Patterson Companies Inc (PDCO) 2011 Q3 法說會逐字稿

Ladies and gentlemen, thank you for standing by.

Welcome to the Patterson Companies third quarter fiscal 2011 earnings conference call.

(Operator Instructions)

This conference is being recorded today, February 24, 2011.

And I would now like to turn the conference over to Scott Anderson, President and CEO.

Please go ahead, sir.

Thank you Douglas.

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

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

At the conclusion of our formal remarks, Steve and I will be pleased to take your questions.

Since regulation FD prohibits us from providing investors with any earnings guidance unless we release that information simultaneously, we have provided financial guidance for fiscal 2011 in our press release earlier this morning.

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

Turning to our third-quarter results.

Patterson's performance was consistent with the news release we issued on February 18 regarding our third-quarter outlook.

Consolidated sales of $824.7 million were up slightly from $820.1 million in last year's third quarter.

Net income of $55.4 million, or $0.40 per diluted share were essentially unchanged and $56 million, or $0.47 per diluted share, in the year-earlier period.

We are disappointed in our third-quarter performance, make no mistake about it.

As we indicated in this morning's release, the cause of the third-quarter sales and earnings shortfall was largely isolated to our dental technology equipment business, where sales of our CEREC and various digital offerings were much softer than planned.

In contrast, dental consumable sales grew 3% during this period, an indication that our underlying dental market is gradually strengthening.

Earlier in the year we made the decision to reduce promotional activities for our CEREC and digital products during the latter half of fiscal 2011.

This decision was based upon our assumption that our market was regaining significant strength to sell our technology offerings without additional incentives.

This assumption proved premature.

As a result, our technology sales fell short of planned levels, causing Patterson Dental's third-quarter sales to decline 3% from the year-earlier level.

And this, in turn, was primarily responsible for Patterson's flat consolidated sales and earnings for this period.

In response, we began to modify certain marketing programs during the quarter, and have revised our technology marketing programs, which we believe will start rebuilding sales momentum for this equipment category in the fourth quarter.

Patterson Dental's sales organization is fully committed to this goal.

Turning now to Patterson Medical.

Sales of our rehabilitation supply and equipment unit increased 22% to $117.9 million in the third quarter.

Although the rehabilitation business acquired in June of this year from DCC Healthcare accounted for the majority of this unit's third-quarter sales growth, we were encouraged by the internal growth of 6% from Patterson Medicals reported for this period.

Internally generated sales of equipment and software were particularly strong, growing 14% from the year-earlier level.

Patterson Medical's overall results for this period were affected somewhat by the weakness in its UK sales, due to budgetary constraints being imposed by the British government on its national health service.

The impact of this situation has lessened, and we believe this will continue to be the case.

But despite the UK austerity moves, Patterson Medical sales continue to grow nicely.

Expenses related to the acquired DCC units also had an impact on Patterson Medical's third-quarter performance, but these expenses are expected to diminish significantly in the fourth quarter as the integration of these businesses proceed on schedule.

In all, we are pleased with Patterson Medical's performance thus far in fiscal 2011 and we believe this unit is well-positioned domestically and internationally as an ongoing growth driver.

Turning to Webster Veterinary, sales of our veterinary unit declined 1% to $149.7 million in the third quarter.

The year-over-year comparability of Webster's sales continued to be affected by previously reported changes in the distribution arrangements for certain pharmaceuticals, which reduced Webster's third-quarter sales growth by an estimated 3 percentage points.

This change-over is expected to have no further material impact on Webster sales going forward.

Even though the third quarter marks the seasonally lowest sales period this year for Webster, we were encouraged by the unit's equipment and software sales during this period, which increased a strong 11%.

In addition, early demand for a number of new combination products in the Flea, Tick and Heartworm category has been strong.

Given these factors, we believe Webster's performance should strengthen in this year's fourth quarter.

Regarding our financial outlook, contained in this morning's release, we have revised our full-year guidance to $1.86, to $1.88 per diluted share from the previously issued guidance of $1.89 to $1.99.

This revision reflects both our third-quarter results and the outlook for the fourth quarter.

Despite the difficulties we encountered in the third quarter, we remain optimistic about Patterson's future.

Our served markets are strengthening and have attractive long-term fundamentals.

Looking ahead to fiscal 2012, we believe the consumable markets for our three businesses will grow by an estimated 1% to 3%.

We anticipate that the equipment portions of the markets could grow in the mid- to upper-single digits.

Within this context, each of our businesses is well-positioned to capitalize upon their market opportunities.

Moreover, we are generating strong operating cash flows providing us with ample resources for supporting our various growth initiatives.

Thank you.

Now Steve Armstrong will review some financial highlights from our third-quarter results.

Steve?

Thank you, Scott.

I'll begin with two housekeeping notes on our sales performance.

On a consolidated basis, acquisitions accounted for 2 percentage points of our revenue growth for the quarter, while currency exchange had a 20 basis point positive impact.

Our consolidated gross margins in the third quarter improved by 40 basis points from the prior year's quarter, as a result of product mix in the dental segment, and the higher relative contribution to our consolidated results from the medical segment.

With a higher percentage of sales from consumables during the quarter, the dental segment improved its product margins by 70 basis points.

Since the medical segment has the highest gross margin of our three segments, medical's 22% sales growth in the fourth quarter had a positive impact on our consolidated gross margin.

Our ratio of consolidated operating expenses in relation to sales increased 60 basis points in the quarter.

The reduced level of dental sales had an adverse impact on this segment expense leverage for the quarter, despite actual expenses being lower than the prior period.

The increased expenses of integrating the recent acquisitions from DCC Healthcare within the medical segment caused its expense ratio to also increase in the quarter.

The expense ratios of these acquisitions are higher than our historical medical operations.

And in addition, included in the current period were approximately $1.1 million of redundancy costs, which will not recur.

We expect that the expense ratios of these acquisitions will approach our norms as we get further into the integration, and will have much less impact on the medical ratio beginning in the fourth quarter.

By segment, our third-quarter operating margins were 13.2% for dental, 10.9% for medical, and 4.1% for veterinary.

In addition to the integration impact of the DCC acquisitions on the medical segment operating margin, the impact of the British government's austerity measures on medical's UK sales contributed about 20 basis points to the decline in that segment's operating margins for the quarter.

During the quarter, the veterinary segment took a non-recurring, non-cash charge of $1.4 million, arising from certain equity transactions at VetSource prior to our investment in this veterinary pharmaceuticals services company.

Since we account for this investment under the equity method, this charge is reported in the Other Income and Expense section of the income statement.

For the current quarter, we had favorable discrete tax items that lowered our tax rate for the quarter.

In addition, we have been able to realize certain net operating loss carry-forwards on our UK tax returns that were acquired in the purchase of the Mobilis entities in 2009.

Overall, our tax rate for fiscal 2011 is estimated to be approximately 36.7%, as the dividends that we paid provide a beneficial tax treatment from the shares held by the company's employee stock ownership plan.

Our DSO stands at 44 days, compared to 45 in the prior year, while inventory turns are at 6.9 compared to 7.2 a year ago.

The DSO excludes the impact of the finance contracts that have been generated during our various finance promotions over the past year or so.

We generated cash from operations of approximately $84 million in the third quarter, compared to $98 million in the year-earlier period.

The cash flow from operations in the third quarter of last year did benefit from a larger sale of promotional finance contracts than did the current quarter.

As a reminder, and as reported in our public filings, early in the third quarter we completed a modification of our funding agreement that we used to provide financing for our customers.

The previous agreement did not meet certain accounting provisions that would have allowed us to report the customer contracts as sold, and remove from our balance sheet when they were transferred to the funding sources.

As a result, at the end of the second quarter we reported approximately $122 million of transferred contracts as a current asset and current liability on our balance sheet.

And the statement of cash flow reported the transfer as a reduction of operating cash flow and an increase in financing cash flow.

With the modifications in place, the $122 million of contracts have been removed from the balance sheet and the proceeds from the sale are included in operating cash flow.

The $84 million of cash flow from operations in the current quarter that I just provided excludes the impact of these accounting machinations.

We are estimating that capital expenditures will total approximately $35 million for the full fiscal year.

The major projects for the year include the new midwestern distribution center build-out, and the replacement facility for the Patterson Technology Center, which should be occupied in early fall.

With that, I'll turn it back to the conference operator, and we'll poll you for your questions, Douglas?

Thank you, sir.

We will now begin the question-and-answer session.

(Operator Instructions)

Our first question is from the line of Larry Marsh with Barclays Capital.

Please go ahead.

Thanks, and good morning.

Hi, guys.

So, let me get you to drill down, Scott, on the promotion conversation.

What a surprise I was going to ask about that.

Earlier in your tenure you had sent a pretty strong message, I thought, that said you wanted to try to communicate to the sales force, to the customer, that you wanted to break the habit of deals especially as the market strengthened.

And you went into the summer with the trade-up program, which ultimately became -- it was reasonably successful.

And I know this fall you had dialed back promotions.

So the message you are sending is you were a little too optimist in that.

So I guess there's two questions.

One is, based on the feedback we're getting from some of the shows, there was still promotional activity in the marketplace.

But maybe help us understand why that was so much less than in the past?

And then I guess the second question along with that is now that you are going back to more heavily promoting the product, how are you going to go back to the sales force and customer of the future to dial back promotions?

Yes, Larry, good question, and I think a good chronology of looking back at how we promoted this technology.

Almost going back two years, I think we made the right strategic decision with the strength we had on our technology product, CEREC, cone beam, Schick, and digital products through the last two years.

But we also wanted to wean ourselves off of some of the more aggressive promotions.

And we've always also been very open that we're always going to promote these products, and there's always going to be some type of incentives.

So, we really planned the year to back off a little bit in the second half and felt good that we were making the right decision, based on the strength of our technology performance in the second quarter and the strengthening of our consumable sales that we were starting to see, and just the anecdotal feedback we were getting from customers that attitudes were changing.

We went into the quarter -- we had a solid November, but really our third quarter is all about December and year-end decisions by the dentists.

Yes.

And, really, I think it was a function of three things -- one, part of what we have articulated about reduced incentives, incremental incentives; two, some confusion, uncertainty by customers over personal tax issues with the Bush tax cuts not getting resolved until mid-December; and then a cautious attitude by our customers, particularly around the higher ticket-price items.

And I think you know our industry feedback from the quarter bears out that while the calendar fourth quarter was okay for the dental industry, it was not a gang-buster.

So going forward to the second part of your question, we still feel there needs to be some stimulus in the market, so we are looking at new ways to promote the products to give them a little boost.

But we feel, and where we have confidence, is the markets are strengthening, and over the next 12 to 18 months we feel we are going to get back to a more normal type of promotional schedule.

But I also look at the promotions that we're able to do, as part of the strength of Patterson.

In essence, I think we grabbed significant share over the last two years because of our promotional activity.

Right.

So is the message, Scott, then the promotions you are going to be providing are going to be a little less focused on the long extended no-cash-pay, no-interest period?

And are we going to see more of the creative promotions such as the free blocks and the training credits?

Exactly.

And we did the no-interest, no-payment, and held our balance sheet up for about a year.

We don't want to go back to those types of programs.

So you are exactly correct on the type of promotions you described.

Right.

And then a second question along with that, maybe, Steve.

I know you are not talking too much about fiscal '12, but sort of the idea that you are going to get mid- to high-single digit equipment growth implies rebound in the marketplace.

And is the implicit assumption associated with that, that you'll be consistent in promotional support next year to this year?

Or, again, do you feel like by the time next year rolls around we'll have enough strength in the market to try to dial back again?

Well, yes.

I think it's important, Larry, to look at the whole portfolio products we sell.

We do see a strengthening, particularly in the chair business, chair unit-like cabinetry.

So we think that is going to have some nice support in the next 12 months.

And then we'll evaluate the promotional activity around our technology products throughout the year and plan accordingly.

We are right in the midst of our planning process for the next fiscal year.

But we'll leave all options open to drive sales.

Okay.

Another follow-up then on -- I just want to make sure I'm clear what you are saying on medical.

Obviously, at Analyst Day, you sent a message you expect to see nice margin expansion in the business as you get leverage in building the platform that's been in place.

Now, we've seen that, but obviously a little bit of a caveat here with funding issues with the UK.

I know it's not a big part of that business.

But as you think about broadening that footprint in the next year or so, is more of that going to be international, and how do we think about funding issues with different markets?

I'll let Steve start in and then I'll follow-up.

I think from the metric perspective, Larry, the numbers should start to improve now that we are deeper into the DCC acquisition.

Each acquisition we do in medical probably has a lesser impact, or a shorter impact, on those metrics.

And we're starting to see that with DCC late in the quarter here.

And you should see it beginning in the fourth quarter.

As far as where the footprint's going to go, I'm going to turn it back to Scott and let him talk about that aspect of it.

Yes, when you look at North America, we feel real good about the investments we've made over the last two to three years and feel we're growing five to six points faster than the market, and it is really going to be an internally generated strategy in North America and also, as always, opportunistic on the acquisition side.

The international opportunities come fast and furious at Dave and his group, so it would really be how we manage those.

But we are very encouraged by the footprint we have, both in our direct business in the UK and France, in our dealer business, and also now having bricks and mortar in Australia.

I think we've got a lot of different growth avenues and profitable growth avenues for that business going forward.

Right.

So it sounds like you are as bullish on the margin opportunities there in the next two years than you were six months ago, notwithstanding some smaller funding issues?

Absolutely.

Okay.

Very good, thanks.

Thanks, Larry.

Our next question comes from the line of Robert Jones with Goldman Sachs.

Please go ahead.

Thanks so much.

Just to go back to the promotional conversation.

Just on the reaction to the promotional pull back, can you maybe share your thoughts on this about the perceived value proposition of these technologies?

In another way, what gives you confidence that this really is just more of an impact from the market backdrop?

Well, I think at the end of the day the decision point is made not on promotions, Robert, but made on the value of the product.

And you look at how we have grown CEREC from 500 users to almost 12,000 today.

That at the end of the day is the real reason why a dentist buys the technology and buys technology.

But sometimes the promotions heat up the deal and gets them to a quicker decision point.

And that's really where -- what we found is effective.

But at the end of the day, you are correct.

The technology purchase is made because of the underlying return on investment of putting that technology in the office.

Makes sense.

And then just to switch over to consumables.

I believe -- correct me if I'm wrong.

You're calling for about a 1% to 2% growth there on dental consumables this year.

It seems like based on your results, and some of your peers, little bit more strength near-term.

Can you maybe just walk us through the thought process of what you are seeing out there in the market today that leads you to this 1% to 2% outlook?

Sure, and we said 1% to 3% for the market.

We feel we are growing a little bit faster than market right now and probably taking some share from some of our smaller competitors.

Some of the good news we are seeing in the sundries business is growth in key restorative categories.

So, some of this pent-up demand we've talked about over the last 18 months, we feel the dentists had an increased yield out of their chair in the calendar fourth quarter.

The beauty of dentistry is it doesn't get better if you put it off.

So that's a key area, and we did see, we feel, through the products we looked at, increased foot traffic in the dental office in the third quarter.

So we think that will be a positive going forward.

As we said, sort of two key indicators are consumer confidence and unemployment.

And as those two improve, that will help strengthen the market.

Appreciate the questions.

Thanks.

Thanks, Robert.

Our next question comes from the line of A.J.

Rice with Susquehanna Financial.

Please go ahead.

Thanks.

First of all, just on the DCC Healthcare comment, a relatively specific question.

Steve, it sounded like you were saying the upside to margin wasn't realized in the quarter that you'd expect, but over the next two quarters or so you should see it.

Can you sort of give us some framework on how much of an impact that would have on the overall margin and medical, holding everything else constant, just getting to that run-rate, is it enough to move the needle for the whole division?

Yes.

If you look at it -- we did the hypothetical -- and you took out DCC from the activities in the third quarter, for instance, you would have seen the margins in the medical business almost flat year-over-year.

So it had a fairly significant drain on the margin in the current quarter.

A lot of that was due to the redundancy, as well as the other incremental expenses as we were integrating those businesses.

Okay.

In the vet business, obviously you called out some of the dynamics that have impacted your quarter results, products going direct and so forth, especially on the drug side.

Can you maybe step back and just give us a little bit of a flavor for what sort of the underlying tone of the business is right now?

Your perspective on growth, maybe looking out over the next year, and whether we'll see that with the economy rebound as you seem to be seeing in the consumable sides on dental?

Yes, A.J.

I think we see the vet market right now very similar to the dental market, that the market has stabilized, and you'll see modest growth as the economy improves in this next year.

And we feel we are well-positioned to grow faster than market with the programs and initiatives Webster has under way.

You seeing any kind of market share shift with the consolidation that occurred over the last year, or is it pretty stable?

Your sense -- maybe comment about that kind of opportunity as well?

I think on the companion animal side, we've seen very little share shift in the last year as the market has consolidated into three large players.

There was a bankruptcy, in terms of PVP, which we really didn't benefit at all from.

So that share probably went to another competitor.

But I think we feel very comfortable in our competitive position in the vet space.

Okay.

All right.

Thanks a lot.

Thanks, A.J.

(Operator instructions)

Our next question comes from the line of Steven Valiquette with UBS.

Please go ahead.

Thanks, good morning.

A couple of questions here.

I guess first on your equipment outlook for fiscal '12, just want to clarify, it wasn't quite crystal clear to me whether that was the Patterson growth or just the market growth outlook?

I just wanted to clarify that.

Yes, Steve, that would be market growth.

Okay, and I guess the other question tied into some of those outlooks.

I mean, you guys obviously have one less week in your fiscal year next year.

So when the official guidance comes out, obviously that will be incorporated in there.

That kind of clarified what you just said on the prior question.

So I guess that covers that.

The other question I had, just in general, is when you guys are looking at acquisitions outside the US -- which obviously in some of your non-dental segments you are active there -- in terms of getting a sense where you stand right now in your appetite for expanding dental distribution outside of North America, are you actively looking at acquisitions?

Or is it something you kind of kick around, but it's not a serious part of the business plan?

Just trying to get a sense of that for just the dental piece?

Thanks.

Yes, Steve.

Our focus has really been predominantly North America.

We do have relationships with distributors around the world, and I'd prefer not to tip our hand as to our acquisition strategy.

But we look at similar metrics in terms of pricing and opportunity for expansion.

There are some unique opportunities that may come down the road from the fact we have infrastructure through our medical group overseas at this time.

But it's something we always evaluate, but I would not say is a top priority at this time.

Okay.

Actually, one other quick follow-up just on the dental equipment.

So, given just what happened in the current fiscal quarter, do you view it as Patterson maybe has some increment pent-up demand over and above the market for the Patterson fiscal '12 equipment view?

Yes, but I think the way I look at it, particularly that this shortfall was isolated to the areas where we feel we have the biggest competitive advantage, and have best-in-class products and partners, that this was not -- and I think the market data from the quarter proves it out -- this was not us losing technology sales to anybody.

So I would agree that this creates more opportunity for us, and that is the message to our sales force that the opportunity in the coming calendar year is tremendous.

Okay, got it.

Okay, thanks.

Thank you, Steve.

Our next question comes from the line of David Leckow with Barrington Research.

Please go ahead.

Hi, it's Derek Leckow.

Good morning.

Hi, Derek.

The pricing and volume trends within the high-tech equipment category is something I don't have a good handle on.

I wonder if you could maybe describe what's been happening with pricing out there.

Because obviously you pulled back on promotions.

But if I look at certain products, it seems to me that prices have risen anywhere in the neighborhood of 5% to 10%.

So I'm wondering if that's also a factor pulling back some demand here?

I wouldn't think so, Derek.

We really look at promotions as functional discounts.

It creates the to-price for the product for the dentist, or the veterinarian, or the rehab specialist.

I look at it as a positive, actually, that the manufacturing community sees the market is going to strengthen, and price increases are a natural part of business and helps our manufacture partners devote money to research and development.

So I would not pinpoint that as a reason for the shortfall in the quarter.

So pricing has been strengthening, and you are seeing that as well across the board in the technology category?

I think what we are seeing as a more normalized pricing environment across all our products.

Okay.

Then, secondarily, looking at the guidance here, we got about a $0.03 to $0.04 shortfall, it looks like in each of these two quarters, in Q3 and Q4.

And the Q4 piece, is that related to startup activities, or is that precisely driven increased spending on these promotions, or is it something else?

I'm trying to gather what the exact impact is on the fourth quarter?

It is probably a little of both, Derek.

But it is mostly going to be the cost of funding those programs, the estimated cost of the programs for the fourth quarter.

Are these start-up related?

Are they going to pay off in several quarters after that?

Or are they going to be isolated, do you think, in the form of price discounting, et cetera ?

I think that will depend on the momentum that the division generates during this fourth quarter.

As Scott said, they'll re-evaluate the effectiveness of each of those promotions, and they'll keep measuring it and trying to find the answer that keeps driving the sales momentum.

Okay.

It was good to hear that we're not going to see the balance sheet get tied up either with those types of promotions, so that was a positive thing, I think.

The other question was on the basic equipment.

Steve, you gave the number of growth, I believe.

I kind dropped off the call for a second there.

What was the basic growth number again?

Well, our light cabinet business was up slightly over prior year.

So the shortfall that gets you to the 10% was all around the technology products.

Okay, good.

The basic backlog, does that give you any better visibility into what's happening with capital spending plans on the part of US dentists?

Yes.

I would say we are more encouraged today than we were a year ago, but there is still always some volatility and uncertainty, even in backlogs.

Okay.

But the planning is still there, the activity's there, and you are seeing relatively flat comparisons with last year.

So it seems to me that the business certainly is getting stronger there, and your backlog, is it bigger than it was last quarter?

Or what can you tell us about the --?

I'll just say, Derek, similar comments that I made in the last quarter was we feel -- and this is one of the things that's very important for our sales force to bring in front of their customers -- is this is an incredible time for a dentist to invest in their practice, and a veterinarian, with the tax benefits that are out there, with a customer base that has really pulled back over the last 24 months.

As we have said before, cost of capital is low.

Real estate negotiations are in the favor of our customers at this point.

So, it is our job to really inspire our customers going forward in this next year.

All right.

Thank you.

I wish you the best of luck.

Thanks, Derek.

Our next question comes from the line of Lisa Gill with JPMorgan.

Please go ahead.

Thanks very much.

Just a couple of quick follow-up questions.

First on the consumable side, can you maybe talk about the competitive environment right now?

I know you talked about the trend in the market being kind of 1% to 3%.

But obviously the quarter was better.

Have things dropped off in the most recent quarter?

Are you seeing -- are you able to take market share from some of the smaller players?

Just want to kind of understand the competitive landscape right now.

Yes.

I think, Lisa, the other thing I didn't mention about our consumables strength is we feel our sales force hiring and training initiatives that we put in place a couple of years ago are starting to bear fruit.

So we feel like we are in a very strong position to grab shares and grow faster than market.

And I think we have competitive advantage to do so.

So all indicators would lead to that we should see incremental improvement quarter-to-quarter going forward in consumables, albeit gradual.

Right, and are you seeing that the dentist volumes are starting to increase as well?

Unemployment trends have gotten a little bit better.

Unemployment trends aren't great, but they do look a little bit better than we've seen over the last few months.

Yes, I would say that our belief is the strength in the last quarter really was not tied to unemployment but tied to the dentists doing more dentistry in key restorative categories, crown and bridge, and really getting that higher yield from the hygiene chair over into their restorative chair.

I believe the growth was more dentistry being done, not so much more patients yet coming through the door.

Okay, great.

And just another follow-up question for Steve.

Factors impacting your margin performance, can you just talk about the gross profit in the quarter?

Up to slightly year-over-year, is that a factor of mix, or something else that we should be thinking about when we think about gross profit going forward?

No, I think it is a combination of things.

But the two I called out earlier were the two primary drivers.

And that was the mix in the dental business.

As the consumables revenues strengthened relative to the other revenue categories, you are going to see margins get a bit better.

And then you've also got the -- I'll call it the mathematical impact of stronger medical performance, which has the highest margin of the three divisions.

So their growth drives more consolidated results.

Okay, great.

Thanks for that.

You bet.

Our next question comes from the line of John Kreger with William Blair.

Please go ahead.

Hi, thanks.

A follow-up question on the dental equipment trends that you have seen recently.

Do you think '12 will be a typical calendar year, in that any recovery that you see would probably come late in the calendar year?

Or do you think this might be different, given that we didn't see the real boost in year-end buying in late 2010?

Yes, I would see, John, incremental strength throughout the year.

I think you'll still see the same percentage of equipment going in certain parts of the calendar.

But, overall, I believe we will see strength in the market throughout the year.

Great.

And, Scott, just so we understand the -- if you look across your portfolio of equipment, what's really the portion that you've given extra promotional support to over the last couple of years?

Is it just the high-tech component?

Most of it's been the -- incremental has been the high-tech, John.

In the more traditional parts of equipment, we have learned from past promotions that if you put too much promotional fire, you really pull sales forward.

And we look at technology different in the fact that we're changing offices from film to digital.

We're taking someone into a new modality like CEREC and CAD/CAM, so we're really adding new users to a market that is not saturated.

So when we look at incremental promotions, we try to put them in markets that aren't saturated yet.

Okay, great.

And then finally, realizing that you haven't given official fiscal '12 guidance yet, but as you look across your businesses, it seems like you are starting to see some improved market growth.

Are you feeling like we are getting back to a point where you can have the more typical margin leverage in your business?

Or should we be thinking about '12 more like '11, with more modest margin improvement?

I think it's a little bit early on to answer that question yet.

A little of both, probably.

But we'll give you the better look in another 90 days, John.

Great, thanks Steve.

Thank you.

Thanks, John.

(Operator instructions)

Our next question is from the line of Jeff Johnson with Robert W.

Baird.

Please go ahead.

Thanks.

Good morning, guys.

Hi ,Jeff.

A couple of follow-up questions here.

Most of my questions have been answered, but, Steve, I guess as I'm looking at fourth quarter guidance, and going back to Derek's question, if the promotional activity picks up some of the equipment performance, we see some recovery there, but EPS guidance still down year-over-year in the fourth quarter, is it fair then to think of maybe a 20 to 30 basis point company-wide operating margin compression in the fourth quarter?

Is that how we get to your guidance?

Hang on a second.

Let me -- you got me into basis points here.

I better look.

Or even just bigger picture, I think operating margin on a year-over-year basis goes down in the fourth quarter given the heavier promotional activity?

Yes, you've got a combination of things going on, Jeff.

You've got the realization that if the promotions aren't effective, maybe the revenues don't go up.

It's going to cost you.

You may have some margin erosion at the gross profit or the product level, and there is going to be some costs to getting these products out.

So, yes, if you look year-over-year, you are probably going to see, and the expectation would be to get what we want in the fourth quarter, or what we are expecting, it's probably going to cause us to see some margin erosion.

If we are extremely successful and Scott gets out the bull whip and the guys are lashed accordingly, it could result in a very good fourth quarter.

But at this point, based on the tea leaves, we have to be a bit more cautious.

Yes.

No, that makes sense, Steve.

I guess that is the main question I had there.

But on dental, one other clarifying question.

I think you had mentioned earlier that there was a 50 basis-point tailwind from currency on the dental consumables number, and that was the Canada impact there.

Was that any acquisition component in dental this quarter at all?

No.

No.

So the 3% number was a 2.5% constant currency number, and that's kind of your organic consumables number as well?

Correct.

Yes.

Okay.

And then as I step back and just look at the CEREC business -- last question here from me.

You had two and a half months of promotional activity really in place in November/December.

And then I think you started them up again in late January.

It seems like you are indicating maybe that business was down year-over-year.

Was that a new user down year-over-year?

I think, Steve, you had mentioned at one point that sequentially CEREC new users were up in the quarter.

But what were they -- what did they do on a year-over-year basis?

On the year-over-year they were down in the quarter.

They were up sequentially from the second quarter but down year-over-year, Jeff.

Okay, Scott.

And I guess as I think about that CEREC business, you've obviously got the 12,000 users now.

If you take out major upgrade programs -- AC, MCSL from a few years ago, things like that -- what do you need new users to grow on an annual basis?

You have got some recurring revenue that comes on the consumables side, or on the block side, plus the programs each year to -- the upkeep programs and all that, on CEREC.

Do you need new users to grow each year to keep your CEREC revenues growing?

Or do you have enough recurring revenues in that business that you don't need that new user base growing each year?

I think we really look at growing those new users each year.

And I think, as a reminder, the CAD/CAM CEREC story, I think, is still in the maybe third inning of the baseball game.

And we have great belief and great excitement over what can happen in this next decade as Sirona continues to evolve their product as the market leader, and so many factors point toward this next generation of dentists practicing dentistry in a different way.

So our focus in terms of growing the CEREC business, number one priority is to grow new users.

Upgrades are great.

We love them.

But strategically, that new user is very important to us.

All right, great.

That's all I've got.

Thanks guys.

Thanks, Jeff.

Our next question comes from the line of Karl Poehls with Fiduciary Management.

Please go ahead.

Hi, guys.

Hi, Karl.

Scott, in the past we have talked about the concept of under-promising and over-delivering, and it had been the opposite, I think, in the '08/'09 fiscal years, and then we saw a good result last fiscal year, but now again we have a tough equipment quarter.

I think if we look back to a year ago, there was a fair amount of optimism projected for dental equipment in fiscal '11.

Could you maybe just talk about if there is any lessons learned here in dealing with this issue of -- may seem like a minor issue, but I think it's a psychology thing, and if you can get into the habit of under-promising and over-delivering, I think that would actually help the stock perform better.

So any comments there?

Yes, thanks, Carl.

Obviously, as I said before, we are not pleased with the third quarter performance around technology.

But at the same time, and this is very important to manage both investor expectations and the expectations of our customers and our employees, is we look at the technology side of our dental business as one of our greatest opportunities.

So this time we didn't live up to our expectations.

But I will tell you that our shareholders will be served better long-term by high expectations in that part of our business.

Thanks.

There are no further questions in queue at this time.

I would turn the call back over to Management for closing remarks.

Thanks, Douglas.

We appreciate your questions and your time today on the call and look forward to updating you on the Company's progress at the end of our fourth quarter.

Thank you.

Ladies and gentlemen, that does conclude our conference for today.

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