rehab and is consumables still higher than that?

  • Peter Frechette - Chairman

  • See what we can do in terms of remembering all of that.

  • I think it's very difficult for us to put a number around how many customers have a piece of equipment purchased from Patterson.

  • I don't know that you can do any better than I can, Steve.

  • Steve Armstrong - EVP and CFO

  • I wouldn't even touch that one.

  • Peter Frechette - Chairman

  • I don't know how we can -- we essentially, if you start out with an assumption that says, well, we have roughly 900 territory reps; just assume that the average territory rep has -- I don't care -- Steve, you want to call it, what, 75 to 100 accounts kind of thing?

  • Steve Armstrong - EVP and CFO

  • Yes.

  • Peter Frechette - Chairman

  • So, we are kind of touching -- and assume they call on those customers, sometimes once a week, sometimes twice a week, sometimes once a month.

  • But on a monthly basis, that's the number of customers we are touching.

  • But to say how many have a piece of equipment would be very tough for us trying to be specific.

  • I think it would probably be correct if we said to you a lot of customers have purchased equipment from Patterson, but I don't know that we can be any more specific than that.

  • Charles Reed - Analyst

  • Fair enough.

  • Maybe if you could just talk about more what is the general lifecycle on some of these products.

  • Peter Frechette - Chairman

  • That's the second piece.

  • If you take basic equipment -- chairs, lights, units -- some customers have basic equipment that's 15 years old.

  • Some customers have basic equipment that's 20 years old.

  • We would tell you that probably the basic turnover, and I don't think it's changed, is somewhere in the area of 10 years.

  • Now, what has happened as a result, and we think we see that kind of what I would call redoing of the office cycle accelerating, because -- and we have said this before -- dentists, first of all, are "busier."

  • The number of dentists per 100,000 is coming down.

  • Second of all, their big problem, quite frankly, in the future is their ability to hire, retain staff.

  • So their interest in equipment is first of all increased productivity, and that I think starts with the interest in high-tech equipment but does go to basic equipment, because productivity goes up with that as well.

  • The second kind of interest the dentist has in terms of beyond increased productivity is the fact that if I have an attractive up-to-date office, I have an easier time attracting staff, etcetera.

  • So there are a number of reasons in our view the dentists would get involved in terms of moving to equipment and accelerating that kind of lifecycle or turnover.

  • The third piece is, I think you asked about was this whole subject of margins.

  • And I think it's fair to say that our equipment margins are less by about 2 to 3 percentage points, Steve, than our consumable dental product margins.

  • And they are less than our high-tech margins.

  • Anything you want to add, Steve?

  • Steve Armstrong - EVP and CFO

  • I would just -- I'll run through the relative contribution here to the margins on the businesses.

  • The medical business generally runs -- would be our highest performing gross margin business at about low 40s to margins.

  • Dental has historically run in the mid 30s, but that is kind of in the low 20s right now.

  • As Pete said, within the dental business, the equipment and the consumables are fairly close, with the equipment being just slightly less than the consumables business.

  • Obviously, as we've talked about many times in the past, our opportunity is always to find those highly-valued services that we can sell to the dentist or the veterinarian or to the rehab practitioner that help to complement that gross margin and keep growing it over time.

  • So it's a mix issue for us.

  • It's a mix opportunity.

  • Obviously, you get into high-tech or software-type products, or educational products; all of those carry a much higher margin than a traditional dental chair or piece of cabinetry.

  • Does that help?

  • Charles Reed - Analyst

  • That was great.

  • Thanks a lot.

  • Operator

  • Sam Harvey (ph), Harvey Investment Company.

  • Sam Harvey

  • My questions have been dealt with.

  • Thank you.

  • Operator

  • Fred Weiss, Atlantic Trust.

  • Fred Weiss - Analyst

  • Could you tell us anything about the acquisition market and the acquisition appetite, in terms of availability in the three different areas you're in or other areas, and sort of valuations?

  • Are you seeing private equity as a competitor or not, or are you seeing interest in private companies selling at this point?

  • Peter Frechette - Chairman

  • I think as we have said in the past we continue to have conversations.

  • I think that the opportunities continue to exist for us.

  • And my view is we are not seeing any increased competition from private equity, but I ought to let Steve chat on that subject as well.

  • Steve Armstrong - EVP and CFO

  • I guess I would characterize that the competition is still the strategic buyer in dental.

  • I don't see an equity player coming into that market today, as consolidated as that has become.

  • We have not seen an equity buyer in that area.

  • Equity buyers -- obviously, Oak Hill was involved in the Butler/Burns transaction, so we could characterize them as an equity buyer, which I would.

  • They were a partial buyer in that merger between Butler and Burns.

  • So, they have come into play in the veterinary marketplace.

  • We know that there's some out there dabbling around in some of the opportunities that might be available to us in the medical arena, but I wouldn't characterize them as a major threat to us, or somehow impinging on the opportunity.

  • Operator

  • Robert Willoughby.

  • Robert Willoughby - Analyst

  • You've answered most of this.

  • Steve, the DSOs well decline, I think, in the fourth quarter by 30 million, I guess, with the contract sales.

  • Was that the correct number?

  • And is there anything unusual about Accu-Bite in that DSO number as well?

  • Steve Armstrong - EVP and CFO

  • Third quarter -- fourth quarter or third quarter, I think you're talking fourth calendar quarter, our third fiscal quarter, we would anticipate some decline just as a result of the sales of contracts, Bob.

  • Now, that can flip-flop back and forth, because if we have -- knock on wood -- we would like to have a nice strong equipment quarter.

  • And depending on when the financing contract gets placed, you can just replace contracts and you don't get a net result.

  • But what we know today would tell us that we should see about a 25 to $30 million decrement in the receivable, adjusting in the contracts.

  • Nothing unusual in the Accu-Bite situation that would somehow embed an unfavorable impact into the DSOs.

  • Robert Willoughby - Analyst

  • Okay.

  • Just a follow-up to an earlier question that was there.

  • Is kind of the focus on the equipment business jump-starting sales on the low-end equipment side of things, is it enough -- is it a drag on management time and attention that maybe the pace of acquisitions does slow down here near-term?

  • Peter Frechette - Chairman

  • In my opinion, there should not be any impact there.

  • The people that would be involved in the equipment emphasis programs would not necessarily be the people that spend time on the acquisition side, in terms of getting those done.

  • So, there should not be any impact.

  • Your comments, Steve?

  • Steve Armstrong - EVP and CFO

  • I would agree.

  • Operator

  • Larry Marsh.

  • Larry Marsh - Analyst

  • Just a couple of quick follow-ups.

  • Steve, I know in the past you've given us some sense of direction of gross margins by division.

  • Are you in a position to do that today?

  • Steve Armstrong - EVP and CFO

  • Gross margins by division -- I think we just kind of went through them in a macro sense, and I wouldn't anticipate -- thinking forward to third quarter, I don't know why we should see any dramatic deviation from those at this point.

  • Larry Marsh - Analyst

  • I know you don't break it out in your Q, but for instance last quarter you said vet was down 70 basis points year-over-year, rehab was down 70 basis points.

  • So are you in a position to give us that kind of specificity?

  • Steve Armstrong - EVP and CFO

  • I can't -- no, I don't think I can.

  • I would just generally tell you, I think as I went through the litany during the prepared remarks year-over-year, each of the operations declined this year for different reasons.

  • Milburn pulled down vet a little bit, mix had an impact on rehabilitation, and then, obviously, the Accu-Bite and contract issue hit the dental margins.

  • So, everybody was down this quarter.

  • That's about as much as I can give you at this point.

  • Larry Marsh - Analyst

  • Second question.

  • Accu-Bite -- I assumed it closed the beginning of September.

  • Is that right?

  • Steve Armstrong - EVP and CFO

  • Right after Labor Day.

  • Correct.

  • Larry Marsh - Analyst

  • The contribution, I guess, if you look at the numbers was about 11.5 million in the quarter, which was a little bit -- a couple million stronger than we would have thought, given (indiscernible) 50 million in annual revenues.

  • Was it just a timing standpoint from the quarter, or would you say it's now tracking a little bit above 50 million?

  • Steve Armstrong - EVP and CFO

  • Pete, you want me to take that?

  • Peter Frechette - Chairman

  • Yes.

  • Steve Armstrong - EVP and CFO

  • I want to be very careful here, Larry, because I hate to discourage anything from happening.

  • Right?

  • But we know that historically when you have a transaction like Accu-Bite, like ProVet, like Thompson Dental, that the disruption in your revenue stream usually happens four to eight months after you close the deal.

  • You have employees making decisions, you have customers making decisions; they don't do these instantaneously.

  • Some do, but most of them kind of linger for a while.

  • We told you that Accu-Bite we thought would do about 50-plus million.

  • I'm sticking to that number.

  • Larry Marsh - Analyst

  • I see.

  • I understand.

  • Finally, just a little bit of clarification on the question Bob asked earlier about chronology.

  • I think you announced that you would be releasing this quarter today on the 11th, and then a week later you give us some sense of some reduction in expectations for the quarter.

  • So I've gotten some questions saying they didn't know it on the 11th.

  • Could you just talk about the chronology and why you wouldn't have just put out the release on the 11th or when you first announced the quarter?

  • Peter Frechette - Chairman

  • Steve?

  • Steve Armstrong - EVP and CFO

  • The answer to that is we have to go through the closing process.

  • We don't know.

  • We have three businesses that we have to close up.

  • We try to get the information out to you as fast as possible.

  • We didn't know until just before Friday of last week that we were going to be in the position we were in with the current quarter.

  • At the same time, we had to then assess where we were going to be for the year and make those decisions in a relatively short period of time.

  • We tried to get the information out as soon as we could.

  • If we misled somebody with the 11th (indiscernible) we apologize.

  • But unfortunately we were not in a position to tell you anything on the 11th.

  • Larry Marsh - Analyst

  • That helps clarify it.

  • Thank you.

  • Operator

  • One additional question from Charles Reed.

  • Charles Reed - Analyst

  • Just had a quick question on the guidance.

  • The initiative you sort of talked about here in the basic dental equipment -- should we assume that your guidance here for the third quarter, as well as for full year, assumes that you're going to start seeing material benefits from these initiatives, or should we think about the strategies you put in place for equipment really affecting fiscal '07?

  • Peter Frechette - Chairman

  • I think what we have said, and then I will let Steve comment, is that we would not expect any impact of these initiatives in the third quarter, but we would begin to expect to see an impact in the fourth quarter.

  • Steve Armstrong - EVP and CFO

  • I believe that is very well said, Pete.

  • It's going to take a while.

  • The other thing I would throw into Pete's qualifier, into Pete's comments -- the reason the third quarter is going to be difficult is that we did have a very robust third quarter last year.

  • So, it's going to be difficult to show growth on top of that quarter.

  • And we anticipated that earlier in the year as well.

  • Operator

  • Management, at this time I will turn the presentation back to you for any closing remarks.

  • Peter Frechette - Chairman

  • Thank you.

  • We appreciate everybody's attendance and continued interest, and we'll look forward to chatting with you at the completion of our third quarter.

  • Thank you very much.

  • Operator

  • Ladies and gentlemen, at this time we will conclude today's conference call.

  • If you would like to listen to the replay of today's presentation, please dial 303-590-3000 with the access code of 11044919.

  • Thank you for participating on today's conference.

  • At this time, you may now disconnect, and please have a pleasant day and a great Thanksgiving.