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 28, 2001 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 16, 2001, was approximately $1,555,474,000. As of July 16, 2001, there were 67,828,739 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 2001 Annual Meeting of Shareholders Part III
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.............................. 16 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> i
PART I 1. BUSINESS Certain information of a non-historical nature contained in Items 1, 2, 3 and 7 of this Form 10-K includes forward-looking statements. Reference is made to Item 7 - Management's Discussion and Analysis of Financial Condition and Results of Operations - Factors that May Affect Future Operating Results, for a discussion of certain factors which could cause the Company's actual operating results to differ materially from those expressed in any forward-looking statements. General Patterson Dental Company ("Patterson" or the "Company") is one of the two largest distributors of dental products in North America. The Company, a full- service, value-added supplier to dentists, dental laboratories, institutions, physicians, and other healthcare professionals, provides: consumable products (including x-ray film, restorative materials, hand instruments and sterilization products); advanced technology dental equipment; practice management software; and office forms and stationery. The Company offers its customers a broad selection of dental products including more than 82,500 stock keeping units ("SKU's") of which approximately 2,800 are 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. 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 1,000 direct sales representatives, 220 of whom are equipment specialists, operating from 95 sales offices in the United States and Canada. The Company processes nearly 13,000 customer orders each business day using a computerized order processing network that links the Company's sales offices and 11 distribution centers. The Company estimates that 96% 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 18,000 dental products; a tri-yearly 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 electronically through various media, including the Internet, or by mail or telephone. Patterson Dental Company was founded by M.F. Patterson in 1877. In May 1985, the Company's management and certain investors purchased the Company from a subsidiary of The Beatrice Companies, Inc. Patterson became a publicly traded company in October 1992. Net sales have increased from $165.8 million in fiscal 1986 to $1,156.5 million in fiscal 2001, operating margins have increased every year since fiscal 1985 and profitability has increased from an operating loss in fiscal 1986 to operating income of $115.1 million in fiscal 2001. Industry Background Total expenditures for dental services in the United States increased from $13 billion in 1980 to $60 billion in 2000. Domestic dental care expenditures are projected by the Health Care Financing Administration to grow 6% annually, reaching $109 billion by the year 2010. The Company believes that the demand for dental services, equipment and supplies will continue to be influenced by the following factors: . Demographics. The U.S. population grew from 235.1 million in 1980 to 277.8 million in 2000, and is expected to reach 300.0 million by 2010. 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 implants. . 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. 2
. 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 $60 billion in total expenditures for 2000 as compared to approximately 30% of the $13 billion in total expenditures for 1980. See Management's Discussion and Analysis of Financial Condition and Results of Operations - 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. There are approximately 17,000 licensed dentists in Canada according to the Canadian Dental Association. 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 value-added, full-service capabilities, using technology to enhance customer service, continuing to improve operating efficiencies, and growing through internal expansion and acquisitions. Emphasizing Value-Added, 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. 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. The educational benefits that Patterson's sales force provides are essential for the dental practitioner as the sales force is often one of their primary links to industry knowledge, especially with respect to new products. In addition, the high quality sales force allows Patterson to offer broader product lines. Most dentists are independent, sole practitioners who are unable to store and manage large volumes of supplies in their offices. Patterson meets its customers requirements by delivering frequent, small quantity orders rapidly and reliably from its strategically located distribution centers. As part of its focus on complete customer satisfaction, Patterson's trained service technicians perform equipment installation, maintenance and repair services. Using Technology, Including the Internet, to Enhance Customer Service. As part of its commitment to providing superior customer service, the Company offers its customers easy order placement. The Company has offered electronic ordering capability since 1987 when it first introduced Remote Order Entry (REMO(SM)). The Company believes that its computerized order entry systems help to establish relationships with new customers and increase loyalty among existing customers. The remote order entry systems permit customers to place orders from their offices directly to Patterson 24 hours a day, seven days a week. Over the years, the Company has continued to introduce new order entry systems designed to meet the varying needs of its customers. Today the Company offers five systems, REMO(SM), REMO-Net(SM), REMO-Ware(SM), PDXpress(R) and PassPort(SM) Plus. These systems are used by customers as well as the Company's sales force. Over the years, the number of orders transmitted electronically has grown steadily to approximately 50% of Patterson's consumable dental products volume or $345 million in fiscal year 2001. 3
The Company's current Internet system, REMO-Net(SM), in addition to on-line ordering capabilities, provides order status and shipment tracking, product look-up, comparison shopping, new product introduction and access to "Patterson Today" articles. Longer term, the goal of the Company's Internet strategy is to distribute information and service related products over the Internet to enhance customers' practices and to increase sales force productivity. During the past year, the Company has been augmenting its Internet system, and plans to launch the enhanced Internet system in late summer of this year. The new Internet environment will include enhanced order entry via eMAGINE-Net(SM), continuing education products, manufacturers' product information, an office design application and a tool to provide real time customer and Company information to the Company's sales force. For those customers not using the Internet, the Company offers four alternative products. REMO(SM) and REMO-Ware(SM) give customers direct and immediate ordering access through a personal computer to a database containing Patterson's complete inventory. PDXpress(R) is a handheld 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(SM) Plus is a smart phone which incorporates automated ordering and bar code scanning with credit card processing. The Company has begun the rollout of its newest order entry system, eMAGINE(SM). eMAGINE(SM) has become the standard platform for the sales representative. Beta testing for customers is under way and the system should be available for all customers wishing to use it in early fall 2001. It will replace REMO-Ware(SM) and includes many new features and upgrades including: up to three years of order history for the customer's reference, faster searches for products and reports, order tracking, instant information on monthly product specials, descriptions and photographs of popular products and an electronic custom catalog, including a printable version with scanable bar codes. These systems, including eMAGINE(SM), are provided at no additional charge to customers who maintain certain minimum purchase requirements. Continuing to Improve Operating Efficiencies. Patterson continues to implement programs designed to improve operating efficiencies and allow for continued sales growth over time. 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 customers, Patterson enables its sales representatives to spend more time with existing customers and to call on additional customers. Most recently, the Company launched its new Infosource program, a web-based system that disseminates key sales reports, customer purchasing trends and other administrative information to the Company's sales force and branch managers. Infosource allows sales representatives to more effectively and efficiently market the Company's broad product line while enabling branch managers to increase their productivity. 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 14 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 2001, Patterson acquired the customer base and certain assets of 23 smaller dental dealers throughout the United States. During fiscal 2001, the Company acquired Micheli Dental Supply, Inc., which did business as A.B.E. Dental, of Belmont California. 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 463 people, 129 of whom are sales representatives. In August 1997, the Company acquired Canadian Dental Supply Ltd. which expanded the Company's market share in British Columbia, Alberta, Saskatchewan and Ontario. 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 printed office products used in medical and dental offices. In February 1999, the Company acquired Professional Business Systems, Inc. (PBS), Colwell's largest supplier, to expand production capacity. 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 is located in Effingham, Illinois. In September 2000, the Company acquired eCheck-up.com, a web-based, value-added service that complements and expands the Company's current product offerings to the front office of the dental practice. ECheck-up.com is a newly developed Internet service that provides on-line payroll, human resources, payables processing and benchmarking services to subscribing dental customers through its website. The Company has operations in the U.S. and Canada and conducts business in one segment, dental distribution. This segment is comprised of the Company's dental supply, printed office products and software groups. Approximately half of the printed office products are sold to non-dental healthcare practitioners. The following table shows the approximate percentages of net sales contributed by sales category for the last three fiscal years: <TABLE> <CAPTION> 2001 2000 1999 ---- ---- ---- <S> <C> <C> <C> Consumable Dental and Printed Products ..................... 63% 63% 63% Equipment and Software...................................... 28 28 27 Other (1)................................................... 9 9 10 --- --- --- Total.................................................. 100% 100% 100% === === === </TABLE> (1) Consists of other value-added products and services. Consumable Dental and Printed Products Dental Supplies. Patterson offers a broad product line of consumable dental supplies 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, and diamonds. Patterson markets its own private label line of dental supplies including anesthetics, instruments, preventive 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. Printed 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 two channels: . The Company's dental distribution sales force . Catalogs distributed to over 150,000 customers several times a year 5
Both 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 printed office products group employs 476 people and operates from two facilities located in Champaign, Illinois, and one in Roselle, Illinois. 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 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. Equipment and Software Equipment. Patterson offers a wide range of dental equipment products 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 newer technology equipment that provides customers with the tools to improve productivity and patient satisfaction. Examples of such innovative and high-productivity products include the CEREC product family, a chair side restoration system; air abrasion systems; digital x-rays; and the Triangle Sterilization Center. Software. The Company develops and markets practice management software for dental professionals. Products include software for scheduling, billing, charting and storage/retrieval of digital images. The Company also sells software products developed by third parties including Sidexis by Sirona, Dimax2 by Planmeca and VixWin by Gendex. These value-added products are designed to help achieve office productivity improvements which translates into higher profitability for the customer. To support its customers as they continue to integrate newer technology into their dental practice, the Company established the Patterson Technology Call Center at EagleSoft to assist customers with problems or questions related to digital software integration. A key element of the Company's strategy is to provide seamless integration of digital imaging products with practice management software so that customers can quickly store, retrieve and transfer images. In fiscal 2001, the Company realigned its EagleSoft sales force to report directly to Patterson's sales offices. As Patterson Technology Representatives, they team with other sales representatives and are responsible for selling digital products as well as practice management software. Management believes this realignment enables the Company more to fully capitalize on market demand and based on fiscal 2001 results believes the realignment was a sound decision. EagleSoft has a total of 153 employees, of whom 122 are dedicated to software development, sales and product support. Other Software Services. The Company offers a variety of services to complement its software products such as service agreements, electronic claims processing and billing statement processing. These services provide value to customers by allowing them to receive payments more rapidly while obtaining greater productivity. 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 807 service technicians call on dental offices throughout the United States and Canada. 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 provides a variety of options to fulfill its customers' financing needs. For qualified purchasers of equipment, the Company will arrange financing for the customer through Patterson or a third party, or will arrange a leasing program with an outside party. These alternatives allow the Company to offer its customers convenience while still meeting their diverse financing needs. In fiscal 2001, the Company originated over $101 million of equipment finance contracts. Equipment leasing is provided by Banc of America Vendor Finance, a unit of BankAmerica, pursuant to an agreement entered into in July 1993. Applications for financing originated by the Company are reviewed by Banc of America Vendor Finance, 6
which upon approval may purchase the equipment and lease it to the customer or purchase an installment sale contract from the Company without recourse. In November 1998, Patterson entered into a finance referral agreement with The Matsco Companies. Referral fees are received for financing contracts that are initiated by Patterson. There are no recourse provisions under this agreement. The Company has entered into a combined Contract Purchase and Revolving Credit Agreement with U.S. Bank National Association, under which U.S. Bank National Association and three additional banks 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 2001, the combined Contract Purchase Agreement and unsecured revolving credit facility with the banks allowed for a maximum credit line of $100 million. As of April 28, 2001, contracts with an outstanding principal balance of $100 million had been sold under the Contract Purchase Agreement. The Company had no outstanding borrowings under the Revolving Credit Agreement. On April 30, 2001, the Company extended its bank contract and revolving purchase agreement which now provides for unsecured borrowings and sales of installment contract receivables of up to a combined $125 million. See Note 5, "Financing," of the Consolidated Financial Statements. Sales and Marketing During fiscal 2001, Patterson sold consumable dental products to over 114,000 customers in the U.S. and Canada 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 2001, and Patterson is not dependent on any single customer or geographic group of customers. The Company's sales and marketing efforts are designed to establish and improve customer relationships through personal interaction with its sales representatives and frequent direct marketing contact, which underscores the Company's value added approach. A primary component of the Company's value-added approach is its sales force. 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. Sales representatives provide an education link to the overall dental industry, assist dentists in selecting and purchasing products and help customers efficiently manage their supply inventory. Each representative works within an assigned sales territory from one of 95 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 18,000 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 tri-yearly 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. Distribution The Company believes that responsive delivery of quality dental supplies and equipment is a key element to providing complete customer satisfaction. Patterson ships its dental supplies and printed office products from 11 distribution centers with 478 warehouse employees. The Company's dental sales offices 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 for consumable supplies can be placed by telephone or electronically 24 hours a day, seven days a week. All orders are routed through the Company's centralized computer ordering, shipping and inventory management system, which is linked to each of the Company's strategically located 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. Rapid and accurate order fulfillment is another principal component of the Company's value-added approach. The Company estimates that 96% of its consumable goods orders are shipped complete within 24 hours. The Company believes it averages only one error per every 1,150 orders. In order to assure the availability of the Company's broad product lines for prompt delivery to customers, the Company must maintain sufficient inventories at its distribution centers. Purchasing is centralized and inventory levels are managed by the purchasing department using a real-time perpetual inventory system. The Company's inventory consists mostly of dental supply 7
items; equipment is generally custom-ordered for 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 Effective purchasing is a key strategy the Company has adopted in order to achieve its objective of continuing to improve profitability. Recently, the Company began a program to effectuate electronic data interchange (EDI) with its major vendor partners. In fiscal 2001, the Company processed 45% of its vendor invoices using EDI capabilities. In addition, 35% of Patterson's purchase order volume was conducted employing EDI, which represented 60% of purchase order dollars placed during the fiscal year. Utilizing EDI allows the Company to improve efficiencies and reduce administrative costs. The Company obtains dental products from approximately 1,100 vendors. In addition, the Company has exclusive distribution agreements with several quality dental equipment manufacturers including Sirona on the CEREC, Triangle for sterilization centers, and Schick Technologies for digital x-rays. The Company is the only national dealer for A-dec equipment, including chairs, units and cabinetry. In fiscal 2001, the Company's top 10 vendors and single largest vendor accounted for approximately 50% 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. Competition The highly competitive U.S. dental products distribution industry consists principally of national, regional and local full-service distributors and mail- order distributors. The dental supply market is extremely fragmented. In addition to Patterson and one other national, full-service firm, Henry Schein, Inc., there are at least 20 full-service distributors which operate on a regional level, and hundreds of small local distributors. Also, some manufacturers sell directly to end-users, and thereby eliminate the role of the Company. Patterson believes that it differentiates itself from its competition 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. The Company also experiences competition in Canada. Principal competitors include two national, full-service distributors, Ash Temple and Arcona, a division of Henry Schein, Inc. The Company believes it competes in Canada on essentially the same basis as in the United States. 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. The Company also claims rights in the mark "eMAGINE". Employees As of April 28, 2001, the Company employed 3,853 people in the United States and Canada on a full-time basis. 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. 8
Subsequent Event On July 9, 2001, the Company acquired certain assets of J. A. Webster, Inc., the leading distributor of veterinary supplies to companion pet (dogs, cats and other common household pets) veterinary clinics in the eastern United States and the third largest nationally. One of the most respected names in the veterinary supply industry, Webster is a value-added, full service distributor of consumable supplies, equipment, diagnostic products, biologicals (vaccines) and pharmaceuticals. A description of J. A. Webster's business, industry, and factors that may affect its future operating results is included in Item 5 of the Form 8-K filed by the Company on July 9, 2001 announcing the acquisition. The information set forth under Item 5 captioned "About J. A. Webster, Inc." on Form 8-K is included as Exhibit 99 to this Form 10-K and is incorporated into this Item 1 by reference. Executive Officers of the Registrant Set forth below are the names, ages and positions of the executive officers of the Company as of June 30, 2001. <TABLE> <S> <C> Peter L. Frechette 63 President, Chief Executive Officer, and Director - Patterson Dental Company R. Stephen Armstrong 50 Executive Vice President, Chief Financial Officer and Treasurer - Patterson Dental Company James W. Wiltz 56 Vice President and Director - Patterson Dental Company and President Patterson Dental Supply, Inc. Mary H. Baglien 58 Vice President, Human Resources - Patterson Dental Company Lynn E. Askew 39 Vice President, Management Information Systems - Patterson Dental Company Gary D. Johnson 54 Vice President, Sales - Patterson Dental Supply, Inc. R. Reed Saunders 53 Vice President - Patterson Dental Supply, Inc. and President - Colwell Systems Richard A. Kochmann 49 Vice President , Marketing - Patterson Dental Supply, Inc. Normand Senecal 56 President - Patterson Dental Canada, Inc. </TABLE> 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 is also a director of FinishMaster, Inc. R. Stephen Armstrong was elected Executive Vice President, Treasurer and Chief Financial Officer of the Company effective July 31, 1999. Prior to joining Patterson, Mr. Armstrong had been an Assurance Partner with Ernst & Young LLP. Ernst & Young LLP is currently the Company's independent public auditor. James W. Wiltz has been a Vice President of the Company since 1986 and has been employed by Patterson since September 1969, initially as a territory sales representative. In 1980, Mr. Wiltz was appointed Vice President of the Midwestern Division and was appointed Vice President, Sales and Distribution in 1986. In 1996, Mr. Wiltz became President of the Company's subsidiary, Patterson Dental Supply, Inc. He was appointed to the Board of Directors in March 2001. 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. 9
Lynn E. Askew became Vice President, Management Information Systems, on September 1, 1999. Mr. Askew joined Patterson in 1994 as Manager, Distributed Systems, and was promoted to Director, Systems and Development in 1996. Prior to joining Patterson, Mr. Askew provided advanced technology consulting and project management services to various organizations, including Patterson. 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. Richard A. Kochmann was promoted to Vice President, Marketing, of Patterson Dental Supply, Inc. in November 2000. Mr. Kochmann began his career with Patterson in 1980 as a college representative and has held various sales and management positions within the Company. Normand Senecal has been President of the Company's Canadian subsidiary Patterson Dental Canada Inc., since it was acquired from Healthco International, Inc. in 1993. 2. PROPERTIES The Company owns its principal executive offices in St. Paul, Minnesota. Distribution facilities are located in California, Florida, Illinois, Indiana, Iowa, Pennsylvania, Texas, Washington and Canada. Approximately 75%, or 378,000 square feet, of the total distribution space is owned by the Company and the balance is leased. The Company also maintains sales and administrative offices inside the United States at 86 locations in 45 states and outside the United States at 11 locations in Canada. All of these locations are leased. The Company has two owned manufacturing facilities, which are used in the Colwell division. In management's opinion, all buildings, machinery and equipment are in good condition, suitable for their purposes and are maintained on a basis consistent with sound operations. Currently, the Company does not have substantial idle facilities. 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 judgment. Among the product liability cases in which the Company is currently a defendant, fifteen involve claims by healthcare workers claiming damages from allergic reactions from 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 28, 2001. PART II 5. MARKET FOR REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER MATTERS The Company's common stock trades on the Nasdaq Stock Market(R) under the symbol "PDCO". 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. Sales prices are adjusted for the two-for-one stock split on June 13, 2000. Such quotations reflect inter-dealer prices, without retail mark-up, mark-down or commission, and may not necessarily represent actual transactions. <TABLE> <CAPTION> <S> <C> <C> High Low ---- --- Fiscal 2000 First Quarter............................... $ 21.00 $ 16.75 Second Quarter.............................. $ 25.06 $ 18.38 Third Quarter............................... $ 24.13 $ 19.44 Fourth Quarter.............................. $ 24.75 $ 16.25 High Low ---- --- Fiscal 2001 First Quarter............................... $ 26.94 $ 21.44 Second Quarter.............................. $ 31.00 $ 18.75 Third Quarter............................... $ 34.38 $ 26.06 Fourth Quarter.............................. $ 33.88 $ 29.13 </TABLE> On July 16, 2001, the number of holders of record of common stock was 2,874. The transfer agent for the Company's common stock is Wells Fargo Bank Minnesota, N.A., 161 North Concord Exchange, South St. Paul, Minnesota, 55075-0738, telephone: (651) 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. 11
6. SELECTED CONSOLIDATED FINANCIAL DATA (In thousands, except per share amounts) <TABLE> <CAPTION> Fiscal Year Ended ----------------------------------------------------------------------- April 28, April 29, April 24, April 25, April 26, 2001 2000 1999 1998 1997/(2)/ ---------- ----------- ----------- ----------- ----------- Statement of Operations Data: - ---------------------------- <S> <C> <C> <C> <C> <C> Net sales/(3)/ $1,156,455 $ 1,045,883 $ 883,268 $ 782,284 $ 691,779 Cost of sales/(3)/ 747,301 678,766 571,698 505,069 455,967 ---------- ----------- ----------- ----------- ----------- Gross margin/(3)/ 409,154 367,117 311,570 277,215 235,812 Operating expenses/(3)/ 294,039 269,658 234,098 212,833 184,627 ---------- ----------- ----------- ----------- ----------- Operating income 115,115 97,459 77,472 64,382 51,185 Other income (expense) - net 7,081 5,540 2,239 1,324 1,119 ---------- ----------- ----------- ----------- ----------- Income before income taxes 122,196 102,999 79,711 65,706 52,304 Income taxes 45,721 38,527 29,815 24,937 19,687 ---------- ----------- ----------- ----------- ----------- Net income $ 76,475 $ 64,472 $ 49,896 $ 40,769 $ 32,617 ========== =========== =========== =========== =========== Earnings per share - diluted/(1)/ $ 1.13 $ 0.95 $ 0.75 $ 0.61 $ 0.50 ---------- ----------- ----------- ----------- ----------- Weighted average dilutive potential shares outstanding/(1)/ 67,763 67,544 66,993 66,325 65,379 ---------- ----------- ----------- ----------- ----------- Dividends per common share -- -- -- -- -- Balance Sheet Data: - ------------------ Working capital $ 310,046 $ 238,502 $ 187,952 $ 133,256 $ 96,893 Total assets 549,180 451,976 373,250 316,373 255,311 Total debt 990 1,719 2,097 7,202 10,792 Stockholders' equity 408,515 330,470 265,199 210,303 163,662 </TABLE> (1) Amounts are adjusted for two-for-one stock split on June 13, 2000 and 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. (3) Net sales, cost of sales, gross margins, and operating expenses have been reclassified for all periods presented to comply with Emerging Issues Task Force Issue 00-10, "Accounting for Shipping and Handling Fees and Costs." See Note 1, "Reclassification of Shipping Fees," 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 historically included increasing net sales four percentage points faster than the average industry growth rate, which it believes is 7% to 9%, but increased this goal to six points for fiscal years 2000 and 2001. The Company also targets a 50 basis point annual improvement in its operating margin. On average, attaining these goals should translate into annual earnings growth between 18% and 20%. The Company achieved these goals in fiscal year 2001, reporting a 13% increase in comparable net sales, a 70 basis point expansion in net margin versus fiscal 2000 and an 18.6% increase in net income. Over the recent five-year period, sales have grown 13.6% and net income advanced 21.7% compounded annually. Net income over the five years benefited from cost controls that reduced operating expenses in relation to sales to 25.4% of sales in fiscal 2001 versus 26.7% in fiscal 1997, and improved the gross profit margin to 35.4% in fiscal 2001 compared with 34.1% in fiscal 1997. The Company's effective strategy for growth has focused on internal growth and the acquisition of smaller dental distributors to achieve a broader customer base and expanded direct sales representation. The acquisition strategy also features 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 has completed 14 acquisitions of companies with annual sales of $159.9 million and 12
gained a total of 136 sales representatives. The Company estimates its internal growth excluding acquisitions was approximately 11% during this period. The number of direct sales representatives has increased 38% since fiscal 1997, and sales per direct sales representative have increased more than 28%, evidencing the effectiveness of the Company's strategies. The Company operates in one segment, dental products 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: 2001 2000 1999 ---- ---- ---- Net sales 100.0% 100.0% 100.0% Cost of sales 64.6% 64.9% 64.7% ------ ------ ------ Gross margin 35.4% 35.1% 35.3% Operating expenses 25.4% 25.8% 26.5% ------ ------ ------ Operating income 10.0% 9.3% 8.8% Other income 0.6% 0.5% 0.2% ------ ------ ------ Income before taxes 10.6% 9.8% 9.0% Income taxes 4.0% 3.6% 3.4% ------ ------ ------ Net income 6.6% 6.2% 5.6% ====== ====== ====== Fiscal 2001 Compared to Fiscal 2000 Net Sales. Sales for the year increased 10.6% to $1,156.5 million from $1,045.9 million in fiscal 2000. Results for fiscal 2001 are based on a 52-week year versus 53 weeks in fiscal 2000. Excluding the impact of the additional week in fiscal 2000, sales increased 13%. Sales of dental equipment were the Company's principal sales growth driver during the fiscal year increasing 18% on a comparable basis. Equipment sales were fueled by sales of new generation dental equipment and solid performance from the Company's core dental equipment lines. Acquisitions added approximately 2% or $23.8 million to the overall sales increase. Sales references in parentheses exclude the additional week. Sales of consumable dental supplies, including printed office products increased 8.1% (10%) for the year paced by the US dental market where consumable sales increased 10.4% (13%). A nominal increase in the Canadian market and a 4.2% (2%) decline in printed office products tempered consumable sales growth in fiscal 2001. Printed office product sales to the dental market increased in step with consumable dental supplies. However, total printed office product sales were lower than last year due to reduced sales to the non-dental markets. Equipment and software sales grew 15.4% (17%). The Company experienced double-digit sales growth in most equipment product offerings in the U.S. dental market. Sales of clinical software units grew with digital equipment, but total software unit sales declined in fiscal 2001 due to reduced sales of front-office practice management software. Sales of practice management software were enhanced significantly in fiscal 2000 by the need of many dental offices to become Y2K compliant. Sales of other services and products, up 13.2% (15%) from last year, benefited from strong sales of technical service and parts, software support and insurance e-claims. Gross Margin. Gross margins increased $42.0 million or 11.5% over fiscal 2000 due to increased sales volumes and an improvement in the gross margin rate to 35.4% in fiscal 2001 from 35.1% in fiscal 2000. The 30 basis point increase in the gross margin rate reflects better margins at the point-of-sale and changes in product mix. Operating Expenses. Operating expenses for the year increased 9.0% over the prior year but declined as a percent of sales from 25.8% to 25.4%. Higher sales volumes, higher commission expense resulting from the Company's margin based commission programs, and increased spending on advertising were the primary factors driving the 9.0% increase in operating expenses. The 40 basis point improvement in the expense rate reflects the benefit of improved operating leverage and cost containment efforts. Operating Income. Operating income increased 18.1% and amounted to 10.0% of sales in fiscal 2001. As a percent of sales, operating income was 70 basis points better than fiscal 2000 due to both improvements in the gross margin and operating expense rates. 13
Other Income. Other income, net of expenses, came to $7.1 million for fiscal 2001 compared to $5.5 million for fiscal 2000. The increase in other income reflects higher average short-term investments of cash. Income Taxes. The effective income tax rate at 37.4% remained the same as last year. Net Income. Net income increased to $76.5 million, or 18.6% due to the factors discussed above. Earnings Per Share. Diluted earnings per share increased to $1.13 versus $0.95 reported a year ago, an 18 cent or 18.9% increase over a year ago. Fiscal 2000 Compared to Fiscal 1999 Net Sales. Net sales for fiscal 2000 increased 18.4% to $1,045.9 million from $883.3 million in fiscal 1999. Results for fiscal 2000 are based on a 53-week year versus 52 weeks in 1999. Excluding the impact of the additional week, sales increased approximately 16%. Significant improvements in Canada, acquisitions and increases in both sales representatives and customer base were the primary contributors to the sales increase. In fiscal 2000, Patterson Dental Canada sales increased by 18.6% to $88.8 million. Acquisitions added approximately $18.6 million or 2 percentage points to the overall sales increase. During 2000 the Company's sales force grew by 60 representatives and the total number of customers who purchased supplies from the Company increased approximately 16%. Sales mix was consistent with prior year. Sales references in parentheses exclude the additional week. Sales of dental and printed products increased 19.0% (17%) due primarily to contributions from an expanded sales force, an increase in the number of customers and the PBS acquisition. Excluding the impact of the acquisition of PBS, and the additional week, consumable dental products were up 14.5%. Equipment and software sales increased 18.5% (17%) due to strong demand across the equipment product lines and incremental software sales from customers upgrading their systems to be year 2000 compliant. Other revenues increased 13.6% (12%) reflecting growth in equipment repair and maintenance services and electronic claims processing and software maintenance contract sales. Gross Margin. Gross margin decreased to 35.1% in fiscal 2000 from 35.3% in 1999 due primarily to the absence of certain buying opportunities that were available last year. Point-of-sale margins were the same as fiscal 1999. Gross profit increased 17.8% to $367.1 million for fiscal 2000. The increase in gross profit was due primarily to the increase in sales volume. Operating Expenses. Operating expenses increased 15.2% to $269.7 million for fiscal 2000 from $234.1 million in 1999. The majority of the increase in operating expenses was related to greater sales volume, incentive compensation and higher healthcare costs. Operating expenses as a percent of sales declined from 26.5% to 25.8% reflecting increased productivity across all business lines. Operating Income. Operating income increased 25.8% to $97.5 million for fiscal 2000 from $77.5 million for fiscal 1999. The Company was able to leverage its infrastructure against the strong sales increase which improved the operating margin to 9.3% of sales versus 8.8% reported a year ago. Other Income. Other income, net of expenses, was $5.5 million for fiscal 2000 compared to $2.2 million for fiscal 1999. Other income increased due primarily to increased average short-term investments of cash. Income Taxes. The effective income tax rate at 37.4% remained the same as last year. Net Income. Net income increased to $64.5 million, up $14.6 million or 29.2% over last year due to strong sales performance and the improved utilization of the Company's cost structure. Earnings Per Share. Diluted earnings per share increased to $0.95 versus $0.75 reported a year ago, a 20 cent or 26.7% increase. Intuitively earnings were increased by the additional week in fiscal 2000; however, the impact on earnings of that additional week cannot be reasonably measured. 14
Liquidity and Capital Resources Patterson's operating cash flow, which generally parallels net earnings, has been the Company's principal source of liquidity in 2001, 2000 and 1999. Cash generated from operating activities was invested in working capital, capital expenditures and acquisitions. Operating activities generated cash of $80.1 million in 2001 compared with $67.9 million in 2000 and $51.6 million in 1999. The $12.2 million increase in 2001 over 2000 and the $16.3 million increase in 2000 over 1999 reflected the Company's continuing increase in profitability and improved productivity in the use of working capital. Capital expenditures net of dispositions were $10.0, $15.4, and $7.1 million in 2001, 2000 and 1999, respectively. The increase in fiscal 2000 reflected spending for a new distribution center which came on line in February 2000. The Company expects to invest about $12.0 million in capital spending in 2002 to enhance information systems and upgrade facilities. In 2001, the Company invested $3.8 million to acquire one dental distribution business and eCheck-Up.com, a web-based value-added service company. In comparison, the Company invested $12.6 million in 2000 to obtain three dental distribution businesses and made a $1.3 million investment in 1999 to purchase two smaller dental distributors. Available liquid resources at April 28, 2001, consisted of $184.5 million of cash and short-term investments and $3.6 million available under existing bank lines. In May 2001, the Company amended its Contract Purchase Agreement and unsecured revolving credit facility to increase its maximum borrowing limit by $25 million. The Company believes that these resources and funds generated from operations are sufficient to meet any existing and presently anticipated cash 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: 2001 2000 1999 ---- ---- ---- Days sales outstanding 43 43 43 Inventory turnover (1) 7.1 6.5 6.0 Sales per employee (000's) $300 $276 $244 (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, Colwell and EagleSoft inventories. Foreign Operations Foreign sales are derived primarily from operations in Canada. Fluctuations in currency exchange rates have not significantly impacted earnings. However, net sales in fiscal 2001 were adversely affected by the strengthening of the U.S. dollar. Without foreign currency effects, net sales would have increased by an additional $2.5 million. The Company expects the unfavorable US/Canadian exchange rate to continue to impact its rate of year-over-year sales growth during the first half of fiscal 2002. Changes in currency exchange rates is a risk accompanying foreign operations, but this risk is not considered material with respect to the Company's business. Subsequent Event On July 9, 2001, the Company acquired certain assets of J. A. Webster, Inc., the leading distributor of veterinary supplies to companion pet (dogs, cats and other common household pets) veterinary clinics in the eastern United States and the third largest nationally. One of the most respected names in the veterinary supply industry, Webster is a value-added, full service distributor of consumable supplies, equipment, diagnostic products, biologicals (vaccines) and pharmaceuticals. A description of J. A. Webster's business, industry, and factors that may affect its future operating results is included in Item 5 of the Form 8-K 15
filed by the Company on July 9, 2001 announcing the acquisition. The information set forth under Item 5 captioned "About J. A. Webster, Inc." on Form 8-K is included as Exhibit 99 to this Form 10-K and is incorporated into this Item 7 by reference. 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," "intends" 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 cause the Company's actual operating results to 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. . The 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 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 the 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. . The 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. 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK Market Risk The Company is subject to market risk associated with changes in interest rates and foreign currency exchange rates. The Company's earnings are affected by changes in short-term interest rates as a result of its investment in short-term commercial paper and government securities. As of the end of fiscal 2001 and 2000, the fair market value of the investments approximated the carrying value. If market interest rates for these investments averaged 10 percent more or less in 2001 and 2000, the Company's interest income would have changed by approximately $0.5 million in 2001 and $0.3 million in 2000. 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 experienced translation adjustments of $(0.3) million in 2001 and $0.2 million in 2000 which were reflected in the balance sheet as an adjustment to stockholders' equity. The cumulative translation adjustment at the end of 2001 showed a negative translation adjustment of $(2.3) million. 16
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 foreign exchange rates is not material as a majority of these purchases are denominated in the U.S. dollar. 17
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 28, 2001 and April 29, 2000, 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 28, 2001. 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 auditing standards generally accepted in the United States. 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 28, 2001, and April 29, 2000, and the consolidated results of its operations and its cash flows for each of the three years in the period ended April 28, 2001, in conformity with accounting principles generally accepted in the United States. /s/ Ernst & Young LLP Minneapolis, Minnesota May 24, 2001, except note 11 as to which the date is July 18, 2001 18
PATTERSON DENTAL COMPANY CONSOLIDATED BALANCE SHEETS (Dollars in thousands, except per share amounts) <TABLE> <CAPTION> April 28, April 29, 2001 2000 ---- ---- <S> <C> <C> ASSETS Current assets: Cash and cash equivalents..................................................... $ 160,024 $ 113,453 Short-term investments........................................................ 24,484 4,720 Receivables, net of allowance for doubtful accounts of $4,166 and $4,208 at April 28, 2001 and April 29, 2000, respectively........................ 144,625 132,419 Inventory..................................................................... 103,700 92,838 Prepaid expenses and other current assets..................................... 9,928 7,978 --------- --------- Total current assets........................................................ 442,761 351,408 Property and equipment, net..................................................... 48,575 46,022 Intangibles, net................................................................ 51,892 50,730 Other........................................................................... 5,952 3,816 --------- --------- Total assets................................................................ $ 549,180 $ 451,976 ========= ========= LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Accounts payable.............................................................. $ 89,321 $ 80,097 Accrued payroll expense....................................................... 20,866 15,194 Income taxes payable.......................................................... 4,805 1,110 Other accrued liabilities..................................................... 17,723 16,505 --------- --------- Total current liabilities................................................... 132,715 112,906 Non-current liabilities......................................................... 3,693 3,458 --------- --------- Total liabilities........................................................... 136,408 116,364 Deferred credits................................................................ 4,257 5,142 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 - 67,489,466 and 67,363,446 at April 28, 2001, and April 29, 2000, respectively....................... 675 674 Additional paid-in capital...................................................... 68,049 67,022 Accumulated other comprehensive loss............................................ (2,316) (2,060) Retained earnings............................................................... 354,371 277,896 Note receivable from ESOP....................................................... (12,264) (13,062) --------- --------- Total stockholders' equity.................................................. 408,515 330,470 --------- --------- Total liabilities and stockholders' equity.................................. $ 549,180 $ 451,976 ========= ========= </TABLE> See accompanying notes 19
PATTERSON DENTAL COMPANY CONSOLIDATED STATEMENTS OF INCOME (In thousands, except per share amounts) <TABLE> <CAPTION> Fiscal Year Ended ------------------------------------------------- April 28, April 29, April 24, 2001 2000 1999 ---------- ---------- --------- <S> <C> <C> <C> Net sales.............................................. $1,156,455 $1,045,883 $883,268 Cost of sales.......................................... 747,301 678,766 571,698 ---------- ---------- -------- Gross profit........................................... 409,154 367,117 311,570 Operating expenses..................................... 294,039 269,658 234,098 ---------- ---------- -------- Operating income....................................... 115,115 97,459 77,472 Other income and expense: Amortization of deferred credits.............. 885 885 885 Finance income, net .......................... 6,534 4,826 2,012 Interest expense.............................. (123) (132) (517) Loss on currency exchange..................... (215) (39) (141) ---------- ---------- -------- Income before income taxes............................. 122,196 102,999 79,711 Income taxes........................................... 45,721 38,527 29,815 ---------- ---------- -------- Net income............................................. $ 76,475 $ 64,472 $ 49,896 ========== ========== ======== Earnings per share -- basic............................ $ 1.13 $ 0.96 $ 0.75 ========== ========== ======== Earnings per share -- diluted.......................... $ 1.13 $ 0.95 $ 0.75 ========== ========== ======== Weighted average shares outstanding: Basic......................................... 67,435 67,346 66,793 Diluted....................................... 67,763 67,544 66,993 </TABLE> See accompanying notes 20
PATTERSON DENTAL COMPANY CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY (Dollars in thousands) <TABLE> <CAPTION> Accumulated Other Additional Compre- Note Common Paid-in hensive Retained Receivable Stock Capital (Loss) Earnings from ESOP Total ---------------------------------------------------------------------------- <S> <C> <C> <C> <C> <C> <C> Balance at April 25, 1998........... $ 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 Payment on ESOP note................ -- -- -- -- 669 669 Pooling-of-interests - PBS ......... 2 (202) -- 1,068 -- 868 Stock issued for acquisition........ -- 371 -- -- -- 371 ------ -------- --------- --------- --------- ---------- Balance at April 24, 1999........... 336 66,992 (2,222) 213,761 (13,668) 265,199 Change in translation adjustment.... -- -- 162 -- -- 162 Net income.......................... -- -- -- 64,472 -- 64,472 ------ Comprehensive income................ 64,634 Common stock issued, net............ 1 3,784 -- -- -- 3,785 Payment on ESOP note................ -- -- -- -- 606 606 Share repurchases................... -- (3,754) -- -- -- (3,754) Stock split (2 for 1)............... 337 -- -- (337) -- -- ------ -------- --------- --------- --------- ---------- Balance at April 29, 2000........... 674 67,022 (2,060) 277,896 (13,062) 330,470 Change in translation adjustment.... -- -- (256) -- -- (256) Net income.......................... -- -- -- 76,475 -- 76,475 ------ Comprehensive income................ 76,219 Common stock issued, net............ 1 4,610 -- -- -- 4,611 Payment on ESOP note................ -- -- -- -- 798 798 Share repurchases................... -- (3,583) -- -- -- (3,583) ------ -------- --------- --------- --------- ---------- Balance at April 28, 2001........... $ 675 $ 68,049 $ (2,316) $ 354,371 $ (12,264) $ 408,515 ====== ======== ========= ========= ========= ========== </TABLE> See accompanying notes 21
PATTERSON DENTAL COMPANY CONSOLIDATED STATEMENTS OF CASH FLOWS (Dollars in thousands) <TABLE> <CAPTION> Fiscal Year Ended ---------------------------------------------- April 28, April 29, April 24, 2001 2000 1999 ---------------------------------------------- <S> <C> <C> <C> Operating activities: Net income............................................................. $ 76,475 $ 64,472 $ 49,896 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation....................................................... 7,771 7,161 6,366 Amortization of deferred credit.................................... (885) (885) (885) Amortization of goodwill........................................... 3,306 3,029 2,716 Bad debt expense................................................... 821 1,267 1,148 Deferred taxes..................................................... (1,038) (3,141) (367) Change in assets and liabilities net of acquired: Increase in receivables........................................... (13,889) (17,367) (6,364) (Increase) decrease in inventory.................................. (10,981) 3,211 (9,212) Increase in accounts payable...................................... 9,307 10,154 6,127 Increase in accrued liabilities................................... 7,295 163 3,216 Other changes from operating activities, net...................... 1,877 (183) (1,028) --------- --------- --------- Net cash provided by operating activities.............................. 80,059 67,881 51,613 Investing activities: Proceeds from sale of facility......................................... -- -- 2,215 Additions to property and equipment, net............................... (10,014) (15,373) (7,088) Purchase of investments................................................ (19,764) (4,720) -- Acquisitions........................................................... (3,797) (12,569) (1,280) --------- --------- --------- Net cash used in investing activities.................................. (33,575) (32,662) (6,153) Financing activities: Payments of long-term debt............................................. (683) (425) (4,825) Repayments of revolving credit borrowings.............................. -- -- (1,850) Cash payments received on note receivable from ESOP.................... 798 606 669 Repurchases of common stock............................................ (3,583) (3,754) -- Common stock issued, net............................................... 3,668 3,135 3,690 --------- --------- --------- Net cash provided by (used in) financing activities.................... 200 (438) (2,316) Effect of exchange rate changes on cash................................ (113) (74) (17) --------- --------- --------- Net increase in cash and cash equivalents.............................. 46,571 34,707 43,127 Cash and cash equivalents at beginning of period....................... 113,453 78,746 35,619 --------- --------- --------- Cash and cash equivalents at end of period............................. $ 160,024 $ 113,453 $ 78,746 ========= ========= ========= Supplemental disclosures: Income taxes paid...................................................... $ 42,162 $ 37,148 $ 32,062 Interest paid.......................................................... 127 134 575 </TABLE> See accompanying notes 22
PATTERSON DENTAL COMPANY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS APRIL 28, 2001 (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. Significant intercompany transactions and balances have been eliminated in consolidation. Certain reclassifications of previously reported amounts have been made to conform to the current year presentation. Description of Business The Company is one of the two largest distributors of dental products in North America. The Company, a full-service, value-added supplier to dentists, dental laboratories, institutions, physicians, and other healthcare professionals, provides: consumable products (including x-ray film, restorative materials, hand instruments and sterilization products); advanced technology dental equipment; practice management software; office forms and stationery; and related dental services. The Company markets its products and services through more than 1,000 sales representatives and equipment specialists in the United States and Canada. Fiscal Year End The Company utilizes a fifty-two, fifty-three week fiscal year ending on the Saturday nearest April 30. Fiscal years 2001 and 1999 each consisted of fifty-two weeks. Fiscal year 2000 consisted of fifty-three weeks. 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. Cash and Cash Equivalents Cash equivalents consist primarily of investments in money market funds, highly-rated commercial paper and government securities. The maturities of these securities at the time of purchase is 90 days or less. Short-term investments consist of highly-rated commercial paper, corporate notes and bonds and government securities with maturities longer than 90 days at the date of purchase. All cash equivalents and short-term investments are classified as available for sale and cost approximates market 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 84% and 85% of total inventories at April 28, 2001, and April 29, 2000, respectively. The accumulated LIFO provision was $15,981 at April 28, 2001, and $15,355 at April 29, 2000. The Company believes that inventory replacement cost exceeds the inventory balance by an amount approximating the LIFO reserve. 23
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. 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 on a straight-line basis over a period of 20 years. Accumulated amortization at April 28, 2001 and April 29, 2000 was $13,164 and $9,858, respectively. The Company periodically reviews its long-lived assets, including fixed assets, for indicators of impairment using an estimate of the undiscounted cash flows generated by those assets. The Company's financial statements for fiscal years 1999 through 2001 reflect no such impairments. Revenue Recognition Revenues recognized include product sales, billings for freight and handling charges, and fees earned for services provided. Consumable dental and printed product sales and billings for freight and handling charges are recorded as products are shipped. Equipment and software product revenues are also recognized upon shipment. Revenue derived from post contract customer support for software is deferred and recognized ratably over the period in which the support is provided. Other service revenues are recorded on the date services are completed. In December 1999, the Securities and Exchange Commission issued Staff Accounting Bulletin (SAB) 101, "Revenue Recognition in Financial Statements," which provided additional guidance and clarified the application of generally accepted accounting principles to revenue recognition in financial statements. The Company's adoption of SAB 101 did not have a material impact on the Company's results of operation, financial position or cash flows. Reclassification of Shipping Fees In July 2000, the Emerging Issues Task Force (EITF) reached a consensus on EITF Issue 00-10, "Accounting for Shipping and Handling Fees and Costs." This consensus requires companies to classify amounts billed to customers for shipping and handling as revenue. Prior to the consensus, the Company reported the net costs of its shipping and handling activities as operating expenses. In addition to reclassifying shipping charges recovered from customers to revenue, the Company reclassified freight-out expense to cost of sales. The impact of these reclassifications increased previously reported net sales and cost of sales while reducing operating expenses. Reported earnings did not change. The amounts reclassified from operating expenses to net sales were $5,535 and $4,495; and from operating expenses to cost of sales were $21,464 and $18,761 for fiscal years 2000 and 1999, respectively. 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 $11,987, $7,799 and $9,224 for fiscal years 2001, 2000 and 1999, respectively. Deferred Credits Negative goodwill (deferred credits) arose from 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. 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. 24
Employee Stock Ownership Plan (ESOP) Compensation expense related to the Company's defined contribution ESOP is computed based on the shares allocated method. Stock-Based Compensation 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 fiscal years 2001, 2000 and 1999. Stock Split On June 13, 2000, the Company declared a two-for-one stock split in the form of a 100% stock dividend payable July 21, 2000, to shareholders of record on June 30, 2000. 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 Basic earnings per share is computed by dividing net earnings by the weighted average number of outstanding common shares during the period. Diluted earnings per share is computed by dividing net earnings by the weighted average number of outstanding common shares and common share equivalents, when dilutive. Certain director and employee stock options are not included in the April 28, 2001, April 29, 2000, and April 24, 1999 calculations because they are anti-dilutive. The following table sets forth the denominator for the computation of basic and diluted earnings per share. There were no adjustments to the numerator. <TABLE> <CAPTION> Fiscal Year ------------------------------------------ 2001 2000 1999 --------- --------- -------- Denominator: (in thousands) <S> <C> <C> <C> Denominator for basic earnings per share - weighted average shares 67,435 67,346 66,793 Effect of dilutive securities: Stock Option Plans 245 111 114 Employee Stock Purchase Plan 10 10 10 Capital Accumulation Plan 73 77 76 ------ ------ ------ Dilutive potential common shares 328 198 200 ------ ------ ------ Denominator for diluted earnings per share - adjusted weighted average shares 67,763 67,544 66,993 ====== ====== ====== </TABLE> 25
2. Cash Equivalents and Investments All cash equivalents and short-term investments are available for sale and stated at cost, which approximates market value. At April 28, 2001 and April 29, 2000 cash equivalents and investments consisted of the following types: Fiscal Year ---------------------- 2001 2000 -------- -------- Cash on hand $ 37,218 $ 31,090 Cash Equivalents: Certificates of deposit 5,350 -- Commercial paper 10,761 14,260 Corporate notes and bonds 7,081 -- Government securities 9,422 7,118 Money market funds 90,192 60,985 -------- -------- 122,806 82,363 Short-term investments: Commercial paper 4,170 724 Corporate notes and bonds 17,294 2,996 Government securities and other 3,020 1,000 -------- -------- 24,484 4,720 -------- -------- $184,508 $118,173 ======== ======== 3. Acquisitions The Company made the following acquisitions that affect the periods covered by these financial statements: <TABLE> <CAPTION> Entity Closing date Consideration ------------------------------------ ------------------- --------------- <S> <C> <C> ECheck-Up.com September 15 , 2000 Cash & Earn-out Micheli Dental Supply, Inc. August 1, 2000 Cash & Earn-out Guggenheim Brothers Dental Supply Co. March 27, 2000 Cash & Earn-out Kentucky Dental Supply Company, Inc. October 25, 1999 Cash Barr Dental Supply, Inc. June 28, 1999 Cash J&S Dental Supply Company, Inc. February 9, 1999 Cash & Earn-out Professional Business Systems ("PBS") February 5, 1999 428,634 shares Dentaplex, Inc. July 27, 1998 Cash & Earn-out </TABLE> The above acquisitions have been recorded using the purchase method of accounting, except PBS, which was accounted for as a pooling-of-interests. The aggregate purchase price for the purchase acquisitions was allocated as follows: <TABLE> <CAPTION> Fiscal Year --------------------------------------- 2001 2000 1999 ---------- --------- ---------- <S> <C> <C> <C> Purchase price $3,797 $12,569 $ 1,280 Allocated to the following: Accounts receivable 318 4,082 271 Inventory 420 4,351 326 Fixed assets 491 802 29 Accounts payable (83) (2,765) -- Accrued expenses -- (336) -- ------ ------- ------- Goodwill $2,651 $ 6,435 $ 654 ====== ======= ======= </TABLE> 26
The operating results of each of these acquisitions are included in the Company's consolidated statements of income from the date of each acquisition. Pro forma results of operations have not been presented for the acquisitions since the effects of these business acquisitions were not material to the Company either individually or in the aggregate. The financial statements do not reflect the financial position and results of operations prior to the date of acquisition for the pooling-of-interest acquisition, PBS, based on materiality. 4. Property and Equipment <TABLE> <CAPTION> April 28, 2001 April 29, 2000 -------------- -------------- <S> <C> <C> Land $ 3,790 $ 3,882 Buildings 22,432 21,505 Leasehold improvements 2,381 2,042 Furniture and equipment 31,684 26,951 Data processing equipment 27,047 24,834 ------------ ------------ 87,334 79,214 Accumulated depreciation (38,759) (33,192) ------------ ------------ $ 48,575 $ 46,022 ============ ============ </TABLE> 5. Financing The Company initiated a combined Contract Purchase and Revolving Credit Agreement with U. S. Bank National Association, as agent, which allows the Company to sell, with limited recourse on an ongoing basis, its installment sale contract receivables secured by dental equipment to U. S. Bank National Association and three additional banks. This financing arrangement is accounted for as a sale of assets under the provisions of SFAS No.'s 125 and 140, "Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities." During fiscal 2001, the Company sold approximately $73.7 million of its contracts under this program. The Company retains servicing responsibilities, for which it is paid a servicing fee. The servicing fees received by the Company are considered adequate compensation for services rendered. Accordingly, no servicing asset or liability has been recorded. The Company extended its bank contract purchase and revolving credit agreement on April 30, 2001 which now provides for unsecured borrowings and sales of installment contract receivables of up to a combined $125 million until April 2002. 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 28, 2001. A total of $100.0 million of installment contracts receivable sold under the agreement were outstanding at April 28, 2001. 6. Leases The Company leases facilities for its branch office locations, two distribution facilities, and also certain 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> 2002 $ 5,734 2003 4,727 2004 4,053 2005 2,598 2006 1,370 Thereafter 960 ---------- Total minimum payments required $ 19,442 ========== </TABLE> Rent expense was $6,839, $7,075, and $6,020 for the years ended April 28, 2001, April 29, 2000 and April 24, 1999, respectively. 27
7. Income Taxes Significant components of the provision (benefit) for income taxes are as follows: <TABLE> <CAPTION> Fiscal Year --------------------------------------------- 2001 2000 1999 ---------- --------- ---------- <S> <C> <C> <C> Current: Federal $ 40,878 $ 37,594 $ 27,012 Foreign 1,056 -- -- State 4,825 4,074 3,170 --------- --------- --------- Total current 46,759 41,668 30,182 Deferred: Federal (1,402) (2,437) (336) Foreign 481 (481) -- State (117) (223) (31) --------- --------- --------- Total deferred (1,038) (3,141) (367) --------- --------- --------- Provision for income taxes $ 45,721 $ 38,527 $ 29,815 ========= ========= ========= </TABLE> Significant components of the Company's deferred tax assets (liabilities) as of April 28, 2001 and April 29, 2000 are as follows: <TABLE> <CAPTION> Fiscal Year --------------------------------- 2001 2000 ------------ ------------- <S> <C> <C> Canadian net operating loss carryforward $ -- $ 481 Bad debt allowance 1,065 1,081 LIFO reserve (2,360) (1,742) Financing income (1,467) (922) Hospital insurance 1,053 783 Capital Accumulation Plan 2,973 1,773 Inventory obsolescence 1,928 808 Other 515 407 ---------- -------- Total $ 3,707 $ 2,669 ========== ======== </TABLE> Income tax expense varies from the amount computed using the U.S. statutory rate. The reasons for this difference and the related tax effects are shown below: <TABLE> <CAPTION> Fiscal Year ------------------------------------------ 2001 2000 1999 ----------- ------------ ----------- <S> <C> <C> <C> Tax at U.S. statutory rate $ 42,769 $ 36,048 $ 27,899 State tax provision, net of federal benefit 3,060 2,503 2,066 Effect of foreign taxes 392 (2,130) 107 Tax settlements and exposures -- 2,350 -- Amortization of deferred credit (310) (310) (310) Other (190) 66 53 -------- ---------- ---------- $ 45,721 $ 38,527 $ 29,815 ======== ========== ========== </TABLE> At April 29, 2000, the Company had net operating loss carryforwards of $1,048 for Canadian income tax purposes that were to expire in years 2001 through 2006. As of April 2001, all net operating loss carryforwards have been utilized. 28
8. Segment and Geographic Data The Company has one reportable segment, dental distribution. This segment 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 ---------------------------------------------- 2001 2000 1999 ----- ---- ---- <S> <C> <C> <C> Net Sales Consumable dental and printed products $ 719,510 $ 665,411 $ 559,032 Equipment and software 336,856 292,018 246,380 Other 100,089 88,454 77,856 ----------- ---------- --------- Total $ 1,156,455 $1,045,883 $ 883,268 =========== ========== ========= </TABLE> The following table presents information about the Company by geographic area. There were no material sales between geographic areas. <TABLE> <CAPTION> Fiscal Year ---------------------------------------------- 2001 2000 1999 ----- ---- ---- <S> <C> <C> <C> Net Sales United States $ 1,068,871 $ 957,107 $ 808,427 Canada 87,584 88,776 74,841 ----------- ---------- --------- Total $ 1,156,455 $1,045,883 $ 883,268 =========== ========== ========= Long-lived Assets United States $ 102,209 $ 95,843 $ 81,504 Canada 4,210 4,725 5,102 ----------- ---------- --------- Total $ 106,419 $ 100,568 $ 86,606 =========== ========== ========= </TABLE> 9. Shareholders' Equity Share Repurchases In September 1999, the Board of Directors authorized the repurchase of up to two million shares of the Company's common stock. The Company repurchased 125,000 and 180,000 shares of its common stock for $3,583 and $3,754 during fiscal 2001 and 2000, respectively. Employee Stock Ownership Plan 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 which was subsequently converted to common stock. At April 28, 2001, and April 29, 2000, indebtedness of the ESOP to the Company is shown as a deduction from stockholders' equity in the consolidated balance sheets. 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 fiscal 2001, 2000 and 1999, shares with a cost of $798, $606 and $669, respectively, were earned and allocated to ESOP participants. These amounts represented the Company's contribution for each fiscal year. At April 28, 2001, 4,588,210 shares of the common stock were allocated to participants and had a fair market value of $139,940. 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 4,050,000 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 nine-year period, and expire ten years following the date of the grant. Director Stock Option Plan In June 1992, the Company adopted a Director Stock Option Plan (the "Director Plan"), pursuant to which 675,000 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 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 25, 1998 4,050,000 - - 270,000 252,000 $ 9.11 Granted (425,964) 425,964 $ 20.28 (54,000) 54,000 19.00 Exercised - - - - (36,000) 7.28 ----------- ----------- --------- --------- ----------- --------- Balance April 24, 1999 3,624,036 425,964 20.28 216,000 270,000 11.33 Granted (74,298) 74,298 18.12 (72,000) 72,000 23.81 Exercised - - - - (54,000) 6.00 Canceled 45,178 (45,178) 20.28 - - - ----------- ----------- --------- --------- ----------- --------- Balance April 29, 2000 3,594,916 455,084 19.93 144,000 288,000 13.87 Granted (226,103) 226,103 24.74 (72,000) 72,000 22.50 Exercised - - - - (54,000) 8.83 Canceled 36,974 (36,974) 20.82 - - - ----------- ----------- --------- --------- ----------- --------- Balance April 28, 2001 3,405,787 644,213 $ 21.58 72,000 306,000 $ 18.27 =========== =========== ========= ========= =========== ========= </TABLE> The 644,213 options outstanding under the Employee Plan have exercise prices ranging from $17.41 to $33.00. The 306,000 options outstanding under the Director Plan at April 28, 2001, have exercise prices ranging from $9.33 to $23.81. At April 28, 2001, the outstanding options had a weighted average contractual life of 6.5 years. 30
Employee Stock Purchase Plan In June 1992, the Company adopted an Employee Stock Purchase Plan (the "Stock Purchase Plan"). A total of 1,375,000 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 99,276, 100,716 and 89,398 shares in fiscal 2001, 2000 and 1999, respectively. At April 28, 2001, 654,850 shares were available for purchase under the Stock Purchase Plan. Capital Accumulation Plan In 1996, the Company adopted an employee Capital Accumulation Plan (the "CAP Plan"). A total of 3,000,000 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 161,251, 160,734 and 155,182 shares of restricted stock in fiscal 2001, 2000 and 1999, respectively. At April 28, 2001, 2,380,128 shares were available for purchase under the Plan. 10. 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. 11. Subsequent Event On July 9, 2001, the Company purchased substantially all of the assets of J. A. Webster, Inc. and assumed certain liabilities, for a purchase price of $92.5 million, consisting of $81.8 million in cash and $10.7 million in stock. The acquisition agreement also includes an earnout provision tied to future product sales, which could result in additional cash payments over five years if certain minimum revenue milestones are achieved. J. A. Webster is the leading distributor of veterinary supplies to companion-pet veterinary clinics in the eastern United States and the third largest nationally. The acquisition will be accounted for using the purchase method of accounting. Because the transaction was consummated following the effective date specified in Statement No. 142 of the Financial Accounting Standards Board on "Goodwill and Other Intangible Assets," the Company will not amortize goodwill for this transaction in future financial statements. 31
12. Quarterly Results (unaudited) 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 except for the fiscal 2000 first quarter ending July 31, 1999, which included 14 weeks. Net sales and gross profit have been reclassified to comply with Emerging Issues Task Force Issue 00-10, "Accounting for Shipping and Handling Fees and Costs." See Note 1, "Reclassification of Shipping Fees." The following table summarizes results for fiscal 2001 and 2000. <TABLE> <CAPTION> Three Months Ended --------------------------------------------------------- Apr. 28, Jan. 27, Oct. 28, Jul. 29, 2001 2001 2000 2000 -------- -------- -------- --------- <S> <C> <C> <C> <C> Net sales $ 305,119 $ 290,579 $ 290,717 $ 270,040 Gross profit 109,307 104,753 101,999 93,095 Operating income 31,532 30,603 28,782 24,198 Net income 21,026 20,386 18,969 16,094 Basic earnings per share $ 0.31 $ 0.30 $ 0.28 $ 0.24 Dilutive earnings per share $ 0.31 $ 0.30 $ 0.28 $ 0.24 Three Months Ended --------------------------------------------------------- Apr. 29, Jan. 29, Oct. 30, Jul. 31, 2000 2000 1999 1999 -------- -------- -------- --------- Net sales $ 278,840 $ 261,543 $ 249,674 $ 255,826 Gross profit 98,252 92,703 86,913 89,249 Operating income 27,035 25,971 22,310 22,143 Net income 17,980 17,192 14,811 14,489 Basic earnings per share $ 0.27 $ 0.25 $ 0.22 $ 0.22 Dilutive earnings per share $ 0.27 $ 0.25 $ 0.22 $ 0.21 </TABLE> 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 10, 2001 (the "2001 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." Information regarding compliance with Section 16(c) of the Securities Exchange Act of 1934 is incorporated herein by reference to the information set forth under "Section 16(a) Beneficial Ownership Reporting Compliance" in the 2001 Proxy Statement. 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 2001 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 2001 Proxy Statement. 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS None. 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, are included in Part II, Item 8: Report of Independent Auditors Consolidated Balance Sheets as of April 28, 2001 and April 29, 2000 Consolidated Statements of Income for the Years Ended April 28, 2001, April 29, 2000 and April 24, 1999 Consolidated Statement of Changes in Stockholders' Equity for the Years Ended April 28, 2001, April 29, 2000 and April 24, 1999 Consolidated Statements of Cash Flows for the Years Ended April 28, 2001, April 29, 2000 and April 24, 1999 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 28, 2001, April 29, 2000 and April 24, 1999 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)* 10.8 ESOP Loan Agreement dated June 15, 1990 as amended July 13, 1992* 10.9 Amended and Restated Term Promissory Note dated July 13, 1992* 33
10.10 Second Amended and Restated Contract Purchase Agreement dated April 28, 2000 between Patterson Dental Company and U.S. Bank National Association*** 10.11 Amended and Restated Credit Agreement dated April 28, 2000 between Patterson Dental Company and U.S. Bank National Association*** 10.12 Asset Purchase Agreement by and among Patterson Dental Company and J. A. Webster, Inc. 21 Subsidiaries 23 Consent of Independent Auditors 99 Item 5 captioned "About J. A. Webster, Inc." of Form 8-K dated July 9, 2001 _________________________________ * 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 10-K for the fiscal year ended April 29, 2000. (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 28, 2001. 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 24, 2001 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> <CAPTION> Date ---- <S> <C> <C> /s/ Peter L. Frechette President and Chief Executive Officer and July 24, 2001 - ----------------------------------- Peter L. Frechette Director (Principal Executive Officer) /s/ R. Stephen Armstrong Executive Vice President, Treasurer, and July 24, 2001 - ----------------------------------- R. Stephen Armstrong Chief Financial Officer (Principal Financial and Accounting Officer) /s/ Ronald E. Ezerski Director July 24, 2001 - ----------------------------------- Ronald E. Ezerski /s/ David K. Beecken Director July 24, 2001 - ----------------------------------- David K. Beecken /s/ Burt E. Swanson Director July 24, 2001 - ----------------------------------- Burt E. Swanson /s/ Andre B. Lacy Director July 24, 2001 - ----------------------------------- Andre B. Lacy /s/ James W. Wiltz Director July 24, 2001 - ----------------------------------- James W. Wiltz </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 28, 2001: Deducted from asset accounts: Allowance for doubtful accounts $ 4,208 $ 821 $ -- $ 863/(1)/ $ 4,166 ========== =========== =========== ============== ============ LIFO inventory adjustment $ 15,355 $ 626 $ -- $ -- $ 15,981 Inventory obsolescence reserve 3,149 9,982 -- 6,908/(2)/ 6,223 ---------- ----------- ----------- -------------- ------------ Total inventory reserve $ 18,504 $ 10,608 $ -- $ 6,908 $ 22,204 ========== =========== =========== ============== ============ Year ended April 29, 2000: Deducted from asset accounts: Allowance for doubtful accounts $ 4,096 $ 1,267 $ 8/(3)/ $ 1,163/(1)/ $ 4,208 ========== =========== =========== ============== ============ LIFO inventory adjustment $ 13,991 $ 1,364 $ -- $ -- $ 15,355 Inventory obsolescence reserve 1,955 4,058 -- 2,864/(2)/ 3,149 ---------- ----------- ----------- -------------- ------------ Total inventory reserve $ 15,946 $ 5,422 $ -- $ 2,864 $ 18,504 ========== =========== =========== ============== ============ 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 ========== =========== =========== ============== ============ </TABLE> (1) Uncollectible accounts written off, net of recoveries. (2) Inventory disposed of and written off. (3) Acquisition of Professional Business Systems in fiscal 1999 and Dentaplex, Inc. in fiscal 2000. 36
INDEX TO EXHIBITS Exhibit 10.2 Asset Purchase Agreement by and among Patterson Dental Company and J. A. Webster, Inc. Exhibit 21 Subsidiaries Exhibit 23 Consent of Independent Auditors Exhibit 99 Item 5 captioned "About J. A. Webster, Inc." of Form 8-K dated July 9, 2001 37