Patterson Companies Inc (PDCO) 2013 Q2 法說會逐字稿

Ladies and gentlemen, thank you for standing by.

And welcome to the Patterson Companies' earnings conference call.

During today's presentation all participant lines will be muted.

Following the presentation the conference will be open for your questions.

(Operator Instructions)

Today's conference is being recorded November 20, 2012.

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

Please go ahead.

Thank you, Alicia.

Good morning.

And thanks for taking time to participate in our second-quarter earnings conference call.

Joining me today is Steve Armstrong, our Executive Vice President and Chief Financial Officer, who will review some highlights of our second-quarter performance following my opening remarks.

Since regulation FD prohibits us from providing investors with earnings guidance, unless we release that information simultaneously, we've provided financial guidance for fiscal 2013 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 forecasts.

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 now to our second-quarter results, Patterson reported consolidated sales of $867.2 million for the second quarter of fiscal 2013 ended October 27, an increase of 1% from $856.9 million in the year-earlier period.

Net income of $45.5 million, or $0.44 per diluted share, compared to $49 million, or $0.43 per diluted share, in the second quarter of fiscal 2012.

Our earnings were affected primarily by below plan sales of dental equipment, as well as the absorption of $3 million of incremental interest expense related to Patterson's debt issuance in the third quarter of fiscal 2012.

As I will discuss during the next few minutes, several areas of our business, including dental technology equipment and Webster Veterinary, performed well in the second quarter.

On balance, however, we are not satisfied with our recent operating results, which did not meet our expectations.

Patterson Dental, our largest business, reported sales of $549.1 million, which was substantially unchanged from last year's second quarter.

Within this unit, sales of consumable supplies rose 1%, which was consistent with our internal forecast.

We believe the consumable market is stable.

But until unemployment is significantly reduced and consumer confidence improves, it is unrealistic to expect that the underlying market for consumables can perform much beyond current levels.

Sales of basic dental equipment, including chairs, units, and lighting, were well below forecasted levels, making this product category the primary reason behind our second-quarter sales shortfall.

While we are encouraged that the dental practitioners have been willing to expend funds on technology-related products over the past several years, the basic equipment market recovery has been at a much slower pace.

We continue to work with our customers on investments in their basic operatory infrastructure.

However, the predictability of when they will commit to these investments quarter to quarter remains volatile.

Consistent with this pattern, we reported mid-single-digit revenue growth for dental technology products in the second quarter, which partially offset the weakness in basic equipment.

Total sales of dental equipment and software were down 3% in the second quarter.

Within our technology category, which is benefiting from the ongoing trend towards the digitization of dentistry, sales of CEREC systems and [exterol] x-ray products were strong during the quarter.

CEREC demand received a boost from the launch of the Omnicam by Sirona Dental System at its CEREC 27.5 anniversary event in Las Vegas in August.

The thousands of dental professionals who attended this event gave Omnicam an overwhelmingly positive reception as a major technological advancement in CAD/CAM technology.

Omnicam's positive initial reception has subsequently been matched by strong continuing demand for this next-generation product from both new and existing CEREC customers.

However, the number of Omnicam systems timely delivered to us during the second quarter was less than anticipated.

This development constrained Omnicam sales in the second quarter.

In short, demand for this next-generation system outstripped product availability, which was a risk factor we mentioned in our last conference call.

Based on information from Sirona, we expect Omnicam production volumes to ramp up over the next six months.

I also want to emphasize that, since Sirona and Patterson are in complete agreement about wanting to avoid any quality issues on this technologically advanced system, we are not pressuring Sirona for faster Omnicam deliveries.

Given our conviction that digital technology represents the future of dentistry, we plan to continue our focus on selling and supporting technologies that improve the efficiency and clinical outcomes of dental practitioners.

As the market for basic infrastructure stabilizes and begins to grow, we will be there with our industry-leading offerings of chairs, units, and cabinetry to assist the dentist in achieving greater efficiencies for their practice.

Our long-term commitment to technology is exemplified by our new exclusive North American marketing agreement with Sirona, the undisputed leader in digital dental technology.

This recently expanded agreement, which now covers Sirona's complete product line, has further strengthened Patterson Dental's position as the leading distributor of dental technology and other equipment.

Our Dental division also completed a strategic acquisition in the second quarter with the purchase of Iowa Dental Supply.

While not having a significant impact on reported results, the addition of the well-respected and experienced management and staff of Iowa Dental further strengthens our position in our Midwestern market and provides another avenue for technology and equipment growth.

We were very pleased in the second -- of the second-quarter performance of our Webster Veterinary supply unit.

Webster's internally generated sales increased 13% in the second quarter.

A change in distribution agreement for nutritional products in the fourth quarter of fiscal 2012 reduced Webster's second-quarter actual sales results growth by approximately 6 percentage points.

As a result, Webster reported sales of $184.4 million for the quarter.

Webster's solidly higher second-quarter sales growth was generated by strong demand for consumable supplies, including combination flea and heartworm and other parasite-prevention products.

To further strengthen its competitive position, Webster is focusing resources on its growing range of technology solutions for veterinarians and their clients, in addition to expanding local technical support capabilities for its equipment business.

Sales of Patterson Medical, our rehabilitation supply and equipment unit, totaled $133.7 million, which was virtually unchanged from the year-earlier period.

The April 2012 acquisition of Surgical Synergies, a distributor of physiotherapy, rehabilitation, and mobility products serving the Australian and New Zealand markets, contributed approximately 1 percentage point of sales growth for this division in the second quarter.

Patterson Medical's second-quarter sales were below our internal forecast, as moderately higher sales of consumable supplies in the US were offset by continued weakness in the unit's international and equipment businesses.

The softness in the unit's international and equipment businesses is likely to persist throughout the balance of fiscal 2013.

Despite US healthcare regulatory uncertainties and the weak economic environment in its global markets, we believe Patterson Medical is well positioned to capitalize upon positive long-term demographic trends in the worldwide rehabilitation market.

Our short-term challenge in the rehabilitation market is to deploy our resources in the most efficient manner to support our core customers as they cope with a very unsettled environment.

Finally, as we stated in this morning's release, our second-quarter sales shortfall, and the outlook for continued economic uncertainty, causes us to reduce our full-year earnings guidance.

Our new range is $2 to 2.06 per diluted share, compared to our previously issued guidance of $2.10 to $2.16.

As I said at the outset, we are not satisfied with our recent results.

While our business, like many others, are facing economic headwinds over the near term, we will continue to make investments that we believe will further strengthen the competitive position and long-term performance of our veterinary and rehabilitation units.

Finally, October 28, 2012, marked Patterson's 20th anniversary as a publicly traded company.

We have experienced considerable success since 1992, growing from $277 million in annual revenue and $10 million of stockholders' equity.

Throughout our first 20 years we have remained focused on our future by continually strengthening our organization through the commitment and dedication of Patterson's outstanding people.

Today, we are continuing to strengthen the competitive position of our businesses by enhancing our value-added approach for the customer, and our confidence in Patterson's future is undiminished.

Thank you.

Now Steve will review some additional financial highlights from our second-quarter results.

Thank you, Scott.

I have two additional points on our sales performance for the second quarter.

As we disclosed in this morning's release, and as Scott mentioned earlier, the change in a nutritional product arrangement in our veterinary unit reduced consolidated sales by 130 basis points in the quarter.

This change, which will continue to affect our sales volumes into the first half of this year's fourth quarter, has had a minimal impact on our operating profit, since we now sell this product line under a national agency commission arrangement.

And, second, on a consolidated basis, acquisitions added 50 basis points to our second-quarter sales growth, while currency exchange had essentially no impact.

We realized sequential improvement in our consolidated gross margin for the first quarter, but two primary factors accounted for the 40-basis-point decline year-over-year.

In the Dental division, the mix of CEREC revenue shifted to a much higher proportion of sales from trade-ups to the AC or Bluecam acquisition unit from the Redcam that we saw in the same period last year, or were anticipating this quarter.

We had been planning for a higher percentage of Omnicam sales.

But, as Scott mentioned, the delays in the timing of shipments from the manufacturer during our quarter did not provide us sufficient product to achieve our forecasted sales of Omnicam.

This trade-up activity not only generates a lower level of revenue per unit, but it produces a much lower gross margin than the sale of the new CEREC unit.

However, we believe the additional volume of trade-ups from the Redcam to the Bluecam is further endorsement of Omnicam's market opportunity.

The second factor affecting our consolidated gross margin was the erosion of the gross margin in the international operations of our Medical segment.

Both channel pressures and sales mix caused this decline, particularly in the European markets, which are being affected by austerity measures in Europe's healthcare systems.

Our second-quarter operating expense ratio increased as the softness in Dental and Medical sales did not allow us to gain any operating leverage.

By segment, our second-quarter operating margins were 9.2% for Dental, 13.4% for Medical, and 5.0% for Veterinary.

As I have mentioned in previous quarters, our effective tax rate has been favorably impacted by the dividends paid on the Patterson shares owned by our ESOP.

And, as the dividend increases, our tax rate is reduced further.

Another factor contributing to the lower tax rate in the current and future fiscal years involve the benefit of the domestic manufacturing deduction.

We have previously believed that we did not qualify for a meaningful benefit under this provision of the tax code.

But further study revealed that we can claim this deduction on several portions of our domestic operations.

A review of our balance sheet shows that inventory levels increased by approximately $11 million from the start of the fiscal year.

The growth in inventories resulted from normal seasonal fluctuations during the quarter.

Our DSO stands at 43 days in the current period, down 2 days from the prior year, while inventory turns are at 7.1 compared to 6.6 one year ago.

We generated cash from operations of approximately $73 million in the second quarter, compared to $52 million in the year-earlier period.

The year-over-year increase is the result of our decision to fund the prior-year contribution to our employee stock ownership plan by purchasing Patterson shares in the open market in the second quarter of fiscal 2012.

At that time we transferred $23 million to the ESOP, which then purchased 844,000 shares.

Effectively, we converted the non-cash ESOP expense for fiscal 2012 into a cash expense, and the impact of that decision on operating cash flow occurred in the last year's second quarter.

Market conditions allowed us to fund that year's contribution for approximately $4 per share less than if we had allocated shares from the tranche acquired by the ESOP in 2006.

The economic benefit to the shareholder of that decision was approximately $3.5 million.

For the current year, we are planning to fund our contribution with shares from the 2006 tranche, which results in a non-cash expense as reflected in the operating cash flow.

Our CapEx for the first half of the year principally included regular ongoing expenditures, in contrast to last year, when expenditures were incurred on the new facility for the Patterson Technology Center and the new South Bend distribution center.

We are still anticipating fiscal 2013 CapEx in the range of $25 million to $30 million, as we will be increasing investments in our information systems applications and infrastructure beginning in the second half of this fiscal year.

Also in the second quarter we repurchased approximately 1.6 million Patterson shares under our 25 million-share buyback authorization that expires in 2016.

Approximately 8 million shares remain available for purchase under this authorization.

During the second quarter, we retired $75 million of term debt that would have matured in March of 2013, since there was no penalty for the repayment, and our cash investments were [not] at equivalent or better rates.

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

Alicia?

(Operator Instructions)

Lisa Gill, JPMorgan.

Can you maybe just give us a little more color around Omnicam?

Is this just a timing issue as far as what we're going to see?

Or is there something more?

And then can you give us more insights into what you're seeing right now in the overall equipment market?

We know the economy is still tough but how are dentists looking at things?

And then, lastly, if we think about this, Steve, is there anything specific we need to think about other than some of the comments you made around timing as far as what's happening with the guidance?

Is there anything else that is underlying that, that again we need to think about as we model?

Thanks.

Sure.

Thanks, Lisa.

I'll start out with Omnicam.

Obviously, as I said in my comments, we had a spectacular launch of the product with Sirona in August.

When we had planned the year back last spring, knowing that Omnicam was coming, we made some assumptions with Sirona about delivery.

I would tell you that we're probably 45 to 60 days behind the schedule we had anticipated.

So we do not expect there to be a makeup in terms of the fiscal year.

It's really moving the delivery schedules back a month or two.

In our second quarter we had anticipated a delivery schedule where we would have the ability to invoice a good number of products.

We got those deliveries late enough in the quarter where we could not invoice those.

But to be perfectly clear, it's not like there will be a makeup in our next quarter.

The whole delivery schedule just was moved back a little bit.

And obviously, in a launch as big as this, there's always some risk to the timing of the delivery.

But I don't want that in any way to dampen our enthusiasm about the product, because we're absolutely thrilled with the technological advance and the CEREC offering we're going to have for our customers going forward.

But it's probably going to be six months until we're hitting at full speed.

And we see this as a major turning point, and part of a good three to five-year run for the CEREC Omnicam.

So when you think about the equipment market, this is a new product to the market, you're seeing interest in this product, but what are you seeing overall from equipment, generally speaking?

The overall equipment market continues to be lumpy.

When you go back and look at our last 10 quarters, we've had growth in seven of the 10 quarters.

And four of those seven, we have had double-digit growth.

But we've also hit patches like we just hit in the last 90 days where dentists will get conservative, particularly around their investments in the traditional piece of equipment.

The core equipment business, which took a very hard hit in fall of 2008-2009, has been slow to recover.

We believe it is recovering, but it's at a pace that's obviously frustrating to us in terms of how it's coming back.

The good news is -- and I think I talked about it on the last call -- was when you talk to customers, the fear aspect that many customers had maybe four years ago, that doesn't play out at all in the current psyche of the dentists.

Their cash flows are strong.

Their patient flows are strong in their practices.

But they're small business people and the reality is, small business people are dealing with a lot of uncertainty right now in terms of tax rates and Section 179, what's going to happen to that.

And when you have uncertainty, sometimes you have dentists become more conservative than invest in their practice.

Great.

And anything to think about on the guidance side?

Is it all related to Omnicam and your initial expectations?

Or is there anything else in your underlying assumptions for the new guidance range?

Thank you.

Lisa, maybe just I'll summarize some things and then come back if I don't touch on the points that you're finding helpful.

We softened up the medical outlook for the remainder of the year based on what we've seen in the first six months.

And what is really projecting out for the next six months in that market, particularly in the European market.

And somewhat in their equipment market here domestically again.

Again, uncertainty around what's going to happen, who's going to be paying, who's going to be receiving what has put some paralysis into the market.

So we softened up the revenue outlook there.

Now, on the other hand, you've got the med tech tax coming in beginning January 1. That will probably drive some revenue lift, but it's not going to help, obviously, the operating margin or the bottom line.

We also lowered our tax rate, as I mentioned during my prepared remarks, because of some additional benefit we get out of a domestic manufacturing deduction under the current tax code.

And heaven only knows what they're going to do on the next round of tax adjustment.

We did not build in any assumption of further stock purchases.

So we used the share count outstanding currently to project the second half of the year.

I would say from that perspective, that we will probably continue to buy shares in the second half at a pace similar to what we have through the first half.

So those are some of the high points of the guidance.

And I'll quit rambling.

That's very helpful.

Thank you.

Robert Willoughby, Bank of America.

Scott or Steve, if you look at the valuation for MWI and some of the other -- basically all of the other Dental constituents, and the multiples somebody's paying for PSS World here, you have to think that some of the parts now must be worth more than the whole.

What's the action plan here in light of what we could view now has some serial disappointments over the years?

How do you monetize this franchise, other than the token buybacks that you have been making?

Bob, I think that's a great question.

It's something, when we look at long-term strategy and value creation, that we discuss with our Board.

And obviously it's something I wouldn't get into great detail on a public call.

We feel we've got market-leading franchises in all three businesses.

And have a long-term perspective that there's a very strong value-creation story here beyond share buybacks as we go forward.

Are the businesses so intertwined now that they can't be easily extricated?

No.

And if you could answer -- has there been interest in any of these franchises from external players?

No comment.

All right.

Thank you.

Michael Cherny, ISI.

Just quickly on the OpEx line, given your somewhat muted expectations for growth, especially on the Medical side, as you think about OpEx, how much of the line is fixed versus variable?

And in a given quarter how much flexibility do you have to potentially cut costs if you see some of the trends throughout the quarter not playing out as you had hoped?

I'll start and then I'll turn it over to Steve.

I think it's very important when you look at the Patterson story that our key strategy is being a value-added distributor.

And there are expectations our customers expect from us in terms of how we take care of them.

And deliver best-in-class service and logistics.

And at the same time we are the most efficient in terms of profitability of anyone in our industry.

So we take a long-term perspective when we look at how we run this business.

And while we could drive some short-term leverage through cost cutting, we believe that's not the right strategy for this business.

So I'll let Steve talk about the fixed versus variable aspect of the business.

Michael, I would just tell you that directly variable costs would be your commission cost.

And basically the packaging and freight costs on your shipments.

So it's about somewhere between 9.5% and 11%, would be the totally variable costs in a particular period.

Great.

Thanks.

That's helpful.

And then just quickly on the M&A side, obviously the cash flow generation filled in fairly strong here.

You guys made a few smaller tuck-in acquisitions recently.

As you think about your portfolio, and even with the leading platforms you have, with the cash position, would you ever look to potentially be slightly more aggressive?

Or look to larger deals to augment your business to get some more scale?

Or is it more the tuck-in, look for truly the best assets that fit your portfolio?

Mike, I think it goes back to what we've been very clear in terms of our capital allocation strategy.

Our top priority is to invest it back in the business.

And that's through a combination of investments in internal programs and infrastructure.

But also through complementary acquisitions in the three businesses we have.

We are very disciplined in terms of the prices we pay.

But we're willing to pay market prices to get properties that make good strategic sense for the Company and have strong growth dynamics behind them.

So, we are very active in terms of strategically looking at the markets.

And obviously are in a very strong position from a cash perspective to execute on those opportunities when they are in front of us.

Great.

Thanks.

Kevin Ellich, Piper Jaffray.

Scott, going back to the comment about Omnicam and what's going on with the equipment sales, could you just help us understand where the disconnect could be between the strength in stock from Sirona last week versus what you guys put up today?

Yes.

The strength from Sirona was really about the Bluecam trade-up program where we exceeded expectations.

There was very little Omnicam deliveries in their numbers.

So I think one of the silver linings of what's happened over the last four months is that our upgrade program, where we were moving customers from the old Redcam to the Bluecam, which is critical because it gets the customer on the equivalent software platform as the Omnicam, really positions us well when we get into a full ramp-up in terms of production.

So, obviously we're going through some of the growing pains of a new product launch.

But I couldn't be more excited to be the company selling this really game-changing product.

Okay.

That makes a lot of sense.

And then just wondering what's your view on the macro right now?

What are the sales guys telling you in terms of demand that they're hearing from the dentists?

Are you expecting normal seasonality, so increase in consumable sales like we've seen historically?

Or have you picked up anything new?

I think the consumable market, as I said, is stable, and that's encouraging.

But still faces some headwinds in terms of choppy consumer confidence and still high unemployment.

The feedback we get from our salespeople -- and I talk to a lot of them all over the country -- is there's definitely a frustration at the customer level just in terms of their view of the short-term macro environment.

But there's really an underlying optimism.

Because when you look at dentistry, and you look at the demand that's going to happen in this space over the next 10 to 15 years, just from a pure demographic standpoint, and couple that with a new generation of dentists who are embracing technology, there is an excitement and an optimism about the profession.

Even though it continues to muddle along here in the short term.

Got it.

And then just a couple debt questions.

How much did flea, tick and heartworm products like Trifexis contribute to the 13% internal growth you saw in Webster?

And then how much agency business does Webster do?

Can you remind us?

Yes.

As far as the impact on the quarter, Kevin, obviously, the increased dosages of flea, tick and heartworm have been driving the activity.

As far as breaking that down, I think that's pretty difficult.

But I would tell you that a good portion of it has been driven by not only the change in buy-sell in some of those various parasiticides and preventatives, but also by just the sheer volume and the seasonal aspect of that.

It's been a very strong season for those.

Sure.

And then the agency mix, Steve?

The agency mix right now, we're probably doing -- and this is really off the top of my head, Kevin, so bear with me, come back and we'll clarify it for you.

But I believe we're doing about $150 million to $175 million of gross transactions under agency today.

Great.

Okay.

Thank you.

Brandon Couillard, Jefferies.

Scott, I hate to beat a dead horse here but could you help us understand the disparity between your dental equipment revenue trends and those of your closest North American competitor, which I believe were up 6% in the second quarter?

Is that a function of mix or pricing pressure?

Is there something that needs to be changed with the sales force?

I'd take you back maybe more than just 90 days, Brandon.

We're up 7.5% for the last six months.

As I said, if you look back at the last 10 quarters, we've grown 7 of the 10.

So, even though versus our high standards we had a disappointing quarter, I can confidently say that we continue to take market share on the technology and equipment side.

And, Scott or Steve, any sense of where your basic equipment revenues stand relative to the pre-recession levels of 2007?

Are we even back to that prior downturn level in terms of aggregate revenue for the basic equipment?

No, Brandon.

We're still probably 20% to 25% below what the average production was back in 2008 and prior.

All right.

Thank you.

John Kreger, William Blair.

Another question about dental equipment.

Can you guys just talk a little bit more about what your pipeline looks like?

And do you think we'll get a normal calendar year end buying period in dental equipment?

Or is there enough uncertainty around tax policy and so forth that it might be a little bit more anemic than normal?

John, I think that's a great question.

Historically, if you look at our third quarter, which coincides with the calendar fourth quarter, it historically is our largest quarter of our fiscal year in terms of volume.

But it also historically is a quarter that we have the least visibility.

In essence, because our customers historically will sit down with their tax advisers in the fourth quarter and make buying decisions.

We think there are some tailwinds to this time period for us in terms of tax policy with Section 179, the medical device tax coming into play after January 1. But you also couple that with a lot of uncertainty around personal tax rates and what Washington, DC's going to do here potentially over the next 30 days.

So I think that's one of the reasons why we're taking a cautious tone, is because it's going to be more difficult to predict the basic equipment business here over the next 90 days.

The Omnicam business will be, obviously, dependent upon delivery because we have plenty of demand for that product.

Great.

Thanks.

And then just a quick follow-up about the profitability of the Dental business.

It seems like the margins that you had in this quarter were the lowest we've seen in a while.

And I'm guessing that's probably driven by the Bluecam upgrade.

Is that pretty much done?

Or do you have a backlog of upgrades that could cause the margins to continue to be low over the couple of quarters?

The expectation, John, with regard to the mix would be that it would be predominantly new cameras, Omnicams.

Realistically there's going to be some trade-up activity as old Redcam owners decide whether they want to go up to the Omnicam or not.

And if they want to go through the Bluecam progression.

But no, the expectation would be that most of it will be Omnicams going forward.

The backlog has pretty much moved out of the system.

Okay.

Great.

Thank you.

Steven Valiquette, UBS.

My question was tied into the other previous one.

Just looking at the gross margin trends.

In the fiscal first quarter, you guys had strong dental equipment sales.

And that was cited as a mixed reason for softer gross margins in the fiscal first quarter.

With this quarter, obviously dental equipment a little bit softer, but yet the gross margins are still down a pretty good clip a year-over-year.

Just any additional color on that would be helpful.

Sure.

Steven, it is different between the two quarters but still somewhat the same because the trade-up activity dominated CEREC.

CEREC was actually up in the quarter as far as total revenues were concerned, but most of it was trade-ups versus Omnicam.

And the other factor that went with that is that, because of a supply disruption in Bluecams, we were using and, if you will, cleansing our training inventory.

So it exacerbated the margin impact, because those were going out at even lower margins than you would have sent out a new Bluecam unit under the trade-up provision.

So we were discounting to get the customers the Bluecam so that they would be in line for the progression up to the Omnicam, if that helps.

Okay.

Yes, that's helpful.

And then just one quick clarification on the guidance revision.

You mentioned a bunch of reasons but the largest portion, is it just the soft demand of the basic dental equipment?

When I think about the Omnicam, you guys mentioned at the analyst day back in September, back then pretty clearly, I thought, that supply shortages would prevent any meaningful sales of that product.

So I would have thought that would have been factored into the previous guidance already.

So, just to clarify, then, is the biggest change today really, it's the softer basic equipment is more the culprit?

Is that the way to think of it?

Yes.

I think it's a combination of we don't feel it's realistic to make up the shortfall we just had in the second quarter.

Particularly around the unpredictability in the dental equipment market.

And on the Omnicam issue, as I said earlier in the question from Lisa, it wasn't the number of deliveries we got.

It was more the timing didn't happen at how we had anticipated it when we planned out the fiscal year last spring.

So it really has moved the supply chain back 30 to 60 days and that obviously impacted the second quarter.

And we don't anticipate a makeup in terms of getting those 30 to 60 days back in this fiscal year.

Okay.

Thanks.

(Operator Instructions)

Glen Santangelo, Credit Suisse.

Just two quick ones, if I could.

Scott, in describing the equipment market, you described it as it's been lumpy over the last year.

But I'm curious about what you're seeing on the consumables side.

Essentially you only grew 1%.

So I'm wondering, if you strip price inflation out, what are you seeing about market growth?

Is it really at zero or potentially minus 1%?

Or do you think there's some share-shifting going on?

Any insights or elaboration on the consumable market would be helpful.

Yes, Glen, we really see the market right now, and it's slowed down, as I mentioned in the last call, over the summer.

That it's a flattish market.

And I would say we're maintaining market share.

I would not be bold enough to say it's growing 1%.

We're taking market share.

But obviously, -- and I talked about it last quarter, as well -- it's a big focus area for us.

Because when we get back to historical operating performance, a key piece of our leverage story is to grow the consumable business in that 4% to 5% range.

So implicit in the guidance, then, as we look to the remainder of the year, you're assuming that the market stays flat or recovers a little bit?

Recovers a little bit.

But our internal forecasts for consumables are pretty conservative in the guidance.

Okay.

And then, just my second question is on the vet business.

Clearly the internal sales growth of 13% is pretty surprising.

Particularly if you say your sales were impacted 6% by a change in the distribution agreement for nutritional products.

And so if we think about that apples to apples, you're saying your vet business grew 19%.

Following up on a previous question, it sounds like some of it was due to Trifexis and maybe some changes in agency agreements.

I'm not sure.

Steve, I just want to make sure that I heard you correctly.

Did you say the bulk of all that growth was attributable to those two issues that we just highlighted?

Or is there something else?

And how should we think about the sustainability of these double-digit growth you've been posting in vet?

First of all, let's clarify.

The 13% that we talked about, Glen, is after adjusting for the nutritional change -- arrangement change.

So you've added on top of it.

Our actual revenue growth, reported revenue growth, in that segment or the quarter is about 6.5%, 7%.

Okay, perfect.

All right.

And then you're correct, most of the growth is still coming because of the seasonality.

It was a long severe season for flea, tick, and heartworm.

I think we're starting to come to the end of that.

So I would caution that you're not going to see -- I don't think any distributor's going to see double-digit consumable growth in their vet businesses as we go forward.

Unless the ticks live through the entire season and we have no snow and no freezing.

But we're grandfathering in that really early flea and tick season last year.

So I think you're going to see the growth rates for everybody come back down again as we get through that cycle.

I would just add, Glen, I think we see the underlying market -- obviously a lot of moving pieces with buy-sell and agency that everyone works through.

But the underlying market probably is growing in the 2% to 5% range.

So Webster's performance is obviously above market.

And, as I said, we're very pleased in the progress they're making.

Okay.

Thanks.

That's helpful.

Ross Taylor, CL King.

I have two fairly simple questions.

First, with regards to CEREC, I just wondered if you could comment about what kind of interest you're seeing in Omnicam versus Bluecam and what may unfold over the next several quarters.

Are virtually all of your sales there likely to be Omnicam?

And then my second question just relates to basic equipment.

I think you actually had pretty good basic equipment numbers in the April and July quarters.

I just wondered if the timing of when things maybe changed during the October quarter, because that just feels like the basic equipment was below your expectations several months ago.

Sure.

Thanks, Ross.

I'll start with CEREC.

And, obviously, there's high demand right now in terms of interest in Omnicam.

But we, with Sirona, really look at it as a very compelling portfolio of products, of which Bluecam will play a very big role, as well as Omnicam going forward.

And we think at Patterson that we go to the customer with more choices than any distributor in terms of products that go all the way from digital scanning up to the most advanced scanning and chairside milling.

So great interest in Omnicam, but also, as I said, a very unique portfolio approach to go after the market.

And we believe we're really in the second or third inning of this CAD/CAM story and this digitization of dentistry.

And that's what makes us so excited to really start a new innovation cycle with Sirona with the introduction of Omnicam.

On the basic equipment side, we were frustrated by the slowdown that we saw in September, October.

But we don't think that it is a trend.

And going back to the question that John asked previously, we do have a lot of activity right now out in the field.

But a lot of decisions are made right in this time period with customers sitting down with tax advisors.

And that's what makes this third quarter always tough to predict.

And we probably have more surprises to the upside, historically, than we have had to the downside.

But given the macro environment, we're not going to make any bold predictions on quick recovery to the core equipment market.

That's good color.

Thank you.

Jeff Johnson, Robert W. Baird.

Just a couple questions here.

One, just on the Dental margin, if I step back and take a bigger picture view, where, over the last couple years -- two, three years -- down probably 300 to 400 basis points on that margin line.

And I know ESOP is part of that.

Obviously some cyclical issues here on Bluecam upgrades.

But what over a multi-year period has compressed that margin so much?

And how does that play out, do you think, over the next year or two?

The reality, Jeff, as Scott mentioned earlier, we have to continue to invest in this business to stay competitive.

We got that margin up over a long period of time through leveraging the business.

And when your revenues are soft to flattish, it's very hard to maintain that, just based on your expense structure.

If you go back just to mention a few-- I mentioned a couple of them during the prepared remarks -- and that is the investments that we've made in our infrastructure with regard to distribution and the Patterson Technology Center and so forth.

We're going to be continuing to make those investments.

We froze wages several years ago during the height of this malaise.

And then actually took the wages back.

But that's really about the only triggers we have in the expense structure, as lean as we run it today.

I'll turn it over to Scott to talk more philosophically about this.

Yes.

Obviously we're frustrated by that, Jeff.

But we're also absolutely committed to continuing to invest through this soft patch.

Another area where we continue to invest is in new salespeople.

So the key to margin expansion for us is revenue growth.

It's not cutting deeper into the cost infrastructure over the next 12 months.

And I know this may be a strange question, but have you over-invested in the dental equipment side?

Is there too much value add you can give these dentists?

Is there too much tech support, too much where they don't have to wait a single second on a call, or you can be than 5 minutes instead of 20 minutes or something?

Is there anything there that needs to be evaluated going forward?

I don't think so.

I wish we were as good as you say we are.

But when we look at the long term and how compete in the space, the things that we are doing have very strategic reasons.

And when we look at what a modern dental office is going to look like in five to 10 years, and what the expectations of a new generation of customers is going to be, one of the great barriers that we create around our customers is this high-touch service we deliver.

So it's part of our DNA and we think very strategic to the future.

And we also think it's a model that, obviously, most of our competitors try to replicate.

And we just need to continue to do it better than our competition.

Great.

And then last two quick, just quick clarifying questions.

Steve, was Dental consumables growth, was organic growth this quarter positive, if I back out Iowa and any currency benefits, things like that?

Yes, sir, it was almost 1%.

Almost 1%?

And then last question, I had been hearing from a couple of my guys in the field you guys probably took delivery on maybe pushing 100 Omnicams in the quarter, maybe even more than that.

But a lot of those were going to stock showrooms, being used as training units, things like that.

So trying to figure out how much was just maybe a timing issue of those initial products coming into you, just not being recognized in revenue, or not being able to recognize those in revenue, versus a true setback in the manufacturing schedule?

As I said before, the deliveries we took were so late in the quarter that we just physically couldn't turn them into sales.

But at the same time, the delivery schedules, while Sirona are hitting their commitments, that the timing has been pushed back from what we originally thought.

And we don't see a catch-up period here potentially over the next three to six months.

And we think we'll be at full production, full ramp up, full sales execution towards the latter half of our fiscal year.

All right.

Thanks, guys.

Robert Jones, Goldman Sachs.

It's Stefan calling for Bob.

Just quickly, on the CEREC category, would you say your installed base for Redcam is now somewhere in the 25% range, given your recent trade-ups?

And also, can you remind us on how we should be thinking about the margins for the tech equipment business, with the more core basic equipment?

Stefan, I'll take the first one.

I think your number is in the ballpark in terms of number of Redcam still in the market.

And then, could you repeat the second question?

Yes, because we want to be sure we understand it.

Yes.

Just how we should think about the margin difference in tech relative to basic.

As we think about your guidance, and the reduction in basic equipment outlook, how those margins compare to margins for more high-tech equipment?

Yes.

I think that depends, again, somewhat of the mix, Stefan.

Your basic equipment is generally in the low 30%s, as far as the gross margin is concerned.

Some of the tech will get up in the mid or higher 30%s.

But, again, some of the tech actually carries a lower average margin just because of some of the competitive nature.

So if you look at the big-ticket 3-D scanners that are out there, they tend to come in a little bit less than the average gross margin on a dental equipment transaction.

Great, thanks.

And lastly, on the med tech tax assumptions you make, is this the correct way to think about it?

Most of the increase would be passed on to customers?

I think we're still in the preparation phase for that.

And most of that will be a decision by the manufacturer on how they handle the tax.

Okay, great.

Thank you.

Karl Poehls, Fiduciary Management.

Scott, two years ago on this call, I asked you about a fairly simple concept of under-promising and over-delivering.

And that was right after you brought down your fiscal 2011 guidance.

And since that time, the Company has missed five out of seven quarters from an earnings perspective.

And this is a great franchise that just seems to be stumbling along.

And there seems to be an under-execution issue.

This quarter it's basic equipment, which by my math roughly missed the budget by 25% or more.

Last quarter, dental consumables were noted as having poor execution.

The margin issue is a constant theme.

And we're just curious, what are you doing to address the execution directly And more specifically?

And how does the Board view this?

And even outside of Dental, a lot of incremental capital has been redeployed into the Medical segment, which has been disappointing from a return on capital perspective.

And has taken incremental capital.

And now the theme is pricing pressure, margin degradation there.

Can you comment on any of those things, please?

Thank you.

Sure.

Thanks, Karl.

And I share in your frustration.

I remember well the question two years ago.

And the answer I gave two years ago is consistent with how we plan our year.

In that we tie the incentives of all of our people to the expectations we put out on the street.

And we have a culture that's been developed over the last 20 years of stretching the organization.

Obviously, in times where our underlying markets have been very soft, stretching the organization to that level has been difficult to reach those goals.

And for that, we're very frustrated.

But at the same time, this is a fantastic franchise.

And we are the most profitable and most efficient distributor in nearly every metric versus the competition we compete against.

So we do not take lightly the performance issue or the fact that there are times where there are areas where we have not executed to the standards we have.

So there are pieces of that question that I agree with.

And our management team is absolutely committed to improving the performance and execution of the business.

We're running this business for the long term.

And I will continue to drive to make investments to position this company in the best way to meet what we think is going to be very strong demand in all three of these businesses.

There's a great term that demographics is destiny.

And these are three businesses that are in the center of very strong demographic trends over the next 20 years.

But we are absolutely aligned as a management team with everything you said in terms of your interest.

And we know that execution is A number one on our priority.

Thank you.

(Operator Instructions)

Joe Van Cavage, River Road Asset Management.

Do you have any guidance you want to give on maybe what percentage of your sales starting in '13 would be subject to the medical device tax?

Joe, this is Steve.

We've done some preliminary work.

As Scott mentioned earlier, some of this is going to be dependent on how the manufacturers actually pass it on to us.

But technically about 50% to 60% of our products across all of our businesses are subject to the tax.

More heavily in the dental than any of the other businesses because of the definitions under the Food and Drug Administration guidelines and regulations.

Okay.

Thanks.

Maybe just assuming that, say, your suppliers were to try to pass it along to you, do you expect it would be more difficult in certain end markets to pass it along to your customers?

Historically, price increases have been passed on to customers in all three of our markets.

Okay.

Thanks.

That's all I had.

At this time I'd like to turn the conference back to management for any final remarks.

Thanks, Alicia.

I'd like to thank of all of you for your time and interest in the Company today on our call.

I'd also like to wish everyone a happy Thanksgiving.

We look forward to updating you on our progress in 90 days.

Thank you.

Ladies and gentlemen, this concludes our conference for today.

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