SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-K (Mark One) [X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the fiscal year ended April 24, 1999 OR [_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from __________ to __________ Commission File No. 0-20572 PATTERSON DENTAL COMPANY (Exact name of registrant as specified in its charter) Minnesota 41-0886515 (State or other jurisdiction of (I.R.S. Employer Identification No.) incorporation or organization) 1031 Mendota Heights Road St. Paul, Minnesota 55120 (Address of principal executive offices including Zip Code) Registrant's telephone number, including area code: (651) 686-1600 Securities registered pursuant to Section 12(b) of the Act: None Securities registered pursuant to Section 12(g) of the Act: Common Stock, par value $.01 Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months, and (2) has been subject to such filing requirements for the past 90 days. Yes X No___ --- Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [X] The aggregate market value of voting stock held by nonaffiliates of the registrant as of July 14, 1999 was approximately $863,761,039. As of July 14, 1999, there were 33,660,333 shares of Common Stock of the registrant issued and outstanding. Documents Incorporated By Reference Certain portions of the document listed below have been incorporated by reference into the indicated part of this Form 10-K. Document Incorporated Part of Form 10-K --------------------- ----------------- Proxy Statement for 1999 Annual Part III Meeting of Shareholders
FORM 10-K INDEX <TABLE> <CAPTION> Page <S> <C> PART I .................................................................................................. 2 Item 1. BUSINESS............................................................................... 2 Item 2. PROPERTIES............................................................................. 10 Item 3. LEGAL PROCEEDINGS...................................................................... 10 Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.................................... 11 PART II .................................................................................................. 11 Item 5. MARKET FOR REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER MATTERS................... 11 Item 6. SELECTED CONSOLIDATED FINANCIAL DATA................................................... 12 Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.. 12 Item 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK............................. 18 Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA............................................ 18 Item 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE... 32 PART III .................................................................................................. 32 Item 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT..................................... 32 Item 11. EXECUTIVE COMPENSATION................................................................. 32 Item 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT......................... 32 Item 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS......................................... 32 PART IV .................................................................................................. 33 Item 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K........................ 33 SIGNATURES................................................................................................... 35 SCHEDULE II.................................................................................................. 36 INDEX TO EXHIBITS............................................................................................ 37 </TABLE>
PART I 1. BUSINESS Certain information of a non-historical nature contained in Items 1, 2, 3 and 7 of this Form 10-K include forward-looking statements. Reference is made to Item 7 - Management's Discussion and Analysis of Operations and Financial Condition - Factors that May Affect Future Operating Results, for a discussion of certain factors which could in the future affect the Company's actual operating results which could differ materially from those expressed in any forward-looking statements. General Patterson Dental Company ("Patterson" or the "Company") distributes dental supplies and equipment in the United States and Canada. The Company currently supplies a full line of over 82,500 products to dentists, dental laboratories and institutions. These products include supplies such as x-ray film and solutions, impression materials and restorative materials, hand instruments and sterilization and protective products and equipment such as x-ray machines, handpieces, dental chairs, dental handpiece control units, diagnostic equipment, sterilizers, dental lights and compressors. The Company's product line includes approximately 2,000 private-label products sold under the Patterson name. Patterson also offers customers a full range of related services including dental equipment installation, maintenance and repair, dental office design and equipment financing. Patterson also provides a variety of printed products and office supplies to office-based healthcare providers including medical and dental offices, and Windows(R) based practice management software for dental offices. Unless otherwise indicated, all references to Patterson or the Company include its subsidiaries: Direct Dental Supply Co.; Patterson Dental Canada, Inc.; Patterson Dental Supply, Inc. The Company markets its dental products and services through over 900 direct sales representatives and equipment specialists who operate through 92 sales offices in the United States and Canada. The Company processes an average of more than 10,000 customer orders each business day using a computerized order processing network that links the Company's sales offices and 10 distribution centers. The Company estimates that 97% of its consumable goods orders are shipped complete within 24 hours. To support its marketing efforts and facilitate order entry, Patterson publishes a catalog containing approximately 15,000 dental products; a semiannual publication, Patterson Today, featuring dental equipment; and periodic direct mail advertisements highlighting popular and specially priced items. Customers may order through a sales representative or directly from the Company by mail, telephone or electronically through various media, including the internet. In May 1985, a holding company formed by the Company's management and certain investors purchased the Company's predecessor, then a Delaware corporation, from a subsidiary of The Beatrice Companies, Inc. Following the acquisition, management implemented strategies to enhance profitability through improving operating efficiency and the quality and breadth of customer service. The Company instituted a computerized order processing network, improved inventory tracking and other management information systems, introduced centralized purchasing, and reduced the number of distribution locations in the U.S. from 56 to 8. Management also enhanced revenue growth through internal expansion and strategic acquisitions, including the 1987 acquisition of the third largest U.S. distributor of dental products, the 1993 acquisition of the second largest distributor of dental products in Canada and the October 1996 acquisition of Colwell Systems, a direct marketer of stationery and office products to healthcare providers, and other dental distributors. As a result of implementing these strategies, net sales increased from $165.8 million for fiscal 1986 to $878.8 million for fiscal 1999, operating margins increased every year since fiscal 1985 and profitability increased from an operating loss for fiscal 1986 to operating income of $77.5 million for fiscal 1999. Industry Background Total expenditures for dental services in the United States increased from $13.3 billion in 1980 to over $53 billion in 1998. Domestic dental care expenditures are projected by the Health Care Financing Administration to grow 6% annually reaching $95 billion by the year 2007. The Company believes that the demand for dental services and dental equipment and supplies will continue to be influenced by the following factors: 2
. Demographics. The U.S. population grew from 235.1 million in 1980 to 272 million in 1998, and is expected to reach 290 million by 2007. The median age of the population is also increasing and Patterson believes that older dental patients spend more on a per capita basis for dental services. . Dental products and techniques. Technological developments in dental products have contributed to advances in dental techniques and procedures, including cosmetic dentistry and dental implantation. . Demand for certain dental procedures. Demand is growing for preventive dentistry and periodontic (the treatment of gums), endodontic (root canals), orthodontic (braces) and other dental procedures which enable patients to keep their natural teeth longer and improve their appearance. . Demand for infection control products. Greater public awareness and new regulations and guidelines instituted by OSHA, the American Dental Association and state regulatory authorities have resulted in increased use of infection control (asepsis) products such as protective clothing, gloves, facemasks and sterilization equipment to prevent the spread of communicable diseases such as AIDS, hepatitis and herpes. . Coverage by dental plans. An increasing percentage of dental services are being funded by private dental insurance. The Health Care Financing Administration statistics on expenditures for dental services in the United States indicate that private dental insurance paid approximately 50% of the over $53 billion in total expenditures for 1998 as compared to approximately 30% of the $13.3 billion in total expenditures for 1980. See, "Factors That May Affect Future Operating Results." --- According to the American Dental Association, there are over 150,000 dentists practicing in the United States in approximately 113,000 dental practices, representing a fragmented, geographically diverse market. Dental supplies and equipment are purchased by dentists from full-service dental distributors such as Patterson, through mail order distributors, or, as to certain products, directly from manufacturers. Full-service distributors typically employ a sales force to make calls on dental offices and to provide quick response time, personal attention and product knowledge. With the introduction of new products and technologies, dentists are demanding more sophisticated, personalized service from distributors of dental products. The Company believes that it is well positioned to compete as a full-service distributor of dental products, based primarily on its qualified and motivated sales force, experienced service technicians, broad range of products and services, accurate and timely delivery, strategic location of sales offices and distribution centers, and competitive pricing. Patterson's Strategy Patterson's objective is to remain a leading national distributor of dental supplies, equipment and related services while continuing to improve its profitability and enhance its value to customers. To achieve this objective, Patterson has adopted a strategy of emphasizing its full-service capabilities, using technology to enhance customer service, continuing to improve operating efficiencies, and growing through internal expansion and acquisitions. Emphasizing Full-Service Capabilities. Patterson believes that its customers value full service and responsive delivery of quality supplies and equipment, in addition to competitive prices. Customers also increasingly expect suppliers to be knowledgeable about products and services. Patterson currently supplies a full line of over 82,500 different inventoried items. Patterson generally ships within 24 hours from distribution centers located strategically throughout the United States. The Company's knowledgeable sales representatives and equipment specialists assist customers in the selection and purchasing of supplies and equipment and provide consultation on office design, equipment requirements and financing. Equipment installation, maintenance and repair is performed by Patterson's trained service technicians. 3
Using Technology to Enhance Customer Service. The Company's computerized, remote order entry systems permit customers to place orders from their offices directly to Patterson 24 hours a day, seven days a week. Remote Order Entry (REMO(TM), introduced in 1987 and the Windows(R) based version (REMO(TM)ware) introduced in 1998, give customers direct and immediate ordering access through a personal computer to a database containing Patterson's complete inventory. In September 1991, the Company began offering customers PDXpress(R), a hand held order entry system that eliminates handwritten order forms by permitting a user to scan a product bar code from an inventory tag system or from Patterson's bar-coded catalog. PassPort Plus(TM) is a smart phone which incorporates automated ordering and bar code scanning with credit card processing. REMO(TM), REMO(TM)ware, PDXpress(R) and PassPort Plus(TM) are provided at no additional charge to customers who maintain certain minimum purchase requirements. The Company recently introduced a new system, REMOTMnet, which allows customers to access the online ordering system, as well as their order history and other inventory management reports, via the Internet. In addition, by utilizing technologies such as computer-aided design (CAD), Patterson is able to provide faster generation and revision of dental office blueprints and a more effective dental office design presentation. Continuing to Improve Operating Efficiencies. Patterson continues to implement programs designed to improve operating efficiencies. These programs include enhancing its management information and product handling systems and consolidating its distribution centers to improve product availability and to reduce redundancies in personnel, equipment and certain inventories. In addition, by offering its electronic order entry systems to dentists, Patterson enables its sales representatives to spend more time with existing customers and to call on additional customers. Growing through Internal Expansion and Acquisitions. The Company intends to continue to grow by opening additional sales offices, hiring established sales representatives, hiring and training college graduates as territory sales representatives, and acquiring other distributors in order to enter new markets and expand its customer base. The Company believes that it is well positioned to take advantage of expected continued consolidation in the dental products distribution industry. Over the past twelve years the Company has made the following acquisitions: Dental distribution acquisitions in the United States . In August 1987, Patterson acquired the D.L. Saslow Co., which at the time was the third largest distributor of dental products in the United States. Between 1989 and 1999, Patterson acquired the customer base and certain assets of smaller dental dealers in Boston; Portland, Maine; Memphis; Salt Lake City; the Washington, D.C. area; Raleigh, North Carolina; Akron, Ohio; St. Louis; Erie (Pa.), Kansas City, Omaha, Youngstown, San Antonio and the Tampa-Orlando-Miami area. In addition, Patterson also expanded by opening additional sales offices and hiring established sales representatives in Baltimore; Tulsa; Charlotte, North Carolina; and Greenville, Columbia and Charleston, South Carolina. In fiscal 1998 the Company acquired Hill Dental Company, Inc. with locations in Atlanta, Georgia; Birmingham and Mobile, Alabama; New Orleans, Louisiana; Jackson, Mississippi; Houston and San Antonio, Texas; and Memphis, Tennessee. This past year the Company acquired Dentaplex, Inc. located in the Detroit metropolitan area and J&S Dental Supply Co., Inc. of Hollywood, Florida. Subsequent to year-end, the Company acquired Barr Dental Supply, Inc. of Medford, Oregon. Dental distribution acquisitions in Canada . In October 1993, the Company completed the acquisition of Healthco International, Inc.'s Canadian subsidiary, Healthco Canada, Inc. Now known as Patterson Dental Canada, Inc., this subsidiary, which the Company believes is one of the two largest full service dental products distributors in Canada, employs approximately 440 people, 115 of whom are sales representatives. Patterson Dental Canada, Inc. has eleven sales offices throughout Canada, including its headquarters facility in Montreal, which also serves as a distribution center. In August 1997, the Company acquired Canadian Dental Supply Ltd. which expanded the Company's market share in British Columbia, Alberta, Saskatchewan and Ontario. As a result of the acquisition, a new distribution center was added in Edmonton, Alberta to service the western provinces. 4
Printed office products acquisitions . In October 1996, the Company acquired the Colwell Systems division of Deluxe Corporation. Colwell Systems produces and sells a variety of products used in medical and dental offices including appointment books, insurance and billing forms, stationery, envelopes, business cards, reminder cards, file folders, labels and other office supply products. Colwell Systems, which employs approximately 562 people, has two facilities in Champaign, Illinois; a production facility which produces custom printed products, and a distribution facility which houses the telemarketing operations and ships orders for stock items. In February 1999, the Company acquired Professional Business Systems, Inc. (PBS), Colwell's largest supplier, to expand production capacity and gain a commissioned sales force to service the medical market. PBS manufactures and distributes from its headquarters in Roselle, Illinois and has sales offices in Massachusetts, Missouri and California. Software acquisitions . In July 1997, the Company acquired EagleSoft, Inc., a developer and marketer of Windows(R) based practice management software for dental offices. EagleSoft employs approximately 116 people and is headquartered in Effingham, Illinois. The Company has operations in the U.S. and Canada and conducts business in one segment, dental distribution. This segment, which is comprised of the Company's dental supply, printed office products and software groups, distributes consumable supplies, equipment, services and software primarily to dental professionals in the U.S. and Canada. Approximately half of the printed office products are sold to non-dental healthcare practitioners. Products Dental Supply Products Patterson distributes approximately 82,500 dental products categorized as supplies, equipment and other. The following table shows the approximate percentages of net sales contributed by sales category for the last three fiscal years: <TABLE> <CAPTION> 1999 1998 1997 ---- ---- ---- <S> <C> <C> <C> Dental & Office Supplies.................................... 64% 64% 63% Equipment................................................... 27 27 27 Other....................................................... 9 9 10 --- --- --- Total.............................................. 100% 100% 100% === === === </TABLE> Supplies. Patterson offers a wide range of consumable dental products such as x-ray film and solutions; impression materials; restorative materials (composites and alloys); hand instruments; sterilization products; infection control products such as protective clothing, gloves and facemasks; paper, cotton and other disposable products; toothbrushes and a full line of dental accessories including instruments, burs, diamonds and office supplies. Patterson markets its own private label line of dental supplies consisting of approximately 2,000 items, including anesthetics, instruments, preventative and restorative products, and cotton and paper products. Compared to most name brand supplies, the private label line provides lower prices for the Company's customers and higher margins for the Company. Equipment. Patterson offers a wide range of dental equipment including x-ray machines, high and low speed handpieces, dental chairs, dental handpiece control units, diagnostic equipment, sterilizers, dental lights and compressors. The Company also distributes various high-productivity products including CEREC 29(TM), a chair side restoration system, air abrasion systems, digital x-rays, the Welch Allyn Reveal(R) intra oral camera, and the Triangle Sterilization Center. Patterson estimates that approximately 90% of its equipment sales are made to established dentists, dental laboratories and institutions and that the remainder are made to dentists and dental clinics establishing new practices. Most of the equipment sold by Patterson is custom-ordered. Other. Patterson also offers repair parts and labor as well as teeth for use in dentures and software. 5
Printed Office Products The Company provides a variety of printed products, office filing supplies, and practice management systems to office-based healthcare providers including medical and dental offices. Products include custom printed products, insurance and billing forms, stationery, envelopes and business cards, labels, file folders, appointment books and other stock office supply products. Products are sold through three channels: . The Company's dental distribution sales force, . catalogs distributed to over 160,000 customers several times a year, . and a dedicated office products sales organization, acquired with PBS. All three channels are supported by a telemarketing staff located in Champaign, Illinois. Orders are received by telephone, through the mail or electronically from the dental distribution order processing system. The business operates from two facilities located in Champaign, Illinois, and one each in Roselle, Illinois, Marlboro, Massachusetts, Jefferson City, Missouri and San Diego, California. The largest facility is an 86,200 square foot printing plant located in Champaign specializing in short-run printing and custom printed products. The other facility in Champaign serves as its distribution center for its stock items, the call center for its telemarketing group and administrative offices. The Roselle facility is a 32,000 square foot building that houses printing, assembly, distribution and sales operations. The Marlboro, Jefferson City, and San Diego facilities are sales offices with limited distribution and product assembly capabilities. The printed office products business employs a total of 562 people. Principal competition includes two other national direct marketers of forms and office supplies to the healthcare market, local printing companies and local and national chain office supply stores. Software Products The Company develops and markets practice management software for dental professionals. Products include software for scheduling, billing, charting and storage/retrieval of digital images, service agreements and electronic claims processing. The business is based in Effingham, Illinois and has a total of 116 employees. Services Patterson offers a broad range of services to its customers to complement and support its supply and equipment sales business. Equipment Installation, Repair and Maintenance. To keep their practices running efficiently, dentists require reliable performance from their equipment. All major equipment sold by Patterson includes installation and Patterson's 90-day labor warranty at no additional charge. Patterson also provides complete repair and maintenance service for all dental equipment, whether or not purchased from Patterson, including 24-hour handpiece repair service. Patterson's service technicians call on dental offices throughout the United States for equipment repair and maintenance. A computerized scheduling, tracking and billing system documents and instantly retrieves customer repair histories, and helps Patterson to keep frequently needed repair items in inventory. Dental Office Design. Patterson provides dental office layout and design services through the use of Patterson's own computer-aided design (CAD) program. Equipment specialists can create original or revised dental office blueprints in a fraction of the time required to produce conventional drawings. Customers purchasing major equipment items receive dental office design services at no additional charge. Equipment Financing. The Company arranges financing for qualified purchasers of equipment. The Company sells its retail installment contracts to a third party or, alternatively, arranges financing or leasing through a third party. In fiscal 1999, the Company originated over $76 million of equipment finance contracts. Equipment leasing is provided by BA Credit Corp., a unit of BankAmerica, pursuant to an agreement entered into in July 1993. Applications for financing originated by the Company are reviewed by BA Credit Corp. which upon approval may purchase the equipment and lease it to the customer or purchase an installment sale contract from the Company without recourse. 6
In April 1996, the Company entered into a Contract Purchase Agreement with U.S. Bank National Association, under which U.S. Bank National Association committed to purchase from the Company, on a limited recourse basis, the Company's installment sale contracts secured by dental equipment. The Company continues to service the accounts. As of April 1999, the combined Contract Purchase Agreement and unsecured revolving credit agreement with U.S. Bank National Association and two additional banks allows for a maximum credit line of $85 million. As of April 24, 1999, contracts with an outstanding principal balance of $77 million had been sold under the Contract Purchase Agreement. The Company had no outstanding borrowings under the Revolving Credit Agreement Sales and Marketing During fiscal 1999, Patterson sold dental products to over 90,000 customers who made one or more purchases of supplies during the year. Patterson's customers include dentists, dental laboratories and institutions. No single customer accounted for more than 1% of sales during fiscal 1999, and Patterson is not dependent on any single customer or geographic group of customers. Due to the fragmented nature of the dental products market, Patterson believes that a large sales force is necessary to reach potential customers and to provide full service. As of April 24, 1999, Patterson employed approximately 935 trained dental sales representatives, 138 of whom were equipment specialists. Each representative works within an assigned sales territory from one of 92 sales offices under the supervision of a branch sales manager. Sales representatives are all Patterson employees and are generally compensated on a commission basis, with some representatives receiving a base salary and commission. To assist its sales representatives, Patterson publishes a variety of catalogs and fliers containing product and service information. Patterson's customers receive a full-line product catalog containing over 10,000 inventoried items. Selected consumable supplies, new products, specially priced items and high-demand items such as asepsis products are promoted through merchandise fliers printed bimonthly and distributed to over 100,000 dentists nationwide. In addition, equipment sold by the Company is featured in the Company's semiannual publication, Patterson Today, which also includes articles on dental office design, trends in dental practice, products and services offered by Patterson, and information on equipment maintenance. The Company believes that its computerized order entry systems, REMO(TM), REMO(TM)ware, REMO(TM)net, PDXpress(R) and PassPort Plus(TM) help to establish relationships with new customers and increase loyalty among existing customers. Patterson provides these systems at no additional cost to customers who maintain certain minimum purchase requirements. Distribution Patterson ships its dental supplies from 10 distribution centers. The Company's 92 dental sales offices in the United States and Canada are configured with display areas where the latest dental equipment can be demonstrated. Equipment inventory is also staged at sales offices before delivery to dental offices for installation. Orders can be placed by telephone or electronically 24 hours a day, seven days a week. All orders are routed through the Company's computerized ordering, shipping and inventory management system, which is linked to each of the Company's distribution centers. If an item is not available in the distribution center nearest to the customer, the computer system automatically directs shipment of the item from another center. Purchasing is centralized and inventory levels are managed by the purchasing department using a real-time perpetual inventory system. Each order is printed out in the shipping department of the appropriate distribution center, where employees pick and pack the order. All orders are checked for accuracy before shipment by common carrier. The Company estimates that 97% of its consumable goods orders are shipped complete within 24 hours. In order to assure the availability of products for delivery to customers, the Company must maintain significant working capital to enable it to carry substantial inventories at its distribution centers. The Company's inventory consists mostly of dental supply items; equipment is generally custom-ordered by customers. By utilizing its computerized inventory management and ordering systems, the Company is able to accurately predict inventory turns in order to minimize inventory levels for each item. Sources of Supply The Company obtains dental products from approximately 1,100 vendors. In fiscal 1999, the Company's top 10 vendors and single largest vendor accounted for approximately 45% and 12%, respectively, of the cost of products sold. There is more than one source of supply for almost all of the categories of products sold by the Company. 7
Competition The highly competitive U.S. dental products distribution industry consists principally of national, regional and local full-service distributors and mail-order distributors. In addition to Patterson and one other national, full-service firm, Henry Schein, Inc. ("Schein"), there are at least 20 full-service distributors which operate on a regional level, and hundreds of small local distributors. Although the Company does not have reliable information regarding the market share of mail-order companies, it believes that Schein is the largest distributor in the industry. Patterson believes that it competes with full-service distributors and mail-order distributors based primarily on its qualified and motivated sales force, experienced service technicians, broad range of products and services, accurate and timely delivery, strategic location of sales offices and distribution centers, and competitive pricing. Trademarks Patterson has registered with the United States Patent and Trademark Office the marks "Patterson" and "PDXpress." The Company believes that the Patterson mark is well recognized in the dental products industry and by dental professionals, and is therefore a valuable asset of the Company. Employees As of April 24, 1999, the Company employed 3,623 people in the United States and Canada on a full-time basis, consisting of 986 sales representatives, 131 telemarketing employees, 721 service technicians, 465 distribution employees, 229 manufacturing employees, and 1,091 general and administrative employees. Patterson has not experienced a shortage of qualified personnel in the past, and believes that it will be able to attract such employees in the future. None of Patterson's employees is subject to collective bargaining agreements or represented by a union. The Company considers its relations with its employees to be good. Governmental Regulation The marketing, distribution and sale of certain dental products sold by the Company is subject to the requirements of various state, local and federal laws and regulations. Among the federal laws which impact the Company are the Federal Food, Drug and Cosmetic Act, which regulates the advertising, record keeping, labeling, handling, storage and distribution of drugs and medical devices, and which requires the Company to be registered with the Federal Food and Drug Administration, and the Safe Medical Devices Act of 1990, which imposes certain reporting requirements on distributors in the event of an incident involving serious illness, injury or death caused by a medical device. In addition, the Company is required to be licensed as a distributor of drugs and medical devices by each state in which it conducts business. The Company believes that it is in substantial compliance with all of the foregoing laws and that it possesses all licenses required in the conduct of its business. Executive Officers of the Registrant Set forth below are the names, ages and positions of the executive officers of the Company. <TABLE> <S> <C> <C> Peter L. Frechette 61 President and Director - Patterson Dental Company Ronald E. Ezerski 53 Executive Vice President, Treasurer and Director - Patterson Dental Company James W. Wiltz 54 Vice President - Patterson Dental Company and President - Patterson Dental Supply, Inc. Mary H. Baglien 56 Vice President, Human Resources - Patterson Dental Company John V. Dodd 62 Vice President, Management Information Systems - Patterson Dental Company Gary D. Johnson 52 Vice President - Patterson Dental Supply, Inc. R. Reed Saunders 51 Vice President - Patterson Dental Supply, Inc. Normand Senecal 54 President - Patterson Dental Canada, Inc. Brian S. Watson 39 Vice President - Patterson Dental Supply, Inc. </TABLE> On July 1, 1999 Mr. Ezerski resigned as Executive Vice President and Treasurer effective July 31, 1999. R. Stephen Armstrong, 48, was elected to the positions of Executive Vice President and Treasurer effective July 31, 1999. 8
The officers of the Company are elected annually and serve at the discretion of the Board of Directors. None of the Company's officers is employed pursuant to a written employment contract Background of Executive Officers Peter L. Frechette has been President and Chief Executive Officer of the Company since September 1982 and has been a director of Patterson since March 1983. Prior to joining Patterson, Mr. Frechette was employed by American Hospital Supply Corporation for 18 years, the last seven of which he served as president of its Scientific Products Division. Mr. Frechette holds an MBA degree from Northwestern University and a BS degree in economics from the University of Wisconsin. Ronald E. Ezerski has been Vice President and Chief Financial Officer of the Company since December 1982 and was President of its subsidiary, Dental Capital Corporation, from December 1982 until October 1988 when it was merged into the Company. In 1997 Mr. Ezerski became Executive Vice President of the Company. Mr. Ezerski resigned as Executive Vice President, Treasurer and Chief Financial Officer effective July 31, 1999. Mr. Ezerski has been a director of Patterson since March 1983. Mr. Ezerski holds a BS degree in accounting from DePaul University and is a certified public accountant. R. Stephen Armstrong was elected Executive Vice President, Treasurer and Chief Financial Officer of the Company effective July 31, 1999 to replace Mr. Ezerski. Mr. Armstrong has been a Senior Assurance Partner with Ernst & Young LLP since 1986. Ernst & Young LLP is currently the Company's independent public accountants. Mr. Armstrong holds a BS degree from St. John's University and is a certified public accountant. James W. Wiltz has been Vice President of the Company since it was acquired from The Beatrice Companies, Inc. and has been employed by Patterson since September 1969, initially as a territory sales representative, then an equipment specialist and later a branch manager. In 1980, Mr. Wiltz was appointed Vice President of the Midwestern Division and was appointed Vice President, Sales and Distribution in 1986. Mr. Wiltz is also President of the Company's operating subsidiary, Patterson Dental Supply, Inc. Mary H. Baglien joined Patterson Dental Company in November of 1977 as Sales Training Director. In 1981 Ms. Baglien became Director of Human Resources and continued in that capacity until June of 1998 when she was named Vice President of Human Resources. Ms. Baglien holds an MA degree from Bowling Green State University and a BA from Carthage College. John V. Dodd joined Patterson in February 1989 as Vice President, Management Information Systems. Prior to joining Patterson, Mr. Dodd was Director of System Development for Ecolab, Inc. Mr. Dodd is a graduate of the University of Illinois and has been associated with G.D. Searle Corporation and Wilson Companies, where he implemented data processing programs for increased productivity in distribution organizations. Mr. Dodd has more than 25 years of experience in the management information systems area. Gary D. Johnson has been Vice President, Sales, of Patterson Dental Supply, Inc. since October 1996. Mr. Johnson has served in various sales and management positions since he joined the Company in August 1981. R. Reed Saunders has been a Vice President of Patterson Dental Supply, Inc. since March 1997 and is President of its Colwell Systems division. Prior to joining Patterson, Mr. Saunders spent 15 years with American Express Company as Senior Vice President - Chief Marketing Officer of its division, American Express Financial Advisors. He holds an MBA from Amos Tuck School, and an undergraduate degree from Dartmouth College. Brian S. Watson has been Vice President, Marketing of Patterson Dental Supply, Inc. since October 1996. Mr. Watson joined the Company in May 1982. During his career with the Company, Mr. Watson has served in various sales and management capacities. Mr. Watson holds a BS degree in Marketing from Indiana University. 9
2. PROPERTIES The following table summarizes Patterson's properties as of April 24, 1999: <TABLE> <CAPTION> Number Total Square Cost Per of Properties Footage Square Foot ------------- ------------ ----------- <S> <C> <C> <C> Leased facilities Branch sales offices 93 496,887 $ 6.86 Distribution centers 4 113,110 4.82 Combined sales & distribution 2 70,068 6.30 Software support 1 11,715 11.37 --- -------- ------ Total leased 100 691,780 $ 6.62 Owned facilities Distribution centers 4 208,000 Combined sales & distribution 2 98,000 Corporate office 1 50,800 Printing plant 1 82,600 --- -------- Total owned 8 439,400 --- -------- Total 108 1,131,180 === ========= </TABLE> The Company considers its facilities to be well-maintained and suitable for its purposes. The Company has made a significant investment in computer, data processing and automated office equipment systems and it plans to continuously upgrade these systems. The Company believes that technology-based systems are crucial in supporting its operating efficiency and providing it with a competitive advantage. 3. LEGAL PROCEEDINGS The Company has been involved in various product related and employment related legal proceedings arising in the ordinary course of business. Some of these proceedings involve product liability claims arising out of the use of dental products manufactured by third parties and distributed by the Company. The Company believes that if any such product liability cases are determined in favor of the claimants, the manufacturers of such products would have primary responsibility for any damages because Patterson is a distributor of finished goods manufactured by third parties. In the event a manufacturer of a defective product is unable to pay a judgment for which the Company may be jointly liable, the Company could have liability for the entire judgement. Among the product liability cases in which the Company is a defendant, thirteen involve claims by healthcare workers claiming damages from allergic reactions to exposure to latex gloves distributed by the Company. In each of these cases the Company acted as a distributor of "Patterson" private label gloves manufactured by third parties, as well as gloves bearing the brand names of other suppliers. In each of these cases the Company intends to seek indemnification from or assert claims against the glove manufacturers pending completion of product identification. 10
Since May 1985 the Company has maintained product liability insurance coverage for any potential liability for claims arising out of products sold by the Company. The Company believes that any liabilities which might result from pending cases and claims relating to events occurring after May 1985 would be adequately covered by such insurance and that any unfavorable results in such cases would not have a material adverse effect on the Company's business or financial condition. With respect to claims relating to events occurring prior to May 1985, the agreement providing for the acquisition of Patterson from The Beatrice Companies, Inc. provides that Beatrice and its successors are obligated to indemnify the Company for losses exceeding a litigation reserve established at the time of the acquisition plus $200,000. The successor to Beatrice has not been asked to indemnify the Company regarding any pending cases and has not contested its obligation to indemnify the Company. Although the Company has insurance coverage for product liability claims relating to events occurring after May 1985 and may be entitled to indemnification from third parties under certain circumstances, any additional litigation could have a material adverse effect on the Company's business or financial condition in the future. 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS There were no matters submitted to a vote of the Company's shareholders during the three-month period ended April 24, 1999. PART II 5. MARKET FOR REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER MATTERS The Company's Common Stock began trading under the symbol "PDCO" on the NASDAQ National Market in October 1992. The following table sets forth the range of high and low sale prices for the Company's Common Stock for each full quarterly period within the two most recent fiscal years. Quotations for such periods are as reported by NASDAQ for National Market issues. <TABLE> <CAPTION> <S> <C> <C> Fiscal 1998 First Quarter............................... $ 24.33 $ 20.58 Second Quarter.............................. $ 28.08 $ 22.50 Third Quarter............................... $ 31.83 $ 23.92 Fourth Quarter.............................. $ 32.67 $ 28.13 High Low ---- --- Fiscal 1999 First Quarter............................... $ 39.50 $ 29.00 Second Quarter.............................. $ 39.25 $ 29.50 Third Quarter............................... $ 46.38 $ 36.63 Fourth Quarter.............................. $ 45.75 $ 33.13 </TABLE> On July 14, 1999, the number of holders of record of Common Stock was 2,282. The transfer agent for the Company's Common Stock is Norwest Bank Minnesota, NA, 161 North Concord Exchange, South St. Paul, Minnesota, 55075-0738, telephone: (612) 450-4064. The Company has not paid any cash dividends on its Common Stock since its initial public offering in 1992 and expects that for the foreseeable future it will follow a policy of retaining earnings in order to finance the continued development of its business. Payment of dividends is within the discretion of the Company's Board of Directors and will depend upon the earnings, capital requirements and operating and financial condition of the Company, among other factors. Recent Sales of Unregistered Securities On February 5, 1999 the Company issued 214,317 shares of common stock to two persons who were the shareholders of Professional Business Systems, Inc. ("PBS"), an Illinois corporation, which was acquired by merger with the Company's subsidiary. 11
No underwriters were involved and no underwriting compensation was paid to any person. The shares were issued in a transaction not involving a public offering and were exempt from registration under Section 4(2) of the Securities Act of 1933, as amended (the "Act") and Regulation D, Rule 506. The securities issued to the stockholders of PBS contained restrictive legends and are restricted as to transfer, subject to compliance with applicable registration requirements under the Act. The Company furnished to the stockholders of PBS material information concerning the Company, including the information specified in Rule 502 of Regulation D. These shares were registered under the Act for resale on May 28, 1999. 6. SELECTED CONSOLIDATED FINANCIAL DATA (In thousands, except per share amounts) <TABLE> <CAPTION> Fiscal Year Ended ------------------------------------------------------------------------ April 24, April 25, April 26, April 27, April 29, 1999 1998 1997(2) 1996(2) 1995(2) ----------- ----------- ----------- ----------- ----------- <S> <C> <C> <C> <C> <C> Statement of Operations Data: - ----------------------------- Net sales $ 878,773 $778,169 $ 687,895 $ 606,983 $ 558,648 Cost of sales 552,937 488,279 440,262 392,091 358,868 ----------- ----------- ----------- ----------- ----------- Gross profit 325,836 289,890 247,633 214,892 199,780 Operating expenses 248,364 225,508 196,448 170,958 160,501 ----------- ----------- ----------- ----------- ----------- Operating income 77,472 64,382 51,185 43,934 39,279 Other income (expense) - net 2,239 1,324 1,119 1,711 946 ----------- ----------- ----------- ----------- ----------- Income before income taxes 79,711 65,706 52,304 45,645 40,225 Income taxes 29,815 24,937 19,687 16,997 15,396 ----------- ----------- ----------- ----------- ----------- Net income $ 49,896 $ 40,769 $ 32,617 $ 28,648 $ 24,829 =========== ============ =========== =========== =========== Earnings per share - diluted/(1)/ $ 1.49 $ 1.23 $ 1.00 $ 0.86 $ 0.75 ----------- ----------- ----------- ----------- ----------- Weighted average dilutive potential shares outstanding (1) 33,496 33,163 32,689 32,477 32,400 ----------- ----------- ----------- ----------- ----------- Dividends per common share -- -- -- -- -- Balance Sheet Data: - ------------------- Working capital $ 187,952 $133,256 $ 96,893 $ 114,883 $ 90,392 Total assets 373,250 316,373 255,311 212,973 179,307 Total debt 2,097 7,202 10,792 10,681 9,664 Stockholders' equity 265,199 210,303 163,662 127,852 97,555 </TABLE> (1) Amounts are adjusted for three-for-two stock split on January 12, 1998. See Note 1, "Earnings per Share," to the Consolidated Financial Statements. (2) Consolidated results have been restated to include the operations of Canadian Dental Supply, Ltd. acquired in August 1997, and accounted for as a pooling-of-interests. See Note 2, "Acquisitions," of the Consolidated Financial Statements. 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Patterson has established certain operating goals which call for increasing sales four percentage points greater than the average industry growth rate, and achieving double-digit net income growth. The Company exceeded these goals in fiscal year 1999, reporting a 12.9% increase in sales, a 22.4% increase in net income, and a 50 basis point expansion in net margin versus fiscal 1998. Over the recent five-year period, sales have grown 12.3% and net income advanced 20.3% compounded annually. Net income over the five years benefited from cost controls that reduced operating expenses in relation to sales to 28.3% of sales in fiscal 1999 versus 28.7% in fiscal 1995, and improved gross profit margin that was 37.1% in fiscal 1999 compared with 35.8% in fiscal 1995. 12
The Company's effective strategy for growth focused on the acquisition of smaller dental distributors to achieve a broader customer base and expanded direct sales representation. The acquisition strategy also featured the addition of complementary product lines, such as supplies and forms for the dentist's front office, and practice management software. Over the last five years, Patterson completed 11 acquisitions of companies with annual sales of $143 million and gained a total of 109 sales representatives. The number of direct sales representatives has increased 36% since 1995, and sales per direct sales representative have increased more then 18%, evidencing the effectiveness of the Company's strategies. The Company operates in one segment, dental distribution. The Company distributes consumable supplies, equipment, printed office products, services and software primarily to dental professionals in the U.S. and Canada. Results of Operations The following table summarizes the results of operations over the past three fiscal years as a percent of sales: <TABLE> <CAPTION> 1999 1998 1997 ------- ------- ------- <S> <C> <C> <C> Net sales 100.0% 100.0% 100.0% Cost of sales 62.9% 62.7% 64.0% -------- -------- -------- Gross profit 37.1% 37.3% 36.0% Operating expenses 28.3% 29.0% 28.6% -------- -------- -------- Operating income 8.8% 8.3% 7.4% Other income 0.3% .1% .2% -------- -------- -------- Income before taxes 9.1% 8.4% 7.6% Income taxes 3.4% 3.2% 2.9% -------- -------- -------- Net income 5.7% 5.2% 4.7% ======== ======== ======== </TABLE> Fiscal 1999 Compared to Fiscal 1998 Net Sales. Net sales for fiscal 1999 increased 12.9% or $100.6 million to $878.8 million from $778.2 in fiscal 1998. Expansion in customer base, an increase in the number of sales representatives and acquisitions were the primary factors that drove the increase. The number of dental customers that purchased supplies increased 12,000 or 15% in fiscal 1999, while the average amount of consumables sold to these customers remained approximately the same at $5,400 in comparison to fiscal 1998. The number of sales representatives in North America increased 100 from 886 reported at the end of last year to 986 at the end of fiscal 1999. Acquisitions, including Hill Dental Company which was acquired in the fourth quarter of fiscal 1998, contributed approximately $19 million or 19% to the increase. Sales mix remained consistent with prior year levels. Sales of dental products and services, which represents 92% of sales, increased $92.5 million or 13% reflecting strong demand for both sundries and equipment in the U.S. dental market. Sales of printed office products, which represent 7% of sales, increased $3.9 million or 7% as a result of marketing these products through the dental sales force and the introduction of new products. Software, at 1% of sales, increased 68% in response to strong demand for Windows(R) based software products and support services. Gross Profit. Gross profit increased 12.4% to $325.8 million for fiscal 1999 compared to $289.9 million for fiscal 1998 due to increased sales volume. Gross margin decreased to 37.1% in fiscal 1999 versus 37.3% reported last year due primarily to a reduction in dental equipment gross margins in the U.S. and Canada. Operating Expenses. Operating expenses increased 10.1% to $248.4 million for fiscal 1999 versus $225.5 million for fiscal 1998. Operating expenses as a percent of sales decreased to 28.3% in fiscal 1999 from 29.0% in fiscal 1998. The reduction of operating expenses in proportion to sales occurred in the U.S. and Canadian operations where operating expenses as a percent of sales declined due to improved operating leverage. Operating Income. Operating income increased 20.3% to $77.5 million in fiscal 1999 from $64.4 million in fiscal 1998. As a percent of net sales, operating income increased to 8.8% in fiscal 1999 from 8.3% in fiscal 1998 due principally to improved operating leverage in the U.S. and Canada. 13
Other Income. Other income was $2.2 million in fiscal 1999, up $0.9 million from the $1.3 million reported last year. Finance income and interest earned on short-term investments increased $0.8 million and interest expense declined $0.1 million from prior year levels. Income Taxes. The effective tax rate was 37.4% for fiscal 1999 down slightly from 38.0% reported in fiscal 1998 due to $1.0 million reduction in the loss in Canada where no net tax benefit was recognized. Net Income. Net income increased $9.1 million, or 22.4%, to $49.9 million in fiscal 1999 versus $40.8 million in the prior year. Net margin increased one-half percentage point to 5.7% of sales in fiscal 1999 due primarily to improved operating leverage. Fiscal 1998 Compared to Fiscal 1997 Net Sales. Net sales for fiscal 1998 increased 13.1% or $90.3 million to $ 778.2 million from $687.9 million in fiscal 1997 due to contributions from newly acquired businesses and increased demand for dental supplies and equipment. Colwell, which was acquired in the second quarter of fiscal year 1997, and accounted for as a purchase, affects the year-to-year comparisons as only seven months of sales for the operation are included in prior year results versus a full twelve months in the current year. Excluding the impact of Colwell, sales were up 10.8%. EagleSoft, acquired July 1997 in a pooling transaction, and Hill Dental Company, purchased in February 1998, contributed approximately $11 million to the increase. Dental products and services represented 92% of sales in fiscal 1998 versus 95% in fiscal 1997, and printed office products accounted for 7% of sales in fiscal 1998 versus 5% in the prior year due to having only seven months of results in the prior year. Software represented 1% of sales and was new in fiscal 1998. The number of dental practitioners who purchased consumable dental supplies from Patterson grew 6% increasing from 74,000 in fiscal 1997 to 78,500 in fiscal 1998, while at the same time, average sales per customer increased 8% to $5,400 from $5,000 reported last year. The Company had 886 sales representatives throughout the U.S. and Canada at the end of fiscal 1998 versus 786 reported at the end of the prior year. Sales of high-technology products such as the CEREC 2(TM), air abrasion systems and digital imaging products, continue to drive the growth of equipment sales. Gross Profit. Gross profit grew 17.1% to $289.9 million for fiscal 1998 compared to $247.6 million for fiscal 1997 due to a combination of increased sales volume and higher margins. Gross margin increased to 37.3% in fiscal 1998 versus 36.0% reported last year reflecting greater contribution from printed office product lines and software, which have higher gross margins than the dental products and services and higher margins in the U.S. dental products. Excluding printed office products and software, margins in dental products and services were up 50 basis points over last year. Operating Expenses. Operating expenses grew 14.8% to $225.5 million for fiscal 1998 versus $196.4 million for fiscal 1997. Operating expenses as a percent of sales increased to 29.0% in fiscal 1998 from 28.6% in fiscal 1997 due to higher operating expenses in the software and printed office products product lines where expenses were higher as a percent of sales. Operating expenses in relation to sales in dental products and services were down 10 basis points from prior year levels. Operating Income. Operating income increased to $64.4 million or 8.3% of sales in fiscal 1998. This represented a 25.8% increase from $51.2 million or 7.4% of sales reported in fiscal 1997. Operating margins improved slightly reflecting the higher margin contribution from acquisitions, and improved operating margins, brought on by increased prices and lower operating expenses in relation to sales in dental products and services. Other Income. Other income was $1.3 million in fiscal 1998 compared to $1.1 million in fiscal 1997. Interest costs were lower due to a reduction in borrowing levels in fiscal year 1998. Income Taxes. The effective tax rate was 38.0% for fiscal 1998 up slightly from 37.6% reported in fiscal 1997 due to an increase in the loss in Canada, for which no net tax benefit was recognized. Net Income. Net income grew $8.2 million, or 25%, to $40.8 million in fiscal 1998. The net margin increased from 4.7% of sales in fiscal 1997 to 5.2% of sales in fiscal 1998 due to increased gross margin. 14
Liquidity and Capital Resources The following table summarizes certain balance sheet items as a percent of total assets. <TABLE> <CAPTION> April 24, April 25, 1999 1998 -------- -------- <S> <C> <C> Total assets 100.0% 100.0% Current assets 76.8% 72.0% Current liabilities 26.4% 29.8% Long-term debt 0.6% 0.9% Stockholders' equity 71.1% 66.5% </TABLE> Patterson's operating cash flow which generally parallels net earnings continued to grow reflecting higher profitability and improved productivity in the use of working capital. Available liquid resources at April 24, 1999 consisted of $78.7 million cash and cash equivalents and $8 million available under existing bank lines, as amended on April 30, 1999. Working capital increased $54.7 million during fiscal 1999 to $188.0 million at April 24, 1999. Cash and cash equivalents increased $43.1 million reflecting cash generated from operating activities of $51.6 million offset by $6.2 million used in investing activities and $2.3 million used in financing activities, principally the repayment of debt. Non-cash related working capital increased $ 11.6 million or 11.8% in response to an 12.9% increase in sales in fiscal 1999 versus fiscal 1998. Liquidity as measured by the current ratio at the end of fiscal year 1999 increased to 2.9 to 1 from 2.4 to 1 reported last year. Capital expenditures net of dispositions were $7.1 million in fiscal 1999 versus $6 million in fiscal 1998. One of the acquisitions in fiscal year 1999 was made using common shares and two were made using cash. All of the acquisitions in fiscal 1998 were made using common shares. The Company believes that funds from operations and the remainder of its committed bank lines are sufficient to meet any existing and presently anticipated needs. In addition, the Company believes it has sufficient debt capacity to obtain the necessary funds for use in accomplishing its corporate objectives. Asset Management The following table summarizes the Company's days sales outstanding (DSO), inventory turnover, and sales per employee over the past three fiscal years: <TABLE> <CAPTION> 1999 1998 1997 ---- ---- ---- <S> <C> <C> <C> Days sales outstanding 43 45 46 Inventory turnover (1) 6.0 7.2 7.4 Sales per employee (000's) $243 $242 $223 </TABLE> (1) The inventory values used in this calculation are the LIFO inventory values for U.S. dental inventories and the FIFO inventory value for Canadian and Colwell inventories. The inventory balance increased $ 9.9 million to $ 91.7 million at the end of fiscal 1999 from $81.8 million at the end of fiscal 1998. The increase was due primarily to purchases made in anticipation of increased demand in the first quarter of fiscal 2000. Effect of Inflation Inflation has not had a significant effect on the Company's operations and the Company believes that supplier price increases can be passed on to its customers. 15
Impact of Year 2000 The Year 2000 issue is the result of the widespread use of computer programs which were written using two digits rather than four to define the applicable year in performing computations or decision-making functions. The Company has completed its assessment of its major information technology and technology reliant operating systems, including its internal accounting, general ledger, billing, inventory and accounts payable systems. Necessary modifications or replacements of existing systems, including testing of these systems, have been substantially completed. The Company anticipates that the remaining remediation and testing of these systems will be completed by September 30, 1999. The Company has also assessed the need for modifications or replacements of existing hardware, particularly personal computers, and has completed this assessment phase. The remediation and testing of existing hardware has been completed. As a result, the Company believes that substantially all critical business systems and hardware are Year 2000 compliant. The Company has been implementing the necessary modifications and replacements of its operating systems in the ordinary course of its business over the last four years and believes the incremental costs to complete this program were less than $200,000. Over the past four years the Company has invested approximately $500,000 in new systems. The Company is also dependent on its vendors to supply the products it sells and on service providers, including transportation providers and utilities. The Company has sought assurances from its significant suppliers of products and services to determine the impact on the Company if such suppliers fail to convert their computer systems. While many of the Company's significant suppliers have assured the Company that their systems are currently Year 2000 compliant, or will be made Year 2000 compliant prior to December 31, 1999, the Company has not yet received such assurances from a sufficient number of its product suppliers to enable the Company to complete its assessment of the impact on the Company if a substantial number of significant suppliers fail to convert their systems. The Year 2000 efforts of third parties are ultimately beyond the Company's control. The risk to the Company if significant product vendors fail to convert their computer systems and, as a result, are unable to ship products to the Company in a timely manner after the year 2000 is that the Company may not be able to offer such products to its customers and will be able to offer only replacement products, if available. The Company generally has more than one source of supply for almost all categories of products it sells. The risks to the Company if significant service providers fail to timely convert their computer systems may include, in the case of vital utility services, the inability of a branch office or distribution center to operate. In such an event, the Company does have the ability to shift its distribution and branch office operations to other distribution centers and branches within its system. However, notwithstanding the Company's efforts to substitute products or shift distribution or branch operations, the inability of significant suppliers of products and services to complete their Year 2000 resolution process in a timely fashion could materially adversely affect the Company. The amount of lost revenue and impact on the Company can not be reasonably estimated at this time. The Company currently has no contingency plans in place in the event all phases of the Year 2000 program are not completed or significant suppliers of products and services fail to complete their Year 2000 resolution process. The Company is in the process of evaluating whether such a plan is necessary. The Company believes it has an effective program in place to resolve the Year 2000 issue in a timely manner. As noted above, the failure of significant suppliers of products and services to the Company to resolve their own Year 2000 issues could materially adversely affect the Company. In addition, disruptions in the economy generally as a result of Year 2000 issues also could materially adversely affect the Company. The foregoing discussion regarding Year 2000, including the discussion of the timing and effectiveness of the Company's Year 2000 remediation efforts, contains forward-looking statements which are based on management's best estimates derived using assumptions and information considered reasonable. These forward-looking statements involve inherent risks and uncertainties, and actual results could differ materially from those contemplated by such statements. Factors that might cause material differences include, but are not limited to, the Company's ability to locate and correct all relevant Year 2000 computer code and the ability of significant suppliers of products and services to effectively address the Year 2000 issue. Such material differences could result in business disruption, operational problems, and similar risks. 16
Factors That May Affect Future Operating Results Certain information of a non-historical nature contained in Items 1, 2, 3 and 7 of this Form 10-K include forward-looking statements. Words such as "believes," "expects," "plans," "estimates" and variations of such words are intended to identify such forward-looking statements. The statements are not guaranties of future performance and are subject to certain risks, uncertainties or assumptions that are difficult to predict: therefore, the Company cautions shareholders and prospective investors that the following important factors, among others, could in the future affect the Company's actual operating results which could differ materially from those expressed in any forward-looking statements. The statements under this caption are intended to serve as cautionary statements within the meaning of the Private Securities Litigation Reform Act of 1995. The following information is not intended to limit in any way the characterization of other statements or information under other captions as cautionary statements for such purpose. The order in which such factors appear below should not be construed to indicate their relative importance or priority. . Reduced growth in expenditures for dental services by private dental insurance plans. . Accuracy of the Company's assumptions concerning future per capita expenditures for dental services, including assumptions as to population growth and the demand for preventive dental services such as periodontic, endodontic and orthodontic procedures. . The rate of growth in demand for infection control products currently used for prevention of the spread of communicable diseases such as AIDS, hepatitis and herpes. . The effects of health care reform, increasing emphasis on controlling health care costs and legislation or regulation of health care pricing, all of which may affect the ability of dentists to obtain reimbursement for use of new and state-of-the-art procedures and technologies. . The amount and growth of the Company's selling, general and administrative expenses. . The effects of, and changes in, U.S. and world social and economic conditions, monetary and fiscal conditions, laws and regulations, other activities of governments, agencies and similar organizations, trade policies and taxes, import and other charges, inflation and monetary fluctuations; the ability or inability of the Company to obtain or hedge against foreign currencies, foreign exchange rates and fluctuations in those rates. . Ability of the Company to retain its base of customers and to increase its market share. . The ability of the Company to maintain satisfactory relationships with qualified and motivated sales personnel. . Changes in economics of dentistry affecting dental practice growth and the demand for dental products, including the ability and willingness of dentists to invest in high-technology diagnostic and therapeutic products. . The Company's ability to meet increased competition from national, regional and local full-service distributors and mail-order distributors of dental products, while maintaining current or improved profit margins. . Continued ability of the company to maintain satisfactory relationships with key vendors and the ability of the Company to create relationships with additional manufacturers of quality, innovative products. . The ability of the Company and its suppliers to upgrade their computer systems to adequately address the Year 2000 issue. . Future operating results of the Company's printed office products group depends upon its ability to attract and retain customers by offering quick response time and innovative products that meet industry reporting standards. Cost of paper stock represents over half the cost of its paper and printed products, future operating results may be subject to fluctuations in paper prices. The introduction of computer-based technologies into the management of health care practices may affect future demand for printed products. 17
7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK Market Risk The Company has operations in Canada which it considers to be both long-term and strategic. As a result, the Company does not hedge the long-term translation exposure to its balance sheet. The Company has experienced negative translation adjustments of $0.6 million and $0.7 million in 1999 and 1998, respectively, which were reflected in the balance sheet as an adjustment to stockholders' equity. The cumulative translation adjustment at the end of 1999 showed a negative translation adjustment of $2.2 million. The Company purchases a portion of the products it sells from suppliers located in countries other than where the products are sold. The risk of transaction gains and losses from changes in the Company's foreign exchange position is not material as a majority of these purchases are denominated in the functional currency. 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA REPORT OF INDEPENDENT AUDITORS The Board of Directors and Stockholders Patterson Dental Company We have audited the accompanying consolidated balance sheets of Patterson Dental Company as of April 24, 1999 and April 25, 1998, and the related consolidated statements of income, changes in stockholders' equity and cash flows for each of the three years in the period ended April 24, 1999. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of Patterson Dental Company at April 24, 1999 and April 25, 1998, and the consolidated results of its operations and its cash flows for each of the three years in the period ended April 24, 1999, in conformity with generally accepted accounting principles. /s/ Ernst & Young LLP Minneapolis, Minnesota May 20, 1999 18
PATTERSON DENTAL COMPANY CONSOLIDATED BALANCE SHEETS (Dollars in thousands, except per share amounts) <TABLE> <CAPTION> April 24, April 25, ASSETS: 1999 1998 ----------- ----------- <S> <C> <C> Current assets: Cash and cash equivalents.............................................................. $ 78,746 $ 35,619 Receivables, net of allowance for doubtful accounts of $4,096 and $3,954 at April 24, 1999 and April 25, 1998, respectively................................. 112,521 106,252 Inventory.............................................................................. 91,722 81,810 Prepaid expenses and other current assets.............................................. 3,655 3,980 ---------- ---------- Total current assets..................................................................... 286,644 227,661 Property and equipment, net.............................................................. 37,018 37,998 Intangibles, net......................................................................... 46,867 48,013 Other.................................................................................... 2,721 2,701 ---------- ---------- Total assets......................................................................... $ 373,250 $ 316,373 ========== ========== LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Accounts payable....................................................................... $ 67,213 $ 60,652 Accrued payroll expense................................................................ 14,342 13,852 Other accrued expenses................................................................. 16,556 13,426 Bank indebtedness...................................................................... -- 2,033 Income taxes payable................................................................... 166 2,009 Current maturities of long-term debt................................................... 415 2,433 ---------- ---------- Total current liabilities............................................................ 98,692 94,405 Long-term debt........................................................................... 1,682 2,736 Deferred taxes........................................................................... 1,650 2,017 ---------- ---------- Total liabilities.................................................................... 102,024 99,158 Deferred credits......................................................................... 6,027 6,912 Stockholders' equity: Preferred Stock Series A, $.01 par value, $11.20 per share liquidation value: Authorized shares - 10,000,000.................................................... -- -- Preferred Stock, $.01 par value: Authorized shares - 20,000,000.................................................... -- -- Common Stock, $.01 par value: Authorized shares - 100,000,000 Issued and outstanding shares - 33,649,313 and 33,282,493 at April 24, 1999, and April 25, 1998, respectively.................................. 336 333 Additional paid-in capital............................................................... 66,992 63,134 Retained earnings........................................................................ 213,761 162,797 Accumulated other comprehensive loss..................................................... (2,222) (1,624) Note receivable from ESOP................................................................ (13,668) (14,337) ---------- ---------- Total stockholders' equity........................................................... 265,199 210,303 ---------- ---------- Total liabilities and stockholders' equity........................................... $ 373,250 $ 316,373 ========== ========== </TABLE> See accompanying notes 19
PATTERSON DENTAL COMPANY CONSOLIDATED STATEMENTS OF INCOME (In thousands, except per share amounts) <TABLE> <CAPTION> Fiscal Years Ended ------------------------------------------------- April 24, April 25, April 26, 1999 1998 1997 ---------- ---------- ---------- <S> <C> <C> <C> Net sales.............................................. $ 878,773 $ 778,169 $ 687,895 Cost of sales.......................................... 552,937 488,279 440,262 ---------- ---------- ---------- Gross profit........................................... 325,836 289,890 247,633 Operating expenses..................................... 248,364 225,508 196,448 ---------- ---------- ---------- Operating income....................................... 77,472 64,382 51,185 Other income and expense: Amortization of deferred credits.............. 885 885 885 Finance income, net .......................... 2,012 1,188 1,289 Interest expense.............................. (517) (670) (1,021) Loss on currency exchange..................... (141) (79) (34) ---------- ---------- ---------- Income before income taxes............................. 79,711 65,706 52,304 Income taxes........................................... 29,815 24,937 19,687 ---------- ---------- ---------- Net income............................................. $ 49,896 $ 40,769 $ 32,617 ========== ========== ========== Earnings per share -- basic and diluted................ $ 1.49 $ 1.23 $ 1.00 ========== ========== ========== Weighted average and dilutive potential shares outstanding.................................. 33,496 33,163 32,689 ========== ========== ========== </TABLE> See accompanying notes 20
PATTERSON DENTAL COMPANY CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY (Dollars in thousands) <TABLE> <CAPTION> Accumulated Preferred Additional Compre- Note Stock Common Paid-in hensive Retained Receivable Series A Stock Capital loss Earnings from ESOP Total ------------------------------------------------------------------------------------ <S> <C> <C> <C> <C> <C> <C> <C> Balance at April 27, 1996........ $ 21,885 $ 178 $ 32,382 $ (411) $ 89,718 $ (15,900) $ 127,852 Change in translation adjustment. -- -- -- (488) -- -- (488) Net income....................... -- -- -- -- 32,617 -- 32,617 ---------- Comprehensive income............. 32,129 Preferred shares exchanged for common or cash - ESOP redemptions............ (21,885) 39 21,846 -- -- -- -- Common stock issued, net......... -- 1 1,901 -- -- -- 1,902 Cash payments received on note receivable from ESOP......... -- -- -- -- -- 831 831 Pooling-of-interests -Thau Nolde. -- 1 39 -- 908 -- 948 --------- ------ -------- -------- --------- --------- ---------- Balance at April 26, 1997....... $ 0 $ 219 $ 56,168 $ (899) $ 123,243 $ (15,069) $ 163,662 Change in translation adjustment. -- -- -- (725) -- -- (725) Net income....................... -- -- -- -- 40,769 -- 40,769 ---------- Comprehensive income............. 40,044 Common stock issued, net......... -- -- 2,796 -- -- -- 2,796 Stock split (3 for 2)............ -- 111 -- -- (130) -- (19) Cash payments received on note receivable from ESOP......... -- -- -- -- -- 732 732 Pooling-of-interests - EagleSoft -- 2 1,710 -- (1,085) -- 627 Stock issued for acquisition..... -- 1 2,460 -- -- -- 2,461 --------- ------ -------- -------- --------- --------- ---------- Balance at April 25, 1998........ $ 0 $ 333 $ 63,134 $ (1,624) $ 162,797 $ (14,337) 210,303 Change in translation adjustment. -- -- -- (598) -- -- (598) Net income....................... -- -- -- -- 49,896 -- 49,896 ---------- Comprehensive income............. 49,298 Common stock issued, net......... -- 1 3,689 -- -- -- 3,690 Cash payments received on note receivable from ESOP......... -- -- -- -- -- 669 669 Pooling-of-interests - PBS....... -- 2 (202) -- 1,068 -- 868 Stock issued for acquisition..... -- -- 371 -- -- -- 371 --------- ------ -------- -------- --------- --------- ---------- Balance at April 24, 1999........ $ 0 $4 336 $ 66,992 $ (2,222) $ 213,761 $ (13,668) $ 265,199 ========= ====== ======== ======== ========= ========= ========== </TABLE> See accompanying notes 21
PATTERSON DENTAL COMPANY CONSOLIDATED STATEMENTS OF CASH FLOWS (Dollars in thousands) <TABLE> <CAPTION> Year Ended ----------------------------------------------- April 24, April 25, April 26, 1999 1998 1997 ----------------------------------------------- <S> <C> <C> <C> Operating activities: Net income............................................................. $49,896 $40,769 $32,617 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation....................................................... 6,366 5,924 4,942 Amortization of deferrals.......................................... (885) (885) (885) Amortization of goodwill........................................... 2,716 2,423 1,339 Bad debt expense................................................... 1,148 1,092 356 Deferred taxes..................................................... (367) 655 (75) Change in assets and liabilities net of acquired: Increase in receivables........................................... (6,364) (8,706) (7,176) Increase in inventory............................................. (9,212) (13,983) (7,879) Increase in accounts payable...................................... 6,127 7,479 2,785 Increase in accrued liabilities................................... 3,216 5,341 1,735 Other changes from operating activities, net...................... (1,028) (1,113) (1,383) ------- -------- ------- Net cash provided by operating activities.............................. 51,613 38,996 26,376 Investing activities: Proceeds from sale of facility........................................ 2,215 -- -- Additions to property and equipment, net............................... (7,088) (5,962) (5,010) Acquisitions........................................................... (1,280) 231 (61,171) ------- -------- -------- Net cash used in investing activities.................................. (6,153) (5,731) (66,181) Financing activities: Payments and retirement of long-term debt and obligations under capital leases..................................... (4,825) (8,169) (334) Increase (decrease) in revolving credit agreement...................... (1,850) (1,707) 501 Cash payments received on note receivable from ESOP.................... 669 732 831 Common stock issued, net............................................... 3,690 2,730 1,902 ------- -------- -------- Net cash (used in) provided by financing activities.................... (2,316) (6,414) 2,900 Effect of exchange rate changes on cash................................ (17) (327) (56) ------- -------- -------- Net increase (decrease) in cash and cash equivalents................... 43,127 26,524 (36,961) Cash and cash equivalents at beginning of period....................... 35,619 9,095 46,056 ------- -------- -------- Cash and cash equivalents at end of period............................. $78,746 $35,619 $ 9,095 ======= ======== ======== Supplemental disclosures: Income taxes paid...................................................... $32,062 $23,811 $ 20,229 Interest paid.......................................................... 575 646 1,024 Exchange of preferred shares into common stock......................... -- -- 21,885 </TABLE> See accompanying notes 22
PATTERSON DENTAL COMPANY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS APRIL 24, 1999 (Dollars in thousands, except per share amounts) 1. Summary of Significant Accounting Policies Basis of Presentation The consolidated financial statements include the accounts of the Company's wholly owned subsidiaries Patterson Dental Supply, Inc., Direct Dental Supply Co. and Patterson Dental Canada, Inc. All significant intercompany transactions have been eliminated in consolidation. Description of Business The Company is one of the largest providers of dental equipment, supplies and services to dentists, institutional customers and dental laboratories in North America, operating from 108 locations with approximately 3,600 employees. The Company distributes approximately 82,500 dental products from over 1,100 manufacturers, offering specialty items and services including the Patterson private label line of dental items. In addition, the Company produces and sells printed office products and software applications for dental offices. Fiscal Year End The fiscal year end for the Company is the last Saturday in April. Revenue Recognition The Company recognizes revenues as products are shipped and as services are rendered to the customer. Cash and Cash Equivalents Cash equivalents consist of investments in money market funds. These investments are classified as available for sale and cost approximates fair value. Inventory Inventory consists of merchandise held for sale and is stated at the lower of cost or market. Cost is determined using the last-in, first-out (LIFO) method for domestic dental inventories and the first-in, first-out (FIFO) method for all other inventories. Inventories valued at LIFO represent 80% of total inventories at both April 24, 1999 and April 25, 1998. The accumulated LIFO provision was $13,991 at April 24, 1999 and $12,131 at April 25, 1998. The Company believes that inventory replacement cost exceeds the inventory balance by an amount approximating the LIFO reserve. Property and Equipment Property and equipment are stated at cost. The Company provides depreciation on the straight-line method over estimated useful lives of 40 years for buildings or expected remaining life of purchased buildings, 3 to 20 years for leasehold improvements or the term of the lease, if less, 5 years for data processing equipment, and 5 to 10 years for office furniture and equipment. 23
Intangibles Intangibles represent primarily the excess of the purchase price over the fair value of the net tangible assets of acquired businesses and are amortized over a period of twenty years. Accumulated amortization at April 24, 1999 and April 25, 1998 was $6,829 and $3,844, respectively. The Company employs the undiscounted cash flow method of assessment for these assets when factors indicating an impairment are present. Advertising The Company expenses all advertising and promotional costs as incurred except for certain catalog costs which are capitalized and amortized over future periods based upon estimates of revenue to be generated. Total advertising and promotional expenses were $9,224, $8,573, and $4,274 for 1999, 1998 and 1997, respectively. Income Taxes The liability method is used to account for income tax expense. Under this method, deferred tax assets and liabilities are determined based on differences between financial reporting and tax bases of assets and liabilities and are measured using the enacted tax rates and laws that will be in effect when the differences are expected to reverse. Employee Stock Ownership Plan Compensation expense related to the Company's defined contribution ESOP is computed based on the shares allocated method. Deferred Credits Negative goodwill (deferred credit) arose through the purchase of the Patterson business in fiscal 1986 and D.L. Saslow Co., Inc. in fiscal 1988. The Company is amortizing the deferred credits on a straight-line basis over 20 years. Use of Estimates in the Preparation of Financial Statements The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Long-Lived Assets Long-lived assets, such as goodwill and property and equipment, are evaluated for impairment when events or changes in circumstances indicate that the carrying amount of the assets may not be recoverable through the estimated undiscounted future cash flows from the use of these assets. When any such impairment exists, the related assets will be written down to fair value. The Company has determined that no long-lived assets have been impaired. Stockholders' Equity On January 12, 1998 the Company declared a three for two stock split in the form of a 50% stock dividend payable February 17, 1998 to shareholders of record January 30, 1998. All references in the financial statements and related notes to weighted average shares outstanding, share issuances, related prices and per share amounts have been restated to reflect the split. Earnings Per Share The following table sets forth the denominator for the computation of basic and diluted earnings per share. There were no adjustments to the numerator. 24
<TABLE> <CAPTION> 1999 1998 1997 -------- -------- -------- <S> <C> <C> <C> Denominator: Denominator for basic earnings per share - weighted-average shares 33,396 33,070 32,618 Effect of dilutive securities: Stock Option Plans 57 68 48 Employee Stock Purchase Plan 5 7 6 Capital Accumulation Plan 38 18 17 --------- --------- -------- Dilutive potential common shares 100 93 71 --------- --------- -------- Denominator for diluted earnings per share - adjusted weighted-average shares 33,496 33,163 32,689 ========= ========= ======== </TABLE> Comprehensive Income In 1999, the Company adopted SFAS No. 130, Reporting Comprehensive Income. SFAS 130 establishes new rules for the reporting and display of comprehensive income and its components. SFAS 130 requires foreign currency translation adjustments, which prior to adoption were reported separately in shareholders' investment, to be included in other comprehensive income. The adoption of SFAS 130 resulted in revised and additional disclosures but had no impact on the Company's consolidated financial position, results of operations or liquidity. Reclassification Certain balances were reclassified to conform to the April 24, 1999 presentation. 2. Acquisitions On July 27, 1998 and on February 8, 1999, the Company acquired the assets of two local dental distributorships, Dentaplex, Inc. and J&S Dental Supply Co., Inc. The acquisitions were accounted for as a purchase and, accordingly, the net assets and operating results are included in the Company's financial statements from the date of acquisition. The pro forma impact of these transactions was not material to the financial statements. On February 5, 1999, the Company acquired all of the common stock of Professional Business Systems, Inc., (PBS) in exchange for 214,317 shares of common stock. PBS is located in Roselle, Illinois and manufactures and distributes filing systems and other practice management systems for healthcare professionals. The acquisition was accounted for as a pooling-of-interests and was not material to the financial statements on a pro forma basis. The financial statements do not reflect the financial position and results of operations prior to the date of acquisition based on materiality. On February 2, 1998, the Company acquired all of the common stock of Hill Dental Company, Inc. located in Birmingham, Alabama, in exchange for 100,770 shares of common stock. The acquisition was accounted for as a purchase and, accordingly, the net assets and results of operations are included in the accompanying financial statements since the date of acquisition. The results of the operations of Hill Dental Company, Inc. prior to the acquisition date were not material to the financial statements on a pro forma basis. Effective August 26, 1997, the Company acquired Canadian Dental Supply Ltd. ("CDS") a Vancouver, British Columbia based dental distributor. Each share of CDS common stock was converted into 6.324 shares of Company common stock. The Company issued 168,648 shares to CDS shareholders. The transaction qualifies as a tax free reorganization and was accounted for as a pooling-of-interests. The accompanying financial statements, for all periods presented, have been restated to include the results of CDS. 25
Separate results of operations for the periods prior to the merger with CDS are as follows: <TABLE> <CAPTION> Period from April 27, 1997 to August 26, 1997 1997 ---------------- ---------- <S> <C> <C> Net Sales Patterson Dental Company $ 231,350 $ 661,518 CDS 8,190 26,377 --------- -------- Total Combined $ 239,540 $ 687,895 ========= ======== Net Income Patterson Dental Company $ 11,292 $ 32,415 CDS 31 202 --------- --------- Total Combined $ 11,323 $ 32,617 ========= ========= Other Changes in Stockholders' Equity Patterson Dental Company $ 1,106 $ 3,211 CDS (24) (18) --------- --------- Total Combined $ 1,082 $ 3,193 ========= ========= </TABLE> Also in fiscal 1998, the Company acquired all of the common stock of EagleSoft Incorporated, located in Effingham, Illinois in exchange for 280,001 shares of common stock. The transaction took place on July 17, 1997 and EagleSoft was merged into the Company and accounted for as a pooling-of-interests. The financial statements do not reflect the financial position and results of operations prior to the date of the acquisition based on materiality. During fiscal 1997, the Company acquired all of the common stock of Thau-Nolde, Inc., located in St. Louis, Missouri, in exchange for 125,100 shares of common stock. Thau-Nolde was merged into the Company and accounted for as a pooling-of-interests. The financial statements do not reflect the financial position and results of operations of Thau-Nolde prior to the date of the acquisition based on materiality. The Company also acquired certain assets of Dental Services Co., Inc., located in Erie, Pennsylvania. This acquisition was accounted for as a purchase and, accordingly, the net assets and operating results are included in the Company's financial statements from the date of acquisition. The pro forma impact of this acquisition on the Company's results of operations was not material. On October 1, 1996 the Company purchased the Colwell division of Deluxe Corporation (Colwell) for an aggregate purchase price of $61.0 million. The acquisition was accounted for as a purchase and, accordingly, the net assets and results of operations are included in the accompanying financial statements since the date of acquisition. The following unaudited pro forma summary presents the consolidated results of operations as if the acquisition had occurred at the beginning of fiscal 1997: <TABLE> <CAPTION> Year Ended (In thousands, except per share data) April 26, 1997 ------------------------------------- -------------- <S> <C> Net sales $711,660 Income before taxes 54,386 Net income 33,887 Earnings per share $ 1.04 </TABLE> 26
3. Property and Equipment <TABLE> <CAPTION> April 24, 1999 April 25, 1998 -------------- -------------- <S> <C> <C> Land $ 3,426 $ 3,446 Buildings 17,074 18,697 Leasehold improvements 1,631 1,536 Furniture and equipment 20,055 16,616 Data processing equipment 23,003 19,968 --------- --------- 65,189 60,263 Accumulated depreciation (28,171) (22,265) --------- --------- $ 37,018 $ 37,998 ========= ========= </TABLE> 4. Long-Term Debt <TABLE> <CAPTION> April 24, 1999 April 25, 1998 -------------- -------------- <S> <C> <C> Mortgage $ 1,466 $ 2,695 Note payable to bank -- 2,100 Other 631 374 ---------- ---------- 2,097 5,169 Less current maturities 415 2,433 ---------- ---------- $ 1,682 $ 2,736 ========== ========== </TABLE> The Company extended its bank revolving credit agreement in April 1999 which now provides for unsecured borrowings and sales of installment contract receivables of up to a combined $85 million until April 2000. The agreement requires that the Company maintain a minimum current ratio, maximum leverage ratio and minimum net worth. The Company was in compliance with the covenants at April 24, 1999. A total of $77 million of installment contracts receivable sold under the agreement were outstanding at April 24, 1999. The remaining mortgage obligation is an 11 1/2%, 20 year mortgage due in 2007. The mortgage covers Patterson Dental Canada's Montreal building. Monthly payments are 52 Canadian dollars. The mortgage obligation for Canadian Dental's Alberta building was paid in full during fiscal 1998. The note payable to bank in the amount of $2,100 at April 25, 1998 was collateralized by the Hill Dental Company, Inc. facility. At April 25, 1998, the loan had an interest rate of 5 3/4%. The Company sold the facility and paid off this note during the first quarter of fiscal 1999. The other long-term debt includes obligations under non-competition agreements and capital leases. Long-term debt becomes due: $415 in 2000, $374 in 2001, $207 in 2002, $217 in 2003, $244 in 2004 and the balance thereafter. The fair value of long- term debt approximates its carrying value. 5. Leases The Company leases facilities for its branch office locations and equipment. These leases are accounted for as operating leases. Future minimum rental payments under noncancelable operating leases are as follows for the years ending in April: <TABLE> <S> <C> 2000 $ 5,825 2001 4,554 2002 3,711 2003 3,447 2004 1,352 Thereafter 851 ----------- Total minimum payments required $ 19,740 =========== </TABLE> Rent expense was $6,822, $6,054 and $5,255 for the years ended April 24, 1999, April 25, 1998 and April 26, 1997, respectively. 27
6. Income Taxes Significant components of the provision (benefit) for income taxes are as follows: <TABLE> <CAPTION> 1999 1998 1997 ---- ---- ---- <S> <C> <C> <C> Current: Federal $ 27,012 $ 21,722 $17,417 Foreign -- 28 147 State 3,170 2,532 2,198 --------- -------- ------- Total current 30,182 24,282 19,762 Deferred: Federal (336) 599 (55) Foreign -- -- -- State (31) 56 (20) -------- -------- ------- Total deferred (367) 655 (75) -------- -------- ------- Provision for income taxes $ 29,815 $ 24,937 $19,687 ======== ======== ======== </TABLE> Significant components of the Company's deferred tax (liabilities) and assets as of April 24, 1999 and April 25, 1998 are as follows: <TABLE> <CAPTION> 1999 1998 1997 ---- ----- ----- <S> <C> <C> <C> Canadian net operating loss carryforward $ 3,124 $ 4,807 $ 4,017 Valuation allowance (3,124) (4,807) (4,017) Bad debt allowance 1,018 1,044 963 LIFO reserve (975) (1,403) (1,111) Financing income (2,556) (1,619) (1,045) Other 2,041 1,139 1,009 ------- ------- -------- Total $ (472) $ (839) $ (184) ======= ======= ======== </TABLE> Income tax expense varies from the amount computed using the U.S. statutory rate. The cause of this difference and the related tax effects are shown below: <TABLE> <CAPTION> 1999 1998 1997 ---------- ---------- --------- <S> <C> <C> <C> Tax at U.S. statutory rate $ 27,899 $ 22,997 $ 18,306 State tax provision, net of federal benefit 2,066 1,701 1,416 Effect of foreign losses 107 490 262 Amortization of deferred credit (310) (310) (310) Other 53 59 13 ---------- --------- --------- $ 29,815 $ 24,937 $ 19,687 ========== ========= ========= </TABLE> At April 24, 1999, the Company had net operating loss carryforwards of $10,977 for Canadian income tax purposes that expire in years 2000 through 2006. Those carryforwards resulted from the Company's fiscal 1994 acquisition of Healthco Canada Inc. For financial reporting purposes, a valuation allowance of $3,124 has been established to reduce the deferred tax assets to their net realizable value. 7. Segment and Geographic Data During 1999, the Company adopted Financial Accounting Standards Board No. 131 ("FAS 131"), "Disclosures about Segments of an Enterprise and Related Information." The management approach required by the statement designates that the internal reporting used by management for making operating decisions and assessing performance is the basis for determining that Company's reportable segment. 28
The Company has one reportable segment, dental distribution. This segment, which is comprised of the Company's dental supply, printed office products and software groups, distributes consumable supplies, equipment, services and software primarily to dental professionals in the U.S. and Canada. The following table presents sales information by product for the Company: <TABLE> <CAPTION> Fiscal Year Ended ------------------------------------------------ 1999 1998 1997 ---- ---- ---- <S> <C> <C> <C> Net Sales Dental products and services $811,217 $ 718,671 $ 654,424 Printed office products 57,202 53,326 33,471 Software 10,354 6,172 -------- --------- --------- - Total $878,773 $ 778,169 $ 687,895 ======== ========= ========= </TABLE> The following table presents information about the Company by geographic area. There were no material amounts of sales among geographic areas. <TABLE> <CAPTION> Fiscal Year Ended -------------------------------------- 1999 1998 1997 ---- ---- ---- <S> <C> <C> <C> Revenues United States $ 803,989 $ 698,390 $ 604,698 Canada 74,784 79,779 83,197 --------- --------- --------- Total $ 878,773 $ 778,169 $ 687,895 ========= ========= ========= Long-lived Assets United States $ 78,868 $ 80,842 $ 74,189 Canada 5,017 5,169 5,187 --------- --------- --------- Total $ 83,885 $ 86,011 $ 79,376 ========= ========= ========= </TABLE> 8. Employee Benefit Plans Employee Stock Ownership Plan (ESOP) During 1990, the Company's Board of Directors adopted a leveraged ESOP. During fiscal 1991, under the provisions of the plan and related financing arrangements, the Company loaned the ESOP $22,000 for the purpose of acquiring its then outstanding preferred stock. The cost of the ESOP is borne by the Company through annual contributions to the plan in amounts determined by the Board of Directors. Shares of stock acquired by the plan are allocated to each employee who has completed 1,000 hours of service during the plan year. During 1999, 1998 and 1997, shares with a cost of $669, $732 and $824, respectively, were earned and allocated to ESOP participants. During 1999 and 1998 the ESOP was funded through Company contributions of $669 and $732, respectively. On June 24, 1996, the Company called for redemption all of the outstanding shares of the Preferred Stock Series A which had a redemption value of $39,792 plus accrued dividends of $231. The trustee for the ESOP converted the Preferred Shares into 5,755,625 shares of Common Stock on July 3, 1996. At April 24, 1999, 1,917,803 shares of the common stock were allocated to participants and had a fair market value of $78,063. At April 24, 1999, and April 25, 1998, indebtedness of the ESOP to the Company is shown as a deduction from stockholders' equity in the consolidated balance sheet. 29
Stock Option Plan In June 1992, the Company adopted the Patterson Dental Company 1992 Stock Option Plan (the "Employee Plan"). The Employee Plan provides for the granting of options to designated employees and non-employees, including consultants to the Company, to purchase up to a maximum of 2,025,000 shares of Common Stock. The Employee Plan is administered by the Stock Option Committee, which determines the employees, officers and others who are to receive options, the type of option to be granted, and the number of shares subject to each option and the exercise price of each option. Stock options must be granted at an exercise price not less than the fair market value of the Common Stock on the dates the options are granted (or, for persons who own more than 10 percent of the Company's outstanding voting stock, not less than 110 percent of such fair market value). Stock options granted under the Employee Plan have exercise prices equal to the market price on the date of the grant, vest over a three to ten year period, and once vested, are exercisable over ten years following the date of the grant. On February 10, 1999 a total of 212,982 options were granted under the Employee Plan to employees at an option price of $40.56. Director Stock Option Plan In June 1992, the company adopted a Director Stock Option Plan (the "Director Option Plan"), pursuant to which 337,500 shares of Common Stock have been reserved for the grant of non-statutory stock options to the Company's outside directors. Options are granted at the fair market value on the date of grant and are exercisable for a period of four years commencing one year after the date of grant. Following is a summary of stock option activity: <TABLE> <CAPTION> Employee Plan Director Option Plan ------------------------------------------------- ----------------------------------------------- Weighted Weighted Average Average Shares Exercise Shares Exercise Available Options Price Available Options Price For Grant Outstanding Per Share For Grant Outstanding Per Share -------------- ----------- --------- --------- ----------- ----------- <S> <C> <C> <C> <C> <C> <C> Balance April 27, 1996 2,025,000 - - 189,000 126,000 $ 12.02 Granted - - - (27,000) 27,000 18.67 Exercised - - - - (22,500) 7.11 --------- ----------- --------- ---------- ----------- ----------- Balance April 26, 1997 2,025,000 - - 162,000 130,500 $ 13.73 Granted - - - (27,000) 27,000 26.92 Exercised - - - - (31,500) 9.24 --------- ----------- --------- ---------- ----------- ----------- Balance April 25, 1998 2,025,000 - - 135,000 126,000 $ 18.21 Granted (212,982) 212,982 $ 40.56 (27,000) 27,000 38.00 Exercised - - - - (18,000) 14.56 --------- ----------- --------- ---------- ----------- ----------- Balance April 24, 1999 1,812,018 212,982 $ 40.56 108,000 135,000 $ 22.65 ========= =========== ========= ========== =========== =========== </TABLE> The 135,000 options outstanding under the Director Option Plan at April 24, 1999, have exercise prices of $12.00, $17.67, $18.67, $26.92 and $38.00. At April 24, 1999 the outstanding options had a weighted average contractual life of 2.4 years. The Company applies Accounting Principles Board (APB) Opinion No. 25, "Accounting for Stock Issued to Employees," and related interpretations to account for its stock option plans. Under APB No. 25, no compensation expense is recognized if the exercise price of the Company's stock options equals the market price on the grant date. SFAS No. 123, "Accounting for Stock-Based Compensation," requires that the fair value of options granted and the pro forma impact on earnings be disclosed when material. The pro forma impact was not material for 1999, 1998 and 1997. 30
Employee Stock Purchase Plan In June 1992, the Company adopted an Employee Stock Purchase Plan (the "Stock Purchase Plan"). A total of 337,500 shares of Common Stock are reserved for issuance under the Stock Purchase Plan. The Stock Purchase Plan, which is intended to qualify under Section 423 of the Internal Revenue Code is administered by the Board of Directors of the Company or by a committee appointed by the Board of Directors. Employees are eligible to participate after a year of employment with the Company if they are employed for at least 20 hours per week and more than five months per year. The Stock Purchase Plan permits eligible employees to purchase Common Stock through payroll deductions, which may not exceed 10 percent of an employee's compensation, at 85 percent of the lower of the fair market value of the Common Stock on the offering date or at the end of each three-month period following the offering date during the applicable offering period. Employees may end their participation in the offering at any time during the offering period, and participation ends automatically on termination of employment with the Company. Employees purchased 44,699, 55,558 and 63,783 shares in 1999, 1998 and 1997, respectively. At April 24, 1999, 77,421 shares were available for purchase under the Stock Purchase Plan. Capital Accumulation Plan In May 1996, the Board of Directors adopted an employee Capital Accumulation Plan (the "CAP Plan"). The CAP Plan was approved by the shareholders at the annual meeting held September 9, 1996. A total of 1,500,000 shares of Common Stock are reserved for issuance under the CAP Plan. Officers and other key employees of the Company or its subsidiaries are eligible to participate by purchasing Common Stock through payroll deductions, which must be between 5% and 25% of an employee's compensation, at 75% of the average closing price of the Common Stock for the calendar year. The shares issued are restricted stock and are held in the custody of the Company until the restrictions lapse. The restriction period is three years from the beginning of the plan year. Employees purchased 77,591, 84,345 and 55,761 shares of restricted stock in 1999, 1998 and 1997, respectively. At April 24, 1999, 1,283,988 shares were available for purchase under the Plan. 9. Litigation In the ordinary course of business, the Company is subject to a variety of product-related and employment related liability claims. The Company's management and legal counsel believe that the loss, if any, resulting from these claims will be substantially covered by insurance or third party indemnification, and any uninsured losses from such claims will not have a materially adverse effect on its operations or financial position. 10. Quarterly Results (unaudited) (In thousands, except per share amounts) Quarterly results are determined in accordance with the accounting policies used for annual data and include certain items based upon estimates for the entire year. All fiscal quarters include results for 13 weeks The fiscal quarter ending prior to the August 1997 acquisition of Canadian Dental Supply has been restated to reflect the pooling-of-interests of that company. The following table summarizes results for fiscal 1999 and 1998. <TABLE> <CAPTION> Three Months Ended ----------------------------------------------------------------------------------------------------- Apr. 24, Jan. 23, Oct. 24, Jul. 25, 1999 1999 1998 1998 -------- -------- -------- --------- <S> <C> <C> <C> <C> Net sales $ 235,199 $ 230,176 $ 213,325 $ 200,073 Gross profit 87,480 85,841 78,924 73,591 Operating income 21,055 21,498 18,676 16,243 Net income 14,022 13,748 11,897 10,229 Basic and dilutive earnings per share $ 0.42 $ 0.41 $ 0.36 $ 0.31 </TABLE> <TABLE> <CAPTION> Three Months Ended ----------------------------------------------------------------------------------------------------- Apr. 25, Jan. 24, Oct. 25, Jul. 26, 1998 1998 1997 1997 -------- -------- -------- --------- <S> <C> <C> <C> <C> Net sales $ 211,006 $ 195,540 $ 191,635 $ 179,988 Gross profit 79,940 73,336 70,748 65,866 Operating income 18,266 17,094 15,689 13,333 Net income 11,568 10,798 10,063 8,340 Basic and dilutive earnings per share $ 0.35 $ 0.33 $ .30 $ 0.25 </TABLE> 31
9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE None. PART III 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT Information regarding the directors of the Company is incorporated herein by reference to the descriptions set forth under the caption "Election of Directors" in the Company's Proxy Statement for its Annual Meeting of Shareholders to be held September 3, 1999 (the "1999 Proxy Statement"). Information regarding executive officers of the Company is incorporated herein by reference to Item 1 of Part I of this Form 10-K under the caption "Executive Officers of the Registrant." 11. EXECUTIVE COMPENSATION Information regarding executive compensation is incorporated herein by reference to the information set forth under the caption "Compensation of Executive Officers" in the 1999 Proxy Statement. 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT Information regarding security ownership of certain beneficial owners and management of the Company is incorporated herein by reference to the information set forth under the caption "Security Ownership of Certain Beneficial Owners and Management" in the 1999 Proxy Statement. 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS Information regarding certain relationships and related transactions with officers and directors is incorporated by reference to the information set forth under the caption "Certain Transactions" in the 1999 Proxy Statement. 32
PART IV 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K (a) 1. Financial Statements. The following consolidated financial statements and supplementary data of the Company and its subsidiaries, required by Part II, Item 8 are filed herewith: Report of Independent Auditors Consolidated Balance Sheets as of April 24, 1999 and April 25, 1998 Consolidated Statements of Income for the Years Ended April 24, 1999, April 25, 1998 and April 26, 1997 Consolidated Statement of Changes in Stockholders' Equity for the Years Ended April 24, 1999, April 25, 1998 and April 26, 1997 Consolidated Statements of Cash Flows for the Years Ended April 24, 1999, April 25, 1998 and April 26, 1997 Notes to Consolidated Financial Statements 2. Financial Statement Schedules. The following financial statement schedule is filed herewith: Schedule II - Valuation and Qualifying Accounts for the Years Ended April 24, 1999, April 25, 1998 and April 26, 1997. Schedules other than that listed above have been omitted because they are not applicable or the required information is included in the financial statements or notes thereto. 3. Exhibits. Exhibit ------- 3.1 The Company's Articles of Incorporation, as amended* 3.2 The Company's Bylaws, as amended* 4.1 Specimen form of the Company's Common Stock Certificate* 4.2 The Company's Articles of Incorporation, as amended (see Exhibit 3.1) 4.3 The Company's Bylaws, as amended (see Exhibit 3.2) 10.1 Patterson Dental Company Employee Stock Ownership Plan, as amended* 10.2 Patterson Dental Company 1992 Stock Option Plan* 10.3 Patterson Dental Company 1992 Director Stock Option Plan* 10.4 Patterson Dental Company Employee Stock Purchase Plan* 10.5 Patterson Dental Company Capital Accumulation Plan** 10.6 Incentive Compensation Program (Fiscal 1992)* 10.7 Asset Purchase Agreement dated September 12, 1996 between Patterson Dental Company and Deluxe Corporation*** 10.8 ESOP Loan Agreement dated June 15, 1990 as amended July 13, 1992* 33
10.9 Amended and Restated Term Promissory Note dated July 13, 1992* 21 Subsidiaries 23 Consent of Ernst & Young LLP 27 Financial Data Schedule ________________________ * Incorporated by reference to the Registrant's Registration Statement on Form S-1 (No. 33-51304) filed with the Securities and Exchange Commission August 26, 1992. ** Incorporated by reference to the Registrant's Form 10-K for the fiscal year ended April 27, 1996. *** Incorporated by reference to the Registrant's Form 8-K filed with the Securities and Exchange Commission October 15, 1996. (b) Reports on Form 8-K. The Company did not file any reports on Form 8-K with the Securities and Exchange Commission during the quarter ended April 24, 1999. 34
SIGNATURES Pursuant to the requirements of section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. PATTERSON DENTAL COMPANY Dated: July 16, 1999 By /s/Peter L. Frechette --------------------------------------- Peter L. Frechette, President and Chief Executive Officer Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated. <TABLE> <S> <C> <C> Date /s/Peter L. Frechette President and Chief Executive Officer and July 16, 1999 - ------------------------------------- Peter L. Frechette Director (Principal Executive Officer) /s/Ronald E. Ezerski Executive Vice President, Treasurer and July 16, 1999 - ------------------------------------- Ronald E. Ezerski Chief Financial Officer and Director (Principal Financial and Accounting Officer) /s/David K. Beecken Director July 16, 1999 - ------------------------------------- David K. Beecken /s/Burt E. Swanson Director July 16, 1999 - ------------------------------------- Burt E. Swanson /s/Andre B. Lacy Director July 16, 1999 - ------------------------------------- Andre B. Lacy </TABLE> 35
SCHEDULE II VALUATION AND QUALIFYING ACCOUNTS PATTERSON DENTAL COMPANY (Dollars in thousands) <TABLE> <CAPTION> Charged Balance at Charged to to Other Balance at Beginning Costs and Accounts - Deductions - End of of Period Expenses Describe Describe Period -------------- -------------- ------------- -------------- ------------- <S> <C> <C> <C> <C> <C> Year ended April 24, 1999: Deducted from asset accounts: Allowance for doubtful accounts $3,954 $1,148 (540) (3) $ 466 (1) $ 4,096 ========= ======== ========= ========= ========= LIFO inventory adjustment $ 12,131 $ 1,860 $ -- $ -- $ 13,991 Inventory obsolescence reserve 1,534 2,221 -- 1,800 (2) 1,955 --------- -------- --------- --------- --------- Total inventory reserve $ 13,665 $ 4,081 -- $ 1,800 $ 15,946 ========= ======== ========= ========= ========= Year ended April 25, 1998: Deducted from asset accounts: Allowance for doubtful accounts $ 3,711 $ 1,041 $ 176 (3) $ 974 (1) $ 3,954 ========= ======== ========== ========= ========= LIFO inventory adjustment $ 10,943 $ 1,188 -- $ -- $ 12,131 Inventory obsolescence reserve 1,346 1,236 -- 1,048 (2) 1,534 --------- -------- --------- --------- --------- Total inventory reserve $ 12,289 $ 2,424 -- $ 1,048 $ 13,665 ========= ========= ========= ========= ========= Year ended April 26, 1997: Deducted from asset accounts: Allowance for doubtful accounts $ 3,997 $ 357 $ 140 (3) $ 783 (1) $ 3,711 ========= ========== ========== ========= ========= LIFO inventory adjustment $ 9,733 $ 1,210 $ -- $ -- $ 10,943 Inventory obsolescence reserve 1,133 1,322 202 (3) 1,311 (2) 1,346 --------- ---------- ---------- --------- --------- Total inventory reserve $ 10,866 $ 2,532 $ 202 $ 1,311 $ 12,289 ========= ========== ========== ========= ========= </TABLE> (1) Uncollectible accounts written off, net of recoveries. (2) Inventory disposed of and written off. (3) Acquisition of Colwell Systems and Thau-Nolde, Inc. in fiscal 1997; Hill Dental Company, Inc. and EagleSoft, Inc. in fiscal 1998 and Professional Business Systems in fiscal 1999. 36
INDEX TO EXHIBITS <TABLE> <CAPTION> Page ---- <S> <C> <C> Exhibit 21 Subsidiaries........................................ 38 Exhibit 23 Consent of Independent Auditors..................... 39 Exhibit 27 Financial Data Schedule............................. 40 </TABLE> 37