Patterson Companies Inc (PDCO) 2007 Q1 法說會逐字稿

完整原文

使用警語:中文譯文來源為 Google 翻譯,僅供參考,實際內容請以英文原文為主

  • Operator

  • Welcome to the Patterson Company's earnings first quarter 2007 conference call. [OPERATOR INSTRUCTIONS] As a reminder, this conference is being recorded, Wednesday, August the 24th of 2006.

  • I would like to turn the conference over to James Wiltz, President and Chief Executive Officer, please go ahead, sir.

  • - President, CEO

  • Thank you.

  • Good morning and thanks for participating in our first quarter conference call.

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

  • We will be pleased to take your questions at the conclusion of our remarks.

  • Since Regulation FD prohibits us from providing investors with any earnings guidance unless we release that information simultaneously, we have included financial guidance for the second quarter of FY 2007 in this morning's earnings release.

  • Our guidance is subject to a number of risks and uncertainties that could cause Patterson's actual results to vary from our forecast.

  • These risks and uncertainties are discussed in detail on our annual report on Form 10-K and our other SEC filings and we urge you to review this material.

  • As an editorial note to my comments references to years will be to our fiscal years unless otherwise indicated.

  • Turning now to our first quarter results, consolidated sales rose 10% to 655.5 million.

  • After adjusting for the impact of two acquisitions in our 2006 year, consolidated sales rose approximately 8%.

  • First quarter net income came to 43.3 million or $0.31 per diluted share on a comparable basis to the prior year.

  • This excludes the impact of the new accounting standard on equity compensation that we are required to adopt this quarter.

  • The after-tax impact of the expense from applying this standard on the quarter was approximately $1.7 million or $0.01 per diluted share.

  • We are estimating a similar impact for each of the remaining three quarters of 2007.

  • Now for the next few minutes, I would like to briefly review the performances of our three business units.

  • Patterson Dental, our largest business, reported sales growth of 9% to nearly $473 million in the first quarter, with the September 2005 acquisition of Accu-Bite accounting for approximately 2 percentage points of this sales growth.

  • Patterson Dental benefited from strong sales of consumable dental supplies, which increased 11% or a strong 8% after excluding the impact of Accu-Bite.

  • We believe this consumables growth, which has continued in this range for the past few quarters is a reflection of the robust condition of the North American dental market.

  • With many dental offices prospering, we believe dentists are continuing to invest in their practice, as evidenced by the highly -- excuse me, by our solidly higher first quarter sales growth in basic dental equipment.

  • We remain fully convinced that chair side CAD/CAM technology represents a major part of the future of dental restorative procedures.

  • In fact, dental technology has a very promising future in dentistry, whether it is in x-rays, cameras, or capturing impressions.

  • We also believe that CEREC systems can eventually penetrate upwards of 50% of all general practitioners, compared to the current penetration level of approximately 5%.

  • We are not overly concerned about the lull in CEREC sales over the past few quarters.

  • This is not unusual for technologies that fundamentally alter the way certain basic procedures are performed.

  • However, we are working hard to reinvigorate CEREC sales.

  • All in all, we believe that forces that have been driving our overall equipment business in recent years remain fully intact with dentists investing in equipment that strengthens productivity, offers increased revenue opportunities and provides their offices with a state of the art appearance.

  • Turning now to Webster, sales of our veterinary supply unit increased 17% in the first quarter of 2007 to slightly over 100 million.

  • Excluding the December 2005 acquisition of InterCorp., the developer and marketer of IntraVet, veterinary practice maintenance software, Webster sales rose a strong 16%.

  • Over the past few quarter's, Webster's performance has benefited from the expansion of its geographic footprint through targeted acquisitions and internal start-ups.

  • We are particularly encouraged by Webster's strong progress in the large California market, which represents its most successful greenfield initiative to date.

  • Another factor contributing to Webster's growth is a strategic emphasis on veterinary equipment.

  • Webster has been laying the groundwork for expanding its position in the equipment market for the past few years and as evidenced by Webster's strong equipment sales in recent quarters, this emphasis is starting to pay off.

  • Webster's equipment initiative has been reinforced by the acquisition of the IntraVet software product line.

  • By optimizing the benefits of digital radiography equipment, IntraVet software positioned Webster to offer veterinarians a compelling value-added solution.

  • We expect to start offering this digital solution later this year.

  • Webster's growing equipment business represents another step forward in its adoption of our full-service business model and we believe veterinary equipment represents an excellent long-term opportunity for this unit.

  • As we reported earlier this month, Jeff Webster has resigned as President of Webster veterinary, based on his desire to evaluate his personal priorities and future direction.

  • To ensure a smooth management transition under the new leadership of George Henriques, previously Webster's Chief Information Officer, Jeff has agreed to continue on a consulting basis through the end of April, 2007.

  • Jeff has been an outstanding leader of our veterinary business and we wish him the very best in all his future activities.

  • At the same time, we are fortunate to have an executive of George's experience and capabilities to take over the leadership roll at Webster veterinarian.

  • He is the right person for this key position and we firmly believe George can successfully build on the solid business foundation that Jeff established during his tenure at Webster.

  • And now, a few words about Patterson Medical Unit.

  • Sales at our rehabilitation supply and equipment unit increased 5% in the first quarter to $83 million.

  • After adjusting for the June 2006 acquisition of Dale Professional Surgical Supply Company and a February 2006 divestiture of a small operating division, Patterson medical's first quarter sales rose approximately 6%.

  • We believe this moderate sales rebound could be an early indication of the impact of strategies that Patterson medical's new management team is implementing.

  • Taken as a whole, these strategies are focused on deploying a more extensive value-added business model.

  • The acquisition of Dale is a direct outgrowth of this strategic emphasis.

  • Based on Long Island, Dale is a full-service dealer distributor of rehabilitation equipment and related supplies that became Patterson medical's first branch office.

  • Similar to a Patterson dental branch office, Dale operates with an equipment showroom, a commission sales staff, and a service department that provides equipment installation, repair, and warranty and service for equipment manufacturers.

  • As such, Dale has successfully -- excuse me, as such, Dale has access to premium equipment lines as historically were unavailable to Patterson medical.

  • Given these factors, this acquisition is strategically important because it marks our initial step towards establishing a branch office structure capable of supporting a full-service value added business model.

  • Patterson medical will also open a branch office in Chicago later this year and we expect to open or acquire additional branch offices in 2007.

  • At the same time, Patterson medical plans to start rolling out our Imagine electronic order entry system to its customers late this year or earlier in 2008.

  • This rollout will mark another key step in the process of implementing our value-added model.

  • Turning now to financial guidance contained in this morning's release, we are forecasting earnings of $0.33 to $0.35 per diluted share for the second quarter of FY 2007 ending October 28, 2006.

  • This guidance includes the impact of stock compensation expense of approximately $0.01 per diluted share.

  • Due to uncertainty over CEREC sales, we are reducing our full-year 2007 earnings guidance by $0.03 to a range of $1.58 to $1.61 per diluted share or $1.54 to $1.57 after the estimated impact of stock compensation expense.

  • In closing, we are taking a variety of actions to strengthen our performance and we believe that you will see an improving result over the course of this year.

  • Thank you.

  • Now Steve Armstrong will review some highlights from our first quarter results.

  • - EVP, CFO

  • Thank you, Jim.

  • I'll begin my remarks by discussing our consolidated gross margin, which declined about 80 basis points to 34% from last year's first quarter.

  • There were four primary factors causing the decline.

  • First, in our dental business, there was a mix shift in equipment sales as a result of the lower CEREC sales.

  • Contributing to this impact on margins was the cost of the 2.9% CEREC financing promotion that started in July.

  • The CEREC sales shortfall from our original expectations coupled with its impact on our gross margin were the primary factors for our first quarter earnings coming in at the low end of our previously issued guidance for this period.

  • Second factor contributing to the gross margin decline as a result of the strong performance of our veterinary business, as its growth outpaced the remainder of the business.

  • While the gross margins of this business improved 80 basis points in the first quarter, primarily due to strong sales of equipment and related software, its margin is the lowest of the three operating units and therefore tends to dilute our consolidated margin.

  • Third, the gross margin of our rehabilitation unit declined during the quarter from a combination of product mix change and the business units growth initiatives.

  • Products mix change resulted from a lower international revenue growth, where our margins are higher relative to the domestic business.

  • With regard to the previously discussed growth initiatives, Patterson medical has recently added a number of new sales representatives and in an effort to develop customer relationships, these reps have been given the latitude to discount for a short period of time.

  • Finally, freight costs have negatively impacted each of the business unit's gross margins.

  • We are continuing to challenge all aspects of our business affected by freight to develop strategies to mitigate the rising cost of fuel.

  • Moving down the P&L, our consolidated operating expense ratio was 23.2% for the quarter, up from 23.1 in the year-earlier period.

  • This comparison excludes the 2.1 million pretax impact of stock compensation expense.

  • Earlier in the year, we'd expected it would be difficult to achieve much improvement on our expense leverage due to investments in people and infrastructure.

  • And indeed, that has been the case.

  • We have added over 300 people to the organization since last year at this time, exemplified by the sales force expansion at Patterson medical and the California greenfield effort by Webster veterinary.

  • In addition, we added a new dental branch in the Los Angeles basin during the quarter, the U.K. operation of Patterson medical has moved into its new facility, the new distribution center in eastern Pennsylvania came online, and the new facility for Patterson office supplies was operational for only part of last year's quarter.

  • The opening of the new Mount Joy distribution facility in eastern Pennsylvania alone added approximately $1 million of incremental costs in the quarter.

  • This new distribution center is expected to eventually have a positive impact on our earnings operating leverage since it will become our first facility to fulfill orders for all three of our businesses.

  • Mount Joy replaced a separate nearby dental facility in the early part of June and Patterson medical's distribution facility in Chicago will transition to this site in October.

  • We expect to consolidate a separate veterinary facility into Mount Joy in this year's fourth quarter.

  • On a consolidated basis, our first quarter operating margin declined by 90 basis points, reflecting the combination of gross margin and operating leverage factors I have just discussed.

  • By business unit, our first quarter operating margins were 10.8% for dental, 17.3% for medical, and 5.3% for veterinary.

  • These margins exclude the impact of the adoption of the new compensation standards.

  • A quick review of our balance sheet reveals that as is typical in the first quarter, our accounts receivable balance was reduced by approximately $20 million in comparison to the fiscal year end level.

  • We historically produce higher levels of sales in our third and fourth quarters in comparison to the first quarter of the new fiscal year, which results in an accounts receivable paydown in most years.

  • In comparison to April 2006, inventory increased by approximately $17 million at the end of this year's first quarter.

  • This increase resulted from the initial stocking of our new Mount Joy distribution center, normal seasonal increases in our warehouse inventories to improve service levels, and higher levels of CEREC inventory.

  • Our DSO stands at 46 days, which is comparable with the prior year while inventory turns are down to 7 times versus 7.6 times a year ago as we work through our higher inventory levels.

  • We generated cash flow from operations of approximately $52 million in the first quarter compared to 29 million in the year earlier period.

  • Due to the completion of the capital projects noted earlier, CapEx is expected to decline substantially in fiscal 2007 from the 2006 level.

  • With, that I'll turn it back to the conference operator who will poll you for your questions.

  • Operator

  • Thank you. [OPERATOR INSTRUCTIONS] Derek Leckow, Barrington Research.

  • - Analyst

  • Good morning Jim and Steve.

  • Just a question on the CEREC unit sales and basic equipment sales in dental.

  • I think we've seen a rebound in basic equipment.

  • Do you guys care to break that out, break those pieces out for us so we can see what the results were on a basic versus high-tech equipment basis?

  • - EVP, CFO

  • Derek, I think we gave you that number in Jim's comments or in the press release.

  • I think we said basic was up about 10%.

  • I'll let you work the numbers for the rest of it.

  • - Analyst

  • Make me do the math guess?

  • - EVP, CFO

  • Yes.

  • - Analyst

  • As it relates to the initiatives you put in place, part of that was a sales effort in increasing the sales force, but we didn't see much growth in the sales force in this quarter.

  • Wondered what your plans are for the year for the dental sales force?

  • - President, CEO

  • We still have the same plan that we have every year.

  • We're training about 120 new sales reps a year and as you go from month to month, the amount of adds varies from month to month because sometimes we have a greater attrition rate than we have in other months, but it's still our goal to get 65 to 75 new reps out there each year in the dental business.

  • - Analyst

  • And just on the promotional activity in late June or early July, the 2.9% financing, what have you seen related to the CEREC sales since that went into place?

  • - President, CEO

  • Derek, we've seen some increased sales, but it hasn't offset the discount that's afforded with the financing.

  • - Analyst

  • Okay.

  • And what do you think is happening -- regarding the issue of the new, the, Sirona is going to be having a promotional event in November, do you think that that is pushing sales from this part of the year into November, perhaps?

  • - President, CEO

  • It's in October, Derek.

  • I think it's possible that some people are holding off until that event happens.

  • - Analyst

  • So at this point, you guys have decided to take down the guidance based on the CEREC performance.

  • Do you think that's being a little conservative in light of that?

  • - President, CEO

  • Derek, I don't think so.

  • - Analyst

  • Okay.

  • - President, CEO

  • Not based on what we've seen on CEREC in the last quarters.

  • - Analyst

  • And as far as the margin concerns you have in the quarter or the pressure on the gross profit.

  • Is it possible for you to quantify each of those four factors and when do you see that becoming positive?

  • When do you see a positive comparison occurring in the gross profit line?

  • - President, CEO

  • Do you want me to take that one?

  • - EVP, CFO

  • Yes.

  • - President, CEO

  • With the last part of your question, Derek, I wish our crystal ball was perfect, but we don't know.

  • So I think the answer is, I don't know.

  • CEREC had the biggest impact in the quarter.

  • - Analyst

  • Okay.

  • - President, CEO

  • Medical was probably the second biggest impact on the margin of the factors I discussed.

  • Freight was ubiquitous.

  • It affected everybody and everything.

  • As I made some comments, we're trying to figure out ways to mitigate that throughout the system, everything from the way we work with our vendors to looking at what we can pass on to the customer, if that's appropriate and so forth.

  • Smarter logistics and so on.

  • And the final factor is the dilution of Webster.

  • And to be sarcastic about that I hope that doesn't quit.

  • They're doing very well and that's just a mix issue within the metrics of the business.

  • But that business is doing very, very well right now.

  • I don't want to see that one stop.

  • - Analyst

  • And as far as pricing goes, is there any pricing that you can take in the dental business, especially with the strength you're seeing in consumables?

  • - President, CEO

  • I think we have some pricing opportunities in consumables, Derek, yes.

  • - Analyst

  • Have you raised prices yet this year, or is that still coming up?

  • - President, CEO

  • We have not yet this year.

  • - Analyst

  • Okay.

  • That's it for now.

  • Thanks a lot guys.

  • Appreciate it.

  • - President, CEO

  • You're welcome.

  • Operator

  • Your next question comes from Bob Willoughby, with Banc of America Securities.

  • - Analyst

  • Steve, you ran through the profit by business lines too quick for me.

  • Can you give that to us again?

  • The operating profits.

  • - EVP, CFO

  • Sure, if you can hang just a second.

  • Dental was 10.8, medical was 17.3, veterinary was 5.3.

  • Those are all excluding that compensation expense from 123R.

  • - Analyst

  • Right.

  • And can you speak to -- what certainties do you have in terms of visibility on CEREC?

  • It doesn't sound like your window of certainty there is much greater than ours based on the results.

  • - President, CEO

  • Well, Bob, I think we see some things in the future that are very positive, unfortunately we have got a quarter or two yet to get through before we get there.

  • There is some uncertainty about the next two quarter, based on what we've seen in the last two quarters.

  • We talked a little bit about overpromoting of the product as we've learned here very quickly in the month of July, the promotion that we launched on financing really hasn't helped.

  • It's increased sales some, but it's been offset by the erosion in the margin.

  • - Analyst

  • The reason for a future surprise is an upgrade, or what's the enthusiasm for a couple quarters down the line?

  • - President, CEO

  • Bob, I really can't answer that.

  • It's probably a question you need to ask to the Sirona folks and where they are with some of that future stuff.

  • - Analyst

  • Okay.

  • Lastly.

  • Maybe just -- never been a huge fan of the share repurchase for you guys, but at this point given the cash on the balance sheet, what you're generating here and the stock price, at what point does that make vastly more sense to you?

  • - President, CEO

  • Very soon, Bob.

  • No, it's -- we've got, as I talked about, it's pretty public, and if it's not, I'll talk about it again.

  • We've got a -- what I'll call a retirement benefit issue that we're trying to solve, 2010 our east op basically runs out of allocable shares.

  • If we're going to deploy some cash and do any kind of capital restructuring, we'd certainly like to try to kill two birds with one stone and consider what to do with that retirement plan as part of potentially reseating it.

  • I think you're probably going to see something shortly on that.

  • We've been working with the Board for the last six, nine months to crystallize a plan there.

  • So hopefully we'll have something shortly on that.

  • - Analyst

  • All right.

  • Thank you.

  • Operator

  • Your next question comes from David Veal, Morgan Stanley.

  • - Analyst

  • I'm just wondering, was there a reclassification within the Patterson medical business in terms of the equipment?

  • - President, CEO

  • Yes.

  • David, back in that detailed supplemental we gave you, they went through their product categories and just reclassed some of their equipment, what they consider equipment down there.

  • And tried to perfect that a little bit.

  • We had a change in controllers down at that unit and as that new controller has gotten its feet on the ground, he's tried to be -- look at the classifications to be more similar as to what the rest of the business are classifying as equipment.

  • So I think it was about a 6 or $7 million reclass in last year's numbers to get it more comparable to this year.

  • - Analyst

  • Can you give us a sense for what kind of equipment might have been moved around into that bucket?

  • - President, CEO

  • It sort of varied all over the place by different product categories and different units.

  • I would tell you that, a little bit sheepishly, I'm not sure the prior classifications were thought out all that well.

  • I think it was more of a knee jerk.

  • He's gone through it fairly systemically and tried to get it consistent.

  • - Analyst

  • Okay.

  • - President, CEO

  • We apologize for that but it was the time to get it done.

  • - Analyst

  • Maybe we can circle back offline and get the right year-over-year comps for the go-forward comparisons.

  • One last question, can you -- on the CEREC amortization side, I know it's still a year away, have you given anymore thought as to how you might approach that linearly, accelerated, so forth?

  • - President, CEO

  • Yes.

  • I've given it a lot of thought, David.

  • I'm not sure I'm willing to commit to anything yet.

  • Obviously $100 million is a big nut.

  • We think over time it will prove to be a very smart investment, but I'm going to reserve any more comments on what I'm going to do.

  • I would tell you, I think it's going to be a minimum straightline.

  • We may try to balance it out with the flow of the product, our forecasted flow of the product.

  • - Analyst

  • Great.

  • Appreciate the comments as always.

  • Operator

  • Your next question comes from Jeff Johnson, with Robert Baird.

  • - Analyst

  • Thanks for taking the question, guys.

  • A couple things here.

  • Steve, can you just clarify -- or Jim -- clarify, in the press release, the 10% growth ex-CEREC that is all dental equipment ex-CEREC is up 10%?

  • I just want to make sure I'm reading that correctly.

  • - EVP, CFO

  • That's correct.

  • - Analyst

  • Okay.

  • Fair enough.

  • As far as operating margins on the dental side go, Steve, was there any impact from Accu-Bite there knowing that you closed the facility down, the Accu-Bite facility down recently?

  • Did that help, hurt operating margins on the dental side?

  • - EVP, CFO

  • Two aspects.

  • That telemarketing group was a drain against operations so it tended to be a positive.

  • We're still having some impact from the integration of the field operation, which is not atypical less than a year after the acquisition, but it had a fairly neutral affect, Jeff.

  • It had a minor impact, a negative impact, but it was for all practical purposes neutral so we quit talking about.

  • - Analyst

  • And I know dental op margins tend to be their lowest in the first quarter.

  • Historically that's been true anyway and this quarter could very well prove that same.

  • But the lowest they've been now in a few years here and again most of that just being the CEREC financing, is that how we think about it?

  • - EVP, CFO

  • No, I would say that it's a combination.

  • A lot of it, Jeff, has to do with if you look at the expense structure, we really sort of keep ramping the business up first quarter to fourth quarter.

  • It's just a historical trend.

  • It's almost a saw tooth as far as the expense structure and then we get to first quarter, the expense structure doesn't go away.

  • You can't turn it off like a faucet, but the revenues tend to settle back a little bit so you start to lose some leverage and then you would pick it back up as we go through the year.

  • That's sort of the historical trend.

  • We exacerbated that in the first quarter this year with a lot of the infrastructure investments that we had coming online.

  • As I in my prepared comments talked about Mount Joy, that added almost $1 million incrementally in the quarter.

  • It will dissipate as the business continues to grow, but it hurts in the short-term.

  • Medical expansions are sales force.

  • You bring all those people on, you're not going to get the revenue production immediately.

  • Freight is eating into it.

  • It's a multitude of things, but the expense structure coming with a 300-person change year-over-year, it's difficult to swallow.

  • And that's why we were very cautious on our first quarter guidance.

  • - Analyst

  • Great.

  • That's helpful, Steve.

  • Thank you.

  • Final question for me then.

  • On the Webster side of the business, obviously it has been growing very nicely on an organic basis here the last few quarters.

  • Did any of that impact -- I know most of that is due to the equipment sales taking off and what have you.

  • Any impact from a change in selling relationship on any specific products to a distribution from an agency relationship?

  • - EVP, CFO

  • I think the only one that's impacted in that period is the West Nile virus, went from agency to distribution.

  • - Analyst

  • So that might be having a little bump out of the top?

  • - EVP, CFO

  • A little bit, but it's very slight.

  • - President, CEO

  • I think you probably heard other people talk about that.

  • It doesn't have that much of an impact on us.

  • I tell you what's -- the bigger impacts are what we've talked about Jeff, and that is the development and the execution on the strategies of that business.

  • That's what's driving those revenue-producing results.

  • We were up over 11% in the consumable category.

  • Obviously the greenfield into California has contributed to that.

  • But that's pretty much across the board through the system.

  • I think it's due to a [Expletive] lot of hard work and execution on the Webster side and not a bunch of mechanics from product moving between distribution and agency.

  • - Analyst

  • Great.

  • Appreciate the comments, guys.

  • Operator

  • Your next question comes from Greg Powell, with Alliance Bernstein.

  • - Analyst

  • You've answered most of my questions, I just had one other.

  • On the $100 million deal for CEREC, is there any provision if sales continue to be weak?

  • - EVP, CFO

  • The answer to that, Greg, is yes.

  • I would refer you to, I think Sirona put that document on file.

  • If you want to go read what some of the nuances of the agreement are, feel free.

  • I can't possibly get into them on the phone, there's a number of permutations that can happen.

  • - Analyst

  • Thanks a lot.

  • Operator

  • Your next question comes from Steven Postal, with Lehman Brothers.

  • - Analyst

  • I just wanted to drill down further to CEREC.

  • Can you talk about the possibility that the promotional activity of the potential competitive product has had an impact on sales trends over the past year or so?

  • - President, CEO

  • D4D, are you talking about?

  • - Analyst

  • Yes.

  • - President, CEO

  • No.

  • We think it had an impact a couple of years ago when they first started talking about it.

  • I really don't believe it's currently having an impact, particularly on the customer.

  • It may be having some impact on our sales force.

  • - Analyst

  • Okay.

  • Have you changed anything in the context of your sales force in terms of training or anything else to try and rejuvenate sales of CEREC.

  • - President, CEO

  • Nothing major.

  • Just some nuances to the way we approach the market, but that's been an ongoing thing for the entire time we've been involved with CEREC.

  • There's been nothing materially changed.

  • - Analyst

  • Jim, I know you mentioned -- I think you mentioned in the next couple of the quarters, you expect some uncertainty around CEREC sales.

  • I'm just wondering in the context of the lowered outlook, how much of that is reflected in fiscal 2Q and how much to any extent is that reflected in the second half of your fiscal year?

  • - President, CEO

  • I think we're most concerned about quarters two and three.

  • We feel pretty good about quarter four.

  • - Analyst

  • And last quarter, your comment was that you expected CEREC to grow in fiscal '07.

  • Is it fair to assume that that assumption has changed?

  • - President, CEO

  • It has changed based on what we've seen over the last two quarters and assuming that might continue for quarters two and quarter three.

  • - EVP, CFO

  • The one thing I -- our current estimates, Steven, just to be perfectly clear here, you asked a question I want to be careful of, we do expect growth in CEREC for the year.

  • - President, CEO

  • Yes.

  • - EVP, CFO

  • It's just not as strong as what we had originally projected.

  • - Analyst

  • Okay.

  • Fair enough.

  • - EVP, CFO

  • Based on what Jim has told you.

  • - Analyst

  • Just a couple of questions on the vet business.

  • It looks to me like there's about 20 basis points of operating margin expanse that, and you also mentioned the gross margin expanse.

  • I'm just wondering why shouldn't we expect greater operating leverage from that business?

  • - EVP, CFO

  • Well, because you're making investments out there at the same time Steven.

  • Putting salespeople on, putting technicians in place, you can get the revenue growth, but you don't necessarily get the leverage right off the box.

  • - President, CEO

  • We're adding infrastructure they've never had before, Steven.

  • We're adding equipment sales people, we're adding service technicians that can install service equipment.

  • We've had a drafting department to be able to do veterinary hospital design.

  • - EVP, CFO

  • Doesn't come free.

  • - Analyst

  • Understood.

  • Do you think that as you look toward the second half of the fiscal year, you would begin to see greater operating leverage in that business?

  • - President, CEO

  • A bit, yes, but you've got to remember that we're only doing this in about 20% of their territory right now.

  • So we've got another 80% yet that we need to expand this to.

  • So there's still some investments to be made.

  • - Analyst

  • Okay, then just one final question.

  • Are you able right now to pass along any freight costs to your customer, and to what extent are higher fuel costs impacting expenses?

  • - President, CEO

  • The answer to your question is, can we pass it along to the customer?

  • Yes, we can.

  • Have we?

  • We're considering it.

  • But that, as I said in my other comment with regard to freight, we're exploring a lot of alternatives.

  • We have probably absorbed most of it that we've incurred over the last 15 months, but we can do a lot of things to mitigate that other than just jacking it into the customer's statement.

  • So we're going to explore all of those, Steven.

  • Yes, we may have to pass some of them along to the customer and we will consider that, obviously.

  • - Analyst

  • Okay.

  • Thanks a lot for the comments.

  • Operator

  • [OPERATOR INSTRUCTIONS] Our next question comes from Sally Yanchus, with Trade Winds.

  • - Analyst

  • Hi.

  • Just a bigger picture question on the CEREC business, I think you mentioned earlier in the call that you thought ultimately penetration in the dental practice market in the U.S. of this technology would be about 50% and it's currently at 5 to 10% right now.

  • First of all, is that correct?

  • And second of all, what do you expect to drive that increased penetration and over what time period do you think we'll start to see penetration grow?

  • - President, CEO

  • First of all, the 50% is of general practitioners.

  • - Analyst

  • Okay.

  • - President, CEO

  • I think you need to keep that in mind.

  • That excludes all the specialist, the orthodontists, the oral surgeons, endodontists and so forth.

  • We're currently at 5%, not 5 to 10.

  • I don't see anything major changing.

  • We'll continue to grow that penetration as we have done over the last five years.

  • As Steve said earlier, we will grow the business again this year, it's just going to be less than we had projected.

  • - Analyst

  • But over the last five years, it went from what 0 to 5%?

  • - President, CEO

  • No, it went from 0 to 5% actually over the last 15 years, Sally.

  • - Analyst

  • Okay.

  • How much -- when do we start to see an acceleration in the penetration rate, I guess?

  • - President, CEO

  • Well, I'm not sure how much quicker it's going to accelerate.

  • We don't know the answer to that.

  • - Analyst

  • What are some of the hurdles or barriers to adoption?

  • - President, CEO

  • Well, the biggest problem you have, is you're dramatically changing the way the dentist does the procedure for taking an impression and producing a crown.

  • And any time you have to change the way they do something technically, it's a long sales cycle, a long training cycle.

  • Currently, after we've sold a machine to a dentist, they spend about a half a day working with the machine, just getting used to it and then we have two full days of training, then they go back to their office and start working with it again and then many times after six months, we have another day-long advanced training program for them.

  • - Analyst

  • Have you been able to quantify any increases in productivity or efficiency?

  • - President, CEO

  • Yes, we have.

  • - Analyst

  • Oh--.

  • - EVP, CFO

  • I think, Sally, the quick answer to that is depending upon the individual practitioner, you can easily quantify the payback of this machine at easily less than two years.

  • - Analyst

  • How much does it cost?

  • I'm sorry, I don't know that.

  • - President, CEO

  • About $95,000.

  • - Analyst

  • Okay.

  • All right.

  • Thank you.

  • - President, CEO

  • You're welcome, Sally.

  • Operator

  • Your next question is a follow-up from David Veal.

  • - Analyst

  • One last thing on the CEREC amortization, would that be taxable or not?

  • - President, CEO

  • Well, I hope it's taxable.

  • I can't imagine why the service would treat any other way.

  • It is probably going to be about a 15-year amortization.

  • It will be a timing difference, David, for tax purposes, because it's an intangible.

  • But it will be deductible for tax purposes.

  • - Analyst

  • Okay, sounds great.

  • Thank you.

  • Operator

  • Management, there are no further questions.

  • I'll turn it back to you for any closing comments you may have.

  • - President, CEO

  • Thank you very much.

  • We appreciate all of you participating today.

  • We appreciate your interest in our stock.

  • And thank you and hopefully we'll see you join us for next quarter.

  • Operator

  • Thank you.

  • Ladies and gentlemen, that concludes today's teleconference.

  • If you would like to listen to replay of today's conference, you may dial in at 303-590-3000, and then with access code 11068456 and then followed by the pound sign.

  • Once again, that number is 303-590-3000 with access code 11068456 and then followed by the pound sign.

  • We thank you again and at this time you may disconnect.