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We reiterate our Neutral recommendation on Patterson Companies, Inc. (PDCO - Analyst Report), a leading distributor of dental, veterinarian and rehabilitation medical supplies.

Patterson’s first quarter fiscal 2013 adjusted earnings of 48 cents per share missed the Zacks Consensus Estimates by a penny. Adjusted earnings include Employee Stock Ownership Plan (“ESOP”) related charges, but exclude an incremental interest expense of $3.2 million associated with the company’s debt issuance in the third quarter of 2012. Including the interest expense adjusted earnings were 45 cents per share.

Revenues for the first quarter increased 5% year over year to $889.2 million, comfortably surpassing the Zacks Consensus Estimate of $883 million. Solid CEREC equipment sales significantly contributed to the growth of the core Patterson Dental business, while high-margin consumable sales remain a drag.

The Veterinary business is benefiting from the American Veterinary acquisition.  However, health care reform related uncertainties continue to plague Patterson Medical.

Profit in the reported quarter dropped 2.2% year over year to $47.5 million (or 45 cents a share). The company’s profit slipped on account of margin contraction due to adverse sales mix.

Patterson provides a wide range of consumable supplies, equipment and software, and value-added services to its customers. The company’s wide range of products hedges it from any meaningful sales shortfall in case of an economic downturn.

The company remains committed to delivering incremental returns to investors by leveraging earnings power. Patterson repurchased roughly 1.1 million shares in the first quarter under its 25 million share buyback program. About 10 million shares are still available for repurchase before the authorization expires in 2016.

Patterson depends heavily on strategic alliances and acquisitions for its growth. In June 2012, Patterson Dental became the exclusive distributor for Sirona Dental Systems (SIRO - Snapshot Report), a leading dental technologies company. The alliance further bolsters Patterson Dental’s leading position in the North American dental distribution business. The Omnicare camera for the CEREC system, developed by Sirona and to be distributed by Patterson, is the latest growth driver for the company.

More recently, Patterson scooped up Iowa Dental Supply, LLC (IDS), a full service distributor of dental products. With IDS generating annual revenues of $13 million in 2011, management at Patterson Dental expect the deal to be modestly accretive in fiscal 2013.

However, Patterson needs to successfully integrate the acquired businesses and achieve operational synergies from these transactions so that these do not turn out to be a waste of resources.

Patterson has a significant key supplier concentration. Loss of relationship with these vendors will disrupt the supply of raw materials, which in turn will decrease sales of Patterson products.  Sales from the Veterinary business were affected by a change in a distribution agreement related to nutritional offerings in the most recent quarter.

Patterson faces significant competition especially in the U.S. dental products distribution industry. The company competes head-to-head with Henry Schein Inc. (HSIC - Analyst Report) in the dental market.

We remain cautious about intense competition, currency fluctuations and the overall weak macroeconomic conditions. We currently have a Neutral recommendation on the stock, which carries a short-term Zacks #3 Rank (Hold rating).

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