Patterson Companies Inc (PDCO) 2018 Q3 法說會逐字稿

Good morning.

My name is Michelle, and I will be your conference operator today.

At this time, I would like to welcome everyone to the Patterson Companies' 3Q 2018 Earnings Call.

(Operator Instructions) I would now like to turn the call over to Mr. John Wright, VP of Investor Relations of Patterson Companies.

Please go ahead.

Thank you, operator.

Good morning, everyone, and thank you for participating in Patterson Companies' Fiscal 2018 Third Quarter Earnings Conference Call.

Joining me today are Mark Walchirk, Ann Gugino and Dennis Goedken.

After a review of the third quarter by management, we will open up the call to your questions.

Before we begin, let me remind you that certain comments made during this conference call are forward-looking in nature and subject to certain risks and uncertainties.

These factors, which could cause actual results to differ materially from those indicated in such forward-looking statements, are discussed in detail in our Form 10-K and our other filings with the Securities and Exchange Commission.

We encourage you to review this material.

In addition, comments about the markets we serve, including growth rates and market shares, are based upon the company's internal analysis and estimates.

The content of this conference call contains time-sensitive information that is accurate only as of the date of the live broadcast, March 1, 2018.

Patterson undertakes no obligation to revise or update any forward-looking statements to reflect events or circumstances after the date of this call.

Also, a financial slide presentation can be found in the Investor Relations section of our website at pattersoncompanies.com.

Please note that in this morning's conference call, we will reference our adjusted results for both the fiscal 2017 and fiscal 2018 third quarters.

The reconciliation tables in our press release, adjusted GAAP -- reported GAAP measures, namely earnings, net income and earnings per diluted share or the impact of transaction-related costs, deal amortization expenses and integration and business restructuring expenses.

We will also discuss free cash flow, which is a non-GAAP measure, and the impact of foreign currency.

The reconciliation of our reported and adjusted results can be found in this morning's press release.

This call is being recorded and will be available for replay starting today at noon, Central Time, for a period of 1 week.

Now I'd like to hand the call over to Mark Walchirk.

Thank you, John, and welcome, everyone, to our third quarter conference call.

The results we reported today clearly did not meet our expectations and fell far short of what we know the business is capable of achieving.

On today's call, I will explain our third quarter results, the outlook for the remainder of the year and the specific actions we're taking to address our current challenges and improve our performance.

I'll get into details about the near-term actions we are taking focused on our performance in a moment, and Ann will provide details on the quarter later in the call.

But first, let me start with a few remarks about the key drivers that impacted our Q3 results.

Overall, the main issues facing our business today is execution.

In the Dental segment, our results reflect the various transitions we have under way in the business, namely changes in our sales organization, disruptions related to our ERP implementation and the transition to selling an expanded digital equipment portfolio.

These factors all contributed to lower revenues and margin compression during the quarter.

While we continue to grow in the companion animal segment, our margins were impacted by shifts in product mix and lower year-end rebates from manufacturers.

As a result of these current trends, we are revising our full year FY 2018 adjusted EPS guidance to $1.65 to $1.70 per diluted share.

Clearly, our results fell short of our expectations, and we can and must do better.

While we are hard at work to improve our performance, we know it will take some time for our actions to take hold.

We are focused on addressing these near-term challenges while building a solid foundation for future growth.

As you know, I officially joined Patterson just over 90 days ago and began a deep dive into the business to develop a thorough understanding of our customers and our business model and develop a near-term action plan to accelerate our path to improve growth and profitability.

My initial focus over the past 90 days has been to engage with and listen to our customers, employees, manufacturers and other business partners.

This time has reinforced my belief in the strength of our market fundamentals, deep customer relationships, broad value proposition and our tremendous potential here at Patterson.

But clearly, we must execute more effectively to capitalize on our full potential.

Improving our overall performance starts with understanding the needs of our customers and how we can best support those needs.

As I've engaged with our customers over the last 90 days, a few key points are clear.

First, our customers choose to work with us because we offer more than just good products at a competitive price.

Our comprehensive offering of products, services, systems, technology, equipment and technical support positions us as a valued business partner that can help our customers exceed as they navigate the challenges and changes they face in their own businesses.

Second, our team has a relentless commitment to supporting our customers and continuing to earn our role as a valued business partner.

Our team's approach to helping enable our customers' success is resonating and provides a platform from which to improve.

Finally, despite the strength of our value proposition and our strong customer focus, our core business execution is not meeting our high standards.

We need to make it easier to do business with Patterson, and improving our execution and the customer experience is our top priority.

During my first 90 days, my review of the business has been focused on execution, strategy and people.

I'll come back to strategy and people in a moment, but wanted to spend a few minutes talking about the steps we have underway to improve execution.

With a heightened sense of urgency and accountability to drive operational excellence across the company, we are focusing our efforts on 3 key areas to improve our execution and improve our results: first, improving the customer experience to stabilize and grow the top line; second, enhancing our operating margins through strategic sourcing, improved mix management and a more efficient cost structure; and third, leveraging our improved profitability, financial discipline and working capital management to drive cash flow.

Let me comment on each of these areas and the actions we are taking to improve.

To start, we have built a formal operating model to support needed customer experience improvements.

This includes measuring our progress against defined metrics and scorecards to track performance and setting clear expectations for our team.

I personally review these metrics with the leadership team on a weekly basis to ensure we hold ourselves accountable for our performance and have the right resources in place to support better outcomes.

The goal is simple.

We need to make it easier to do business with Patterson, and our entire team is focused on serving our customers in meeting the high standards that our customers expect.

We have an outstanding team and the most comprehensive solutions in the market.

And by focusing on the customer experience and providing the support our teams need, we are confident in our ability to improve expectation and improve our results.

Next, as we work to stabilize and grow the top line, we are also taking steps to improve our margins.

Our initiatives are focused on expanding our sourcing capabilities, improving our product mix, including private label, and ensuring we have the right cost structure in place to support the business.

We have organized and aligned our teams around these initiatives and are building detailed work plans to ensure we executive effectively.

We're also making sure we leverage the benefits of our common platform to drive effective and efficient execution across the business.

While the ERP implementation and transition period are presenting challenges, we are confident that being on a common platform will be a key component of our ability to better execute going forward.

Finally, in addition to the strides we are making to improve the customer experience and enhance our profitability, we are also taking actions around inventory, accounts receivable and accounts payable, and we are confident this greater financial discipline will help drive improved cash flow.

The bottom line is that we are disappointed with our results, but we understand the drivers of our performance and we are taking urgent actions to enhance our execution.

I'm confident this set of actions will improve our results and strengthen our foundation for the long term.

In addition to our pursuit of operational excellence and improved execution, we're also focusing on how we need to position the company for long-term profitable growth and success.

We've kicked off our annual strategic planning process, including a thorough review of how we plan to position and grow the company.

We expect this process to evolve in the coming months and look forward to updating you on our strategic approach at the appropriate time.

And finally, I believe sincerely in the power of our people and our culture, and our customer-first, service-focused business, a deeply engaged, aligned and committed team is critical to success.

We have a tremendous 7,000-member team across the organization, and I am proud to be a part of it.

I'm pleased with how our team is responding to the challenges we face and the changes we are implementing to meet those challenges head on.

We are committed to meeting forward with greater urgency and increased emphasis on accountability as we work to improve execution and drive improved performance.

While we clearly have a lot of work to do, I'm very encouraged by the many positive elements I've learned about Patterson and our business, and I thoroughly believe in our ability to leverage these as we move forward.

First, there's strength and opportunity within the markets we serve.

The dental market is poised to benefit from positive trends, including an aging population and technology innovation, and we believe these trends play to our strengths as a full-service provider to our dental customers.

While the results of our Dental segment continue to be impacted by the decision to broaden our portfolio of technology offerings, I want to be clear that I believe the decision to expand our portfolio was the right one.

In fact, technology equipment unit trends strengthened during the quarter.

And for the first time since we decided to broaden our portfolio, the volume of new CAD/CAM placements surpassed prior year.

This upward trend in unit placements reinforces that we made the right strategic decision to adapt to market changes.

In the animal health segment, we see continued growth in pet ownership, which benefits our companion business and increasing worldwide demand for protein, which will drive long-term demand in our production business.

In fact, within our Animal Health segment, our production animal business generated solid growth across species and channels, and we continue to benefit from positive end-market fundamentals.

Customers are affirming our value proposition and the team is executing their plan.

I want to recognize and thank our production animal health team for their solid performance so far this year.

Based on what I've learned over the past several months, I'm very confident in the long-term potential of the organization.

We have a lot of work ahead to realize that potential, but the strength of our end markets, the compelling nature of our value proposition and the commitment of our talented team to supporting our customers provide a strong platform from which we can grow, and I am personally excited to be a part of it.

Before I turn the call over to Ann for some more specific details on the quarter, I want to say a few words about the CFO transition plans we announced earlier today.

First, I want to sincerely thank Ann for her 18 years of contributions to Patterson and for her financial leadership during a time of significant change in growth for the company.

I also want to thank her for her support during my transition, and I'm also very appreciative of Ann's willingness to serve as a special adviser to the company over the next several months to help support the smooth transition with Dennis Goedken, who will serve as our Interim CFO.

We are pleased Dennis has agreed to step into this role while we conduct a search for a permanent successor.

Dennis has spent more than 12 years with Patterson, including 6 as Corporate Controller.

Earlier in his career, he served as Patterson's Assistant Controller and has been directly involved in internal audit, taking the company public and various divestitures and acquisitions.

Dennis currently leads the accounting team and overseas preparation for all SEC filings and certainly is well qualified to be our Interim CFO while we search for a permanent replacement.

We have retained a leading search firm and the process is underway.

With that, I'd like to again thank Ann and turn it over to her.

Thank you, Mark, and good morning, everyone.

Before I review the financials on the quarter, I want to say that it has been a pleasure to be a part of Patterson for the last 18 years, and to have had the opportunity to work with all of you.

I am committed to work with Mark, Dennis and the rest of the team to ensure a smooth transition.

Our performance in the third quarter of fiscal 2018 reflected the factors Mark has described.

Consolidated sales for the fiscal 2018 third quarter were $1.4 billion on a reported basis, down 1.6% versus a year ago.

When adjusting for currency translation, sales declined 2.7%.

Turning to our margins.

Our third quarter consolidated operating margin was 4.3%, a 236 basis point decline versus the prior year quarter.

Our margin compression was driven by decreased sales, lower rebates from manufacturers at the calendar year-end as well as shift in mix compared to the same period last year.

We did have an ERP expense benefit in the quarter as well as continued cost control initiatives.

However, these savings were not enough to offset the lower sales volume and gross margin compression.

On the bottom line, GAAP net income from continuing operations was $109 million or $1.18 per diluted share compared to $27.8 million or $0.29 per diluted share a year ago.

On a reported basis, we recorded a net onetime tax benefit of $77.3 million or $0.83 per diluted share related to the recent U.S. tax reform legislation, which includes the revaluation of our net deferred tax liabilities for the new lower federal corporate tax rate.

This onetime GAAP benefit also includes the impact of the transition tax on unrelated foreign earnings.

Since the company has an April fiscal year-end, the lower corporate rate from the 2017 tax act will be phased in, resulting in an adjusted tax rate of approximately 31% for fiscal 2018.

Keep in mind that for the first half of the year, we were accruing at a tax rate of approximately 35%.

The effective tax rate in the third quarter of 21% reflects the true-up of our year-to-date income before taxes to the new blended effective tax rate for fiscal year 2018.

Adjusted net income from continuing operations, which excludes certain nonrecurring and deal amortization costs and the onetime tax revaluation, totaled $39.6 million for the third quarter of fiscal 2018, down $15.9 million from the same quarter last year.

Adjusted earnings per diluted share from continuing operations was $0.43 in the third quarter of 2018 compared to $0.58 in the third quarter of last year.

Our adjusted earnings per diluted share in the quarter included a $6.3 million or $0.07 per share benefit related to the new U.S. tax legislation.

Now let's turn to our segments.

In Dental, the 2018 third quarter sales reflected the continued disruption of our sales force changes, the workflow impacts from the implementation of our new ERP system and our transition to selling an expanded digital equipment portfolio.

On a reported basis, Dental sales were down 7.7%, and in constant currency, sales decreased 8.1% versus the prior year quarter.

On that same basis, Patterson sales of consumable dental supplies decreased 7.4% during the 2018 third quarter.

Moving on to our dental equipment sales.

On a constant currency basis, equipment sales declined 10.6% in the 2018 third quarter.

In the CAD/CAM category, while total sales dollars are down compared to last year, given the lower average selling price of the mix, we did experience a meaningful increase in unit placement of CAD/CAM products year-over-year as we gained traction selling these new digital products in our portfolio.

Margins in the Dental segment were impacted by lower rebates from manufacturers at calendar year-end, lost expense leverage and a negative product mix.

Now turning to our animal health segment.

On a reported basis, consolidated animal health sales grew 4.2% year-over-year.

After normalizing for currency and changes in product selling arrangements, total animal health segment sales rose 4.6%.

Looking at our companion animal business.

For the third quarter, global companion animal sales were essentially after normalizing for the impact of currency and changes in product selling arrangements.

On that same basis, our U.S. companion animal sales were also flat for the quarter.

Growth in companion animal sales flowed in the period, primarily due to promotional timing compared to a year ago.

Production animal sales in the third quarter of fiscal 2018 grew 8.8% in constant currency versus the year-ago period.

Our overall performance in the production animal segment reflects strong top line sales and share gains within the swine and beef cattle species of our business.

End markets in the production animal space continued to be favorable for swine and beef cattle, with some continue pressured in the dairy part of the business from milk pricing.

While the animal health business posted gross margin improvement during the first half of the year, gross margins in the third quarter faced near-term pressure from the less profitable sales mix and fewer rebates compared to a year ago.

Operating expenses reflected some spending discipline and yielded a 30 basis point year-over-year improvement.

However, operating margins in the quarter were down 114 basis points over the prior year period.

Now I will conclude with a look at several key balance sheet and cash flow items.

On a year-to-date basis, through the first 9 months of 2018, we've generated $40 million of operating cash flow compared to the use of $13 million through the first 9 months of last year, yielding a net improvement of $53 million over last year.

As Mark mentioned, working capital continues to be impacted by the implementation of our ERP system.

Our goal is to stabilize and enhance our processes to further reduce our investments and working capital, and this will certainly be a key component of the fiscal 2019 operating plan.

Our adjusted tax rate in the third quarter was 21%, reflecting the impact of a new U.S. tax legislation.

For the 2018 fiscal year, we now expect our adjusted tax rate to be approximately 31%.

Moving to our capital allocation strategy.

We continue to execute on our strategy to return cash to our shareholders.

In the third quarter of fiscal 2018, we returned nearly $38 million to our shareholders in dividends and share repurchases.

That brings the total for the first 9 months of fiscal 2018 to $162 million.

Given our performance through the first 9 months, we have revised our outlook for the remainder of fiscal 2018.

We now expect GAAP earnings to be in a range of $2.13 to $2.18 per diluted share.

Non-GAAP adjusted earnings are now expected to be in a range of $1.65 to $1.70 per diluted share.

Our adjusted earnings guidance excludes the after-tax impact of deal amortization expenses of $26.9 million or $0.29 per diluted share, integration and business restructuring expenses of approximately $5.7 million or $0.06 per diluted share as well as a provisional net tax benefit related to the 2017 tax act of approximately $77.3 million or $0.83 per diluted share.

And with that, I'll turn the call back over to Mark.

Thanks, Ann.

I expect you may have some questions regarding FTC's administrative complaints.

Let me briefly comment on that before I conclude and Ann and I open the call up to take your questions.

As we announced, Patterson believes the allegations are meritless, and we intend to vigorously defend ourselves.

There are a few items we'd like to highlight regarding this matter.

First, we operate in a market with an extremely competitive dynamic among peers and competitive prices.

Second, Patterson always has and always will act unilaterally and independently on all competitive matters.

And finally, we do not anticipate this matter will have a material adverse effect on our financial condition or results of operations.

It's also important to note that the complaint seeks injunctive relief and does not seek monetary damages.

While we take this matter seriously, we will not allow this complaint to take any attention away from our business.

The entire Patterson team remains squarely focused on improving our execution and improving our performance.

While we have a lot of work ahead, there is tremendous opportunity at Patterson, and my early days with the company have reinforced my confidence in our strong position for the future.

We are implementing the necessary changes across the organization to drive better execution, which will improve our results and strengthen our foundation for the long term.

With that, we'd like to open the line so that Ann and I can take your questions.

Operator?

(Operator Instructions) Your first question comes from John Kreger from William Blair.

Mark, I think one of the things you mentioned in your remarks was sourcing initiatives and private label.

Can you just talk a little bit more about that?

My perception is that was not really part of Patterson's strategy historically.

That would certainly make sense.

How -- what sort of investment and infrastructure changes is it going to take for you to implement that change?

Yes, John.

Thank you.

I think first of all, the first step we took is that part of the organization is now reporting directly to me.

And certainly, I believe there's an opportunity to really build out a strategic sourcing team.

We'll certainly invest in that team and also the technology tools to help advance our initiatives there.

We also -- we have certainly a broad private-label offering today, but we have an opportunity to improve penetration of private label products in our existing accounts and also to expand our portfolio of private label products.

And so we're aggressively pursuing that initiative as well.

And certainly, as we continue to build out those initiatives, ensuring that we have good alignment around our incentive structure with our field teams and sales organizations, will be an important element to executing against that.

So I believe that we have a real opportunity to build out a top flight sourcing team.

And this is going to be -- will need to be a key part of our ability to improve execution of our results over time.

Great.

And then one other thing.

Can you just talk about the corporate account initiatives that Patterson's had over the last couple of years?

How was that doing?

And are you satisfied with the profits that, that's yielding?

Well, I think, that's certainly an area that we've put more focus in.

I've had an opportunity to meet with several of our large DSO customers and also -- both on the dental side and certainly some of the corporate accounts, national accounts on the vet side.

I think this is an opportunity for growth for us as well.

Certainly, the expectations that those large national accounts have are very high.

And we need to ensure that our customer experience is meeting those high standards.

And we also believe that we can bring some valuable business support to those types of customers as well.

So that certainly is an opportunity for us to continue to grow.

The expectations of that marketplace are very high.

But clearly, there is a continued shift in the markets we serve to more national accounts that we need to make sure that we have a strong position there.

The next question comes from Jon Block from Stifel.

Maybe 2 questions.

The first one, just the magnitude of the margin compression.

We're certainly surprised.

I mean, the top line was largely in line.

So maybe twofold.

One, Ann, is there a new animal health margin to think of?

Previously, you used to allude to sort of that 5% bogey a couple years out, but we obviously took a step back in the current quarter.

And then, if we shift over to Dental, can we see dental op margins rebound in fiscal '19?

I'm really not asking for guidance per se, but when I think about dental op margins, the ERP expense should begin to incrementally subside next year.

And then, Mark, I'm guessing a lot of the reps that you're onboarding should also start to turn, I don't know, profitable, but at least contributing to the top line.

And then, I got a quick follow-up.

Sure.

So yes, clearly, the surprise in the quarter and to your point, we were largely in line with the top line, that was really the margin (inaudible) compression, particularly in gross margins.

And as you look at the animal health business, that really was more tied up in some product mix challenges in the current quarter that then impacted our ability to hit certain year-end rebates.

So we really feel like that's more of a temporary issue.

And when you look to the Q4 and FY '19, we expect the margins to rebound to what we've seen earlier in the year to say that 3.5% to 4%.

That's kind of the story with Animal Health.

I think the other thing you'll notice is we did have an increase in the corporate lock, which was really tied to our equipment financing portfolio.

And that's really attributed to an increase in interest rates.

We saw about a 10% increase in the forward rate curve in the last 90 days.

And then that, coupled with the lower equipment sales, definitely had an impact at our gross margins.

And while that's tied to Dental, I think the additional challenges that we had in Dental in the quarter are similar to Animal Health.

It was really more around product mix and year-end rebates.

So I think as we think about long term, I'll turn that over to Mark to talk more about the long-term margin profile.

Yes.

I think it comes back a little bit, Jon, to the first question, which is, we need improve our capabilities and our execution on the buy side.

And that can certainly help stabilize and enhance the margins over time.

I think product mix is a big component of that as well and also making sure that the incentives are aligned with our field sales organization to really focus on those products that drive improved profitability for us and then making sure that the organization is very aligned around selling the products that, again, are important for us to sell that obviously meet our customers' needs but then also improve our overall mix.

And certainly, continuing to ensure we have a cost structure that fits appropriately within the sales and profitability of the business is crucial.

And while that obviously doesn't affect gross margins directly, it certainly would have an effect on our operating margins over time as well.

So those are the things that we're focused on.

And again, while obviously the ERP transition has been very disruptive and has presented a variety of challenges for us, certainly, being on a common platform going forward, and once we really stabilize the situation there and then be able to use the common platform to help execute against these initiatives around customer segmentation, mix management, field sales execution, again, I think there's a variety of initiatives that we're focused on to help drive the margins over time.

Okay, great.

And then, maybe just a quicker, tighter follow-up question, just on the consumable trends specific to Dental, continues to struggle a little bit.

There are some moving parts where, arguably, now you've lapped the Heartland contribution.

Can you maybe comment to the moving parts of bringing sales reps on, lapping Heartland?

And of course, the Block business from CEREC is clearly more competitive today versus what was the case 12 months ago.

Yes.

I'll touch on that and Ann certainly can join me.

I think the results in our consumables product segment, the trends there, I think, are primarily a result of the various disruptions that we've obviously seen over the course of the transition that the company's going through, that we referenced.

We are continuing to invest in our sales organization.

We continue to add new sales reps.

We continue to add new equipment specialists.

And we're also putting in place a very formal methodology to kind of assess the productivity of new sales reps to make sure they have the tools and training necessary to get up to speed quickly and to begin to be productive.

And so I think those are going to be key elements executing well there to really stabilizing and ultimately, obviously, growing our consumables business.

Not sure if you have anything specific to add around that or CEREC in particular.

No.

I think you've touched on it.

I mean, there's clearly a number of factors negatively impacting the category.

So you touched on the added risk to the Block business, given open distribution, we've got the disruption from ERP, and then Mark touched on the headcount.

I would say, while we're not going to quantify those items discreetly, clearly, the headcount is having the largest impact on that number.

And your next question comes from Kevin Ellich from Craig-Hallum.

I guess, first, Ann, it's been great working with you.

I'm sure our paths will cross again.

Talking about animal health side, you guys have seen some really good growth in the production animal business.

Wondering if you're seeing any turn in the dairy market yet.

And then on top of that, Ann, you made a comment about missing some year-end targets for rebates.

Wondering if you could give a little bit more color behind that?

Is that really demand for certain products subsiding or is it a certain product category?

Any color would be helpful.

Sure.

Thanks, Kevin.

So when you look at the production animal sales up 9%, clearly, awesome growth for that segment.

And it really came more out of the – while we saw a small rebound in dairy, it really did come more out of the swine and beef market.

So I would say that we still kind of continue to have a flattish to down dairy market.

But where we're seeing a brighter spot in terms of outlook in the trend is really in the beef and pork market.

As it relates to the rebates, I think the additional color that I would give you is it's more about mix and shift in mix and aligning that, as Mark alluded, with compensation plans that were hitting the rebate targets.

So we just -- it's more about mix than it is particular vendors or product categories.

Great.

And then going back to the dental consumable weakness that you've seen, you've given a lot of good color.

Just wondering if you're seeing any additional pressure from the online sellers like Amazon and if that's having an impact on your consumable growth?

No, yes, thank you.

I think, generally, it's a very competitive market, for sure.

I don't think we're seeing necessarily an added pressure there.

I think certainly, there's pressure, and there's the dynamics going on in the segment.

Certainly, I think our ability to improve the customer experience and really improve our core day-to-day business execution is going to be the key driver of stabilizing and growing our consumables business over time.

And certainly, we'll need to continue to compete in a competitive environment.

Our focus is really on providing a complete value proposition for our customers.

And this idea, we certainly want to be more than a supply partner, we want to be a business partner.

And so we believe that our broad value proposition, services, technical support, broad equipment portfolio, software technology, et cetera, is really key to having a competitive value proposition that can win in the market.

And certainly, as we can improve our execution on the core day-to-day business, we believe that, that will stabilize the consumables business for us.

Your next question comes from Jeff Johnson from Baird.

Ann, I wish you all the best luck in the future.

And Mark, maybe starting with you.

Just if I look at kind of the last few quarters, your dental consumables growth have been trending kind of down 3% to 4% or maybe closer to 4%.

The 300 basis points kind of sequential fall off to 7% -- a little north of 7% this quarter, that represents about $10 million in absolute dollars.

Ann, I respect that you said you don't want to be specific on certain things.

But maybe, just that incremental $10 million fall off, can you help us understand how much of that might have been a downshift in the market, if at all?

How much might be loss of the CEREC consumables versus how much might be just kind of your continued internal issues?

If you could help us bucket in that way or any other way that I think would be helpful.

Yes, sure.

So I would say, it's really more of our internal issues than it is.

We haven't seen much of a change in the end market.

As Jonathan alluded, we did have the Heartland contract annualizing, which was adding some growth.

But I would say, again, it's more around headcount and adding those rest back in the system and more of kind of the internal headwinds we have with ERP than it is anything we're seeing in the market or in the block category, in particular.

All right.

And then 2 clarifying questions.

I guess, one, you talk about CAD/CAM being up for the first time in a while.

It sounds like you're now including DI in there, and we've heard some good initial feedback on some 3Shape sales and all that.

But can you talk at all about kind of the core CAD/CAM, the CEREC or at least high-end premium CAD/CAM versus the DI business, how those 2 trended in the quarter, if at all?

And then secondly, on the interest rate move and the $10 million incremental loss on the corporate costs -- or on the corporate profit side that you tied together, I just want to make sure I understand, is that going to continue going forward then?

Because your fourth quarter implied guidance would seem to imply another margin down in the 3% to 4% all-in range, so it doesn't sound like necessarily that equipment change on the profitability of the contract is going to abate after this quarter.

Yes.

I'll take that one first, and then I think Mark can address the other question.

But yes, that's right, Jeff.

When you look at the increase in the interest rates and the challenge that we had in the equipment portfolio, we are expecting that to continue into the [future].

Yes.

Just, Jeff, back to the first part of your question and certainly wouldn't comment specifically on specific product lines or specific manufacturers.

But I do think we believe that the market continues to evolve.

There's technology innovation.

Obviously, broadening our equipment technology portfolio, I think, was an important decision for the company.

And I think we're seeing some early favorability just in terms of our overall unit placements.

At the same time, we still remain very focused on the CEREC product as well.

We've had an opportunity to connect several times with Don Casey, the new CEO.

And our teams have been meeting to build action plans to continue to focus on that product.

So what I would tell you is, we broadened our portfolio across digital technology and equipment.

And we're focusing actively with all of the products in that portfolio and continue to work closely with the manufacturers to develop our funnels, build action plans, put promotional activities in place in the field.

This obviously is a big focus for us to drive that portfolio of products.

Your next question comes from Sarah James from Piper Jaffray.

I wanted to unpack the sales force turnover.

Was this a loss of a few key salespeople?

Or was it more broad-based that we should think about it more as the scale of sales exits?

Well, I'll maybe comment, and then Ann can provide perhaps a little bit of context.

I mean, I think the original kind of reorganization in the sales force took place quite some time ago.

I think since then, we've had a fair amount of disruption as a result.

And while we have continued to reinvest in the sales organization, both with new territory reps, new equipment specialists, we do see some continued turnover amongst our reps, which is normal in the business that we're in.

So I wouldn't say that there was a specific event that occurred during the quarter but certainly, an issue that has been a disruption for some time.

And our focus now is to, first of all, make sure we have the right people and the right number of people in front of our customers, both from a territory standpoint as well as from an equipment specialist standpoint, make sure that, that team have the right tools to help them be productive and also to ensure that we're delivering an outstanding customer experience to help them be successful in the day-to-day operational elements of working with our customers.

And we believe that improving in those areas can help drive improved performance.

I'm not sure if you want to provide any additional color?

No, I would just add to what Mark said.

It wasn't an event in the current quarter.

It's more -- as Mark said, it's kind of the disruption that's been in the past and our ability to get the new folks that are on board productive and up to speed.

Got it.

And can you talk about the recruiting environment?

Are you finding the type of experienced talent with existing client relationships that you need?

Or is this more about training up new salespeople sort of starting early on in their career?

I think it's a combination.

I've got an opportunity to engage with, I think, 3 of our new sales rep training classes over the past 90 days.

And I think it's a really good mix of folks that have existing sales experience.

Some in the markets that we're in, some in other markets that are really fired up to be part of the Patterson team.

And we're obviously investing heavily in the tools to help make them productive, the training, to get them up to speed quickly.

And we're certainly very focused on a methodology to kind of measure that productivity and make sure that our sales team are meeting the expectations that we have of them and that we're obviously delivering on the expectations they have of training and tools and education.

So I'm very pleased with the profile of the types of individuals that we're bringing on.

It's been exciting to engage with them directly and proud of our team and the experiences that they bring.

Your next question comes from Erin Wright from Crédit Suisse.

What's embedded in guidance at this point as it relates to the new initiatives, I guess, following your 90-day review?

Or will those costs, I guess, associated with those initiatives start more in fiscal '19?

And anything you can quantify at this early juncture?

Yes.

Thanks, Erin.

Obviously, given our guidance for the rest of the year and really for Q4, I mean, certainly, we're seeing -- I mean, we expect some of the challenges and the negative trends to continue, and that's obviously reflected in our expectations.

We are taking urgent action, many of which have been taken, others of which are in the process of being taken.

And we expect that to really be our sole focus here in the coming months.

And we're not in a position today to provide guidance around FY '19.

Certainly, we'll do that on our Q4 call in June and certainly would be in a position to lay out more specifically the additional actions that we're taking and to the extent appropriate, quantify what we expect to deliver from those actions.

Okay, great.

And then I think there may have been some churn amongst GPO relationships on the animal health side.

Does that have a material impact on your business near term?

And can you speak to the nature of the types of relationships you do have in animal health on the GPO side?

And I guess, are any -- are many of them exclusive relationships?

Well, without commenting specifically on our exact customer relationships and the nature, I think there was one group in that part of the business that we, I think, communicated previously.

We've actually been really pleased with our ability to hold on to the business there.

We're obviously engaging directly with those customers.

And so we don't anticipate that, that's having or will have a material effect on our business there.

Your next question comes from Kevin Kedra from Gabelli.

First, Ann, want to extend my best wishes to you.

I have a couple of questions for you and then maybe a follow-up.

First, on tax rate, how should we be thinking about that going forward?

Sounds like, based on the blended rate for this fiscal year you're guiding, but certainly, puts you in a go forward rate in kind of the low 20% rate.

And so how should we think about that?

And then, can you give any clarity between the breakdown between performance of basic equipment versus tech?

Sure.

So if you think about the blended tax rate of 31% for the current year, that's basically 3 quarters of the year at the higher 35% rate.

And then our go-forward rate will actually be closer to the 24% to 27%.

So that's what we're looking for, for FY '19 and beyond at this point.

Obviously, the rules are still -- many of those rules are provisional, but we're thinking in that range of 24% to 27%.

As it relates to the equipment, we mentioned that we were down around 10% to 11%.

And I would say, it was down, that similar range across all product categories, both basic and technology.

Great.

And then, Mark, maybe kind of more broad question.

I know you've only been at the helm for about 90 days or so.

But clearly, the stock's trending down about 8-plus-year lows.

You've got 2 business, Dental and animal health.

One performed -- Dental clearly has some struggles that you're working on.

Animal health seems to be more stable and performing well, and some of the issues there were more short term.

At what point do you consider potential strategic alternatives, given that you have 2 separate businesses that seem to be going in different directions?

Well, certainly, we're focused on improving execution across the company and certainly across both those businesses.

And we do believe that there's an opportunity to support both of those businesses with improved execution.

Obviously, we're committed to delivering long-term shareholder value.

And we think about those businesses both in terms of the unique markets that they're in and the unique strategies they need to employ and the unique value propositions that they need to deliver, but also, how they do tie together.

And we believe many of the steps that we're taking here to improve execution around our core business processes, around strategic sourcing, private label, around our cost structure and around the financial discipline metrics, that those initiatives can support and improve the performance in both businesses.

So certainly, we're pleased with the markets that we're in and the end market fundamentals that are taking place in those segments, and we're continuing to focus on driving results for both our segments.

The next question comes from Robert Jones from Goldman Sachs.

This is Nathan Rich on for Bob this morning.

Just a clarification on the new guidance range.

I understand the moving pieces that you guys laid out.

But just based on what the guidance implies for 4Q, it seems like the margin pressures that you guys saw in the third quarter are expected to accelerate a little bit in the end of the fourth quarter.

So could you just help us better understand kind of what specific areas you think could get a little bit worse in 4Q and maybe some of the steps you're taking to address those in the quarter?

Sure.

I'll start, and then Mark can chime in.

I think we talked about -- the first thing I would point out is Q4 is our largest volume quarter and it's year-end.

So just part of the year-end process, we're doing physical inventories and true-up, and so there's just inherently more risk in the quarter given the volume and the fact that it's year-end.

And then you kind of couple that with the trends that we're seeing.

Certainly, as Mark mentioned, we're urgently putting actions plans in place, but it will take some time to see those in the results.

And so that would be how I would kind of start out.

Yes.

No, I think just to reinforce that, I mean, certainly, we're seeing some challenging trends in the business, obviously, and that's reflected in our results.

We're taking actions to address those, but those actions aren't going to take hold overnight.

And so -- and we expect to see some of the continued trends that we're facing and the challenges in our business that we've outlined here today continue on in Q4.

Okay.

And Mark, just a quick follow-up, if I could.

Just on your comments on the sales force, I mean, this obviously is a core competency for the company, and it seems like an area where you're going to be investing.

I guess, my question is, do you need to maybe do a broader sales force reorg, bring on either more headcount or more specialists to better serve those customers?

I'd just be curious to get your thoughts on how you think the sales force should look like going forward.

Yes.

Thanks, Nathan.

I think we are investing in more territory reps, more equipment specialists.

And I don't think we have a magic number necessarily, but we're going to continue to invest and ensure that we have the right folks on the ground.

And as the markets continue to evolve, we'll continue to evolve our sales force to best support our customers.

Certainly, we're not considering any type of sales force reorganization.

Our focus is on investing our sales team, giving them the tools to help improve their productivity, making sure their incentive structure is aligned with the key focus areas of the company and frankly, ensuring that we improve our execution around the customer experience so that they can be focused on working with our customers and talking about our value proposition.

So that is a core competency here at Patterson.

The sales reps and our field teams play a crucial role in our success, and we're going to continue to invest there and make sure that they continue to help drive performance.

And your next question comes from Stephen Hagan of RBC.

I just wanted to follow up on the question we just had about the expectations for Q4.

Some of your comments before have kind of indicated that animal health had some onetime items in this quarter.

So what really gets worse in Q4 and offsets -- what should be a bit of a benefit there?

Yes.

So I think it's just more on the Dental side and some of the items that we talked about.

So certainly, yes, we think that the animal health Q3 is more of anomaly.

We expect Q4 to sequentially improve and be more in line.

The 2 things that I would point to is kind of the continued uncertainty with interest rates and the impact on the equipment financing portfolio at corporate as well as some of the headwinds on the Dental business.

Clearly, just inherently, based on the results in the current quarter, there's more risk in that business than it was 90 days ago.

And so I think we've put guidance together that we think is prudent based on that information.

Okay.

And then just on the dental equipment.

The comps seem to get easier in Q4.

You're probably getting closer the end of the disruption related to the digital equipment.

Should we see a better year-over-year trend for that line in Q4?

Or does the kind of interest rate environment still make it challenging?

Yes.

We don't necessarily give revenue guidance or guidance by specific categories.

But I would say, if you look at the current quarter, you're definitely seeing we're still down in the current quarter.

But we're definitely seeing an improvement in the trends.

And I would just keep in mind, as we're making progress in the digital product categories, they have a lower average selling price, so it's just going to take some time to annualize that in.

And I would also just add, I think with just the changes in the portfolio, I think some new product development and new introductions that are taking place, I do think our customers are still thinking through what their options are in terms of these products.

And so I do think that, that also has contributed to some of the softness in this area.

And your final question for today will come from Michael Minchak from JPMorgan.

So you mentioned private label as an opportunity to drive margin expansion.

Was just wondering if you could talk about sort of where you currently stand with respect to private label penetration in the Dental business and where you think that could potentially go over time, whether there's any issues with your larger branded suppliers as you look to grow that private label category?

And then maybe if you could just give us a sense for how the margins on those products compare to branded products.

Well, without getting into specifics, we're not where we need to be from a penetration standpoint.

We have, certainly, I think, a fair amount of opportunity and upside to get to penetration rates that we believe that would be appropriate for these types of products.

We also have an opportunity to expand our portfolio.

So obviously, multiple ways to grow private label and we're focused on both.

Obviously, expanding the portfolio takes more time than improving penetration with the existing portfolio that we have.

I think in terms of implications with our supplier partners, obviously, private label is an important part of our portfolio.

We work with many of our suppliers actually on private label.

And we look forward to continuing to work closely with our suppliers to ensure that we have a very competitive cost position, both across our private label products as well as our branded products.

And we think about the portfolio comprehensively, and we need be to ensure that we have a market-leading cost position going forward.

And certainly, a good mix of both private brand and branded products will be important to that.

So that'll be a big focus for us.

And I would just, again, reiterate, critical to success for that type of initiative is to make sure that your incentive structure is aligned because all of these -- the sales reps and the relationships that they have and the importance of that, that I just referred to is a critical element to executing against that initiative as well.

Got it.

And then maybe just to go back to the dental consumables side.

Obviously, a couple of company-specific factors are driving the recent trend there.

I'm sorry if I missed this early on the call, but can you give us any color in terms of your thoughts on the underlying market growth?

Are we still seeing sort of flattish but stable trends there?

Any updated thoughts on sort of what might be driving the sustained weakness that we've been seeing there?

Well, I think our view of the market, I think, is reasonably stable.

I think probably flat to very slight low-single-digit growth.

I think that kind of continues to evolve.

But I think we certainly believe that it's reasonably stable.

Thank you.

Well, thanks, again, for joining us today, and we look forward to speaking with you again in June as we close out our fiscal year with our Q4 results and provide our guidance for FY '19.

Thanks very much.

Thank you, everyone.

This will conclude today's conference call.

You may now disconnect.