Seeking Alpha
We cover over 5K calls/quarter
Profile| Send Message|
( followers)  

Patterson Companies (NASDAQ:PDCO)

Q2 2013 Earnings Call

November 20, 2012 10:00 am ET

Executives

Scott P. Anderson - Chief Executive Officer, President and Director

R. Stephen Armstrong - Chief Financial Officer, Principal Accounting Officer, Executive Vice President and Treasurer

Analysts

Lisa C. Gill - JP Morgan Chase & Co, Research Division

Robert M. Willoughby - BofA Merrill Lynch, Research Division

Michael Cherny - ISI Group Inc., Research Division

Kevin K. Ellich - Piper Jaffray Companies, Research Division

S. Brandon Couillard - Jefferies & Company, Inc., Research Division

John Kreger - William Blair & Company L.L.C., Research Division

Steven Valiquette - UBS Investment Bank, Research Division

Glen J. Santangelo - Crédit Suisse AG, Research Division

Ross Taylor - CL King & Associates, Inc., Research Division

Jeffrey D. Johnson - Robert W. Baird & Co. Incorporated, Research Division

Stephan Stewart - Goldman Sachs Group Inc., Research Division

Karl T. Poehls - Fiduciary Management, Inc.

Joe Van Cavage - River Road Asset Management, LLC

Operator

Ladies and gentlemen, thank you for standing by, and welcome to the Patterson Companies Earnings Conference Call. [Operator Instructions] Today's conference is being recorded, November 20, 2012. I would now like to turn the conference over to Scott Anderson, President and CEO. Please go ahead.

Scott P. Anderson

Thank you, Alicia. Good morning, and thanks for taking time to participate in our second quarter earnings conference call. Joining me today is Steve Armstrong, our Executive Vice President and Chief Financial Officer, who will review some highlights of our second quarter performance following my opening remarks.

Since Regulation FD prohibits us from providing investors with earnings guidance unless we release that information simultaneously, we provided financial guidance for fiscal 2013 in our press release earlier this morning. This guidance is subject to a number of risks and uncertainties that could cause Patterson's actual results to vary from our forecast. These risks and uncertainties are discussed in detail in our annual report on Form 10-K and our other SEC filings, and we urge you to review this material.

Turning now to our second quarter results. Patterson reported consolidated sales of $867.2 million for the second quarter of fiscal 2013 ended October 27, an increase of 1% from $856.9 million in the year-earlier period. Net income of $45.5 million or $0.44 per diluted share compared to $49 million or $0.43 per diluted share in the second quarter of fiscal 2012. Our earnings were affected primarily by below sale – planned sales of dental equipment, as well as the absorption of $3 million of incremental interest expense related to Patterson's debt issuance in the third quarter of fiscal 2012.

As I will discuss during the next few minutes, several areas of our business, including dental technology equipment and Webster Veterinary performed well in the second quarter. On balance, however, we are not satisfied with our recent operating results, which did not meet our expectations. Patterson Dental, our largest business, reported sales of $549.1 million, which was substantially unchanged from last year's second quarter. Within this unit, sales of consumable supplies rose 1%, which was consistent with our internal forecast. We believe the consumable market is stable. But until unemployment is significantly reduced and consumer confidence improves, it is unrealistic to expect that the underlying market for consumables can perform much beyond current levels.

Sales of basic dental equipment, including chairs, units and lightning, were well below forecasted levels, making this product category the primary reason behind our second quarter sales shortfall. While we are encouraged that the dental practitioners have been willing to expend funds on technology-related products over the last several years, the basic equipment market recovery has been at a much slower pace. We continue to work with our customers on investments in their basic operatory infrastructure, however, the predictability of when they will commit to these investments quarter-to-quarter remains volatile. Consistent with this pattern, we recorded mid single-digit revenue growth for dental technology products in the second quarter, which partially offset the weakness in basic equipment. Total sales of dental equipment and software were down 3% in the second quarter.

Within our technology category, which is benefiting from the ongoing trend towards the digitization of dentistry, sales of CEREC systems and extraoral x-ray products were strong during the quarter. CEREC demand received a boost from the launch of the Omnicam by Sirona Dental System and at CEREC 27.5 Anniversary event in Las Vegas in August. The thousands of dental professionals who attended this event gave Omnicam an overwhelmingly positive reception as a major technological advancement in CAD/CAM technology. Omnicam's positive initial reception has subsequently been matched by strong continuing demand for this next-generation product from both new and existing CEREC customers.

However, the number of Omnicam systems timely delivered to us during the second quarter was less than anticipated. This development constrained Omnicam sales in the second quarter. In short, demand for this next-generation system outstripped product availability, which was a risk factor we mentioned in our last conference call. Based on information from Sirona, we expect Omnicam production volumes to ramp up over the next 6 months. I also want to emphasize that since Sirona and Patterson are in complete agreement about wanting to avoid any quality issues on this technologically advanced system, we are not pressuring Sirona for faster Omnicam deliveries. Given our conviction that digital technology represents the future of dentistry, we plan to continue our focus on selling and supporting technologies that improve the efficiency and clinical outcomes of dental practitioners.

As the market for basic infrastructure stabilizes and begins to grow, we will be there with our industry-leading offerings of chairs, units and cabinetry to assist the dentists in achieving greater efficiencies for their practice. Our long-term commitment to technology is exemplified by our new exclusive North American marketing agreement with Sirona, the undisputed leader in digital dental technology. This recently expanded agreement, which now covers Sirona's complete product line, has further strengthened Patterson Dental's position as the leading distributor of dental technology and other equipment.

Our dental division also completed a strategic acquisition in the second quarter with the purchase of Iowa Dental Supply. While not having a significant impact on reported results, the addition of the well-respected and experienced management and staff of Iowa Dental further strengthens our position in our Mid-western market and provides another avenue for technology and equipment growth.

We were very pleased in the second -- of the second quarter performance of our Webster Veterinary supply unit. Webster's internally-generated sales increased 13% in the second quarter. A change in distribution agreement for nutritional products in the fourth quarter of fiscal 2012 reduced Webster's second quarter actual sales results growth by approximately 6 percentage points. As a result, Webster reported sales of $184.4 million for the quarter. Webster's solidly higher second quarter sales growth was generated by strong demand for consumable supplies, including combination flea and heartworm and other parasite-prevention products. To further strengthen its competitive position, Webster is focusing resources on its growing range of technology solutions for veterinarians and their clients, in addition to expanding local technical support capabilities for its equipment business.

Sales of Patterson Medical, a rehabilitation, supply and equipment unit, totaled $133.7 million, which was virtually unchanged from the year-earlier period. The April 2012 acquisition of Surgical Synergies, a distributor of physiotherapy, rehabilitation and mobility products serving the Australian and New Zealand markets, contributed approximately 1 percentage point of sales growth for this division in the second quarter. Patterson Medical's second quarter sales were below our internal forecast, as moderately higher sales of consumable supplies in the U.S. were offset by continuing weakness in the unit's international and equipment businesses. The softness in the unit's international and equipment businesses is likely to persist throughout the balance of fiscal 2013. Despite U.S. health care regulatory uncertainties and the weak economic environment in its global markets, we believe Patterson Medical is well positioned to capitalize upon positive long-term demographic trends in the worldwide rehabilitation market. Our short-term challenge in rehabilitation market is to deploy our resources in the most efficient manner to support our core customers as they cope with a very unsettled environment.

Finally, as we stated in this morning's release, our second quarter sales shortfall and the outlook for continued economic uncertainty causes us to reduce our full year earnings guidance. Our new range is $2 to $2.06 per diluted share compared to our previously issued guidance of $2.10 to $2.16. As I said at the outset, we are not satisfied with our recent results. While our business like many others are facing economic headwinds over the near term, we will continue to make investments that we believe will further strengthen the competitive position and long-term performance of our veterinary and rehabilitation units.

Finally, October 28, 2012 marked Patterson's 20th anniversary as a publicly traded company. We have experienced considerable success since 1992, growing from $277 million in annual revenue and $10 million of stockholders' equity. Throughout our first 20 years, we have remained focused on our future by continually strengthening our organization through the commitment and dedication of Patterson's outstanding people. Today, we are continuing to strengthening the competitive position of our businesses by enhancing our value-added approach for the customer and our confidence in Patterson's future is undiminished.

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

R. Stephen Armstrong

Thank you, Scott. I have 2 additional points on our sales performance for the second quarter.

As we disclosed in this morning's release, and as Scott mentioned earlier, the change in the nutritional product arrangement in our veterinary unit reduced consolidated sales by 130 basis points in the quarter. This change, which will continue to affect our sales volumes into the first half of this year's fourth quarter, has had a minimal impact on our operating profit since we now sell this product line under a national agency commission arrangement.

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

We realized sequential improvement in our consolidated gross margin for the first quarter, but 2 primary factors accounted for the 40 basis point decline year-over-year. In the dental division, the mix of CEREC revenue shifted to a much higher proportion of sales from trade-ups to the AC or Bluecam acquisition unit from the Redcam that we saw in the same period last year or were anticipating this quarter. We have been planning for a higher percentage of Omnicam sales. But as Scott mentioned, the delays in the timing of shipments from the manufacturer during our quarter did not provide us sufficient product to achieve our forecasted sales of Omnicam. This trade-up activity not only generates a lower level of revenue per unit, but it produces a much lower gross margin than the sale of a new CEREC unit. However, we believe the additional volume of trade-ups from the Redcam to the Bluecam is further endorsement of Omnicam's market opportunity.

The second factor affecting our consolidated gross margin was the erosion of the gross margin in the international operations of our medical segment. Both channel pressures and sales mix caused this decline, particularly in the European markets, which are being affected by austerity measures in Europe's health care systems. Our second quarter operating expense ratio increased as the softness in dental and medical sale did not allow us to gain any operating leverage. By segment, our second quarter operating margins were 9.2% for dental, 13.4% for medical and 5.0% for veterinary.

As I have mentioned in previous quarters, our effective tax rate has been favorably impacted by the dividends paid to the -- on the Patterson shares owned by our ESOP. And as the dividend increases, our tax rate is reduced further. Another factor contributing to the lower tax rate in the current and future fiscal years involve the benefit of the domestic manufacturing deduction. We have previously believed that we did not qualify for a meaningful benefit under this provision of the tax code. But further study revealed that we can claim this deduction on several portions of our domestic operations.

A review of our balance sheet shows that inventory levels increased by approximately $11 million from the start of the fiscal year. The growth in inventories resulted from normal seasonal fluctuations during the quarter. Our DSO stands at 43 days in the current period, down 2 days from the prior year, while inventory turns are 7.1 compared to 6.6 one year ago.

We generated cash from operations of approximately $73 million in the second quarter compared to $52 million in the year-earlier period. The year-over-year increase is the result of our decision to fund the prior-year contribution to our Employee Stock Ownership plan by purchasing Patterson shares in the open market in the second quarter of fiscal 2012. At that time, we transferred $23 million to the ESOP, which then purchased 844,000 shares. Effectively, we converted the noncash ESOP expense for fiscal 2012 into a cash expense, and the impact of that decision on operating cash flow occurred in last year's second quarter.

Market conditions allowed us to fund that year's contribution for approximately $4 per share less than we had allocated -- less than if we had allocated shares from the tranche acquired by the ESOP in 2006. The economic benefit to the shareholder of that decision was approximately $3.5 million. For the current year, we are planning to fund our contribution with shares from the 2006 tranche, which results in a noncash expense as reflected in the operating cash flow.

Our CapEx for the first half of the year principally included regular ongoing expenditures, in contrast to last year when expenditures were incurred on the new facility for the Patterson Technology Center and the new South Bend distribution center. We are still anticipating fiscal 2013 CapEx in the range of $25 million to $30 million, as we will be increasing investments in our information systems application and infrastructure beginning the second half of this fiscal year.

Also in the second quarter, we repurchased approximately 1.6 million Patterson shares under our 25 million share buyback authorization that expires in 2016. Approximately 8 million shares remain available for purchase under this authorization. During the second quarter, we retired $75 million of term debt that would have matured in March of 2013 since there was no penalty for the repayment and our cash investments were not earning at equivalent or better rates.

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

Question-and-Answer Session

Operator

[Operator Instructions] And our first question comes from the lines of Lisa Gill with JPMorgan.

Lisa C. Gill - JP Morgan Chase & Co, Research Division

Can you maybe just give us a little more color around Omnicam? And is this just a timing issue as far as what we're going to see, or is there something more? And then can you give us more insight into what you're seeing right now on the overall equipment market? We know the economy is still tough, but how are dentists looking at things? And then lastly, if we think about this, Steve, is there anything specific we need to be thinking about other than some of the comments you made around timing as far as what's happening with the guidance? Is there anything else that's underlying that, that again, we need to think about as we model?

Scott P. Anderson

Sure. Thanks, Lisa. I'll start out with Omnicam. Obviously, as I said in my comments, we had a spectacular launch of the product with Sirona in August. When we had planned the year back last spring knowing that Omnicam was coming, we made some assumptions with Sirona about delivery. I would tell you that we're probably 45 to 60 days behind the schedule we had anticipated. So we do not expect there to be a makeup in terms of the fiscal year. It's really sort of moving the delivery schedules back a month or 2. So in our second quarter, we had anticipated a delivery schedule where we would have the ability to invoice a good number of products. We got those deliveries late enough in the quarter where we could not invoice those. But to be perfectly clear, it's not like there'll be a makeup in our next quarter. The whole delivery schedule just was moved back a little bit. And obviously, in a launch as big as this, there's always some risk to the timing of the delivery. But I don't want that in any way to dampen our enthusiasm about the product because we're absolutely thrilled with the technological advance and the CEREC offering we're going to have for our customers going forward. But it's probably going to be 6 months to roll [ph] until we're hitting at full speed. And we see this as a major turning point, and it’s a part of, I think, a good 3 to 5-year run for the CEREC Omnicam.

Lisa C. Gill - JP Morgan Chase & Co, Research Division

And so when you think about the equipment market, this is a new product to the market. You're seeing interest in this product. But what are you seeing overall from equipment, generally speaking?

Scott P. Anderson

Yes, the overall equipment market continues to be lumpy. When you go back and look at our last 10 quarters, we've had growth in 7 of the 10 quarters. In 4 of those 7, we've had double-digit growth. But we've also hit patches like we just hit in the last 90 days where dentists will get conservative, particularly around their investments in the traditional piece of equipment. The core equipment business, which took a very hard hit in the fall of 2008, 2009, has been slow to recover. We believe it is recovering, but it's at a pace that's, obviously, frustrating to us in terms of how it's coming back. The good news is, and I think I talked about it on the last call, was when you talk to customers, the fear aspect that many customers had maybe 4 years ago, that doesn't play out at all in the current psyche of the dentist. Their cash flows are strong. Their patient flows are strong in their practices. But they're small-business people, and the reality is small-business people are dealing with a lot of uncertainty right now in terms of tax rates and Section 179, what's going to happen to that. And when you have uncertainty, sometimes, you have -- dentists become more conservative than invest in their practice.

Lisa C. Gill - JP Morgan Chase & Co, Research Division

Great. And then Steve, anything to think about on the guidance side? I mean, is it all related to Omnicam and your initial expectations, or is there anything else in your underlying assumptions for the new guidance range?

R. Stephen Armstrong

Lisa, maybe just -- I'll summarize some things, and then come back if I don't touch on the points that you're finding helpful. We softened up the medical outlook for the remainder of the year based on what we've seen in the first 6 months and what is really projecting out for the next 6 months in that market, particularly in the European markets. And somewhat in their equipment market here is domestically again uncertainty around what's going to happen, who's going to be paying, who's going to be receiving what, has put some paralysis into the market. So we softened up the revenue outlook there. Now on the other hand, you got the med tech tax coming in beginning January 1; that will probably drive some revenue lift. But it's not going to help, obviously, the operating margin or the bottom line. We also lowered our tax rate, as I mentioned during my prepared remarks, because of some additional benefit we get out of a domestic manufacturing deduction under the current tax code. And heaven only knows what they're going to do to the next -- on the next round of tax adjustment. We did not build in any assumption of further stock purchases so we used the share count outstanding currently to project the second half of the year. I would say from that perspective that we will probably continue to buy shares in the second half at a pace similar to what we have through the first half. So those are kind of some of the high points of the guidance, and I'll quit rambling and let…

Operator

Our next question comes from the lines of Robert Willoughby with Bank of America.

Robert M. Willoughby - BofA Merrill Lynch, Research Division

Scott or Steve, I guess if you look at the valuation for MWI and some of the other -- basically all of the other dental constituents and the multiple somebody's paying for PSS World here, you have to think that some of the parts now must be worth more than the whole. What's the action plan here in light of what we could view now as some serial disappointments over the years? I mean, how do you monetize this franchise other than the token buybacks that you have been making?

Scott P. Anderson

Well, Bob, I think that's a great question. It's something when we look at long-term strategy and value creation that we discuss with our board, and obviously, it's something I wouldn't get into great detail on a public call. We feel we've got market-leading franchises in all 3 businesses and have a long-term perspective that there is a very strong value creation story here beyond share buybacks as we go forward.

Robert M. Willoughby - BofA Merrill Lynch, Research Division

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

Scott P. Anderson

No.

Robert M. Willoughby - BofA Merrill Lynch, Research Division

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

Scott P. Anderson

No comment.

Operator

Our next question comes from the line of Michael Cherny with ISI.

Michael Cherny - ISI Group Inc., Research Division

So just quickly on the OpEx line, given your somewhat muted expectation for growth and especially on the medical side, as you think about OpEx, how much of the line is fixed versus variable? In a given quarter, how much flexibility do you have to potentially cut costs if you see some of the trends throughout the quarter not playing out as you had hoped?

Scott P. Anderson

I'll start and then I'll turn it over to Steve. I think it's very important when you look at the Patterson story that our key strategy is being a value-added distributor. And there are expectations our customers expect from us in terms of how we take care of them and deliver best-in-class service and logistics. And at the same time, we are the most efficient in terms of profitability of anyone in our industry. So we take a long-term perspective when we look at how we run this business. And while we could drive some short-term leverage through cost cutting, we believe that's not the right strategy for this business. So I'll let Steve talk about the fixed versus variable aspect of the business.

R. Stephen Armstrong

Yes, Michael, I would just tell you that directly, variable costs would be your commission cost and basically, the packaging and freight costs on your shipment. So it's about somewhere between 9.5% and 11% would be the totally variable cost in a particular period.

Michael Cherny - ISI Group Inc., Research Division

Great, that's helpful. And then just quickly on the M&A side. Obviously, the cash flow generation has still been fairly strong here. You guys had made a few smaller tuck-in acquisitions recently. As you think about your portfolio and even with the leading platforms you have, with the cash position, would you ever look to potentially be slightly more aggressive or look to larger deals to kind of augment your business to get some more scale, or is it more kind of tuck-in, look for truly the best asset to fit your portfolio?

Scott P. Anderson

Michael, I think it goes back to what we've been very clear in terms of our capital allocation strategy. Our top priority is to invest it back in the business, and that's through a combination of investments and internal programs and infrastructure, but also through complementary acquisitions in the 3 businesses we have. We’re very disciplined in terms of the prices we pay, but we're willing to pay market prices to get properties that make good strategic sense for the company and have strong growth dynamics behind them. So we are very active in terms of strategically looking at the markets and, obviously, are in a very strong position, from a cash perspective, to execute on those opportunities when they're in front of us.

Operator

Our next question comes from the lines of Kevin Ellich with Piper Jaffray.

Kevin K. Ellich - Piper Jaffray Companies, Research Division

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

Scott P. Anderson

Yes, the strength from Sirona was really about the Bluecam trade-up program where we exceeded expectations. There was very little Omnicam deliveries in their numbers. So I think one of the silver linings of what's happened over the last 4 months is that our upgrade program where we were moving customers from the old Redcam to the Bluecam, which is critical because it gets the customer on the equivalent software platform as the Omnicam, really positions us well when we get into a full ramp-up in terms of production. So obviously, we're going through some of the growing pains of a new product launch. But I couldn't be more excited to be the company selling this really game-changing product.

Kevin K. Ellich - Piper Jaffray Companies, Research Division

Okay. Yes, that makes a lot of sense. And then just wondering, what's your view on the kind of macro right now? I mean, what are the sales guys telling you in terms of demand that they're hearing from the dentists? Are you expecting normal seasonality, so increasing consumable sales like we've seen historically, or have you picked up anything new?

Scott P. Anderson

I think the consumable market, as I said, is stable and that's encouraging, but still faces some headwinds in terms of choppy consumer confidence and still high unemployment. The feedback we get from our salespeople, and I talk to a lot of them all over the country, is there's definitely a frustration at the customer level just in terms of their view of the short-term macro environment. But there's really an underlying optimism because when you look at dentistry and you look at the demand that's going to happen in this space over the next 10 to 15 years, just from a pure demographic standpoint, and couple that with a new generation of dentists who are embracing technology, there is an excitement and an optimism about the profession even though it continues to sort of muddle along here in the short term.

Kevin K. Ellich - Piper Jaffray Companies, Research Division

Got it. Okay then just a couple of debt questions. How much did flea, tick and heartworm products like Trifexis contribute to the 13% internal growth you guys saw on Webster? And then how much agency business does Webster do? Can you remind us?

Scott P. Anderson

Steve, jump in.

R. Stephen Armstrong

Yes. As far as the impact on the quarter, Kevin, obviously, the increased dosages of flea, tick and heartworm have been driving the activity. As far as breaking it down, I think that is pretty difficult, but I would tell you that a good portion of it has been driven by those, not only the change in buy/sell in just some of those various parasiticides and preventatives, but also by just the sheer volume and the seasonal aspect of that. We’ve got a very strong season for those.

Kevin K. Ellich - Piper Jaffray Companies, Research Division

Sure. And then the agency mix, Steve?

R. Stephen Armstrong

The agency mix, right now we're probably doing -- and this is really off the top of my head, Kevin, so bear with me or come back, and we'll clarify it for you. But I believe we're doing about 150 million to 175 million of gross transactions under agency today.

Operator

Our next question comes from the line of Brandon Couillard with Jefferies.

S. Brandon Couillard - Jefferies & Company, Inc., Research Division

Scott, I hate to beat a dead horse here, but could you help us understand the disparity between your dental equipment revenue trend and those of your closest North American competitor which, I believe, were up 6% in the second quarter? Is that a function of mix or pricing pressure? Is there something that needs to be changed with the sales force?

Scott P. Anderson

Well, yes, I'd take you back maybe more than just 90 days, Brandon. We're up 7.5% for the last 6 months. And as I said, if you look back at the last 10 quarters, we've grown 7 of the 10. So even though versus our high standards, we had a disappointing quarter, I can confidently say that we continue to take market share on the technology and equipment side.

S. Brandon Couillard - Jefferies & Company, Inc., Research Division

And Scott or Steve, any sense of where your basic equipment revenues stand relative to the pre-recession levels of 2007? I mean, are we even back to that prior downturn level in terms of aggregate revenue for the basic equipment?

R. Stephen Armstrong

No, Brandon. We're still probably 20% to 25% below what the average production was back 2008 and prior.

Operator

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

John Kreger - William Blair & Company L.L.C., Research Division

Another question about dental equipment. Can you guys just talk a little bit more about what your pipeline looks like? And do you think we'll get sort of a normal calendar year-end buying period in dental equipment, or is there enough uncertainty around tax policy and so forth that it might be a little bit more anemic than normal?

Scott P. Anderson

John, I think that's a great question. Historically, if you look at our third quarter, which coincides with the calendar fourth quarter, it historically is our largest quarter of our fiscal year in terms of volume. But it also historically is a quarter that we have the least visibility, in essence, because our customers historically will sit down with their tax advisors in the fourth quarter and make buying decisions. We think there are some tailwinds to this time period for us in terms of tax policy with Section 179, the Medical Device Tax coming into play after January 1. But you also couple that with a lot of uncertainty around personal tax rates and what Washington, D.C. is going to do here potentially over the next 30 days. So I think that's one of the reasons why we're taking a cautious tone is because it's going to be more difficult to predict the basic equipment business here over the next 90 days. The Omnicam business will be -- CEREC business will obviously be dependent upon delivery because we have plenty of demand for that product.

John Kreger - William Blair & Company L.L.C., Research Division

Great. And then just a quick follow-up about the profitability of the dental business. If you -- it seems like the margins that you had in this quarter were the lowest we've seen in a while, and I'm guessing that's probably driven by the Bluecam upgrade. Is that pretty much done, or do you have a backlog of upgrades that could cause the margins to continue to be low over the next couple of quarters?

R. Stephen Armstrong

The expectation, John, with regard to the mix, would be that it would be predominantly new cameras of Omnicam's. Realistically, there's going to be some trade-up activity as old Redcam owners decide whether they want to go up to the Omnicam or not and if they want to go through the Bluecam progression. But no, the expectation would be that most of it will be Omnicam going forward. The backlog has pretty much moved out of the system.

Operator

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

Steven Valiquette - UBS Investment Bank, Research Division

It's just -- my question was kind of tied into the other previous one, just kind of looking at the gross margin trends. I guess in the fiscal first quarter, you guys had strong dental equipment sales and that was kind of cited as sort of a mix reason for softer gross margins in the fiscal first quarter. However, this quarter, obviously, dental equipment, a little bit softer, but yet the gross margins are still kind of down a pretty good clip year-over-year. I guess, just any additional color on that would be helpful.

R. Stephen Armstrong

Sure. Steven, it is different between the 2 quarters, but still somewhat the same because the trade-up activity dominated CEREC. CEREC was actually up in the quarter as far as total revenues were concerned, but most of it was trade-ups versus Omnicam. And the other factor that went with that is that because of supply disruption in Bluecam, we were using and, if you will, cleansing our training inventory. So it exacerbated the margin impact because those were going out at even lower margins than if you would just sent out a new Bluecam unit under the trade-up provision. So we were discounting to get the customers the Bluecam so that they would be in line for the progression up to the Omnicam, if that helps.

Steven Valiquette - UBS Investment Bank, Research Division

Okay, yes, that's helpful. And then just one quick clarification on the guidance revision. You mentioned a bunch of reasons, but just I guess the largest portion is it just the soft demand in the basic dental equipment? I guess when I think about the Omnicam -- you guys mentioned at the Analyst Day back in September, back then, pretty clearly, I thought that supply shortages would prevent any meaningful sales of that product, so I would have thought that would have been sort of factored into the previous guidance already. So I guess just to clarify that, is the biggest change today really is the softer basic equipment is more the culprit. Is that the way to think of it?

Scott P. Anderson

Yes, I think it's a combination of we don't feel it's realistic to make up the shortfall we just had in the second quarter, particularly around the unpredictability in the dental equipment market. And on the Omnicam issue, as I said earlier in the question from Lisa, it wasn't the number of deliveries we got. It was more the timing didn't happen how we had anticipated it when we planned out the fiscal year last spring. So it really has moved sort of the supply chain back 30 to 60 days, and that obviously impacted the second quarter. And we don't anticipate a makeup in terms of getting those 30 to 60 days back in this fiscal year.

Operator

[Operator Instructions] Our next question comes from the line of Glen Santangelo with Crédit Suisse.

Glen J. Santangelo - Crédit Suisse AG, Research Division

Just 2 quick ones, if I could. Scott, in describing the equipment market, you kind of describe it as it's been lumpy over the last year. But I'm kind of curious about what you're seeing on the consumable side. Essentially, it only grew 1%. And so I'm wondering if you stripped price inflation out, what are you saying about market growth? Is it really at 0 or potentially minus 1, or do you think there's some share shifting going on, or any sort of insights or elaboration on the consumable market would be helpful.

Scott P. Anderson

Yes, Glen, we really see the market right now and it's slowed down, as I mentioned in the last call over the summer, that it’s a flattish market, and I would say we're maintaining market share. I would not be bold enough to say growing 1%. We're taking market share. But obviously, and I talked about it last quarter as well, it's a big focus area for us because when we get back to historical operating performance, a key piece of our leverage story is to grow the consumable business in that 4% to 5% range.

Glen J. Santangelo - Crédit Suisse AG, Research Division

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

Scott P. Anderson

Recovers a little bit. But our internal forecast for consumables are pretty conservative in the guidance.

Glen J. Santangelo - Crédit Suisse AG, Research Division

Okay. And then just my second question is on the vet business. Clearly, the internal sales growth at 13% is pretty surprising, particularly if you say your sales were impacted 6% by a change in the distribution agreement for nutritional products. And so if we think about that kind of apples-to-apples, you're saying your vet business grew 19%. Following up on a previous question, kind of sounds like some of it was due to Trifexis and maybe some changes in agency agreements. I'm not sure. Steve, I just want to make sure that I heard you correctly. Did you say the bulk of all that growth was attributable to those 2 issues that we just highlighted, or do you think -- or is there something else? And how should we think about the sustainability of this double-digit growth even posting in vet?

R. Stephen Armstrong

Well, first of all, let's clarify. The 13% that we talked about, Glen, is after adjusting for the nutritional change, arrangement change. So you’ve added on top of it. So our actual revenue growth -- reported revenue growth in that segment for the quarter is about 6.5%, 7%, right?

Glen J. Santangelo - Crédit Suisse AG, Research Division

Okay, perfect, all right.

R. Stephen Armstrong

And then you're correct, most of the growth is still coming because of the seasonality. It was a long severe season for flea, tick and heartworm. I think we're starting to come to the end of that. And so I would caution that you're not going to see -- I don't think any distributor is going to see double-digit consumable growth in their vet business as we go forward, unless the ticks live through the entire season, and we have no snow and no freezing. But we're grandfathering in that really early flea and tick season last year. So I think you're going to see the growth rates for everybody come back down again as we get through that cycle.

Scott P. Anderson

I would just add, Glen, I mean, I think we see the underlying market. Obviously, a lot of moving pieces with buy-selling agency that everyone works through. But the underlying market probably is growing in the 2% to 5% range. So Webster's performance is obviously above market. And as I said, we're very pleased in the progress they're making.

Operator

Our next question comes from the line of Ross Taylor with CL King.

Ross Taylor - CL King & Associates, Inc., Research Division

2 fairly simple questions. First, with regard to CEREC, I just wondered if you could comment about what kind of interest you're seeing in the Omnicam versus Bluecam and what may unfold over the next several quarters. I mean, are virtually all of your sales there likely to be Omnicam? And then my second question just relates to basic equipment. I think you actually had pretty good basic equipment numbers in the April and July quarters. And I just wondered if sort of the timing of when things may be changed during the October quarter because that just kind of feels like the basic equipment was below your expectations several months ago.

Scott P. Anderson

Sure. Thanks, Ross. I'll start with CEREC and obviously, there's high demand right now in terms of interest in Omnicam. But we, with Sirona, really look at it as a very compelling portfolio of products, of which Bluecam will play a very big role, as well as Omnicam going forward. And we think at Patterson that we go to the customer with more choices than any distributor in terms of products that go all the way from digital scanning up to the most advanced scanning and chairside milling. So great interest in Omnicam, but also, as I said, a very unique portfolio approach to go after the market. And we believe we're really in the second or third inning of this CAD/CAM story and this digitization of dentistry. And that's what makes us so excited to really start a new innovation cycle with Sirona with the introduction of Omnicam. On the basic equipment side, we were frustrated by the slowdown that we saw in September, October, but we don't think that it is a trend. And going back to the question John asked previously, we do have a lot of activity right now out in the field. But a lot of decisions are made right in this time period with customers sitting down with tax advisors and that's what makes this third quarter always tough to predict. And we probably have more surprises to the upside historically than we've had to the downside. But given the macro environment, we're not going to make any bold predictions on quick recovery to the core equipment market.

Operator

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

Jeffrey D. Johnson - Robert W. Baird & Co. Incorporated, Research Division

Just a couple of questions here. One, just on the dental margin. I mean, if I step back and take kind of a bigger-picture view, we’re what -- over the last couple of years, 2 to 3 years, down probably 300 to 400 basis points on that margin line. And I know ESOP is part of that. Obviously, some cyclical issues here on Bluecam upgrades. But what, over kind of a multi-year period, has compressed that margin so much? And how does that play out, do you think, over the next year or 2?

R. Stephen Armstrong

Well, the reality, Jeff, is just as Scott mentioned earlier, we have to continue to invest in this business to stay competitive. We got that margin up over a long period of time through leveraging the business. And when your revenues are soft to flattish, it's very hard to maintain that just based on your expense structure. So it's a continual -- if you go back, just to mention a few, I mentioned a couple of them during the prepared remarks, and that is the investments that we've made in our infrastructure with regard to distribution and the Patterson Technology Center and so forth. We're going to be continuing to make those investments. We froze wages several years ago during the heights of this malaise and then actually took the wages back. But that's really about the only triggers we have in the expense structure as lean as we run it today. So I'll turn it over to Scott to talk any more philosophically about this.

Scott P. Anderson

Yes, obviously, we're frustrated by that, Jeff. But we're also absolutely committed, continuing to invest through this soft patch. Another area where we continue to invest is in new sales people. So the key to margin expansion for us is revenue growth. It's not cutting deeper into the cost infrastructure over the next 12 months.

Jeffrey D. Johnson - Robert W. Baird & Co. Incorporated, Research Division

Yes, I mean -- and I know this is maybe a strange question, but have you overinvested in the dental equipment side? Is there too much value-add you can give these dentists? Is there too much tech support, too much -- where they don't have to wait a single second on a call or you can be there in 5 minutes instead of 20 minutes or something? Is there anything there that needs to be evaluated going forward?

Scott P. Anderson

I don't think so. I wish we were as good as you say we are. But when we look at the long term and how we compete in the space, the things that we are doing have very strategic reasons. And when we look at what a modern dental office is going to look like in 5 to 10 years and what the expectations of a new generation of customers is going to be, one of the great barriers that we create around our customers is this high touch service we deliver. So it's a part of our DNA, and we think very strategic to the future. And we also think it's a model that obviously, most of our competitors try to replicate. And we just need to continue to do it better than our competition.

Jeffrey D. Johnson - Robert W. Baird & Co. Incorporated, Research Division

All right, great. And then last 2, just quick clarifying questions. So Steve, with your dental consumables growth, was organic growth this quarter positive if I back out Iowa or any kind of currency benefits, things like that?

R. Stephen Armstrong

Yes, sir. It's almost 1%.

Jeffrey D. Johnson - Robert W. Baird & Co. Incorporated, Research Division

Almost 1%. And then last question, just I had been hearing form a couple of my guys in my field you guys probably took delivery on maybe pushing 100 Omnicams in the quarter, maybe even more than that. But a lot of those were going to stock showrooms, being used as training units, things like that. So I'm trying to figure out how much was just maybe a timing issue of those initial products coming into you just not being recognized in revenue or not being able to recognize those in revenue versus a true kind of setback in the manufacturing schedule.

Scott P. Anderson

Yes, as I said before, the deliveries we took were so late in the quarter that we just physically couldn't turn them into sales. But at the same time, the delivery schedules have -- while Sirona are hitting their commitments, the timing has been pushed back from what we originally thought, and we don't see a catch-up period here potentially over the next 3 to 6 months. And we think we'll be at full production, full ramp-up, full sales execution towards the latter half of our fiscal year.

Operator

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

Stephan Stewart - Goldman Sachs Group Inc., Research Division

It's Stephan calling in for Bob. Just quickly on the CEREC category. Would you say your installed base for Redcam is now somewhere in the maybe 25% range, given your recent trade-ups? And also, can you remind us on how we should be thinking about the margins for tax equipment versus sort of the more core basic equipment?

Scott P. Anderson

Stephan, I'll take the first one. I think your number is in the ballpark in terms of number of Redcams still in the market. And then could you repeat the second question?

R. Stephen Armstrong

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

Stephan Stewart - Goldman Sachs Group Inc., Research Division

Yes, just how we should think about the margin difference in tech relative to basic. As we think about your guidance and the sort of reduction in the basic equipment outlook, how does margins compare to margins for more high-tech equipment?

R. Stephen Armstrong

Yes, I think that depends again on somewhat of the mix, Stephan, between -- your basic equipment is generally in the low 30s as far as the gross margin is concerned. Some of the tech will get up in the mid or higher 30s. But again, some of the tech actually carries a low average margin just because of some of the competitive nature. So if you look at the big-ticket 3D scanners that are out there, they tend to come in a little bit less than the average gross margin on a dental equipment transaction.

Stephan Stewart - Goldman Sachs Group Inc., Research Division

Great. And lastly, on the med tech tax assumptions you make, seems as though -- or is this the correct way to think about it, most of the increase will be passed on to customers?

Scott P. Anderson

Well, I think we're still in the preparation phase for that. And most of that will be a decision by the manufacturer on how they handle the tax.

Operator

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

Karl T. Poehls - Fiduciary Management, Inc.

Scott, 2 years ago on this call, I asked you about a fairly simple concept of under-promising and over-delivering. And that was right after you brought down your fiscal 2011 guidance. And since that time, the company has missed 5 out of 7 quarters from an earnings perspective. And this is a great franchise that just seems to be kind of stumbling along. And there seems to be an under-execution issue. This quarter, it's basic equipment, which by my math, roughly missed the budget by 25% or more. Last quarter, dental consumables were noted as having poor execution. The margin issue is a constant theme. And we're just curious, what are you doing to address the execution directly and more specifically? And how does the board view this? And even outside of dental, a lot of incremental capital has been redeployed into the medical segment, which has been disappointing from a return on capital perspective and has taken incremental capital. And now the theme is pricing pressure, margin degradation there. Can you comment on any of those things, please?

Scott P. Anderson

Sure. Thanks, Karl and I'm sharing your frustration. I remember well the question 2 years ago. And the answer I gave 2 years ago is consistent with how we plan our year in that we tie the incentives of all of our people to the expectations we put out on the Street. And we have a culture that's been developed over the last 20 years of stretching the organization. Obviously, in times where our underlying markets have been very soft, stretching the organization to that level has been difficult to reach those goals. And for that, we're very frustrated. But at the same time, this is a fantastic franchise, and we are the most profitable and most efficient distributor in nearly every metric versus the competition we compete against. So we do not take lightly the performance issue or the fact that there are times where there are areas where we have not executed to the standards we have. So there are pieces of that question that I agree with, and our management team is absolutely committed to improving the performance and execution of the business. But we're running this business for the long term, and I will continue to drive to make investments to position this company in the best way to meet what we think is going to be very strong demand in all 3 of these businesses. There is a great term that demographics is destiny, and these are 3 businesses that are in the center of very strong demographic trends over the next 20 years. But our -- we are absolutely aligned as a management team with everything you said in terms of your interest, and we know that execution is #1 on our priority list.

Operator

[Operator Instructions] And our next question comes from the line of Joe Van Cavage with River Road Asset Management.

Joe Van Cavage - River Road Asset Management, LLC

Do you have any like guidance you want to give on maybe what percentage of your sales starting in '13 would be subject to the Medical Device Tax?

R. Stephen Armstrong

Joe, this is Steve. We've done some preliminary work. As Scott mentioned earlier, some of this is going to be dependent upon how the manufacturers actually pass it on to us. But technically, about 50% to 60% of our products across all of our businesses are subject to the tax, more heavily in the dental than any of the other businesses because of the definitions of -- under the Food and Drug Administration guidelines and regulations.

Joe Van Cavage - River Road Asset Management, LLC

Okay. And maybe just assuming that, say your suppliers were to try to pass it along to you, do you expect any -- be more difficult in certain end markets to pass it along to your customers?

Scott P. Anderson

Historically, price increases have been passed on to customers in all 3 of our markets.

Operator

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

Scott P. Anderson

Thanks, Alicia. I'd like to thank all of you for your time and interest in the company today on our call. And I'd also like to wish everyone a happy Thanksgiving. We look forward to updating you on our progress in 90 days. Thank you.

Operator

Ladies and gentlemen, this concludes our conference for today. If you'd like to listen to a replay of today's conference, you may do so by dialing 1 (800) 406-7325 or (303) 590-3030, and entering the access code of 4574654. Thank you for your participation. You may now disconnect.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!

Source: Patterson Companies' CEO Discusses F2Q 2013 Results - Earnings Call Transcript
This Transcript
All Transcripts