SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
Commission File No. 0-20572
PATTERSON DENTAL COMPANY
(Exact Name of Registrant as Specified in its Charter)
1031 Mendota Heights Road, St. Paul, Minnesota 55120
(Address of Principal Executive Offices)
(Zip Code)
(651) 686-1600
(Registrant’s Telephone Number, Including Area Code)
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 (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for at least the past 90 days.
xYes ¨ No
Indicate by check mark whether the Registrant is an accelerated filer (as defined in rule 12b-2 of the Act.)
x Yes ¨ No
Patterson Dental Company has outstanding 68,235,813 shares of common stock as of December 2, 2003.
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INDEX
PART I – FINANCIAL INFORMATION
Item 1 –
Item 2 –
Item 3 –
Item 4 –
PART II – OTHER INFORMATION
Item 5 –
Item 6 –
Signatures
Safe Harbor Statement Under The Private Securities Litigation Reform Act Of 1995:
This Form 10-Q for the period ended October 25, 2003, contains certain forward-looking statements as defined in the Private Securities Litigation Reform Act of 1995, which may be identified by the use of forward-looking terminology such as “may”, “will”, “expect”, “anticipate”, “estimate”, “believe”, “goal”, or “continue”, or comparable terminology that involves risks and uncertainties and that are qualified in their entirety by cautionary language set forth in the Company’s Form 10-K report filed July 24, 2003, and the Company’s Form 8-K report filed September 15, 2003, and other documents filed with the Securities and Exchange Commission. See also page 14 of this Form 10-Q.
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PART I FINANCIAL INFORMATION
CONSOLIDATED BALANCE SHEETS
(Dollars in thousands)
ASSETS
Current assets:
Cash and cash equivalents
Short-term investments
Receivables, net
Inventory
Prepaid expenses and other current assets
Total current assets
Property and equipment, net
Long-term receivables, net
Goodwill
Identifiable intangibles, net
Other
Total assets
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Accounts payable
Accrued payroll expense
Income taxes payable
Short-term debt
Other accrued expenses
Total current liabilities
Non-current liabilities
Total liabilities
STOCKHOLDERS’ EQUITY
Common stock
Additional paid-in capital
Accumulated other comprehensive income (loss)
Retained earnings
Notes receivable from ESOP
Total stockholders’ equity
Total liabilities and stockholders’ equity
See accompanying notes.
3
CONSOLIDATED STATEMENTS OF INCOME
(Dollars in thousands except per share amounts)
(Unaudited)
October 25,
2003
October 26,
2002
Net sales
Cost of sales
Gross margin
Operating expenses
Operating income
Other income and expense:
Finance income, net
Interest expense
Gain (loss) on currency exchange
Income before income taxes and cumulative effect of accounting change
Income taxes
Income before cumulative effect of accounting change
Cumulative effect of accounting change
Net income
Before cumulative effect of accounting change:
Earnings per share - basic
Earnings per share - diluted
After cumulative effect of accounting change:
Weighted average common shares:
Basic
Dilutive potential
4
CONSOLIDATED STATEMENTS OF CASH FLOWS
Operating activities:
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation
Amortization of intangibles
Bad debt expense
Change in assets and liabilities, net of acquired
Net cash provided by operating activities
Investing activities:
Additions to property and equipment, net
Acquisitions, net
Sale of short-term investments
Net cash used in investing activities
Financing activities:
Payments and retirement of long-term debt and obligations under capital leases
Proceeds from debt
Common stock issued, net
Net cash provided by financing activities
Effect of exchange rate changes on cash
Net (decrease) increase in cash and cash equivalents
Cash and cash equivalents at beginning of period
Cash and cash equivalents at end of period
5
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in thousands except per share data)
October 25, 2003
NOTE 1 GENERAL
Basis of Presentation
In the opinion of management, the accompanying unaudited consolidated financial statements contain all adjustments necessary to present fairly the financial position of the Company as of October 25, 2003, and the results of operations and the cash flows for the periods ended October 25, 2003 and October 26, 2002. Such adjustments are of a normal recurring nature. The results of operations for the quarter ended October 25, 2003 and October 26, 2002, are not necessarily indicative of the results to be expected for the full year. The balance sheet at April 26, 2003, is derived from the audited balance sheet as of that date. These financial statements should be read in conjunction with the financial statements included in the 2003 Annual Report on Form 10-K filed on July 24, 2003.
The consolidated financial statements of Patterson Dental Company include the assets and liabilities of PDC Funding Company, LLC, a wholly owned subsidiary and a separate legal entity under Minnesota law. The assets of PDC Funding Company, LLC, would be available first and foremost to satisfy the claims of its creditors. There are no known creditors of PDC Funding Company, LLC.
Fiscal Year End
The fiscal year end of the Company is the last Saturday in April. The second quarter of fiscal 2004 and 2003 represent the 13 weeks ended October 25, 2003 and October 26, 2002, respectively.
Comprehensive Income
Total comprehensive income was $37,529 and $68,419 for the three and six months ended October 25, 2003, respectively, and $27,978 and $55,838 for the three and six months ended October 25, 2003, respectively.
Stock-Based Compensation
The Company has adopted the disclosure requirements of SFAS No. 148, “Accounting for Stock-Based Compensation-Transition and Disclosure, an amendment of FASB Statement 123.” The Company has chosen to continue with its current practice of applying the recognition and measurement principles of APB No. 25 “Accounting for Stock Issued to Employees.” This method defines the Company’s cost as the excess of the stock’s market value at the time of the grant over the amount that the employee is required to pay. In accordance with APB Opinion No. 25, no compensation expense was recognized for the stock based plans for the quarter ended October 25, 2003 and October 26, 2002, as the price paid was not less than 100 percent of fair market value.
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The following table illustrates the effect on net earnings and net earnings per share if the Company had applied the fair value recognition provisions of SFAS No. 123, “Accounting for Stock Based Compensation” to stock-based employee compensation:
Income before cumulative effect of accounting change, as reported
Deduct: total stock-based employee compensation expense determined under fair value based method for all awards, net of related tax effect
Pro forma net earnings
Earnings per share before cumulative effect of accounting change—basic:
As reported
Pro forma
Earnings per share before cumulative effect of accounting change—diluted:
Earnings Per Share
The following table sets forth the denominator for the computation of basic and diluted earnings per share:
Denominator:
Denominator for basic earnings per share - weighted-average shares
Effect of dilutive securities:
Stock Option Plans
Employee Stock Purchase Plan
Capital Accumulation Plan
Convertible Debenture
Dilutive potential common shares
Denominator for diluted earnings per share - adjusted weighted-average shares and assumed conversions
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NOTE 2 GOODWILL AND OTHER INTANGIBLE ASSETS
The Company adopted Statement No. 142 “Goodwill and Other Intangible Assets”, in the first quarter of fiscal 2003. With the adoption of the statement, the Company recognized as the cumulative effect of a change in accounting principle the remaining balance of its unamortized deferred credits. The deferred credits were negative goodwill that arose from acquisitions in the 1980’s and amounted to approximately $3.4 million at the time of the adoption.
The goodwill balance by business segment as of April 26, 2003 and October 25, 2003 is as follows. The increase in the goodwill balance during the six-month period ended October 25, 2003 reflects the preliminary purchase price allocation of the acquisition of AbilityOne Products Corp., contingent earn-out payments from acquisitions made in prior years and changes in currency exchange rates.
Balance at
April 26, 2003
Acquisition
Activity
Translation
And Other
Dental Supply
Rehabilitative Supply
Veterinary Supply
Total
Accumulated amortization of other intangible assets was $5,849 as of October 25, 2003.
NOTE 3 ACQUISITIONS
On September 12, 2003 the Company acquired the stock of AbilityOne Products Corp. (“AbilityOne”) as a logical extension of Patterson’s value-added, specialty distribution strategy into a large new and growing market. The purchase price of $584.3 million consists of a base price of $575.5 million and an additional $8.8 million for an idle facility and transaction expenses. The idle facility, classified in “Prepaid expenses and other current assets” on the balance sheet, was the former headquarters of an entity acquired by AbilityOne. The activities formerly performed at this facility were moved to other locations within AbilityOne.
The acquisition was initially debt financed through a $500.0 million bridge loan. This loan was replaced by permanent debt financing in the third quarter, which is more fully described in Note 5 to the Consolidated Financial Statements. In conjunction with the transaction, the Company also issued $4.5 million of convertible debentures maturing in 2006. The debentures are convertible into the Common Stock of Patterson Dental Company at a price of $50.98 per share. Interest on the debentures is accrued at the rate of 0.5% per annum.
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The results of AbilityOne’s operations are included in the accompanying financial statements since the date of acquisition. The purchase price plus direct acquisition costs have been allocated on the basis of estimated fair values at the date of acquisition, pending final determination of the fair value of certain acquired assets. Upon final determination, a portion of intangible assets currently classified in goodwill will be reclassified into identifiable intangibles. The preliminary purchase price allocation is as follows:
Purchase price
Less:
Accounts receivable
Income tax receivable
Fixed assets
Other assets
Deferred taxes
Accrued expenses
The following pro forma summary presents the results of operations, as if the acquisition had occurred at the beginning of the fiscal period. The pro forma results of operations are not necessarily indicative of the results that would have been achieved had the two companies been combined:
Net Income before cumulative effect of accounting change
Earnings per share before cumulative effect of accounting change:
Diluted
NOTE 4 SEGMENT REPORTING
Since fiscal 2002 Patterson Dental Company has operated in two reportable segments, dental supply and veterinary supply. In September 2003, the Company purchased AbilityOne Products Corp. AbilityOne is the world’s leading distributor of rehabilitative supplies and non-wheelchair assistive patient products to the global physical and occupational therapy markets. AbilityOne became a reportable business segment of the Company, and now Patterson Dental Company is comprised of three reportable segments: dental supply, veterinary supply and rehabilitative supply. The Company’s reportable business segments are strategic business units that offer similar products and services to different customer bases. The dental supply segment provides a virtually complete range of consumable dental products, clinical and laboratory equipment and value-added services to dentists, dental laboratories, institutions and other healthcare providers throughout North America. The veterinary supply segment provides consumable supplies, equipment, diagnostic products, biologicals (vaccines) and pharmaceuticals to companion-pet veterinary clinics primarily in the Eastern, Mid-Atlantic and Southeastern regions of the United States. The rehabilitative supply segment provides a comprehensive range of distributed and self-manufactured rehabilitative medical supplies and non-wheelchair assistive products to acute care hospitals, long-term care facilities, rehabilitation clinics, dealers and schools.
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The accounting policies of the segments are the same as those described in the summary of significant accounting policies. The Company evaluates segment performance based on operating income.
The following table presents information about the Company’s reportable segments:
Dental supply
Rehabilitative supply
Veterinary supply
Consolidated net sales
Consolidated operating income
Consolidated total assets
The following table presents sales information by product for the Company:
Consumable and printed office products
Equipment and software
NOTE 5 SUBSEQUENT EVENT
In November 2003, the Company executed two debt financing arrangements totaling $650.0 million. A portion of this financing replaces the $500 million bridge loan that was used to fund the acquisition of AbilityOne Products Corp. in September 2003. The financing arrangements, which carried an overall effective rate of less than 4.0% at closing, consist of two components: a $350 million private placement of fixed and floating-rate senior notes, with maturities from November 2006 through November 2010, and a $300 million floating-rate bank credit agreement, consisting of a term loan and revolving credit facility. Under the bank agreement, the $100 million, fully amortizing term loan matures in November 2008, as does the $200 million revolving credit line.
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MANAGEMENT’S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
RESULTS OF OPERATIONS
The following table sets forth, for the periods indicated, the percentage of net sales represented by certain operational data.
Other (expense) income, net
Income before income tax and cumulative of accounting change
QUARTER ENDED OCTOBER 25, 2003 COMPARED TO QUARTER ENDED OCTOBER 26, 2002.
Net Sales. Net sales for the three months ended October 25, 2003 (“Current Quarter”) totaled $477.5 million, a 19.1% increase from $400.8 million reported for the three months ended October 26, 2002 (“Prior Quarter”). Current Quarter results include $31.8 million of incremental rehabilitative sales from the acquisition of AbilityOne Products Corp. (“AbilityOne”) on September 12, 2003. Excluding AbilityOne, net sales increased 11.2%.
Dental segment sales rose 10.4% to $392.7 million. Substantially all of this growth was internally generated. Sales growth in the dental supply segment was led by sales of equipment, which grew 26.0% reflecting strong demand for the CEREC®3 dental restorative system, digital radiography systems and computer hardware. Consumable and printed office products increased 4.5% in the Current Quarter. Sales of other services and products, consisting primarily of parts, technical service labor, software support and insurance e-claims, were flat compared to the Prior Quarter.
Canadian dental sales increased 7.0% over the Prior Quarter in local currencies. Trends in Canada were similar to the U.S. market with equipment sales pacing sales growth.
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Veterinary sales increased 17.2% to $53.0 million compared to $45.2 million in the Prior Quarter. This segment continued to benefit from a temporary pharmaceutical distribution agreement. Excluding this agreement, veterinary supply sales increased approximately 6%. During the quarter this agreement was converted to an agency arrangement. As a result of this conversion the Company expects third quarter growth rates to be more in line with overall market growth.
Rehabilitative sales stemming from AbilityOne amounted to $31.8 million, in line with internal forecasts. On a pro forma basis, sales increased 3.4%.
Gross Margins. Gross margins increased from 34.4% to 34.8% in the Current Quarter solely as a result of the AbilityOne contribution. The AbilityOne product lines carry higher margins overall than either the dental or veterinary segments. Excluding AbilityOne, margins declined to 34.1 % due to a shift in the veterinary sales mix. While the veterinary segment realized substantial sales growth, these sales carry a lower margin rate, which was further impacted this quarter by a significant pharmaceutical distribution agreement. Veterinary margins are expected to improve in the latter half of the year. Dental supply margins were flat on a year-over-year comparison.
Operating Expenses. Operating expenses as percent of sales improved from 23.8% in the Prior Quarter to 23.0% in the Current Quarter. Continued operating leverage from the infrastructure attained through the Thompson Dental and DQD acquisitions, and leverage from the investment in our hardware and networking initiative were contributing factors. To a lesser extent, an improvement of 1.6 percentage points in the veterinary segment reflected the increased sales volume generated by the pharmaceutical distribution agreement. AbilityOne’s impact on the consolidated expense ratio was negligible.
Operating Income. Operating income increased 32.5% and improved 1.2 percentage points as a percent of sales. Excluding AbilityOne, operating income improved 30 basis points. The 1.2 percentage point increase is attributable to the strong operating metrics of AbilityOne combined with the improvement in the expense ratios in the dental and veterinary segments.
Other Income. Other income, net of expenses, was ($0.4) million for the Current Quarter compared to $1.7 million in the Prior Quarter. This decrease is primarily due to the interest expense incurred on the debt financing used to purchase AbilityOne.
Income Taxes. The effective income tax rate is unchanged in the Current Quarter at 37.6%.
Earnings Per Share. Diluted earnings per share increased to $0.51 versus $0.40 a year ago.
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SIX-MONTHS ENDED OCTOBER 25, 2003 COMPARED TO SIX-MONTHS ENDED OCTOBER 26, 2002.
Net Sales. Net sales for the six months ended October 25, 2003 (“Current Period”) totaled $910.8 million, a 15.5% increase from $788.6 million reported for the six months ended October 26, 2002 (“Prior Period”). Results for the period benefited from $31.8 million of incremental revenue from AbilityOne. Excluding AbilityOne, net sales increased 11.5%.
Dental segment sales rose 9.8% to $764.5 million versus $696.3 million in the Prior Period. Six-months trends parallel second quarter results where increases reflect strong equipment sales, which grew 22.3% due to continuing demand for the CEREC®3 dental restorative system, digital radiography systems and computer hardware. Consumable and printed office products increased 4.7% in the Current Period. Sales of other services and products, consisting primarily of parts, technical service labor, software support and insurance e-claims, grew 5.1%. The impact of acquisitions over the first six months was negligible. Canadian dental sales increased 6.1% over the Prior Period in local currencies.
Veterinary sales increased 24.1% to $114.5 million compared to $92.2 million in the Prior Period. Excluding the impact of the previously mentioned pharmaceutical distribution agreement, sales increased by approximately 6%.
On a pro forma basis, rehabilitative sales increased 6.3%.
Gross Margins. Gross profit increased 14.7% but margins declined from 34.4% to 34.1% in the Current Period. This decline reflects the lower margin rate contributed by veterinary sales. Dental supply margins dipped slightly by 10 basis points on a year-over-year comparison. Gross margins benefited from AbilityOne’s contribution of 40 basis points.
Operating Expenses. Operating expenses as percent of sales improved from 24.0% in the Prior Period to 23.0% in the Current Period. Analogous to the second quarter, the expense rate improvement resulted from leveraging both the infrastructure attained through acquisitions and investments in our hardware and networking initiative. The sales volume generated by the pharmaceutical distribution agreement positively impacted veterinary expense ratios. The addition of AbilityOne did not impact the consolidated expense rate.
Operating Income. Operating income increased 24.6% and margins improved 80 basis points. Excluding AbilityOne, operating income improved 40 basis points. The AbilityOne contribution to gross margins combined with the positive trends in the dental and veterinary expense ratios resulted in higher operating margin.
Other Income. Other income, net of expenses, declined $1.3 million compared to the Prior Period reflecting higher interest expense from debt financing used to purchase AbilityOne.
Income Taxes. The effective income tax is 37.6% in the Current and Prior Period.
Earnings Per Share, Before Cumulative Effect of Accounting Change. Diluted earnings per share before the cumulative effect of accounting change increased to $0.94 versus $0.77 a year ago.
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LIQUIDITY AND CAPITAL RESOURCES
In the first half of fiscal year 2004, Patterson generated $71.1 million of cash from operations on earnings of $64.3 million, compared to $25.5 million on earnings before cumulative effect of accounting change of $52.6 million in the Prior Period. Collections on receivables were higher by $6.3 million and payments on trade payables were lower by $27.4 million compared to the same period a year ago.
Cash flows for investing activities include $579.8 million for the acquisition of AbilityOne on September 12, 2003. The acquisition was initially debt financed through a bridge facility. In November 2003, the bridge facility was converted into two permanent debt financing arrangements totaling $650.0 million. The debt financing is more fully described in Note 5 to the Consolidated Financial Statements. After refinancing the bridge facility, approximately $150.0 million remains for future use. Prior Period investments include $4.5 million primarily for the acquisition of Distribution Quebec Dentaire Inc. The Company sold $11.3 million of short-term investments in the Current Period to help finance the purchase of AbilityOne.
The Company expects funds generated by operations, existing cash balances and availability under the new committed debt facilities will be sufficient to meet the Company’s working capital needs and finance anticipated expansion plans and strategic initiatives over the next fiscal year.
CRITICAL ACCOUNTING POLICIES
There has been no material change in the Company’s Critical Accounting Policies, as disclosed in its 2003 Annual Report on Form 10-K filed July 24, 2003.
FACTORS THAT MAY AFFECT FUTURE OPERATING RESULTS
Certain information of a non-historical nature contains 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.
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In September 2003, the Company borrowed $500.0 million, under a short-term, bridge loan to finance the purchase of AbilityOne. A sensitivity analysis of the impact on the bridge loan of a hypothetical 10% change in short-term interest rates indicates that interest expense would not have changed materially for the three months ended October 25, 2003. This loan was replaced by permanent financing arrangements in November 2003, which included floating-rate debt. For that reason, the Company expects its risk exposure to changes in interest rates to increase in the future. Additional information regarding the new debt financing is included in Note 5 to the Consolidated Financial Statements. There have been no other material changes from April 26, 2003 in our market risk. For further information on market risk, refer to Item 7A in our Annual Report on Form 10-K for the fiscal year ended April 26, 2003.
15
As of October 25, 2003, the Company carried out an evaluation, under the supervision and with the participation of the Company’s management, including the Company’s Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of the Company’s disclosure controls and procedures (as defined in Rules 13a-15(e) under the Securities Exchange Act of 1934 (the “Exchange Act”)). Based on that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that the Company’s disclosure controls and procedures were effective as of October 25, 2003 to ensure that information required to be disclosed by the Company in reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in Securities and Exchange Commission rules and forms.
During the fiscal quarter ended October 25, 2003, there were no significant changes in the Company’s internal controls over financial reporting (as defined in Rule 13a-15(f) under the Exchange Act) that have materially affected, or are reasonably likely to materially affect, the Company’s internal controls over financial reporting
PART II OTHER INFORMATION
16
On December 1, 2003, the Company issued a press release announcing the completion of $650.0 million debt financing arrangements. The full text of this release is set forth in Exhibit 99 and is incorporated into this Item 5 by reference.
10.1
31.1
31.2
32.1
32.2
99
17
In a Form 8-K dated August 20, 2003 the Company furnished an earnings press release announcing its 2004 first quarter results.
A Form 8-K was filed on September 15, 2003 announcing the Company’s acquisition of AbilityOne Products Corp.
All other items under Part II have been omitted because they are inapplicable or the answers are negative, or, in the case of legal proceedings, were previously reported in the Annual Report on Form 10-K filed July 24, 2003.
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SIGNATURES
Pursuant to the requirements 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.
(Registrant)
Dated: December 9, 2003
By:
/s/ R. Stephen Armstrong
R. Stephen Armstrong
Executive Vice President, Treasurer and ChiefFinancial Officer
(Principal Financial Officer and PrincipalAccounting Officer)
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