Patterson Companies Inc (PDCO) 2011 Q4 法說會逐字稿

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

During today's presentation all participants will be in a listen-only mode.

Following the presentation the conference will be open for questions.

(Operator Instructions).

Today's conference is being recorded, May 26, 2011.

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

Please go ahead.

Thanks, Alicia.

Good morning and thanks for participating in our fourth-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 provided financial guidance for fiscal 2012 in our press release earlier this morning.

This 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 in our annual report on Form 10-K and our other SEC filings and we urge you to review this material.

Turning to our fourth-quarter results, we ended fiscal 2011 on a strong note due to solid performances in each of our businesses.

Consolidated sales of $883.8 million were up 9% from $812.8 million in last year's fourth quarter.

Net income came in at $62.7 million or $0.53 per diluted share compared to $61.8 million or $0.52 per diluted share in the year earlier period.

Now for the next few minutes I will provide some operational highlights of our three businesses.

Sales at Patterson Dental Supply Rose 5% in the fourth quarter to $573.1 million.

We believe the fundamentals of the North American dental market are continuing to strengthen as evidenced by our 3% consumable sales growth that we posted for the quarter.

Our consumable business has been strengthening in recent quarters and we view this as a leading indicator of the overall dental market.

As a result of improving market fundamentals we believe dentists are gradually becoming more confident about investing in their practices.

In addition, we instituted additional marketing programs at the beginning of the quarter.

These factors helped generate an 11% sales growth of total equipment and software that we registered in the fourth quarter.

Within this overall product category, sales of new technology equipment, including CEREC dental restorative systems and digital radiography products posted mid-teens growth, while sales of basic dental equipment recorded single-digit growth.

All in all we believe we are building sales momentum in our dental equipment business and are forecasting equipment sales growth in the high-single-digits for fiscal 2012.

However, it does bear mentioning that our equipment sales may experience quarterly fluctuations as they have historically, given the sales cycle related to these capital expenditures and the potential impact of prevailing economic conditions.

Turning now to Patterson Medical, sales of our rehabilitation supply and equipment units increased 22% to $126.8 million in the fourth quarter.

Although the rehabilitation business acquired in June 2010 from DCC Healthcare accounted for the majority of the unit sales growth, we were encouraged by Patterson Medical's internal growth of 3%.

Internally generated sales attained planned levels and benefited from solid demand for the unit's industry-leading range of consumable supplies.

Patterson Medical's overall results for this period continue to be affected somewhat by budgetary constraints imposed by the British government on healthcare expenditures, but the impact of this situation is lessening.

Despite these austerity moves, Patterson Medical's UK-based Homecraft operation continued to grow during the fourth quarter as the unit's export business and the contribution from the DCC acquisitions resulted in Homecraft sales growth of 116%.

Expenses related to the acquired DCC units also had an impact on Patterson Medical's results.

But these expenses should continue to diminish going forward as a percentage of revenue as the integration of these businesses proceeds on schedule.

Patterson Medical's management team, especially the staff at the Homecraft unit, had a demanding year as they integrated an operation almost equal in size to their own, coped with an extremely difficult local market and transitioned the top management of the unit.

We are encouraged by Patterson Medical's fiscal 2011 performance and believe this unit is well-positioned domestically and internationally as an ongoing growth driver.

Turning to Webster Veterinary, sales of our veterinary unit increased 14% in the fourth quarter to $183.9 million.

Webster's fourth-quarter sales growth benefited from strong demand for new combination products in the flea, tick and heartworm category which helped fuel a 12% increase in sales of consumable supplies.

In addition, Webster posted continued strong sales of veterinary equipment and software which rose 41% from last year's fourth quarter.

Webster's equipment business has been growing at solid rates in recent quarters and we intend to continue investing in this relatively new portion of Webster's operation that has expanded the unit's full service platform.

Regarding our financial outlook contained in this morning's release, we issued guidance of $1.90 to $2 dollars per diluted share for fiscal 2012.

This guidance includes the impact of an increased non-cash expense related to the employee stock ownership plan which will affect earnings by an estimated $0.12 per share beginning in fiscal 2012.

Steve will provide more detail on this item in his remarks.

In addition, fiscal 2012 will be a 52-week sales year compared to the 53-week year in fiscal 2011 due to Patterson's 52/53-week fiscal year convention.

We are optimistic about Patterson's near- and long-term prospects.

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

Our businesses are positioned to capitalize upon their market opportunities and we are generating strong operating cash flows providing us with ample resources for supporting growth initiatives at our three units and programs aimed at further enhancing shareholder value.

As previously reported, Patterson's Board of Directors increased our quarterly dividend from $0.10 to $0.12 per share in March.

At the same time our Board also replaced an existing share repurchase program with a new 25 million share five-year buyback authorization.

Using internally generated cash we repurchased approximately 1.9 million shares in the fourth quarter under this new authorization.

For the year 3.3 million shares were repurchased returning almost $100 million to our shareholders.

When you add this amount to our dividend we returned approximately $149 million to shareholders in fiscal 2011.

Thank you.

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

Thank you, Scott.

My comments will begin with an overview of our operating margin change that we experienced in the quarter.

Our operating margin declined by 50 basis points in the quarter (technical difficulty) were subsequently revised.

Our ESOP was grandfathered in under the old standards which allowed us to continue accounting for the plan based on the original, or in this case the 1990 cost of the shares to the ESOP.

Our grandfathering under the old accounting standards has now ended and starting in fiscal 2012 expense from the ESOP will be based on the current market value of the shares allocated to the employees each year.

Our earnings guidance includes our best estimate of the expense for a competitive contribution to the ESOP in fiscal 2012.

The estimated expense will increase our operating expenses by approximately $23 million and will reduce our earnings by an estimated $0.12 per share in fiscal 2012.

I want to emphasize this is a non-cash expense.

Obviously this change creates a comparability discrepancy between our past and future accounting performance, but it does not alter Patterson's underlying cash generation ability.

As I said at the outset, the fundamentals of our business remain fully intact despite this non-cash accounting issue.

One other item of note regarding comparability, as Scott noted, fiscal 2012 will be a 52-week year versus our just completed year that had 53 selling weeks.

This means there will be less opportunity to expand our operating expense leverage in fiscal 2012, particularly on fixed cost on a comparable basis.

The combination of the increased ESOP expense and the reduction in selling days will adversely impact our earnings per share by approximately $0.14 to $0.16 during the coming year.

Moving on, our fiscal 2011 tax expense benefited from a full year of dividends paid on the shares held by our employee stock ownership plan.

This portion of the dividend is deductible on our income tax return and accounts for the majority of the difference in the tax rates between fiscal 2010 and the current year.

As we look to fiscal 2012 we expect a tax rate consistent with that for 2011 which would be in the mid to high 36% range.

Looking now at our cash flow, we generated approximately $71 million from operations in the fourth quarter compared to $112 million in the prior year.

As you may recall, our cash flow in last year's fourth quarter benefited from a large sale of finance contracts that had accumulated from promotional activities in earlier periods.

These contracts were not available for sale before then due to restrictions in our arrangements with our funding sources.

A couple quick notes on our balance sheet.

Our DSOs stood at 46 or slightly higher than the year ago 44 which excludes the finance contracts just discussed.

Our inventory turns declined to 6.9 from 7.1 one year ago.

Again looking ahead to fiscal 2012, we expect our CapEx to be approximately $30 million while depreciation and amortization will be in the vicinity of $45 million.

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

Alicia?

(Operator Instructions).

Robert Jones, Goldman Sachs.

Thanks, guys, thanks for the questions.

So clearly it looks like in the quarter that promotional activities around equipment paid off, mid-teen sales growth in the new technology segment.

I imagine these promotions weighed on profitability a little bit.

I guess could you talk a little bit when you expect this to normalize and if you can give us a sense of the sustainability of the equipment growth kind of ex-promotions?

Sure, Robert.

I think we were very encouraged by the quarter across the board in equipment, particularly in the growth in our core equipment category, sort of the basic equipment where we really had no incremental promotions.

So sort of back to my opening remarks about the sundries growth being a leading indicator and the confidence of the dentists growing.

We certainly feel that is happening.

And then on the technology side it was really I think strong execution by our dental team in terms of bringing out some new promotions and unique promotions, but really cranking up the activity in terms of getting in front of our customer in both the CEREC front and the digital front.

In terms of sustainability, as we said, we'll always promote these new technology products that are really sort of changing the face of dentistry and we'll assess in terms of how lucrative those promotions are with our partner on that side.

There are many things that drive sales growth on the technology side and one of the biggest ones is really product innovation and we're very excited about the new product innovations that we'll see here in the coming year.

That's helpful.

And I guess, Scott, just to follow up on the consumable side in dental.

Could you talk a little bit about price inflation and has that come back into the market?

If I think about that 3% you saw in the quarter, I guess how much of that was just purely volume related?

I would say most of it's volume related.

I think as the markets stabilize you'll start seeing some price tailwinds in the coming year.

But I would attribute most of the growth in the quarter to volumes.

That's great.

And then, Steve, just a housekeeping on the ESOP charge.

Is that complete -- I'm sorry if I missed this.

Is that completely incremental?

And if not I guess what was that historically?

Thanks.

No -- well, the $23 million that we talked about is all incremental, it's brand-new obviously the way it was disclosed.

We had ESOP expense in the past, but it was based off the original cost of those shares that were acquired back in 1990.

What this change does is we really move now to more current value accounting which has been the norm in the accounting standards for the last decade or so with regard to stock issued to employees.

Okay, thanks for all the details.

Thanks, Robert.

Lisa Gill, JPMorgan.

Thanks very much and good morning.

Can you maybe just help us to understand, Scott, on the equipment side visibility?

Do you have a pipeline, do you have a backlog number?

I mean, if we think back to February and talking about expectations around the number and then we see how strong it came in in the quarter, can you just help us to understand the visibility around that?

And then just secondly, obviously that was much stronger than we also anticipated.

Can you maybe just give us an update on what your thoughts are around that market and competition, etc.?

In terms of visibility, the equipment visibility has always been one of the most challenging parts of our business because of volatility around time it takes between sale and installation and also decision-making time.

We do feel more confident about our pipeline today than we did a year ago for sure.

On the high-technology side, the CEREC and digital x-ray, usually the decision-making process sometimes gets a little shorter which leads to some more volatility and obviously some upside surprises and, like we had in the third quarter, downside surprise.

But I would say anecdotally, and it goes to my comments in the third quarter where we felt the equipment market was going to grow mid- to high-single-digits in the coming fiscal year.

We probably think the market right now is poised to grow mid-single-digits and we feel with the portfolio of products we have we can outpace that for high-single-digits and, as the economy continues to strengthen, potentially some upside to that.

On the vet side, the Webster group did I think a fantastic job of introducing a new product in the marketplace and grabbed the lion's share of that new product introduction.

It's a market that on the consumable side, and we mentioned this in the third quarter as well, we feel the market will probably grow in the 1% to 3% similar to the dental side, but it's also a market just like dentistry that we think has some momentum starting to build in it.

And historically, with the flea and tick product that you were talking about, historically haven't flea and tick been more on a consignment basis than on a straight sales basis?

Has that changed in the market?

Lisa, you're correct.

Some of those products historically have been under what we refer to as agency agreements where we record a commission off of the transaction.

The two new products and the larger of the two, Trifexis from Elanco, had a significant impact in the quarter, a positive product introduction.

The second product Assurity, also from Elanco, a lesser impact, but those were -- basically our arrangement with Elanco has been on buy/sale.

If you remember a couple years ago we began distributing the Comfortis product for them and so those are buy/sale versus some of the more traditional pharmaceutical arrangements which for those key products which have been under the agency.

Okay, great.

And then just a quick follow-up for you, Steve.

The $0.14 to $0.16 -- you were giving out so many comments there, I was trying to write quickly.

The $0.14 to $0.16, were you saying that that, if we were to have the extra week, if it was a 53-week year there was an incremental $0.14 to $0.16 of margin opportunity?

I guess I just didn't quite understand what --?

Okay, what I was trying to relay there is to try to give you a comparable number if you're looking at 2011 and 2012.

The impact of the ESOP expense and the fact that we've got one less selling week will accumulate to about $0.14 to $0.16 of adverse impact for us.

Oh, okay, so ESOP is $0.12 of it and then another potentially $0.02 to $0.04 would be the impact of the difference between a 52- and 53-week year?

That's correct.

Okay, perfect.

Thank you very much for the clarification.

You're welcome.

(Operator Instructions).

Steven Valiquette, UBS.

Hi, thanks.

On CEREC were there any special promotions in fiscal 4Q that will be different in the rest of calendar '11?

Just trying to get a sense for that.

In the quarter we just completed?

Yes.

Yes, we changed some of the promotions away from financing to a rebate program.

So there really wasn't much of an incremental cost impact to us.

And then we had some very focused programs in terms of some incentives for our salespeople.

So I would give credit to the quarter more to sales execution and activity than any real whiz-bang promotion we did.

Okay.

But as far as a game plan for the rest of calendar '11, any insights you can share on just around additional CEREC promotional activity you're planning on for the rest of the calendar year?

Sure, we launched a trade-up program, Steve, at the beginning of our fiscal year.

One of the exciting developments from Sirona was the launch of the 4.0 software upgrade at the Cologne meeting in Germany.

That will hit the United States this fall and it's probably the biggest software breakthrough for Sirona since we went from 3 to 3-D.

So we'll be upgrading machines so they can utilize this new software package and then we'll be installing the new software with our user base this fall.

And we think the trade-up activity will be a real focus over the summer time and then a very exciting time in the fall as our customer base implements this new software and we'll have promotions that we won't announce today obviously in the fall to drive sales through calendar -- calendar 2011.

Okay, got it.

Thanks.

Brian Delaney, EnTrust.

Thanks for taking my call.

Do you guys have any quick comments on what you think Align's acquisition of Cadent does to the landscape for 3-D technology?

Thanks.

Sure.

Probably no comments here.

We've got a great partner with Sirona and a fantastic franchise in CEREC.

Sirona has responded well to competition at every turn and the modalities of CEREC continue to expand from digital impressioning in chair-side CAD/CAM and integration with Cone Beam and galileos.

So we probably won't comment on the Align marriage with Cadent other than we welcome good competition in the marketplace.

John Krieger, William Blair.

Great, thanks.

Just a follow-up question to sort of your promotional strategy within dental.

Are you promoting anything now beyond CEREC as you move into fiscal '12?

Absolutely, John.

And sometimes we get too focused on the promotional aspects, but there will be marketing programs, as there always are and always have been, around the equipment side.

We think one of the great opportunities in the coming fiscal year is particularly around the pent-up demand on the equipment side of the business.

And we will be very active with our sales force and through our marketing to make sure we gain the lion's share of that opportunity.

Great.

And, Scott, do you think you can do that in a margin neutral way or do you have to just sort of accept some -- perhaps some margin give up to maintain the strong momentum that you've now got?

No, we would look, John, for margin expansion.

We believe we can do it in a way where we're not going to degrade the metrics of the dental business.

Great, thanks.

And that's a good segue to the next question.

As we think about your guidance for '12, it seems like if we normalize for the two unusual factors, it seems like the underlying earnings growth is maybe 10% give or take.

If you agree with that math, how much of that would you say is top-line driven versus perhaps some margin leverage in the business with a better market tone?

Oh, you through that one to me.

I think it's a combination, John, as it always is.

We're looking for some expansion in our product margins and we're looking for some expansion in our operating leverage.

Obviously the operating leverage expansion is not going to be as extensive as it might have otherwise been, but on an equivalent basis with the revenue growth that we anticipate, it's probably right in line with what our model is.

Okay, so just to ask that another way, have the markets now strengthened enough that you think you're back to that core goal of 30, 40, 50 basis points of operating margin leverage?

Go ahead, Scott.

Well, I don't think we're at 50, but we're definitely on the road to 20 and building on that if the markets would strengthen more than we forecast in the next 12 months.

But we definitely are on the path back to historical operating metrics over the next two to three years, we believe.

Great.

Great, thanks.

And then just a final question.

Your view of the dental consumable market.

Where do you think it stands right now in terms of underlying growth?

And do you think that's better traffic at this point or maybe a mix, positive mix towards some of the higher cost procedures?

Yes, I think the sundries strength is a combination and a rebound in restorative procedures, crown and bridge and endo.

And obviously it's not a big leap because we're still in low-single-digits growth.

And from our perspective, we think we're beating the market by a little bit due to sales force expansion and increased productivity from our sales force.

So the theory we had talked about over the last 24 months about deferral of dental care, we think that is playing out where the dentists are starting to harvest some of those procedures that have been put off during the recession.

Great.

Thanks very much.

Thanks, John.

Jeff Johnson, Robert W.

Baird.

Thank you.

Scott, Steve, good morning.

Steve, I guess, could I just start with you just to clarify a question on the dental consumables side.

How much of that was FX?

And I'm assuming there was no acquisition in there.

So just kind of trying to get at a consumables organic growth rate in North America for the quarter.

It was about half a percent of FX in there, Jeff.

Okay, thank you.

That helps.

And then, Scott, on the equipment side, going back to Lisa's question I guess on visibility.

I think where I sit today, just struggling somewhat to try to figure out my model over the next few quarters.

As I think about the promotions you had in place in fiscal fourth quarter and it seems like a couple of those promotions have come off.

So do I assume maybe that comes at a little expense to the top-line but that helps margin, and then every quarter do I need to go out there and figure out what promotions are being run and then dial it into revenue and offset at margin?

It just seems like visibility is getting pretty tough here, volatility has picked up on the equipment side over the last call at four to eight quarters for you guys.

How should we reconcile all of that and what would be your advice to how to think about maybe a quarterly gating of equipment relative to an annualized number?

That's a big question, Jeff.

I would say a part of our volatility has been on the upside obviously as we've outperformed the market, particularly on the technology side of the business.

And in terms of promotions, it's something we evaluate at all times with our partner at Sirona in terms of CEREC.

But we -- the CEREC story to me is more about innovation than promotion and we're very excited about the continuing momentum of the galileos CEREC integration, the launch of the new software which we think will bring a lot of activity to the marketplace, and then the increasing confidence of the dentists.

So all the factors for hitting that high-single-digit growth number on the equipment side I think are coming into place.

On the equipment side, the core equipment, the chair unit light business, we do know that the activity rate has definitely picked up in terms of customers dusting off old projects, looking at expansion.

And we anticipate to see continued momentum building in that business over the next 12 months.

All right, that's helpful.

And on the vet business, I guess a question there.

You guys put up obviously very good consumables growth there in of Elanco products helping and Schein put up admirable 7.5% organic growth in their vet business this quarter, MWI continues to put up good numbers.

The market itself doesn't seem to have accelerated a whole lot, but now the three biggest distributors are putting up very good calendar Q1 numbers.

Is it these multi-products, whether it's the Elanco products or the Bayer multi or some of these -- are some of these multi-products kind of pulling business out of the OTC channel back to the vet office channel?

Or how should we think about what's going on with the three biggest distributors and the strengthening of numbers we're seeing across the board in that channel?

Yes, I don't think it's pulling out of the OTC, I think part of it is the vets stocking up on these new products.

Just like our other businesses, we love companies that innovate and feel that innovation leads to more stickiness between the pet owner and the vet.

And I think the value added proposition that Webster is really driving out there is gaining momentum.

I was just at their national sales meeting last week in Denver and I think when you look at what we're trying to do on the equipment and service side and really be a business partner to the veterinarian, I think that leads to momentum in that side of the business.

All right.

And last question, Steve, for you just on the ESOP and off-line I'll probably want to follow up with you on the accounting there.

But as we think about over the next few years, presuming -- as your stock presumably goes up, will be an expense then go down because you purchased these shares in 2006 or is the current market share price -- I'm just trying to think does this ESOP expense, the $23 million that you talked about for fiscal '12, probably have an upward bias or a downward bias to it over the next three to five years?

I think you've really got to go to the core of the business, Jeff -- what happens to the business over that same period of time.

Because this is going to be fairly well tied expense wise to the growth in underlying payroll cost.

So we're really moving from an old cost basis expense to a current value accounting, but that's pretty much going to be tied to whatever the payroll numbers are for the business, that's how we'll try to manage it.

There is some volatility because it is a mark to market type situation, but it will be more dependent -- the growth of that expense will be more dependent on the growth in the underlying payroll than it will be due to market changes in the stock price.

So as more benefits are earned, if I want to put it that way, then the expense goes up because this is somewhat of a benefit expense?

Is that how to think about it?

Well, I think about it, if you -- I think the easiest way to think about it is if we had a traditional 401(k) plan and were doing a match on the 401(k), it's a percentage of payroll and that's how we're going to target and manage it.

Okay, yes, that makes sense.

Thanks, guys.

Thanks, Jeff.

(Operator Instructions).

Ross Taylor, C.L.

King.

I have two questions.

First one is based on some of your commentary, it sounds like you were able to get a pretty large percentage of the Trifexis sales compared to some of your competitors.

And I just wondered if there was any particular reason for that besides just good execution and focus on your part?

Yes, I would not retract my statement, but I would say we don't know the exact percentage of our share other than that we performed very well, so that's more anecdotal than hard facts.

Okay, that's helpful.

And second question is -- maybe this is just a lack of understanding on my part.

But I was curious as to how the software upgrade program for CEREC works.

My understanding had been, and again, perhaps I'm wrong here, that if an owner was a member of the service club the software upgrades were essentially at no cost.

And I just wondered if you could explain to me how that's going to work with the new 4.0?

Yes, that is true.

Our service club members for CEREC, the CEREC Club members get it at no cost.

The upgrade program I talked about, Ross, was upgrading the hardware over the summer time.

I see.

And then where we're excited for the software upgrade, particularly with our customer base, is just the fact that the 4.0 software really is going to increase work flow and proficiency ability of our customers.

And when the CEREC users get excited they tell their colleagues about it and we benefit.

Okay, that's very helpful.

Thanks very much.

Thank you.

Thank you.

I show no further questions in the queue at this time.

I'd like to turn the conference back to Mr.

Anderson for closing remarks.

Alicia, thank you.

Thank everyone for their interest and we look forward to updating you on our progress after our first quarter.

Ladies and gentlemen, this concludes the Patterson Companies' fourth-quarter fiscal 2011 earnings conference call.

If you'd like to listen to a replay of today's conference, please dial 303-590-3030 and enter the access code of 443-8846 followed by the pound sign.

Thank you for your participation, you may now disconnect.