Form 10-Q
Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

FORM 10-Q

 

 

 

x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934

FOR THE QUARTERLY PERIOD ENDED October 31, 2015.

 

¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934

Commission File No. 0-20572

 

 

PATTERSON COMPANIES, INC.

(Exact Name of Registrant as Specified in Its Charter)

 

 

 

Minnesota   41-0886515

(State or Other Jurisdiction of

Incorporation or Organization)

 

(I.R.S. Employer

Identification Number)

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 the past 90 days.    Yes  x    No  ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  x    No  ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

 

Large Accelerated Filer   x    Accelerated Filer   ¨
Non-Accelerated Filer   ¨  (Do not check if a smaller reporting company)    Smaller Reporting Company   ¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ¨    No  x

As of December 3, 2015, there were 99,430,000 shares of Common Stock of the registrant issued and outstanding.

 

 

 


Table of Contents

PATTERSON COMPANIES, INC.

INDEX

 

     Page  

PART I - FINANCIAL INFORMATION

  

Item 1- Financial Statements (Unaudited)

     3-17   

Condensed Consolidated Balance Sheets as of October 31, 2015 and April 25, 2015

     3   

Condensed Consolidated Statements of Income and Other Comprehensive Income for the Three and Six Months Ended October 31, 2015 and October 25, 2014

     4   

Condensed Consolidated Statements of Cash Flows for the Six Months Ended October 31, 2015 and October  25, 2014

     5   

Notes to Condensed Consolidated Financial Statements

     6-17   

Item 2 - Management’s Discussion and Analysis of Financial Condition and Results of Operations

     18-22   

Item 3 - Quantitative and Qualitative Disclosures about Market Risk

     22   

Item 4 - Controls and Procedures

     22-23   

PART II - OTHER INFORMATION

  

Item 1 - Legal Proceedings

     23   

Item 2 - Unregistered Sales of Equity Securities and Use of Proceeds

     23   

Item 6 - Exhibits

     23   

Signatures

     24   

Exhibit Index

     25   


Table of Contents

PART I—FINANCIAL INFORMATION

PATTERSON COMPANIES, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

(In thousands)

 

     October 31,     April 25,  
     2015     2015  
     (Unaudited)        

ASSETS

    

Current assets:

    

Cash and cash equivalents

   $ 95,451      $ 347,260   

Short-term investments

     —          53,372   

Receivables, net of allowance for doubtful accounts

     734,461        586,263   

Inventory

     752,849        408,422   

Prepaid expenses and other current assets

     83,169        59,561   

Current assets held for sale

     —          118,347   
  

 

 

   

 

 

 

Total current assets

     1,665,930        1,573,225   

Property and equipment, net

     272,190        204,133   

Long-term receivables, net

     75,784        71,686   

Goodwill

     817,595        299,924   

Identifiable intangibles, net

     537,079        125,025   

Other

     83,260        37,919   

Long-term assets held for sale

     —          635,794   
  

 

 

   

 

 

 

Total assets

   $ 3,451,838      $ 2,947,706   
  

 

 

   

 

 

 

LIABILITIES AND STOCKHOLDERS’ EQUITY

    

Current liabilities:

    

Accounts payable

   $ 492,469      $ 323,294   

Accrued payroll expense

     47,671        72,464   

Other accrued liabilities

     162,225        142,611   

Current maturities of long-term debt

     15,991        —     

Borrowings on revolving credit

     80,000        —     

Current liabilities held for sale

     —          39,316   
  

 

 

   

 

 

 

Total current liabilities

     798,356        577,685   

Long-term debt

     1,034,884        725,000   

Other non-current liabilities

     255,341        81,484   

Long-term liabilities held for sale

     —          49,414   
  

 

 

   

 

 

 

Total liabilities

     2,088,581        1,433,583   

Stockholders’ equity:

    

Common stock

     995        1,033   

Additional paid-in capital

     27,759        21,026   

Accumulated other comprehensive loss

     (63,626     (60,346

Retained earnings

     1,475,867        1,630,148   

Unearned ESOP shares

     (77,738     (77,738
  

 

 

   

 

 

 

Total stockholders’ equity

     1,363,257        1,514,123   
  

 

 

   

 

 

 

Total liabilities and stockholders’ equity

   $ 3,451,838      $ 2,947,706   
  

 

 

   

 

 

 

See accompanying notes

 

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Table of Contents

PATTERSON COMPANIES, INC.

CONDENSED CONSOLIDATED STATEMENTS OF INCOME

AND OTHER COMPREHENSIVE INCOME

(In thousands, except per share amounts)

(Unaudited)

 

     Three Months Ended     Six Months Ended  
     October 31,     October 25,     October 31,     October 25,  
     2015     2014     2015     2014  

Net sales

   $ 1,389,210      $ 978,220      $ 2,532,080      $ 1,917,176   

Cost of sales

     1,058,311        718,933        1,912,937        1,407,272   
  

 

 

   

 

 

   

 

 

   

 

 

 

Gross profit

     330,899        259,287        619,143        509,904   

Operating expenses

     247,436        187,147        473,503        371,768   
  

 

 

   

 

 

   

 

 

   

 

 

 

Operating income from continuing operations

     83,463        72,140        145,640        138,136   

Other income and expense:

        

Other income, net

     954        777        1,624        2,147   

Interest expense

     (17,154     (8,544     (29,297     (17,312
  

 

 

   

 

 

   

 

 

   

 

 

 

Income from continuing operations before taxes

     67,263        64,373        117,967        122,971   

Income taxes

     24,700        22,508        55,093        42,781   
  

 

 

   

 

 

   

 

 

   

 

 

 

Net income from continuing operations

     42,563        41,865        62,874        80,190   

Net income (loss) from discontinued operations

     (7,142     11,913        2,250        23,877   
  

 

 

   

 

 

   

 

 

   

 

 

 

Net income

   $ 35,421      $ 53,778      $ 65,124      $ 104,067   
  

 

 

   

 

 

   

 

 

   

 

 

 

Basic earnings (loss) per share:

        

Continuing operations

   $ 0.43      $ 0.42      $ 0.64      $ 0.81   

Discontinued operations

     (0.07     0.12        0.02        0.24   
  

 

 

   

 

 

   

 

 

   

 

 

 

Net basic earnings per share

   $ 0.36      $ 0.54      $ 0.66      $ 1.05   
  

 

 

   

 

 

   

 

 

   

 

 

 

Diluted earnings (loss) per share:

        

Continuing operations

   $ 0.43      $ 0.42      $ 0.63      $ 0.80   

Discontinued operations

     (0.07     0.12        0.02        0.24   
  

 

 

   

 

 

   

 

 

   

 

 

 

Net diluted earnings per share

   $ 0.36      $ 0.54      $ 0.65      $ 1.04   
  

 

 

   

 

 

   

 

 

   

 

 

 

Weighted average shares:

        

Basic

     98,525        98,802        98,981        99,066   
  

 

 

   

 

 

   

 

 

   

 

 

 

Diluted

     99,185        99,376        99,674        99,779   
  

 

 

   

 

 

   

 

 

   

 

 

 

Dividends declared per common share

   $ 0.22      $ 0.20      $ 0.44      $ 0.40   
  

 

 

   

 

 

   

 

 

   

 

 

 

Comprehensive income

        

Net income

   $ 35,421      $ 53,778      $ 65,124      $ 104,067   

Foreign currency translation gain (loss)

     6,941        (36,816     (4,334     (26,506

Cash flow hedges, net of tax

     437        (3,867     1,054        (6,176
  

 

 

   

 

 

   

 

 

   

 

 

 

Comprehensive income

   $ 42,799      $ 13,095      $ 61,844      $ 71,385   
  

 

 

   

 

 

   

 

 

   

 

 

 

See accompanying notes

 

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PATTERSON COMPANIES, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(In thousands)

(Unaudited)

 

     Six Months Ended  
     October 31,     October 25,  
     2015     2014  

Operating activities:

    

Net income

   $ 65,124      $ 104,067   

Net income from discontinued operations

     2,250        23,877   
  

 

 

   

 

 

 

Net income from continuing operations

     62,874        80,190   

Adjustments to reconcile net income from continuing operations to net cash provided by operating activities:

    

Depreciation

     16,791        11,663   

Amortization

     21,609        9,351   

Bad debt expense

     5,674        809   

Non-cash employee compensation

     13,541        11,940   

Accelerated amortization of debt issuance costs on early retirement of debt

     5,153        —     

Excess tax benefits from stock-based compensation

     (1,686     (175

Change in assets and liabilities, net of acquired

     (137,923     (37,233
  

 

 

   

 

 

 

Net cash (used in) provided by operating activities- continuing operations

     (13,967     76,545   

Net cash (used in) provided by operating activities- discontinued operations

     (38,985     21,850   
  

 

 

   

 

 

 

Net cash (used in) provided by operating activities

     (52,952     98,395   

Investing activities:

    

Additions to property and equipment

     (40,978     (29,190

Acquisitions and equity investments, net of cash assumed

     (1,105,229     —     

Proceeds from sale of securities

     48,744        40,775   

Purchase of investments

     —          (543
  

 

 

   

 

 

 

Net cash (used in) provided by investing activities- continuing operations

     (1,097,463     11,042   

Net cash provided by investing activities- discontinued operations

     715,430        4,598   
  

 

 

   

 

 

 

Net cash (used in) provided by investing activities

     (382,033     15,640   

Financing activities:

    

Dividends paid

     (45,356     (40,174

Repurchases of common stock

     (160,579     (47,539

Proceeds from issuance of long-term debt

     1,000,000        —     

Debt issuance costs

     (11,600     —     

Draw on revolver

     80,000        —     

Retirement of long-term debt

     (674,125     —     

Other financing activities

     2,894        844   
  

 

 

   

 

 

 

Net cash provided by (used in) financing activities

     191,234        (86,869

Effect of exchange rate changes on cash

     (8,058     (7,202
  

 

 

   

 

 

 

Net change in cash and cash equivalents

     (251,809     19,964   

Cash and cash equivalents at beginning of period

     347,260        264,908   
  

 

 

   

 

 

 

Cash and cash equivalents at end of period

   $ 95,451      $ 284,872   
  

 

 

   

 

 

 

See accompanying notes

 

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Table of Contents

PATTERSON COMPANIES, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

October 31, 2015

(Dollars, except per share amounts, and shares in thousands)

(Unaudited)

Note 1. General

Basis of Presentation

In the opinion of management, the accompanying unaudited condensed consolidated financial statements contain all adjustments necessary to present fairly the financial position of Patterson Companies, Inc. (“Patterson”) as of October 31, 2015, and our results of operations and cash flows for the periods ended October 31, 2015 and October 25, 2014. Such adjustments are of a normal recurring nature. The results of operations for the periods ended October 31, 2015 and October 25, 2014 are not necessarily indicative of the results to be expected for the full year. These financial statements should be read in conjunction with the financial statements included in our 2015 Annual Report on Form 10-K filed on June 24, 2015.

Such unaudited condensed consolidated financial statements include the assets and liabilities of PDC Funding Company, LLC (“PDC Funding”) and PDC Funding Company II, LLC (“PDC Funding II”), wholly owned subsidiaries and separate legal entities under Minnesota law. PDC Funding and PDC Funding II are fully consolidated special purpose entities established to sell customer installment sale contracts to outside financial institutions in the normal course of their business. The assets of PDC Funding and PDC Funding II would be available first and foremost to satisfy the claims of its creditors. There are no known creditors of PDC Funding or PDC Funding II.

Through fiscal 2015, Patterson was comprised of three reportable segments: dental supply, veterinary supply and rehabilitation supply. This fiscal year, we reorganized our reportable segments as a result of our acquisition of Animal Health International, Inc. and our divestiture of our wholly-owned subsidiary Patterson Medical Holdings, Inc., the entity through which we operated the rehabilitation supply business. We now present three different reportable segments: Dental, Animal Health and Corporate. Prior period segment results have been restated to conform to this revised current period presentation.

Fiscal Year End

We operate with a 52-53 week accounting convention with our fiscal year ending on the last Saturday in April. The second quarters of fiscal 2016 and 2015 include the 13 weeks ended October 31, 2015 and October 25, 2014, respectively. The six months ended October 31, 2015 and October 25, 2014 include 27 and 26 weeks, respectively. Fiscal 2016 will include 53 weeks and fiscal 2015 included 52 weeks of operations.

Comprehensive Income

Comprehensive income is computed as net income including certain other items that are recorded directly to stockholders’ equity. Significant items included in comprehensive income are foreign currency translation adjustments and the effective portion of cash flow hedges, net of tax. Foreign currency translation adjustments do not include a provision for income tax on earnings from foreign operations that are considered to be indefinitely reinvested outside the U.S. The income tax benefit/(loss) related to cash flow hedges was $(265) and $2,321 for the three months ended October 31, 2015 and October 25, 2014, respectively. The income tax benefit/(loss) related to cash flow hedges was $(350) and $7,134 for the six months ended October 31, 2015 and October 25, 2014, respectively.

 

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Earnings Per Share

The following table sets forth the computation of the weighted average shares outstanding used to calculate basic and diluted earnings per share (“EPS”):

 

     Three Months Ended      Six Months Ended  
     October 31,      October 25,      October 31,      October 25,  
     2015      2014      2015      2014  

Denominator for basic EPS – weighted average shares

     98,525         98,802         98,981         99,066   

Effect of dilutive securities

     660         574         693         713   
  

 

 

    

 

 

    

 

 

    

 

 

 

Denominator for diluted EPS – weighted average shares

     99,185         99,376         99,674         99,779   
  

 

 

    

 

 

    

 

 

    

 

 

 

Potentially dilutive securities consisting of stock options, restricted stock and stock purchase plans representing 899 shares for the three and six months ended October 31, 2015 and 124 shares for the three and six months ended October 25, 2014 were excluded from the calculation of diluted earnings per share because their effect would have been anti-dilutive.

Recently Issued Accounting Pronouncements

In May 2014, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2014-09, “Revenue from Contracts with Customers (Topic 606).” ASU No. 2014-09 supersedes the revenue recognition requirements in “Revenue Recognition (Topic 605),” and requires entities to recognize revenue in a way that depicts the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. In July 2015, the FASB deferred the effective date of this pronouncement by one year to December 15, 2017 for interim and annual reporting periods beginning after that date. Early adoption is permitted, but not before the original effective date, which for annual periods was December 15, 2016. We are evaluating the new standard, but do not, at this time, anticipate a material impact to our financial statements once implemented.

In July 2015, the FASB issued ASU No. 2015-11, “Inventory (Topic 330), Simplifying the Measurement of Inventory.” ASU 2015-11 requires inventory measured using any method other than last-in, first-out (LIFO) or the retail inventory method to be subsequently measured at the lower of cost or net realizable value, rather than at the lower of cost or market. Subsequent measurement of inventory using the LIFO and retail inventory method is unchanged. We are required to adopt the new pronouncement in the first quarter of fiscal 2018, and plan to do so at that time. Early adoption is permitted. We are evaluating the effect of adopting this pronouncement, but do not, at this time, anticipate a material impact to our financial statements once implemented.

In August 2015, the FASB issued ASU No. 2015-15, “Interest – Imputation of Interest (Subtopic 835-30), Presentation and Subsequent Measurement of Debt Issuance Costs Associated with Line-of-Credit Arrangements.” This ASU states that ASU No. 2015-03, “Interest – Imputation of Interest (Subtopic 835-30), Simplifying the Presentation of Debt Issuance Costs” does not address debt issuance costs for line-of-credit arrangements, and therefore the SEC staff would not object to an entity deferring and presenting these related debt issuance costs as an asset and subsequently amortizing the deferred issuance costs ratably over the term of the line-of-credit arrangement, regardless of whether there are any outstanding borrowings on the line-of-credit arrangement. At this time, we do not believe that ASU No. 2015-15 will have a material impact on our financial statements and related disclosures.

In September 2015, the FASB issued ASU No. 2015-16, “Business Combinations (Topic 805), Simplifying the Accounting for Measurement-Period Adjustments.” This ASU requires that an acquirer recognize adjustments to provisional amounts that are identified during the measurement period in the reporting period in which the adjustment amounts are determined. The amendments in this ASU require an entity to present separately on the face of the income statement or disclose in the notes the portion of the amount recorded in current-period earnings by line item that would have been recorded in previous reporting periods if the adjustment to the provisional amounts had been recognized as of the acquisition date. We are required to adopt the new pronouncement in the first quarter of fiscal 2017, with early adoption permitted. We are evaluating the effect and timing of adopting this pronouncement, but do not, at this time, anticipate a material impact to the financial statements once implemented.

In November 2015, the FASB issued ASU No. 2015-17, “Income Taxes (Topic 740), Balance Sheet Classification of Income Taxes.” This ASU eliminates the current requirement for an entity to separate deferred income tax liabilities and assets into current and noncurrent amounts in a classified statement of financial position. This ASU requires that deferred tax liabilities and assets be classified as noncurrent in the classified statement of financial position. We are required to adopt the ASU in the first quarter of fiscal 2018, with early adoption permitted. We are evaluating the effect and timing of adopting this pronouncement, but do not, at this time, anticipate a material impact to the financial statements once implemented.

 

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Reclassifications

Certain prior year amounts have been reclassified to conform to the current year presentation.

Note 2. Acquisitions

During our first fiscal quarter of 2016, we completed the acquisition of Animal Health International, Inc., a leading production animal health distribution company in the U.S. This acquisition more than doubled the revenue previously attributable to our animal health business, which was previously focused on the companion animal health market. Our animal health business now offers an expanded range of products and services to a broader base of customers in North America and the U.K. Under terms of the merger agreement, we acquired all of Animal Health International’s stock for $1,100,000 in cash, subject to customary working capital adjustments.

In connection with the acquisition, we entered into a credit agreement consisting of a $1,000,000 unsecured term loan and a $500,000 unsecured cash flow revolving line of credit, described further in Note 11 to the Condensed Consolidated Financial Statements.

The acquisition has been accounted for in accordance with ASC 805, Business Combinations, with identifiable assets acquired and liabilities assumed recorded at their estimated fair values on the acquisition date. A valuation of the assets and liabilities from the business acquisition was performed utilizing cost, income and market approaches resulting in $589,833 allocated to identifiable net assets. The initial accounting for the acquisition is not complete because certain information and analysis that may impact our initial valuations are still being obtained or reviewed. The significant assets and liabilities for which provisional amounts are recognized at the acquisition date are property and equipment, intangible assets, goodwill, working capital adjustments and deferred income taxes. The provisional amounts recognized are subject to revision until our valuations are completed, not to exceed one year, and any material adjustments identified that existed as of the acquisition date will be retroactively recorded.

The following table summarizes the total purchase price consideration and the preliminary fair value amounts recognized for the assets acquired and liabilities assumed related to the acquisition, as of the acquisition date:

 

Total purchase price consideration

   $ 1,108,203   
  

 

 

 

Receivables

   $ 161,427   

Inventory

     195,367   

Prepaid expenses and other current assets

     33,005   

Property and equipment

     44,178   

Identifiable intangibles

     434,300   

Other long-term assets

     40,869   
  

 

 

 

Total assets acquired

     909,146   
  

 

 

 

Accounts payable

     122,129   

Accrued liabilities and other current liabilities

     19,395   

Deferred tax liability

     177,789   
  

 

 

 

Total liabilities assumed

     319,313   
  

 

 

 

Identifiable net assets acquired

     589,833   

Goodwill

     518,370   
  

 

 

 

Net assets acquired

   $ 1,108,203   
  

 

 

 

 

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As a result of recording the stepped up fair market basis for GAAP purposes, but receiving primarily carryover basis for tax purposes in the acquisition, we recorded a deferred tax asset and deferred tax liability of $2,569 and $177,789, respectively.

The goodwill of $518,370 resulting from the acquisition reflects the excess of our purchase price over the fair value of the net assets acquired. An adjustment to increase goodwill by $499 was recorded in the second quarter of fiscal 2016 as a result of working capital adjustments. The goodwill recorded as part of the acquisition primarily reflects the value of the assembled workforce, cost synergies, and the potential to integrate and expand existing product lines. We allocated all of the goodwill to our Animal Health reporting segment. None of the goodwill recognized is deductible for income tax purposes, and as such, no deferred taxes have been recorded related to goodwill.

Revenues of $585,950 and operating income of $12,369 attributable to the acquisition are included in our condensed consolidated statement of income for the six months ended October 31, 2015. Included in operating income for the six months ended October 31, 2015 is amortization expense of $12,048 related to the identifiable intangible assets acquired in the transaction.

The following summarizes the intangible assets, excluding goodwill, acquired as of June 16, 2015. Intangible assets are amortized using methods that approximate the pattern of economic benefit provided by the utilization of the assets.

 

     Gross Carrying
Value
     Weighted
Average Life
(years)
 

Unamortized – indefinite lived:

     

Trade names

   $ 12,300         indefinite   

Amortized:

     

Customer relationships

     291,900         15.0   

Trade names

     111,400         10.0   

Developed technology and other

     18,700         12.2   
  

 

 

    

Total amortized intangible assets

     422,000         13.6   
  

 

 

    

Total identifiable intangible assets

   $ 434,300      
  

 

 

    

The following unaudited pro forma financial results for the combined results of Patterson and Animal Health International for the six month periods ended October 31, 2015 and October 25, 2014 assume the acquisition occurred on April 27, 2014. The unaudited pro forma financial results may not be indicative of the results that would have occurred had the acquisition been completed as of April 27, 2014, nor are they indicative of future results of operations.

 

     Six Months Ended  
     October 31,      October 25,  
     2015      2014  

Pro forma net sales

   $ 2,725,116       $ 2,650,613   

Pro forma net income from continuing operations

     70,957         74,754   

Pro forma net income from continuing operations for the six month period ended October 31, 2015 includes $12,300 of income tax expense related to the repatriation of foreign earnings, described further in Note 12 to the Condensed Consolidated Financial Statements.

Note 3. Discontinued Operations

On July 1, 2015, we entered into a definitive agreement to sell all of the outstanding shares of common stock of Patterson Medical Holdings, Inc., our wholly owned subsidiary responsible for our rehabilitation supply business known as Patterson Medical (“Patterson Medical”), for $715,000 in cash to Madison Dearborn Partners. The definitive agreement includes a working capital adjustment provision that impacts the final sale price. On August 28, 2015, we completed the sale of Patterson Medical for $718,078, with such sales price including the above-described working capital adjustment. As additional consideration for the shares of Patterson Medical, we obtained a number of common units of the parent company of the buyer equal to 10% of the common units outstanding at closing. Unlike the other common units, these units will only become entitled to begin participating in distributions to the common unit holders at such time, if any, as the Madison Dearborn Partners’ investor cash inflows equal or exceed 2.5 times the Madison Dearborn Partners’ investor cash outflows. These units are non-transferrable. We recorded a pre-tax gain of $25,520 on the sale of Patterson Medical during the second quarter of fiscal 2016 within discontinued operations in the condensed consolidated statements of income.

 

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In connection with the above described transaction, we also entered into a transition services agreement with our former subsidiary, pursuant to which Patterson Medical Holdings, Inc., as owned by Madison Dearborn Partners, is paying us to provide, among other things, certain information technology, distribution, facilities, finance, tax and treasury, and human resources services for up to 24 months after closing.

As of October 31, 2015, we classified Patterson Medical’s results of operations as discontinued operations for all periods presented in the condensed consolidated statements of income. The assets and liabilities of Patterson Medical were reflected as held for sale in the condensed consolidated balance sheets as of April 25, 2015. The classification was based on our entering into the definitive agreement to sell Patterson Medical during the first quarter of fiscal 2016, the entity being available for sale in its present condition at that time and the sale being completed in the second quarter of fiscal 2016. The operations and cash flows of Patterson Medical have been eliminated from our continuing operations, which were previously recorded as the rehabilitation supply reportable segment.

The following summarizes the assets and liabilities of Patterson Medical as of April 25, 2015:

 

     April 25,  
     2015  

Assets held for sale

  

Receivables, net of allowance for doubtful accounts

   $ 57,876   

Inventory

     48,265   

Prepaid expenses and other current assets

     12,206   

Property and equipment, net

     22,672   

Goodwill

     537,175   

Identifiable intangibles, net

     74,804   

Other long-term assets

     1,143   
  

 

 

 

Total assets held for sale

   $ 754,141   
  

 

 

 

Liabilities held for sale

  

Accounts payable

   $ 26,341   

Accrued liabilities and other current liabilities

     12,975   

Long-term liabilities

     49,414   
  

 

 

 

Total liabilities held for sale

   $ 88,730   
  

 

 

 

The following summarizes the results of operations of our discontinued Patterson Medical operations for the periods presented:

 

     Three Months Ended      Six Months Ended  
     October 31,
2015 (a)
     October 25,
2014
     October 31,
2015
     October 25,
2014
 

Net sales

   $ 37,693       $ 125,105       $ 168,504       $ 245,678   

Cost of sales

     24,486         78,570         107,359         153,535   

Operating expenses

     22,915         27,454         54,954         54,304   

Gain on sale

     (25,520      —           (25,520      —     

Other expense (income)

     60         17         150         (115
  

 

 

    

 

 

    

 

 

    

 

 

 

Income before taxes

     15,752         19,064         31,561         37,954   

Income taxes

     22,894         7,151         29,311         14,077   
  

 

 

    

 

 

    

 

 

    

 

 

 

Net income from discontinued operations

   $ (7,142    $ 11,913       $ 2,250       $ 23,877   
  

 

 

    

 

 

    

 

 

    

 

 

 

 

(a)  Includes activity up until the sale date of August 28, 2015.

 

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Operating expenses for the three and six months ended October 31, 2015 include professional fees of $9,842 and $13,692, respectively, incurred in connection with the sale of Patterson Medical. Depreciation and amortization were ceased during the three and six months ended October 31, 2015 in accordance with accounting for discontinued operations. Income taxes have been allocated to Patterson Medical based on the accounting requirements for presenting discontinued operations. Income taxes as a percent of income before taxes for both the three and six months ended October 31, 2015 are higher than in the respective prior periods as a result of the requirement to calculate the tax due on the sale of Patterson Medical including certain basis differences that were appropriately not previously recognized for financial reporting purposes.

Note 4. Goodwill and Other Intangible Assets

Goodwill balances and related activity by business segment are as follows:

 

     Balance at
April 25,
2015
     Acquisition
Activity and
Divestitures
     Other Activity      Balance at
October 31,
2015
 

Corporate

   $ —         $ —         $ —         $ —     

Dental

     139,449         —           (738      138,711   

Animal Health

     160,475         518,370         39         678,884   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $  299,924       $ 518,370       $ (699    $ 817,595   
  

 

 

    

 

 

    

 

 

    

 

 

 

Balances of other intangible assets, excluding goodwill, are as follows:

 

     October 31,      April 25,  
     2015      2015  

Unamortized – indefinite lived:

     

Copyrights, trade names and trademarks

   $ 29,900       $ 17,600   

Amortized:

     

Distribution agreement, customer lists and other

     642,614         221,359   

Less: Accumulated amortization

     (135,435      (113,934
  

 

 

    

 

 

 

Net amortized intangible assets

     507,179         107,425   
  

 

 

    

 

 

 

Total identifiable intangible assets, net

   $ 537,079       $ 125,025   
  

 

 

    

 

 

 

Note 5. Derivative Financial Instruments

Patterson is a party to certain offsetting and identical interest rate cap agreements. These interest rate cap agreements are not designated for hedge accounting treatment and were entered into to fulfill certain covenants of an equipment finance contracts sale agreement between a commercial paper conduit managed by The Bank of Tokyo-Mitsubishi UFJ, Ltd. and PDC Funding. On November 25, 2014, this sale agreement was amended on terms generally consistent with the expiring agreement. The interest rate cap agreements provide a credit enhancement feature for the financing contracts sold by PDC Funding to the commercial paper conduit.

The interest rate cap agreements are cancelled and new agreements entered into periodically to maintain consistency with the dollar maximum of the sale agreements and the maturity of the underlying financing contracts. As of October 31, 2015, PDC Funding had purchased an interest rate cap from a bank with a notional amount of $500,000 and a maturity date of February 2022. Patterson sold an identical interest rate cap to the same bank.

Similar to the above agreements, PDC Funding II and Patterson entered into offsetting and identical interest rate cap agreements with a notional amount of $100,000 in fiscal 2014. In August 2015, these agreements were terminated and replaced with offsetting and identical interest rate cap agreements. The notional amount remained at $100,000 and the new maturity date is July 2023.

In addition to the purchased and sold identical interest rate cap agreements described above, in May 2012 we entered into an interest rate swap agreement with a bank to economically hedge the interest rate risk associated with a portion of the finance contracts we had sold through the special purpose entities. This agreement expired in April 2015.

 

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These interest rate contracts do not qualify for hedge accounting treatment and, accordingly, we record the fair value of the agreements as an asset or liability and the change as income or expense during the period in which the change occurs.

In January 2014 we entered into a forward interest rate swap agreement with a notional amount of $250,000 and accounted for as cash flow hedge, to hedge interest rate fluctuations in anticipation of refinancing the 5.17% senior notes due March 25, 2015 with a loan for $250,000 and a term of ten years. This note was repaid on March 25, 2015 and replaced with new $250,000 3.48% senior notes due March 24, 2025. A cash payment of $29,003 was made in March 2015 to settle the interest rate swap. This amount will be recognized as interest expense over the ten-year life of the new notes.

The following presents the fair value of interest rate contracts included in the condensed consolidated balance sheets:

 

          October 31,      April 25,  

Derivative type

  

Classification

   2015      2015  

Interest rate contracts

  

Other noncurrent assets

   $ 835       $ 1,255   

Interest rate contracts

  

Other noncurrent liabilities

     835         1,255   

The following table presents the effect of interest rate contracts on the condensed consolidated statements of income and other comprehensive income (OCI):

 

          Three Months Ended     Six Months Ended  

Derivative type

   Location of gain/(loss)
recognized on derivative
   October 31,
2015
     October 25,
2014
    October 31,
2015
     October 25,
2014
 

Interest rate swap

   OCI    $ 437       $ (3,867   $ 1,054       $ (6,176

We recorded $703 of interest expense during the three months ended October 31, 2015, and $49 as a reduction to interest expense in the three months ended October 25, 2014 related to the interest rate swap. We recorded $1,405 of interest expense during the six months ended October 31, 2015, and $97 as a reduction to interest expense in the six months ended October 25, 2014 related to the interest rate swap. We recorded no ineffectiveness during the three and six month periods ended October 31, 2015 and October 25, 2014.

Note 6. Fair Value Measurements

Fair value is the price at which an asset could be exchanged in a current transaction between knowledgeable, willing parties. The fair value hierarchy of measurements is categorized into one of three levels based on the lowest level of significant input used:

 

  Level 1 - Quoted prices in active markets for identical assets and liabilities at the measurement date.

 

  Level 2 - Observable inputs other than quoted prices included in Level 1, such as quoted prices for similar assets and liabilities in active markets; quoted prices for identical or similar assets and liabilities in markets that are not active; or other inputs that are observable or can be corroborated by observable market data.

 

  Level 3 - Unobservable inputs for which there is little or no market data available. These inputs reflect management’s assumptions of what market participants would use in pricing the asset or liability.

 

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Our hierarchy for assets and liabilities measured at fair value on a recurring basis is as follows:

 

     October 31, 2015  
     Total      Level 1      Level 2      Level 3  

Assets:

           

Cash equivalents

   $ 4,949       $ 4,949       $ —         $ —     

Derivative instruments

     835         —           835         —     
  

 

 

    

 

 

    

 

 

    

 

 

 

Total assets

   $ 5,784       $ 4,949       $ 835       $ —     
  

 

 

    

 

 

    

 

 

    

 

 

 

Liabilities:

           
  

 

 

    

 

 

    

 

 

    

 

 

 

Derivative instruments

   $ 835       $ —         $ 835       $ —     
  

 

 

    

 

 

    

 

 

    

 

 

 
     April 25, 2015  
     Total      Level 1      Level 2      Level 3  

Assets:

           

Cash equivalents

   $ 90,569       $ 90,569       $ —         $ —     

Derivative instruments

     1,255         —           1,255         —     
  

 

 

    

 

 

    

 

 

    

 

 

 

Total assets

   $ 91,824       $ 90,569       $ 1,255       $ —     
  

 

 

    

 

 

    

 

 

    

 

 

 

Liabilities:

           
  

 

 

    

 

 

    

 

 

    

 

 

 

Derivative instruments

   $ 1,255       $ —         $ 1,255       $ —     
  

 

 

    

 

 

    

 

 

    

 

 

 

Cash equivalents – We value cash equivalents at their current market rates. The carrying value of cash equivalents approximates fair value and maturities are less than three months.

Derivative instruments – Our derivative instruments consist of interest rate contracts. These instruments are valued using observable inputs such as interest rates and credit spreads.

Certain assets are measured at fair value on a non-recurring basis. These assets are not measured at fair value on an ongoing basis, but are subject to fair value adjustments under certain circumstances, such as when there is evidence of impairment. There were no fair value adjustments to such assets during the six-month periods ended October 31, 2015 or October 25, 2014.

Our debt is not measured at fair value in the condensed consolidated balance sheets. The estimated fair value of our debt as of October 31, 2015 and April 25, 2015 was $1,058,425 and $746,685, respectively. The fair value of debt was measured using a discounted cash flow analysis based on expected market based yields (i.e. level 2 inputs).

The carrying amounts of receivables, net of allowances, accounts payable, and certain accrued and other current liabilities approximated fair value at October 31, 2015 and April 25, 2015.

Note 7. Securities

On October 25, 2013, we invested in three time deposits with total principal of $110,000 Canadian. On October 24, 2014, time deposits with a principal value of $45,000 Canadian matured with a value of $45,436 Canadian. The remaining time deposits with a principal value of $65,000 Canadian matured on October 28, 2015 with a value of $67,031 Canadian. Our time deposit securities were classified as held-to-maturity securities as of April 25, 2015, as we had both the intent and ability to hold them until maturity. They were carried at cost, adjusted for accrued interest and amortization. The carrying value was not materially different than fair value. The fair value was determined based on a discounted cash flow analysis using unobservable inputs (i.e. level 3 inputs), which included a forward yield curve, the estimated timing of payments and the credit quality of the underlying creditor. Significant changes in any of the significant unobservable inputs in isolation would not have resulted in a materially lower fair value estimate. The interrelationship between these inputs was insignificant.

Note 8. Customer Financing

As a convenience to our customers, we offer several different financing alternatives, including a third party program and a Company-sponsored program. For the third party program, we act as a facilitator between the customer and the third party financing entity with no on-going involvement in the financing transaction. Under our sponsored program, equipment purchased by customers with strong credit may be financed up to a maximum of $500 for any one customer. We generally sell our customers’ financing contracts to outside financial institutions in the normal course of our business. We currently have two arrangements under which we sell these contracts.

 

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First, we operate under an agreement to sell a portion of our equipment finance contracts to commercial paper conduits with The Bank of Tokyo-Mitsubishi UFJ, Ltd. serving as the agent. We utilize a special purpose entity (“SPE”), PDC Funding, a consolidated, wholly owned subsidiary, to fulfill a requirement of participating in the commercial paper conduit. We receive the proceeds of the contracts upon sale. At least 13% of the proceeds are held by the conduit as security against eventual performance of the portfolio. The capacity under the agreement at October 31, 2015 was $500,000.

Second, we also maintain an agreement with Fifth Third Bank whereby the bank purchases customers’ financing contracts. We established another SPE, PDC Funding II, a consolidated, wholly owned subsidiary, which sells financing contracts to the bank. We receive the proceeds of the contracts upon sale. At least 14% of the proceeds are held by the conduit as security against eventual performance of the portfolio. The capacity under the agreement at October 31, 2015 was $100,000.

The portion of the purchase price for the receivables held by the conduits is a deferred purchase price receivable, which is paid to the SPE as payments on the receivables are collected from customers. The deferred purchase price receivable represents a beneficial interest in the transferred financial assets and is recognized at fair value as part of the sale transaction. We value the deferred purchase price receivable based on a discounted cash flow analysis using unobservable inputs (i.e. level 3 inputs), which include a forward yield curve, the estimated timing of payments and the credit quality of the underlying creditor. Significant changes in any of the significant unobservable inputs in isolation would not result in a materially different fair value estimate. The interrelationship between these inputs is insignificant.

These financing arrangements are accounted for as a sale of assets under the provisions of ASC 860, Transfers and Servicing. During the three and six months ended October 31, 2015, we sold $48,172 and $142,939, respectively, and during the three and six months ended October 25, 2014, we sold $47,059 and $132,148, respectively, of contracts under these arrangements. We retain servicing responsibilities under both agreements, for which we are paid a servicing fee. The servicing fees we receive are considered adequate compensation for services rendered. Accordingly, no servicing asset or liability has been recorded. The agreements require us to maintain a minimum current ratio and maximum leverage ratio. We were in compliance with those covenants at October 31, 2015.

Included in cash and cash equivalents in the condensed consolidated balance sheets are $24,793 and $29,863 as of October 31, 2015 and April 25, 2015, respectively, which represents cash collected from previously sold customer financing arrangements that have not yet been settled with the third party. Included in current receivables in the condensed consolidated balance sheets are $105,852, net of unearned income of $6,781, and $88,470, net of unearned income of $4,197, as of October 31, 2015 and April 25, 2015, respectively, of finance contracts we have not yet sold. A total of $529,484 of finance contracts receivable sold under the agreements was outstanding at October 31, 2015. The deferred purchase price under the arrangements was $67,550 and $66,715 as of October 31, 2015 and April 25, 2015, respectively. Since the internal financing program began in 1994, bad debt write-offs have amounted to less than one-percent of the loans originated.

Note 9. Segment Reporting

Through fiscal 2015, Patterson was comprised of three reportable segments: dental supply, veterinary supply and rehabilitation supply. This fiscal year, we reorganized our reportable segments as a result of our acquisition of Animal Health International, Inc. and our divestiture of our wholly-owned subsidiary Patterson Medical Holdings, Inc., the entity through which we operated the rehabilitation supply business. We now present three different reportable segments: Dental, Animal Health and Corporate. Prior period segment results have been restated to conform to this revised current period presentation.

Our Dental and Animal Health reportable business segments are strategic business units that offer similar products and services to different customer bases. Dental provides a virtually complete range of consumable dental products, equipment and software, turnkey digital solutions and value-added services to dentists and dental laboratories throughout North America. Animal Health, formerly our Patterson Veterinary reportable segment, is a leading, full-line distributor in North America and the U.K. of animal health products, services and technologies to both the production-animal and companion-pet markets. Our Corporate segment, which was previously included in our dental supply reporting segment through the end of fiscal 2015, is

 

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comprised of general and administrative expenses, including home office support costs in areas such as information technology, finance, legal, human resources and facilities. In addition, customer financing and other miscellaneous sales are reported within Corporate results. Corporate assets consist primarily of cash and cash equivalents, accounts receivable, property and equipment and long-term receivables. We evaluate segment performance based on operating income. The costs to operate the distribution centers are allocated to the operating units based on the through-put of the unit.

The following table presents information about Patterson’s reportable segments:

 

     Three Months Ended      Six Months Ended  
     October 31,      October 25,      October 31,      October 25,  
     2015      2014      2015      2014  

Net sales

           

Corporate

   $ 13,435       $ 9,110       $ 23,891       $ 18,892   

Dental

     601,322         592,636         1,176,439         1,135,510   

Animal Health

     774,453         376,474         1,331,750         762,774   
  

 

 

    

 

 

    

 

 

    

 

 

 

Consolidated net sales

   $ 1,389,210       $ 978,220       $ 2,532,080       $ 1,917,176   
  

 

 

    

 

 

    

 

 

    

 

 

 

Operating income (loss) from continuing operations

           

Corporate

   $ (15,808    $ (15,623    $ (33,855    $ (26,163

Dental

     74,094         73,427         141,346         135,976   

Animal Health

     25,177         14,336         38,149         28,323   
  

 

 

    

 

 

    

 

 

    

 

 

 

Consolidated operating income from continuing operations

   $ 83,463       $ 72,140       $ 145,640       $ 138,136   
  

 

 

    

 

 

    

 

 

    

 

 

 

 

     October 31,
2015
     April 25,
2015
 

Total assets

     

Corporate

   $ 469,101       $ 539,863   

Dental

     900,668         1,022,257   

Animal Health

     2,082,069         631,445   
  

 

 

    

 

 

 

Total assets, excluding assets held for sale

     3,451,838         2,193,565   

Assets held for sale

     —           754,141   
  

 

 

    

 

 

 

Total assets

   $ 3,451,838       $ 2,947,706   
  

 

 

    

 

 

 

The following table presents sales information by product for all of Patterson’s reportable segments:

 

     Three Months Ended      Six Months Ended  
     October 31,      October 25,      October 31,      October 25,  
     2015      2014      2015      2014  

Net sales

           

Consumables

   $ 1,087,489       $ 686,165       $ 1,982,796       $ 1,381,804   

Equipment and software

     207,809         204,409         361,292         360,803   

Other

     93,912         87,646         187,992         174,569   
  

 

 

    

 

 

    

 

 

    

 

 

 

Consolidated net sales

   $ 1,389,210       $ 978,220       $ 2,532,080       $ 1,917,176   
  

 

 

    

 

 

    

 

 

    

 

 

 

Note 10. Accumulated Other Comprehensive Loss

The following table summarizes accumulated other comprehensive loss (AOCL) at October 31, 2015 and April 25, 2015 and the activity for fiscal 2016:

 

     Cash Flow
Hedges
     Currency
Translation
Adjustment
     Total  

AOCL at April 25, 2015

   $ (18,668    $ (41,678    $ (60,346

Other comprehensive loss before reclassifications

     —           (15,417      (15,417

Amounts reclassified from AOCL

     1,054         11,083         12,137   
  

 

 

    

 

 

    

 

 

 

AOCL at October 31, 2015

   $ (17,614    $ (46,012    $ (63,626
  

 

 

    

 

 

    

 

 

 

 

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The amounts reclassified from AOCL during fiscal 2016 represent gains and losses on cash flow hedges, net of taxes of $350, and amounts reclassified related to the divestiture of Patterson Medical of $11,083. The net impact to the condensed consolidated statements of income was an increase to interest expense of $1,405.

Note 11. Debt Issuance

During the first quarter of fiscal 2016, we entered into a credit agreement with The Bank of Tokyo-Mitsubishi UFJ, Ltd., as administrative agent, and Bank of America, N.A., as syndication agent, (the “Credit Agreement”). Pursuant to the Credit Agreement, the lenders provided us with senior unsecured lending facilities of up to $1,500,000, consisting of a $1,000,000 unsecured term loan and a $500,000 unsecured revolving line of credit. Interest on borrowings under the Credit Agreement is based on LIBOR plus a spread which can range from 1.125% to 2.000%. This spread, as well as a commitment fee on the unused portion of the facility, are based on our leverage ratio, as defined in the Credit Agreement. The initial interest rate under the Credit Agreement is LIBOR plus 2.000%. Initial borrowings under the Credit Agreement were $1,000,000 under the unsecured term loan and $200,000 under the unsecured revolving line of credit. The term loan and revolving credit facilities will mature no later than June 16, 2020.

Upon certain significant asset dispositions, we agreed to use proceeds from such dispositions to effect prepayment of outstanding loan balances under the Credit Agreement. On August 28, 2015, we completed the sale of Patterson Medical, as described further in Note 3 to the Condensed Consolidated Financial Statements. As a result of this sale, $670,000 was repaid on the original outstanding $1,000,000 unsecured term loan. We recorded $5,153 of accelerated debt issuance cost amortization within interest expense concurrent with this early repayment of debt. Additionally, a $4,125 principal payment was made during the three months ended October 31, 2015. As of October 31, 2015, $325,875 was outstanding under the unsecured term loan.

We are subject to various financial covenants under the Credit Agreement including the maintenance of leverage and interest coverage ratios. In the event of our default, any outstanding obligations may become due and payable immediately. We met the covenants under the Credit Agreement as of October 31, 2015.

On June 16, 2015, our previous $300,000 credit facility, which was due to expire in December 2016, was terminated and replaced by the revolving line of credit under the Credit Agreement. As of October 31, 2015, $80,000 was outstanding under our current revolving line of credit. There were no outstanding borrowings under our current or previous revolving lines of credit at April 25, 2015.

Note 12. Income Taxes

The effective income tax rate for the three months ended October 31, 2015 was 36.7% compared to 35.0% for the three months ended October 25, 2014, and for the six months ended October 31, 2015 was 46.7% compared to 34.8% for the six months ended October 25, 2014. The increases in the rates for both periods were primarily due to the current year impact of cash repatriation and the impact of transaction-related costs incurred related to the acquisition of Animal Health International, Inc.

In the first quarter of fiscal 2016, we approved a one-time repatriation of approximately $200,000 of foreign earnings. This one-time repatriation reduced the overall cost of funding the acquisition of Animal Health International, Inc. In addition, certain foreign cash at Patterson Medical was required to be repatriated as part of the sale transaction. The continuing operations tax impact of $12,300 from the repatriation was recorded during the first six months of fiscal 2016. We have previously asserted that our foreign earnings are permanently reinvested. Except for the repatriations described above, there is no change in our on-going assertion.

Note 13. Legal Proceedings

In September 2015, we were served with a summons and complaint in an action commenced in the United States District Court for the Eastern District of New York, entitled SourceOne Dental, Inc. v. Patterson Companies, Inc., Henry Schein, Inc. and Benco Dental Supply Company, Civil Action No. 15-cv-05440-JMA-GRB. SourceOne, as plaintiff, alleges that, through its website, it markets and sells dental supplies and equipment to dentists. SourceOne alleges in the complaint, among other things, that we, along with the defendants Henry Schein and Benco, conspired to eliminate plaintiff as a competitor and to exclude them from the market for the marketing, distribution and sale of dental supplies and equipment in the United States and that defendants unlawfully agreed with one another to boycott dentists, manufacturers, and state dental associations that deal with, or considered dealing with, plaintiff. Plaintiff asserts the following claims: (i) unreasonable

 

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restraint of trade in violation of state and federal antitrust laws; (ii) tortious interference with prospective business relations; (iii) civil conspiracy; and (iv) aiding and abetting the other defendants’ ongoing tortious and anticompetitive conduct. Plaintiff seeks equitable relief, compensatory and treble damages, jointly and severally, punitive damages, interest, and reasonable costs and expenses, including attorneys’ fees and expert fees. Plaintiff has not specified a damage amount in its complaint. We intend to defend ourselves against the action vigorously. We do not anticipate that this matter will have a material adverse effect on our financial condition.

 

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MANAGEMENT’S DISCUSSION AND ANALYSIS OF

FINANCIAL CONDITION AND RESULTS OF OPERATIONS

SAFE HARBOR STATEMENT UNDER THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995

This Form 10-Q for the period ended October 31, 2015 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 that are qualified in their entirety by cautionary language set forth herein, in our 2015 Annual Report on Form 10-K filed June 24, 2015, and in other documents previously filed with the Securities and Exchange Commission.

OVERVIEW

Our financial information for the first six months of fiscal 2016 is summarized in this Management’s Discussion and Analysis and the Condensed Consolidated Financial Statements and related Notes. The following background is provided to readers to assist in the review of our financial information.

Through fiscal 2015, Patterson had traditionally operated a specialty distribution business in three markets: dental supply, veterinary supply and rehabilitation supply. In the first half of fiscal 2016, we acquired Animal Health International, Inc. and divested our wholly-owned subsidiary Patterson Medical Holdings, Inc. (“Patterson Medical”), the entity through which we operated the rehabilitation supply business. As a result of these two transactions, we now operate in two complementary markets: dental and animal health. While our dental business remains the same, our animal health business now consists of both companion animal and production animal lines of business. As of October 31, 2015, we classified the results of operations of Patterson Medical as discontinued operations for all periods presented in the condensed consolidated statements of income. The assets and liabilities of Patterson Medical were reflected as held for sale in the condensed consolidated balance sheets as of April 25, 2015.

Operating margins of the animal health business are considerably lower than the dental business. While operating expenses run at a lower rate in the animal health business, its gross margin is substantially lower due generally to the low margins on the pharmaceutical products that are distributed.

We operate with a 52-53 week accounting convention with our fiscal year ending on the last Saturday in April. The second quarter of fiscal 2016 and 2015 represents the 13 weeks ended October 31, 2015 and October 25, 2014, respectively. The six months ended October 31, 2015 and October 25, 2014 included 27 and 26 weeks, respectively. Fiscal 2016 will include 53 weeks and fiscal 2015 included 52 weeks of operations.

We believe there are several important aspects of Patterson’s business that are useful in analyzing it, including: (1) growth in the various markets in which we operate; (2) internal growth; (3) growth through acquisition; and (4) continued focus on controlling costs and enhancing efficiency. Management defines internal growth as the increase in net sales from period to period, excluding the impact of changes in currency exchange rates, and excluding the net sales, for a period of twelve months following the transaction date, of businesses we have acquired.

The following significant activities occurred in the first and second quarters of fiscal 2016:

Animal Health International Acquisition. On June 16, 2015, we completed the acquisition of Animal Health International, Inc., a leading production animal health distribution company in the U.S. Prior to our acquisition, Animal Health International, Inc. generated sales and earnings before interest, income taxes, depreciation and amortization of $1.5 billion and $68 million, respectively, during the 12 months ended March 2015. Our acquisition more than doubled the revenue of our legacy animal health business which was previously focused solely on the companion animal market. Our animal health business now offers an expanded range of products and services to a broader base of customers in North America and the U.K. During the three and six months ended October 31, 2015, we incurred $0.7 million and $10.0 million, respectively, or $.01 and $0.10 per diluted share on an after-tax basis, respectively, of transaction costs related to the acquisition of Animal Health International, Inc. See Note 2 to the Condensed Consolidated Financial Statements for information regarding the acquisition of Animal Health International, Inc.

 

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Patterson Medical Sale. During the first quarter of fiscal 2016, we entered into a definitive agreement to sell all of the outstanding shares of common stock of Patterson Medical Holdings, Inc. for $715.0 million in cash to Madison Dearborn Partners. The definitive agreement included a working capital adjustment provision that impacts the final sale price. On August 28, 2015, we completed the sale of Patterson Medical for $718.1 million, with such sales price including the above-described working capital adjustment. See Note 3 to the Condensed Consolidated Financial Statements for additional information.

Cash Repatriation. In the first quarter of fiscal 2016, we approved a one-time repatriation of approximately $200.0 million of foreign earnings. This one-time repatriation reduced the overall cost of funding the acquisition of Animal Health International, Inc. In addition, certain foreign cash at Patterson Medical was required to be repatriated as part of the sale transaction. The continuing operations tax impact of $12.3 million from the repatriation was recorded during the first six months of fiscal 2016.

RESULTS OF OPERATIONS

QUARTER ENDED OCTOBER 31, 2015 COMPARED TO QUARTER ENDED OCTOBER 25, 2014

Continuing Operations

The following table sets forth, for the periods indicated, the percentage of net sales represented by certain operational data from continuing operations:

 

     Three Months Ended  
     October 31,
2015
    October 25,
2014
 

Net sales

     100.0     100.0

Cost of sales

     76.2        73.5   
  

 

 

   

 

 

 

Gross profit

     23.8        26.5   

Operating expenses

     17.8        19.1   
  

 

 

   

 

 

 

Operating income from continuing operations

     6.0        7.4   

Other expense (income)

     1.2        0.8   
  

 

 

   

 

 

 

Income from continuing operations before taxes

     4.8        6.6   

Income taxes

     1.7        2.3   
  

 

 

   

 

 

 

Net income from continuing operations

     3.1     4.3
  

 

 

   

 

 

 

Net Sales. Consolidated net sales for the three months ended October 31, 2015 were $1,389.2 million, which represented a 42.0% increase from consolidated net sales of $978.2 million for the three months ended October 25, 2014. The inclusion of results of Animal Health International, Inc. was the main reason for the increase. Foreign exchange rate changes had an unfavorable impact of 2.0% to current quarter sales growth.

Dental segment sales for the three months ended October 31, 2015 were $601.3 million, which represented a 1.5% increase from Dental segment sales of $592.6 million for the three months ended October 25, 2014. Current quarter sales of dental consumables increased 1.8%. Dental consumable sales were negatively impacted by 1.5% by foreign exchange rates. Sales of dental equipment and software increased 0.4% to $196.8 million and sales of other dental services and products increased 2.9%.

Animal Health segment sales for the three months ended October 31, 2015 were $774.5 million, which represented a 105.7% increase from Animal Health segment sales of $376.5 million for the three months ended October 25, 2014. Animal Health International, Inc. contributed $414.0 million of sales in the current quarter. Foreign exchange rate changes had an unfavorable impact of 2.8% to current quarter sales growth. Consumable sales increased 110.0%, equipment and software sales were $11.0 million, an increase of 30.7%, and sales of other services and products decreased 0.8% in the current quarter.

Gross Profit. Consolidated gross profit margin for the three months ended October 31, 2015 decreased 270 basis points from the prior year quarter to 23.8%. The decrease in gross profit margin was predominantly the result of the inclusion of sales and cost of sales from Animal Health International, Inc. in our results, as that business traditionally has lower gross margins than our historical businesses.

 

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Operating Expenses. Consolidated operating expenses for the three months ended October 31, 2015 were $247.4 million, a 32.2% increase from the prior year quarter of $187.1 million. Operating expenses mainly increased due to the acquisition of Animal Health International, Inc. and increased employee healthcare costs. The consolidated operating expense ratio of 17.8% decreased 130 basis points from the prior year quarter.

Operating Income From Continuing Operations. For the three months ended October 31, 2015 operating income was $83.5 million, representing approximately 6.0% of net sales, as compared to $72.1 million, or 7.4% of net sales for the three months ended October 25, 2014. The decrease in operating income as a percent of sales was mainly due to the inclusion of results of Animal Health International, Inc., which have different margins.

Other (Expense) Income, Net. Net other expense for the three months ended October 31, 2015 was $16.2 million compared to $7.8 million for the three months ended October 25, 2014. The increase was mainly due to increased interest expense we incurred relating to the new credit agreement entered into in connection with the acquisition of Animal Health International, Inc., including $5.2 million of accelerated debt issuance cost amortization incurred in the current quarter as a result of early repayment of debt.

Income Tax Expense. The effective income tax rate for the three months ended October 31, 2015 was 36.7% compared to 35.0% in the prior year quarter. The increase in the current quarter rate was primarily due to the impact of the cash repatriation and the impact of transaction-related costs.

Net Income and Earnings Per Share From Continuing Operations. Net income from continuing operations for the three months ended October 31, 2015 was $42.6 million, compared to $41.9 million for the three months ended October 25, 2014. Earnings per diluted share were $0.43 in the current quarter compared to $0.42 in the prior year quarter. Weighted average diluted shares outstanding in the current quarter were 99.2 million compared to 99.4 million in the prior year quarter. The current quarter cash dividend was $0.22 per common share compared to $0.20 in the prior year quarter.

Discontinued Operations

For the three months ended October 31, 2015, we experienced a net loss from discontinued operations of $7.1 million, compared to net income of $11.9 million for the three months ended October 25, 2014. The loss and decrease in net income from discontinued operations were driven primarily by transaction-related costs related to the sale of Patterson Medical.

SIX MONTHS ENDED OCTOBER 31, 2015 COMPARED TO SIX MONTHS ENDED OCTOBER 25, 2014

Continuing Operations

The following table sets forth, for the periods indicated, the percentage of net sales represented by certain operational data from continuing operations:

 

     Six Months Ended  
     October 31,
2015
    October 25,
2014
 

Net sales

     100.0     100.0

Cost of sales

     75.5        73.4   
  

 

 

   

 

 

 

Gross profit

     24.5        26.6   

Operating expenses

     18.7        19.4   
  

 

 

   

 

 

 

Operating income from continuing operations

     5.8        7.2   

Other expense (income)

     1.1        0.8   
  

 

 

   

 

 

 

Income from continuing operations before taxes

     4.7        6.4   

Income taxes

     2.2        2.2   
  

 

 

   

 

 

 

Net income from continuing operations

     2.5     4.2
  

 

 

   

 

 

 

Net Sales. Consolidated net sales for the six months ended October 31, 2015 were $2,532.1 million, a 32.1% increase from $1,917.2 million for the six months ended October 25, 2014. The inclusion of results of Animal Health International, Inc. and an additional week of results were the main reasons for the increase. Foreign exchange rate changes had an unfavorable impact of 2.2% to current period sales growth.

 

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Dental segment sales for the six months ended October 31, 2015 were $1,176.4 million, a 3.6% increase from $1,135.5 million for the six months ended October 25, 2014. Current period sales of consumables increased 5.9%. Consumable sales were positively impacted by an estimated 3.9% by the extra week of results and negatively impacted by 1.5% by foreign exchange rates. Sales of dental equipment and software decreased 1.2% to $340.4 million for the six months ended October 31, 2015. Sales of other dental services and products increased 4.8% for the six months ended October 31, 2015.

Animal Health segment sales for the six months ended October 31, 2015 were $1,331.8 million, a 74.6% increase from $762.8 million for the six months ended October 25, 2014. Animal Health International, Inc. contributed $586.0 million of sales for the six months ended October 31, 2015. Foreign exchange rate changes had an unfavorable impact of 3.2% to current period sales growth. Consumable sales increased 77.0%, equipment and software sales were $20.9 million, an increase of 29.9%, and sales of other services and products increased 10.9% in the current period.

Gross Profit. Consolidated gross profit margin for the six months ended October 31, 2015 decreased 210 basis points from the prior year period to 24.5%. The decrease was predominantly the result of the inclusion of sales and cost of sales from Animal Health International, Inc., which has lower gross margins than our historical businesses.

Operating Expenses. Consolidated operating expenses for the six months ended October 31, 2015 were $473.5 million, a 27.4% increase from the prior year period of $371.8 million. Operating expenses mainly increased due to the acquisition of Animal Health International, Inc. transaction-related costs and increased employee healthcare costs. The consolidated operating expense ratio of 18.7% decreased 70 basis points from the prior year period.

Operating Income From Continuing Operations. For the six months ended October 31, 2015, operating income was $145.6 million, or 5.8% of net sales, as compared to $138.1 million, or 7.2% of net sales for the six months ended October 25, 2014. The decrease in operating income as a percent of sales was mainly due to the inclusion of results of Animal Health International, Inc. and transaction-related costs.

Other (Expense) Income, Net. Net other expense was $27.7 million for the six months ended October 31, 2015 compared to $15.2 million for the six months ended October 25, 2014. The increase was mainly due to increased interest expense related to the new credit agreement entered into in connection with the acquisition of Animal Health International, Inc., including $5.2 million of accelerated debt issuance cost amortization incurred in the current period as a result of early repayment of debt.

Income Tax Expense. The effective income tax rate for the six months ended October 31, 2015 was 46.7% compared to 34.8% for the six months ended October 25, 2014. The increase in the current period rate was primarily due to the impact of the cash repatriation and the impact of the transaction-related costs.

Net Income and Earnings Per Share From Continuing Operations. Net income from continuing operations for the six months ended October 31, 2015 was $62.9 million, compared to $80.2 million for the six months ended October 25, 2014. Earnings per diluted share were $0.63 in the current period compared to $0.80 in the prior year period. Weighted average diluted shares outstanding in the current period were 99.7 million compared to 99.8 million in the prior year period. The current period cash dividend was $0.44 per common share compared to $0.40 in the prior year period.

Discontinued Operations

For the six months ended October 31, 2015, net income from discontinued operations was $2.3 million, compared to $23.9 million for the six months ended October 25, 2014. The decrease in net income from discontinued operations was driven primarily by transaction-related costs related to the sale of Patterson Medical.

LIQUIDITY AND CAPITAL RESOURCES

For the six months ended October 31, 2015, net cash flows used in operating activities were $53.0 million, compared to net cash flows provided by operating activities of $98.4 million for the six months ended October 25, 2014. The decrease was primarily a result of investments in inventory associated with the production animal business acquired from Animal Health International, Inc. and amounts expended to support new equipment product launches in preparation for the peak selling season in the Dental business.

 

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For the six months ended October 31, 2015, net cash flows used in investing activities were $382.0 million, compared to net cash flows provided by investing activities of $15.6 million for the six months ended October 25, 2014. The current period includes the purchase of Animal Health International, Inc. for $1,105.2 million, which was partially offset by the receipt of net cash proceeds from completion of the sale of Patterson Medical in the amount of $715.6 million. We expect to use a total of approximately $60 million to $70 million for capital expenditures in fiscal 2016, with our main investment in our information technology initiatives.

Cash provided by financing activities for the six months ended October 31, 2015 was $191.2 million. Cash proceeds included $988.4 million of net proceeds from a new five year term loan, described further below, and $80.0 million that is attributed to a withdrawal on our revolving line of credit. Uses of our cash from financing activities were as follows: $160.6 million for share repurchases, $674.1 million for the repayment of the new five year term loan, and $45.4 million used to fund dividend payments. For the six months ended October 25, 2014, cash used by financing activities was $86.9 million, including $47.5 million for share repurchases and $40.2 million for dividend payments.

On June 16, 2015, we entered into a credit agreement (the “Credit Agreement”), under which the lenders provided us with senior unsecured lending facilities of up to $1.5 billion, consisting of a $1.0 billion unsecured term loan and a $500 million unsecured revolving line of credit. At October 31, 2015, $325.9 million under the unsecured term loan was outstanding at an interest rate of LIBOR plus 2.000%. The Credit Agreement expires in fiscal 2021. Also on June 16, 2015, our previous $300 million credit facility, which was due to expire in December 2016, was terminated and replaced by the revolving line of credit under the Credit Agreement. As of October 31, 2015, $80.0 million was outstanding under our current revolving line of credit. There were no outstanding borrowings under our current or previous revolving lines of credit at April 25, 2015.

We expect funds generated from operations, existing cash balances and credit availability under existing debt facilities will be sufficient to meet our working capital needs and to finance anticipated expansion plans and strategic initiatives over the remainder of fiscal 2016.

RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS

For information on recently issued accounting pronouncements, see Note 1 to the Condensed Consolidated Financial Statements.

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

During the first quarter of fiscal 2016, we entered into the Credit Agreement under which the lenders provided Patterson with senior unsecured lending facilities of up to $1.5 billion, consisting of a $1.0 billion unsecured term loan and a $500 million unsecured revolving line of credit. Interest on borrowings under this Credit Agreement is based on LIBOR plus a spread which can range from 1.125% to 2.000%. Due to the interest rate being based on LIBOR, fluctuations in this rate impact our earnings. Based on our current level of debt, we estimate that a 100 basis point change in the LIBOR rate would have a $3.3 million impact on our income from continuing operations before taxes on an annualized basis. There have been no other material changes since April 25, 2015 in our market risk. For further information on market risk, refer to Item 7A in our 2015 Annual Report on Form 10-K filed June 24, 2015.

ITEM 4. CONTROLS AND PROCEDURES

Under the supervision and with the participation of our management, including our President and Chief Executive Officer (“CEO”) and our Chief Financial Officer (“CFO”), management evaluated the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Rule 13a-15(e) and 15d-15(e) under the Exchange Act) as of October 31, 2015. Based upon their evaluation of these disclosure controls and procedures, the CEO and CFO concluded that the disclosure controls and procedures were effective as of October 31, 2015.

Except as described below, there were no changes in our internal control over financial reporting (as defined in Rule 13a-15(f) or 15d-15(f) under the Exchange Act) that occurred during the quarter ended October 31, 2015 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

 

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On June 16, 2015, we acquired Animal Health International, Inc., which was a privately-held company prior to the acquisition. We are in the process of integrating Animal Health International, Inc.’s operations, and as permitted under SEC regulations, we will exclude the operations of Animal Health International, Inc. from the scope of our Sarbanes-Oxley Section 404 report on internal control over financial reporting for the fiscal year ending April 30, 2016. We are in the process of evaluating Animal Health International, Inc.’s internal controls and implementing our internal control structure over the acquired operations, and we expect to complete this effort during fiscal 2017.

PART II—OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS

In September 2015, we were served with a summons and complaint in an action commenced in the United States District Court for the Eastern District of New York, entitled SourceOne Dental, Inc. v. Patterson Companies, Inc., Henry Schein, Inc. and Benco Dental Supply Company, Civil Action No. 15-cv-05440-JMA-GRB. SourceOne, a plaintiff alleges that, through its website, it markets and sells dental supplies and equipment to dentists. SourceOne alleges, among other things, that we, along with the defendants Henry Schein and Benco, conspired to eliminate plaintiff as a competitor and to exclude them from the market for the marketing, distribution and sale of dental supplies and equipment in the United States and that defendants unlawfully agreed with one another to boycott dentists, manufacturers, and state dental associations that deal with, or considered dealing with, plaintiff. Plaintiff asserts the following claims: (i) unreasonable restraint of trade in violation of state and federal antitrust laws; (ii) tortious interference with prospective business relations; (iii) civil conspiracy; and (iv) aiding and abetting the other defendants’ ongoing tortious and anticompetitive conduct. Plaintiff seeks equitable relief, compensatory and treble damages, jointly and severally, punitive damages, interest, and reasonable costs and expenses, including attorneys’ fees and expert fees. Plaintiff has not specified a damage amount in its complaint. We intend to defend ourselves against the action vigorously. We do not anticipate that this matter will have a material adverse effect on our financial condition.

ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

On March 19, 2013, our Board of Directors approved a new share repurchase plan that replaced the existing share repurchase plan. Under this new plan, up to 25 million shares may be purchased in open market transactions through March 19, 2018.

The following table presents activity under the stock repurchase program during the second quarter of fiscal 2016:

 

     Total
Number of
Share
Purchased
     Average
Price Paid
per Share
     Total Number of
Shares Purchased
as Part of Publicly
Announced Plans
or Programs
     Maximum
Number of Shares
That May Be
Purchased Under
the Plan
 

August 2, 2015 to August 29, 2015

     —         $ —           —           20,851,993   

August 30, 2015 to September 26, 2015

     1,002,185         45.13         1,002,185         19,849,808   

September 27, 2015 to October 31, 2015

     2,871,139         45.44         2,871,139         16,978,669   
  

 

 

    

 

 

    

 

 

    

 

 

 
     3,873,324       $ 45.36         3,873,324         16,978,669   

As of October 31, 2015, a total of 17.0 million shares remain available under the current repurchase authorization.

ITEM 6. EXHIBITS

The exhibits listed in the accompanying exhibit index are filed as part of this Quarterly Report on Form 10-Q.

All other items under Part II have been omitted because they are inapplicable or the answers are negative, or were previously reported in the 2015 Annual Report on Form 10-K filed June 24, 2015.

 

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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.

 

      PATTERSON COMPANIES, INC.
      (Registrant)

Dated: December 10, 2015

     
    By:   /s/ Ann B. Gugino
      Ann B. Gugino
      Executive Vice President, Chief Financial Officer and Treasurer
      (Principal Financial Officer and Principal Accounting Officer)

 

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EXHIBIT INDEX

 

Exhibit

No.

  

Exhibit Description

10.1    2015 Omnibus Incentive Plan (incorporated by reference to our Definitive Schedule 14A (Proxy Statement), filed on August 7, 2015 (File No. 000-20572)).
31.1    Certification of the Chief Executive Officer pursuant to Rules 13a-4(a) and 15d-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
31.2    Certification of the Chief Financial Officer pursuant to Rule 13a-4(a) and 15d-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
32.1    Certification of the Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
32.2    Certification of the Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
101    Financials in XBRL format.

 

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