Patterson Companies Inc (PDCO) 2018 Q4 法說會逐字稿

Good morning.

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

At this time, I would like to welcome everyone to the Patterson Companies Fourth Quarter 2018 Earnings Conference Call.

(Operator Instructions) John Wright, Vice President, Investor Relations, you may begin your conference.

Thank you, operator.

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

Joining me today are Patterson President and Chief Executive Officer, Mark Walchirk; and Interim Chief Financial Officer, Dennis Goedken.

After a review of the fourth 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 materially differ from those indicated in such forward-looking statements, are discussed in detail in on 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 rate 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, June 21, 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 the fourth quarter and full year of both fiscal 2017 and fiscal 2018.

The reconciliation table in our press release adjusts reported GAAP measures, namely earnings from continuing operations, net income from continuing operations and earnings per diluted share from continuing operations for the impact of the transaction-related costs, deal amortization expenses, intangible asset impairment, integration and business restructuring expenses, along with the related tax effects of these items, the impact of the 2017 Tax Act and other discrete tax matters.

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 turn the call over to Mark Walchirk.

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

On today's call, I will provide a brief overview of our fourth quarter results, the progress we are making against our strategic objectives and our outlook for fiscal year 2019.

Fourth quarter results met our revised expectations.

We delivered adjusted Q4 earnings of $0.30 per diluted share and full year adjusted earnings of $1.68 per diluted share, which was within our revised guidance range.

As we anticipated, our results for the quarter reflected the ongoing business challenges we faced throughout the fiscal year, including the impact of our sales force realignment and ERP implementation, the market transition to new technology offerings and our decision to broaden our portfolio of those offerings within the Dental segment.

While we anticipate that these business challenges and trends will continue in the near term, we are making progress to stabilize the core fundamentals of our business and execute on our growth objectives with the actions we have taken over the last 6 months.

As we continue to stabilize the core, we expect to return to earnings growth in the second half of fiscal year 2019.

Dennis will provide more details on our overall performance, but I'd first like to touch on the results across our segments.

As we expected, our results in the Dental segment reflected softness in both consumables and equipment as well as a change in estimate related to year-end inventory valuations.

In the quarter, we continued to transition our offerings in digital equipment at a time when the overall market dynamic reflects demand for a wider range of digital solutions and a broader mix of products.

While results continue to be impacted by the expansion of our digital portfolio, we believe this is the right approach to capitalize on opportunities to sell new digital solutions.

Our Dental segment is going through a significant transition, and we believe we are focused on the right initiatives to improve performance of the segment in fiscal 2019.

In the Animal Health segment, we reported revenue growth across both the production animal and companion animal businesses.

Profitability in this segment was also impacted by a change in estimate related to year-end inventory valuations as well as faster revenue growth from our production animal business, which typically carries a lower gross margin profile compared to our companion animal business.

Looking ahead to fiscal '19, Animal Health continues to benefit from stable growing end markets, and we expect to improve our performance by taking advantage of these market opportunities, implementing a number of initiatives to improve product mix and continuing to manage our costs effectively.

While we met our revised expectations in the quarter and for the year, our overall performance certainly did not reflect our potential.

We must continue to implement our plans to drive more effective execution and improve performance.

In recent months, our team has been moving to stabilize the business and fix our core fundamentals as we reposition Patterson for long-term growth.

Last quarter, I outlined several areas of focus, and I want to provide an update on the progress we've made against these important initiatives and how we expect to build upon them moving forward.

As a reminder, these key initiatives included: improving the customer experience, enhancing our sales execution, stabilizing margins through our focus on strategic sourcing and product mix, driving improved cash flow and reduced working capital, and finally, continuing to build the overall talent at Patterson.

Let me touch upon our progress in each of these areas.

Last quarter, we talked about the need to improve the customer experience and our focus on making it easier to do business with Patterson.

In my recent conversations with customers and our field team, it's clear that our efforts in this area are having a positive impact in the marketplace as our fill rates, payment processing and overall order quality have shown meaningful improvements over the past 90 days.

We are pleased with the progress in the area and confident that our plans will ensure we continue to provide our customers with the capabilities and support for improved experience and improved customer satisfaction.

Going forward, with the ERP implementation now substantially complete, we are focused on how we can leverage our common platform to improve customer satisfaction.

That includes bringing to market system enhancements that will further improve the customer experience.

And 2 specific examples include the introduction of our new online returns processing tool and an upcoming launch of a new online bill payment platform, again, designed to simplify customer interactions and generally improve the customer experience.

As I indicated last quarter, we also developed a set of customer-focused metrics to hold ourselves accountable against these service improvements.

And while we are pleased with our progress in this area, our entire leadership team will continue to regularly review these metrics as we seek to continue to enhance the customer experience and customer satisfaction.

The second area of focus is on sales execution and productivity.

We remain focused on investing in and building out our sales team, investing in tools to enhance their productivity and ensuring our field teams are aligned to support key initiatives and broader company goals.

During fiscal '19, we expect to continue investing in these areas and believe as we continue to build out our sales organization, we will improve our consumables and equipment results.

In recent months, I've had the opportunity to meet with a number of our sales and field team members across both of our businesses.

The relationship between our field teams and our customers is critically important to the future of Patterson, and we are absolutely committed to helping our team enhance those relationships and to help make them even more productive.

It's clear from my conversations that the investments we are making to support our teams will have an impact, and we will continue to invest in building customer relationships and sales productivity.

For example, we are in the process of rolling out a new sales productivity tool with our dental field sales organization at our upcoming national sales conference, which will give our teams the ability to drive initiatives across the sales organization.

This enhanced tool, which is made possible by our new ERP system, demonstrates one example of how we'll leverage the common platform over time to drive our business goals.

As we focus on the customer experience and improving sales execution to drive top line growth, we are equally focused on stabilizing our margins through our strategic sourcing initiatives and improving our product mix, including our focus on private label.

With respect to strategic sourcing, we are establishing important relationships with our vendors and working to drive more value with our strategic partners.

During the quarter, we completed several RFPs in our dental consumables business designed to improve our sourcing efficiency.

And while we started with smaller categories, we are pleased with the initial results around driving acquisition cost savings and increased marketing and promotional support.

As part of this initiative, we are also evaluating our vendor selection criteria and SKU portfolio with the goal of improving supply chain efficiency, and ultimately, driving greater profitability.

During fiscal 2019, we expect to continue executing our sourcing strategy with the intent of driving additional value for both Patterson and our selected vendor partners.

Similar to our other initiatives, we have established specific goals across the business to ensure strong alignment and accountability on this key initiative.

In terms of our focus on private label, we established specific private-label growth goals across both our businesses, and we've aligned management and the sales team around increasing penetration of our existing portfolio as well as adding new products to our portfolio over time.

Looking ahead, we expect to grow our private-label franchise at a faster rate than our overall consumables business.

Next, we expect continued improvement in cash flow in fiscal 2019, driven by our initiatives across the company around accounts payable, accounts receivable and inventory.

We've also set specific performance measures in this area to improve our working capital performance, and we are committed to using our ERP platform to deliver the fill rates that our customers expect, while also managing our business more efficiently and productively.

Finally, we are excited about the progress we are making to build out our leadership team.

As you've seen, we recently announced the appointments of Don Zurbay as Chief Financial Officer; and Andrea Frohning as Chief Human Resources Officer.

Both Don and Andrea come to Patterson with previous public company experience and bring tremendous leadership expertise as we continue to position the company to drive improved performance.

Don will be officially joining us on June 29 and brings more than 28 years of leadership experience in various accounting and finance positions.

His strong track record of successfully leading finance teams, particularly during periods of growth and change, will be instrumental as we focus on improving our execution and results.

And we look forward to Don joining us at what is obviously a key point in our company's history.

Andrea joined Patterson on May 21.

She brings more than 20 years of experience in leading numerous human resource departments across a diverse set of business environments and industries.

We are excited to benefit from her experience guiding Fortune 500 companies through transformation and helping to align our people and resources to our strategic priorities.

We are glad to have Andrea on board and she's already off to a great start.

I'm excited about the leadership team we have in place and look forward to continuing to build on this momentum.

As a result of these various initiatives and actions, we are confident in our ability to drive improved performance in fiscal '19.

We've issued fiscal year '19 GAAP earnings guidance to be in a range of $1.43 to $1.53 per diluted share, and adjusted earnings guidance in the range of $1.73 to $1.83 per diluted share.

Importantly, as we stabilize the core, we expect year-over-year profit growth in the back half of fiscal 2019.

Looking ahead to fiscal '19 and beyond, our entire organization is operating with a sense of urgency with regard to what we need to do to enable Patterson to reach its full potential.

We've set clear objectives, which include a focus on revenue, margin and cash flow to stabilize the platform, improve profit growth in the second half of the year and deliver shareholder value.

We are aligned around these objectives as a leadership team and are driving the accountability broadly across our business segments and the entire organization.

By taking a more disciplined approach with a greater focus on our operational rigor, we believe we are well positioned to execute against our key initiatives.

As we indicated last quarter, we have also initiated a strategic planning process to review how to best position Patterson for the future.

In recent months, we've made good progress by taking a thoughtful and broad approach when evaluating Patterson's long-term growth opportunities.

Our leadership team and our board are highly engaged in this process and working closely together, and we expect to have more to share later in the year.

Before I turn the call over to Dennis to provide more details on the quarter, I'd like to personally thank him for taking on the added role of Interim CFO and helping to ensure a seamless transition.

Dennis has done a fantastic job these past several months and has played a critical role in supporting our near-term actions and really helping to build out our FY '19 plan and these key initiatives and remains a valued member of our team going forward as he will continue to serve as our Corporate Controller.

So with that, Dennis, thank you, and I'll turn it over to you.

Thank you, Mark, and good morning, everyone.

My comments will focus on the fourth quarter fiscal 2018 and our outlook and guidance for fiscal 2019.

Our performance in the fourth quarter of fiscal 2018 reflect the impact of the factors Mark has described.

Consolidated sales for fiscal 2018 fourth quarter were $1.4 billion, down 3.1% versus a year ago.

Internal sales, which adjust for the effects of currency translation and changes in product selling relationships, declined 3.3%.

Our fourth quarter consolidated adjusted operating margin was 3.6%.

In the quarter, our operating margin compression was driven by the decrease in sales and margin within our Dental business, a contribution to our employee stock ownership plan and a change in estimate related to our year-end inventory valuation as our new ERP platform now gives us better real-time visibility into our inventories.

On the bottom line, GAAP net income from continuing operations for the fourth quarter was $20.9 million or $0.23 per diluted share compared to $61.4 million or $0.65 per diluted share a year ago.

Adjusted net income from continuing operations, which excludes certain nonrecurring deal amortization costs, totaled $28.2 million for the fourth quarter of fiscal 2018, down from $65.6 million in the same quarter last year.

Adjusted earnings per diluted share from continuing operations was $0.30 in the fourth quarter of 2018 compared to $0.69 in the fourth quarter of last year.

Now let's turn to our segments.

In Dental, the 2018 fourth quarter sales reflected the continued disruption from our sales force changes, the customer impact from the implementation of our new enterprise resource planning system and market transition occurring within the digital equipment category.

On a reported basis, Dental sales were down 10.1%.

Internal sales, which adjust for the impact of currency translation, declined 10.5% versus the prior year quarter.

On that same basis, Patterson's sales of consumable dental supplies decreased 6.7% during the 2018 fourth quarter, and total equipment sales declined 20.2%.

Operating margins in the Dental segment were impacted by lower sales volumes and margins and the change in estimate related to our year-end inventory valuations.

Now turning to our Animal Health segment.

Consolidated Animal Health sales for the fourth quarter grew 2.5% year-over-year.

Internal sales, which adjust for the impact of currency and any changes in selling relationships, grew 2.4%.

Looking at our companion animal business.

For the fourth quarter, internal sales for our global companion animal business increased 1.9%.

On that same basis, our U.S. companion animal sales grew 1.1% for the quarter.

For production animal, internal sales in the fourth quarter grew 2.8% compared to the same period a year ago.

As we mentioned last quarter, the third quarter internal sales growth of production animal of 8.8% reflected some timing of sales between quarters.

Our overall performance in the production animal segment continues to reflect solid top line sales and share gains as the end markets remain favorable for swine and beef cattle, with some continued pressure in the dairy part of the business, driven by milk pricing.

Operating margins were down in the quarter versus the prior year, reflecting the change in estimate related to our inventory valuation and an ESOP contribution.

Now for a look at several cash flow and balance sheet items.

During fiscal 2018, we generated $179 million of operating cash flow compared to $163 million during fiscal 2017, yielding a net improvement of $16 million over last year.

Debt was reduced by $57 million during fiscal 2018.

During the fourth quarter, we realized improvements in working capital, most notably an approximately $100 million reduction in inventory.

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

Our adjusted effective tax rate from continuing operations in the fourth quarter was 29.3%, reflecting the impact of the new U.S. tax legislation.

For the 2018 fiscal year, our adjusted effective tax rate from continuing operations was 30.7%.

Turning to our capital allocation strategy.

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

In the fourth quarter of fiscal 2018, we returned approximately $25 million to our shareholders in dividends.

That brings the total amount returned to shareholders during fiscal 2018 to $187 million.

Let me conclude with our fiscal 2019 outlook and guidance.

For fiscal 2019, we expect GAAP earnings from continuing operations to be in the range of $1.43 to $1.53 per diluted share, and we expect non-GAAP adjusted earnings from continuing operations to be in the range of $1.73 to $1.83 per diluted share.

Our adjusted earnings guidance excludes the after-tax impact of deal amortization expenses of $27.3 million or $0.30 per diluted share.

We expect our adjusted effective tax rate for 2019 to be in the range of 25% to 27%.

We intend to invest the year-over-year tax benefit in fiscal 2019 back into the business to lay the foundation for sustainable long-term performance.

Examples of these investments include continuing to build out our field sales teams, new sales productivity tools and our digital platform.

As a result, our non-GAAP adjusted guidance range for fiscal 2019 of $1.73 to $1.83 per diluted share reflects our expectations for mid-single-digit year-over-year profit growth in our business.

As Mark outlined, during fiscal 2019, we continue to intensely focus on execution of initiatives he described, which we believe are critical to top and bottom line expansion.

We are working to stabilize the core business and these actions will take time to be fully reflected on our results.

In the first half, we will continue being impacted by the challenges facing our business.

However, we expect to show sequential profit improvement as we progress through the year.

Our annual operating plan calls for year-over-year EPS comparisons to turn positive in the back half of the year.

Given our emphasis on decreasing working capital and on accountability for that objective in our fiscal 2019 operating plan, we intend to generate between $200 million and $250 million in free cash flow in fiscal 2019.

Our current operating plan for fiscal 2019 does not factor in any share repurchases.

In terms of market conditions, our fiscal 2019 guidance assumes North American and international marketing conditions similar to those experienced in fiscal 2018.

In addition, we anticipate diluted average shares outstanding to be in the range of 92 million to 93 million.

Now I'd like to turn it back over to Mark.

Thanks, Dennis, and thank you, again, for all your great work these past few months.

Before we open it up for your questions, I'd like to make a few quick closing comments.

First, we engage in solid and stable end markets with positive long-term growth prospects.

And while the markets will continue to change and the competitive dynamics will continue to evolve, we believe the core fundamentals of our end markets remain attractive.

We have a compelling value proposition focused on helping to drive our customers' success, and this constant focus on our customers will remain as a foundation of how we continue to invest in building solutions to best meet their needs.

Second, as you are well aware, Patterson has gone through a great deal of change over the past several years.

While we have certainly made progress over the past 6 months, the changes we are implementing and the investments we are making will take time to take hold.

That being said, we have put the right framework in place to stabilize the core business, and we expect to generate year-over-year profit growth in the second half of fiscal '19 and to build on that momentum going forward.

We will also continue to take into account the competitive environment and industry dynamics to help inform our point of view and where we expect to take the company long term.

Finally, I'm confident in our people and our team's ability to adapt to change, align around and execute on our initiatives and ultimately to deliver results.

I'm also inspired by our team's focus and dedication to our customers and the lasting relationships we've built that drive mutual success.

We clearly recognize the need to operate the business with a heightened sense of urgency, accountability and financial discipline.

Our collective focus is on executing our initiatives to improve our financial performance and deliver shareholder value.

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

Operator?

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

This is Jon Kaufman on for John Kreger.

So in regards to your fiscal 2019 guidance, can you talk about your expectations for Dental revenue next year as well as your expectations for margins?

It seems like a material acceleration of margins compared to Q4 is implied in guidance.

We're coming out to maybe about 100 basis points higher than where they were this quarter.

So how much of that is better sales force productivity versus better sourcing versus not having the inventory valuation change?

Any clarity there would be really helpful.

Yes.

Jon, thank you for your question.

I'll ask Dennis maybe to start and then certainly add some comments.

I will suggest we don't specifically give guidance around segment revenue, so just as a way to tee off the answer.

Sure.

Yes, but you're on point there.

Basically, there were some nonrecurring items that happened in Q4 that won't repeat themselves next year.

So I wouldn't label or center yourself on the Q4 margins, maybe look more at the full year margins for the business.

Internally, as we built our plan for FY '19, we've obviously taken those factors into account.

And certainly, we do anticipate, Jon, I think to the second part of your question around how we would continue to generate improved productivity from the investments that we've made in our dental sales organization over the last 6 to 12 months, and certainly, we'll continue to add field sales resources in our Dental business in FY '19, which is, again, part of the foundation of how we've built our expected performance for the fiscal year.

Okay, great.

And then switching gears.

On dental equipment, can you talk about this decline here?

Was this is a matter of lower volumes in aggregate?

Or is this really just a switch from the higher-price full systems to some of the DI offerings that you guys now have?

Yes, yes.

Thanks, Jon.

It's primarily the second, so really more an impact of mix.

We actually generated pretty significant unit increases on a year-over-year basis in the quarter as we obviously expanded the portfolio of products that we offer to the marketplace.

But certainly, due to those changes in mix and the lower average sales price of the broader portfolio in this category, that certainly resulted in the revenue decline in that segment that you saw in the quarter.

And certainly going forward, again, as we built our FY '19 plan, we certainly took into account the continued dynamics around these products in the market and how we expect the kind of volume mix to play out in the future.

Your next question comes from the line of Kevin Ellich from Craig-Hallum.

I guess, just following up on the margin question.

Dennis, you made the comment about the inventory valuations.

Could you give us any detail as to how much that affected the margins this quarter?

So I guess, I don't want to go into a lot of detail on exactly how much it affected the current quarter, but I'd tell you it's really a factor of putting in the SAP system and having better visibility and having an integrated system versus our manual system, on our manual reconciliation process that we had in prior years.

Yes.

And, Kevin, just to add, I think, obviously, now being on an integrated platform gives us improved visibility.

And certainly, as we head into FY '19, an opportunity to improve our processes associated with our inventory and ensure that we can have a consistent way to estimate the valuation going forward.

Got you.

And then just switching over to the Animal Health business.

Still seeing some decent growth out of that business.

Dairy, just wanted to get your overall view as if you think that's going to turn around here in the second half of the calendar year.

And then on top of that, your largest competitor decided to unlock some value by spinning off its animal health distribution business.

Is this something that you guys would consider?

Well, to your first question from a dairy perspective, I think we do anticipate a little bit of pressure in the dairy business.

Certainly keeping a close eye on the market environment there overall within our production animal business, which would certainly -- has been performing well.

Obviously, keeping a close watch on just the general trade environment as well.

But we don't anticipate any material changes as a result of that as we think about our FY '19 growth projections in that part of the business.

And certainly, to your second question, we're very focused on the platform that we have.

We absolutely like the businesses that we're in, as I indicated.

I think we're in attractive markets.

We're actually seeing some positive momentum across both our animal health production and companion businesses.

And we're focused on improving execution across both our businesses and improving our performance, and that's where our focus is.

Your next question comes from the line of Erin Wright from Crédit Suisse.

I guess, can you quantify a little bit more in terms of the sales force investment that's embedded in your guidance and sort of your confidence overall in the ramp-up in the second half and your visibility on that front?

You also have a new CFO coming on board.

Are there elements of conservatism in there or buffers that you could highlight?

Yes.

Thanks, Erin.

I think in terms of the sales force investments, obviously, company's gone through a major change in our Dental segment over the last couple years after the sales force kind of realignment efforts from a couple years ago.

We're certainly continuing to build back from that.

We grew the number of sales reps during FY '18.

We expect to continue to invest and grow the number of sales reps during the coming fiscal year, not only in our territory reps, but certainly in our equipment specialists and our CAD/CAM specialists.

And so we're a very customer-focused, sales-oriented company.

I am very inspired about the ability of our sales teams to develop valuable relationships with our customers.

And I think that's going to be a key element of our ability, certainly, to drive the performance that we expect in FY '19.

Certainly, as we continue to invest in bringing new folks onboard, it does take some time for them to ramp up.

And so certainly, as we think about our Dental business and the overall company growing in the back half of the year, the improved ramp-up of our new folks and obviously the continued productivity and focus of our more experienced sales folks is going to be critically important to that.

And certainly, not only are we investing in new people and feet on the street, but also new tools to help make them more productive and help ensure we can drive the key initiatives that are going to support our customers and our company.

So I have a strong confidence that as we continue to invest, we continue to invest in our people and in the tools to help make them successful, that we'll see the results of those investments during the fiscal year.

And I would just add that we have good metrics on how a new rep comes in, what kind of productivity, what kind of commission cost we pay and how that rolls through the plan for next year.

Last comment I should make, I'm heading out of town on Saturday of this week.

We're bringing our entire dental field sales organization in for our national North American sales meeting.

I'm really excited to have a chance to engage directly with that group, and frankly, due to -- to get our teams fired up for FY '19.

Okay, great.

That's helpful.

And on the Animal Health side, it was a little bit lighter on companion animal, which weighed on profitability from a mix perspective.

Were there any anomalies to call out that should improve in that business in the coming quarters on the companion animal side?

And then more broadly, for fiscal '19 in Animal Health to your growth and profit projections here, anticipate any sort of major shift in your vendor relationship?

Dennis, why don't you take the first part just in terms of the margin piece and then maybe I'll take the second part on the portfolio?

Sure.

So part of our vet business is also on the -- were on the old inventory processes, and we moved them to the SAP processes during the year.

So the inventory valuation change affected that business as well.

And I think in terms of companion, in particular, and kind of the product mix, I don't think we expect a material shift.

We certainly are focused on mix in that part of our business, just as we are across the production business and our Dental business.

And some of the comments that we made around focusing on private label, we've actually seen some very nice trending in the private-label growth within our companion business and albeit on a relatively small base.

We're encouraged by the focus that the leadership team has been putting on private label in that part of the business and did a number of new product launches throughout the course of the back half.

But in terms of our relationship, obviously, with the large farmer manufacturers, we're very focused on bringing value and having a comprehensive offering.

And specifically, to your question, we don't expect any material shifts in mix in FY '19.

Your next question comes from the line of Glen Santangelo from Deutsche Bank.

Mark, just a couple quick ones.

Given that you've anniversaried the sales force reductions and you sort of have now anniversaried the amended agreement with Dentsply Sirona, it's kind of surprising to see the equipment and consumable numbers continue to weaken here, and you're expecting that to continue in the first half.

Is there any sort of read-through here in terms of industry growth rates on either consumables or equipment?

What are you guys seeing in the underlying base business?

Well, I think a couple elements there.

I think, obviously, we need to move past the major changes that have gone on with our sales organization over the past couple of years and I think we're making good progress along those lines.

And I think we've also, obviously, changed our strategy with regard to our technology and equipment portfolio.

And I think we've built our FY '19 plans to support that.

I think the dental consumables market is showing low growth, probably in the 0 to 2% range.

And certainly, we do believe that the initiatives that we've put in place, the investments that we're making, frankly, the focus and accountability that we are driving across the organization will help drive the performance that we expect out of the Dental business in FY '19.

And we expect improved performance both in our consumables and equipment business throughout the year.

Maybe I'd just ask one other follow-up question.

I don't know, Dennis, if you're the right person for this.

But in the back half of fiscal '18, the company saw a noticeable step-up in corporate expenses and I think it probably cost the company at least $0.10 to $0.15 in annual EPS just in these last 2 quarters.

What are you assuming as we look towards fiscal '19?

I know the equipment financing portfolio has had a lot to do with that and the recent rising rates.

Are you assuming some normalization back to historical trend?

Or are you expecting this elevated corporate expense to sort of continue into fiscal '19?

You bet.

So yes, you hit it on the head there.

It is related to our equipment financing business, which is partially tied to our equipment sales number.

But it's also tied to external interest rates.

And in this rising environment, I still see that as being a struggle next year.

I don't see us going back to what you termed as historical rates there.

Yes.

And I would just say, Glen, to just add, I think, from an overall cost structure standpoint, I mean, during our budgeting process, we conducted a very thorough review of our cost structure.

And we are balancing, frankly, investments that we need to make in certain parts of the business with cuts and reductions that we have to make in others.

So we're very conscious of our cost structure.

We're continuing to run the business with, I think, increased financial discipline around our cost and, certainly, something that we put a very close watch on.

Your next question comes from Brandon Couillard from Jefferies.

Mark, could you elaborate a little bit on the private-label opportunity, the gross margin profile?

Would you expect some mix benefit from that and, perhaps, how big of the portfolio that accounts for today?

Yes.

Brandon, thanks for the question.

I think this is an important focus for the company.

I think we have, certainly, an opportunity to improve our -- really, in 2 areas as it relates to private label.

Number one, improving the penetration of our existing portfolio with our existing customer base and then, certainly, adding to our portfolio over time.

And without getting into specifics around penetration rates and margin comparisons, certainly, more private label is good for the company in terms of our mix and our margin.

It's not something that's going to happen overnight.

We look at this as absolutely a long-term strategy and an area that needs to become a real strength for Patterson over time.

But we've set specific goals for our organization around private-label growth in FY '19.

The leadership team has specific objectives tied to that.

We're holding our teams accountable.

Our sourcing organization is focused on continuing to identify and build out our private-label portfolio.

And we expect our private-label consumables to grow at a faster rate than our overall consumables business across all -- across both of our segments and certainly within Animal Health, both in production and companion.

All right.

And then maybe a 2-part question for Dennis.

Number one, obviously understanding that sell-out right now, particularly in Dental, is a little bit slower.

You took down inventories quite a bit in the fourth quarter.

Do you still see more room for inventory reductions on an absolute basis over the balance of the year?

And then number two, why not quantify specifically the impact of the inventory valuation changes on gross margin in the fourth quarter?

Sure.

So the cash flow question, yes, I think our inventory levels are still a little on the high side, and I think we can bring them down over the course of the year.

And I mean, I guess, it's just our practice not to give such detailed information about one of our business units.

Your next question comes from the line of Jonathan Block from Stifel.

This is Denis Kelleher on for Jon.

Just first question regarding FY '19.

Is the right way to think about the dental consumables segment as kind of general improvement throughout the year and exiting the year at that kind of 0 to 2% market rate you mentioned?

I would think that, certainly, we need to stabilize our consumables portfolio and our revenue there.

Certainly, some of the way we've built our plan would assume that, that ramps up in the second half of the year.

And I think the exit rate going into FY '20, we would expect to be back in line with the market.

Understood.

And I guess, the other question would be on the sales force alignment.

Any additional detail in terms of if you do add more reps, would they be kind of more territory reps or equipment specialists and where you are in that process?

Yes.

Thank you, Denis.

So really, we are adding sales resources across all 3 of those kind of categories, if you will, within our Dental segment.

So our territory reps, obviously, that have direct responsibility for the customer relationships, also in our equipment specialists and our CAD/CAM specialists.

So while we don't provide specific numbers around how many reps we have and how many we're adding, we invested heavily in this area in '18.

We expect to continue to invest in this area in '19.

And I'd also tell you, we're investing in resources, sales resources, and field management to support the regional DSO space as well.

And so we view that as a nice opportunity for growth in the years ahead.

And so we're investing across our customer segments, making sure that we have, on the ground, sales and management resources to support our customers.

Your next question comes from the line of Steve Beuchaw from Morgan Stanley.

My first one is more of a clarification question for Dennis, actually.

In that fiscal '19 model, I get that there are a lot of moving parts, right?

We've talked a little bit about the financing element of it.

But there are a lot of moving parts that we have low visibility.

As we try to think about the bridge from EBIT to pretax or the composition of total other income and expense, can you give us a view for what the total other income and expense line looks like for fiscal '19 so we could just think about the model a little bit more smartly?

So the other income and expense, there's not a lot of moving parts in that.

A big part of that is our interest expense on our debt.

So there's really not a big story there.

And then maybe to ask the question a different way.

If I think about the consolidated impact year-on-year between what's going on in financing, which you called out as being relatively stable, and some of the other moving parts that we talked about in the P&L historically, that might have been a little bit separate from operating issues around the top line or even margin.

Is there anything else that might be nonobvious in terms of the model bridge that we should think about?

I think we're all here on the call just sort of scratching our heads a little bit about the margin or profitability change from year-on-year.

Anything else nonoperating, besides financing, that you think might be a lever to contemplate?

I mean, we did make a contribution to our ESOP or our employee stock ownership plan.

And so we went kind of a minimal contribution in the prior year to more of a normal contribution this year, so that's kind of a year-over-year factor.

Okay, appreciate that.

And then for Mark.

I wonder if you could talk just a little bit about the sales force in a different way.

I mean, you've been very clear about the success that you've had growing the team and your plans to continue to invest there.

But can you talk about the average or aggregate experience level on the sales force, where that is today, how that compared to 6 months ago and your level of confidence in driving the average or overall experience level of the sales force higher in fiscal '19?

And I'll get back in queue.

Yes.

Thank you, Steve.

No, it's a good question.

I mean, certainly, if you look at the way that our sales organization is built today, and I'll talk maybe specifically about our territory reps, obviously, we've brought on a lot of new folks over the course of the last 12 to 18 months.

So the average level of experience with Patterson, certainly, would be less than it would have been a couple years ago.

But we're also really excited about the folks that we've brought on board.

Certainly, some that come from other parts of health care, some that have specific industry experience.

So while their tenure with Patterson may be obviously relatively new, their experience levels, certainly, vary.

We're obviously also very excited about the continued opportunity we have for growth with our territory reps who have been with the company and have a great deal of experience.

And frankly, as we talked about previously, really improving the customer experience, putting obviously the ERP implementation behind us and really getting back to the level of outstanding customer service that we would expect, we're excited about our entire sales team, both those with great experience as well as some of our newer reps, frankly, going back on offense and really driving the results that we expect.

And we're also investing in tools to help them achieve their goals.

Again, tools not only for our newer reps that are coming onboard and helping them try to be more productive more quickly, but also tools that we think will enhance the capabilities of our experienced reps and help them make -- become more productive and more valuable to the customer.

So we're excited about the opportunity to continue to grow our sales force, and then continue to see the folks that have less experience continue to ramp up and increase that experience level over time.

Your next question comes from Michael Cherny from Bank of America.

This is Allen Lutz in for Mike.

So going back to the fiscal '19 guide, does your guidance range imply revenue growth and EBIT margin expansion at the consolidated level?

And then if not, which is more likely?

So I would tell you that it does include a mid-single-digits growth on the revenue line and more of a flattish operating margin view.

Got it.

And then moving to the fourth quarter, can you break down the dental equipment performance in terms of basic versus high tech?

And then, what's the current demand within high tech for integrated CAD/CAM versus stand-alone scanners?

Yes.

Thanks, Allen.

I'm not going to break down the specific parts of our equipment business, but certainly, as I indicated earlier, we did see unit volume increases year-over-year.

Obviously, those are having somewhat of a negative impact on our mix.

I would also tell you, just to confirm, certainly, our continued focus on selling the CEREC product, that's critical to our success in FY '19.

And while, obviously, we have a broad portfolio of products, certainly, we're big believers in that technology and we've built plans very much in conjunction with the team at Dentsply Sirona to execute on those plans and to continue to ensure we have the right focus and incentive structure in place to continue to drive the CEREC products as part of our overall portfolio.

So we -- and we've obviously taken those expectations into account as we head into FY '19.

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

This is Nathan Rich on for Bob this morning.

Mark, I just wanted to ask on the strategic planning process that you and the board are undertaking.

Understand it's early, but could you talk about what types of opportunities you're looking at in both the Dental and Animal Health segments?

And then specifically on the Dental side, your peers have talked about investing in kind of broadening their product offering in some of the dental specialty areas.

Just wondering if that would be an area of interest for you guys as well.

Yes.

Nathan, thanks for the question.

I think at a high level, we're taking a very, very broad perspective.

Certainly, I come to Patterson with a lot of experience in health care.

I've got -- take some time to get up to speed on the dental and animal health industries and our business position, the competitive environment.

Certainly, I've been very focused on that the past 6 months.

And so we're really trying to take a very fresh look.

I would tell you, certainly, we're there.

There's a lot of things that we would be considering from a business development standpoint, an M&A standpoint.

Certainly, the ability to close gaps in our product portfolio, you named one example, and obviously, that would be on our radar in terms of how we broaden out our portfolio in the Dental segment where we obviously have a scale position and selling a broader portfolio of products.

And calling out a broader portfolio of customers, I think, would be a natural opportunity to continue to build out our dental strategy.

So certainly, that's something that we're looking closely at as part of our overall broad view of the markets that we're in and our portfolio and how we want to drive growth and long-term value going forward.

Okay, great.

That's helpful.

And then, Dennis, just a quick clarification on one of your previous comments on the corporate segment.

So did you say that this could be more of a headwind from an earnings standpoint in fiscal '19 relative to what you've seen the past couple of quarters if interest rates rise?

Just want to make sure we're thinking about what to expect in that segment correctly.

I guess not more of a headwind than we've experienced in the last few quarters, but a similar headwind.

Your next question comes from Ross Muken from Evercore ISI.

So on that revenue acceleration, which seems to be the kind of crux of the improved profit outlook, how much is coming from sort of the new sales headcount kind of ramping to productivity?

How much is coming from comp in terms of just how bad equipment was and consumables in the back half of this year?

So assumed more normalization.

Because it seems like, obviously, your market assumptions are really for very low single digits, at least on the Dental side.

So just help me on the kind of the drivers of that walk from where we've been in the modest decline range for, I don't know, 12 months now back to kind of mid-singles, which would put you in a growth rate the business hasn't seen in, I don't know, maybe a decade.

Well, I think with respect specifically -- Ross, thanks for the question -- to kind of the revenue expectations for Dental, I think it's a combination of all the factors that you laid out.

I think we expect increased productivity from the investments we've made in our sales organization.

Certainly, obviously, the comps play a role in that.

And frankly, we also expect growth and execution from our experienced sales reps, and certainly, continuing to build out the equipment portfolio.

So I think it's really a combination of factors.

And I think the thing that gives me, frankly, good confidence in this area is we've gone through a major disruption from an operational standpoint over the last couple of years.

I think that is substantially complete and behind us.

We've made -- we haven't talked about it.

We talked about it earlier, but we've made a lot of meaningful progress in terms of the core day-to-day operations of our business.

And for the type of business that we're in, we have to provide outstanding customer service and outstanding customer satisfaction.

And as we do that, it gives our field teams, frankly, the opportunity to have a more comprehensive, strategic conversation with our customer so that we can execute on our value proposition and bring the value that we know we can.

So I think as we've certainly turned the corner around the day-to-day operations of our business, and yes, we continue to have progress to make, but we expect that all these factors tie closely together to give us confidence in our ability to drive some of this revenue growth that we've outlined.

And maybe just on the capital allocation side.

Obviously, the free cash flow's going to step up, but you've typically been more back-end loaded.

Help us just think through.

Where are you right now in terms of your leverage levels relative to the covenants from the AHI loan?

And kind of what pay-down do you have to do kind of in the beginning of the year or over the balance of '19 to kind of keep within the covenants?

Yes.

So we had a very good fourth quarter as far as cash generation and did a, I would say, a significant pay-down of our debt during Q4, which sets us up into a nice spot going into the year.

I would just tell you, there's -- we'd need modest pay-downs of the debt to stay in compliance and actually well within compliance of our debt covenants.

What is the covenant?

Is it [3.5]?

Correct.

And where are you guys trailing 12 months?

Or I guess, what's -- is it TTM or is it forward?

No, it's a trailing 12.

And so where are you guys right now in the trailing 12?

We're well within the 3.5.

We're not at our -- where we would like to be, but it's still well within it.

Your next question comes from Stephen Hagan from RBC.

Can you talk about what you're seeing in terms of the industry growth in Animal Health and whether you feel like your gaining market share in either companion or production animal?

Yes.

Thank you, Stephen.

I think in terms of kind of the industry growth rates in our Animal Health segment, I think we see in the kind of 2% to 4% range.

And we expect to grow within those ranges across both the production and companion business.

Okay.

And then my other question is, if you have any update to the FTC complaint?

If there are any negotiations or if we're getting anywhere near a potential resolution there?

No, thanks for the question.

So certainly, we're at this point expecting the FTC trial to commence in October and that's part of the process that we've been well aware of.

And as obviously we said and certainly would reiterate, we believe the allegations are without merit and we're fighting the situation vigorously.

So we don't anticipate this matter will have a material effect on our financial condition.

And certainly, we're working closely to work through the situation, and again, expect that the trial would commence in October.

Next question comes from Kevin Kedra with Gabelli.

Kind of wanted to follow up on the capital allocation question and how you guys are thinking about using cash.

Certainly, you want to reinvest in the business and stabilize things in Dental.

But how do you think about supporting the dividend versus share repurchase, given the current stock levels, versus debt pay-down?

Yes, I'll take a run and then, certainly, Dennis can chime in.

I mean, I think in general, we're certainly committed to our dividend, and that's an important part of our cash allocation strategy.

We obviously also are focused on ensuring that, as Dennis indicated earlier, we remain in a very good position with regard to our leverage ratio.

And our -- I think, as we outlined, our FY '19 does not anticipate specific share repurchase.

And certainly, as we drive improvements from a cash standpoint throughout the course of the year and believe that we have the opportunity to take advantage of that, we certainly will.

But we also want to ensure we can continue to invest in the business.

And I can tell you from a cash flow standpoint, I believe we provided information about a -- in the range of $200 million, $250 million, so a nice uptick from where we ended in FY '18.

And improving our working capital performance across our accounts receivable, accounts payable, inventory, we think there's an opportunity for us to continue to do that.

We have a very strong focus and emphasis on that.

We have accountabilities across our business units and our leadership team around that, and we think that can be a positive part of our performance.

Anything to add?

No, I think you said that well.

I mean, the cash generation, I think, will be strong this year.

Some of it will be -- definitely be used to pay the dividend and then some modest debt reduction.

Great.

And then just wanted to follow up on the concept of potentially looking at a strategic option like splitting off the veterinary business, similar to what your competitor is doing.

What would be the roadblocks to doing something like that?

I mean, what is the biggest limiting factor should you guys decide that, that's something that you might want to consider?

Is it just kind of separating the systems?

Is it something physically with the warehouses?

Just where do you see kind of the roadblocks of doing that?

Well, certainly, Kevin, as I indicated earlier, we're focused on executing more effectively in the businesses that we're in.

We like the businesses and the markets that we're in.

We think they're attractive.

We think they're stable.

We like the long-term growth prospects, both of our Animal Health and Dental segments.

And we're focused on operating those businesses and improving our performance.

I think we're up to the end of our hour.

Are there any final questions?

Well, thanks -- I'm sorry, no more questions, correct?

We do have additional questions.

Okay.

Well, I think since we're just after 10:00 a.m.

Central time, we're going to stop there.

I want to thank everyone for joining us today.

And for those of you that didn't get an opportunity to ask your questions, apologize for that.

Please feel free to reach out to John Wright directly and we certainly want to be responsive to your questions.

But again, thank you for joining us today.

We look forward to updating you on our progress on our next quarterly earnings call that will take place in late August.

Thanks very much.

This concludes today's conference call.

You may now disconnect.