Overview
Our financial information for fiscal 2020 is summarized in this Management's Discussion and Analysis and the Consolidated Financial Statements and related Notes. The following background is provided to readers to assist in the review of our financial information. We present three reportable segments: Dental,Animal Health and Corporate.Dental and Animal Health 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 throughoutNorth America .Animal Health is a leading, full-line distributor inNorth America and theU.K. of animal health products, services and technologies to both the production-animal and companion-pet markets. Our Corporate segment is 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. 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 when compared to the dental business, gross margins in the animal health business are substantially lower due generally to the low margins experienced on the sale of pharmaceutical products. We operate with a 52-53 week accounting convention with our fiscal year ending on the last Saturday in April. Fiscal 2020, 2019 and 2018 ended onApril 25, 2020 ,April 27, 2019 andApril 28, 2018 , respectively, and all years consisted of 52 weeks. Fiscal 2021 will end onApril 24, 2021 and will consist of 52 weeks. We believe there are several important aspects of our 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, adjusting for differences in the number of weeks in fiscal years, 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. Factors Affecting Our Results COVID-19. The COVID-19 pandemic, including closures and other steps taken by governmental authorities in response to the virus, has had a significant impact on our businesses. ThroughMarch 2020 , sales in ourDental and Animal Health segments were up year over year. InApril 2020 , our Dental segment sales were down approximately 71% and ourAnimal Health segment sales were down approximately 9%, as compared toApril 2019 . In addition, operating expenses were also down significantly inApril 2020 , as compared toApril 2019 , as certain variable expenses decreased with sales. Goodwill Impairment. In the fourth quarter of fiscal 2020, we recorded non-cash pre-tax goodwill impairment charges totaling$675.1 million in ourAnimal Health segment ("Goodwill Impairment"), which were not fully tax deductible. The decrease in the fair value of theAnimal Health reporting unit below its carrying value was mainly the result of a reduction in management's estimates of future cash flows. Future cash flows were affected by a reduction in future sales volume and operating margins. The sales volume estimate is a reflection of recent sales trends we've experienced. Future operating margins are expected to be lower based on current trends in our markets. These trends are driven by customer and vendor consolidation. We experienced a further decrease in the fair value of theAnimal Health reporting unit subsequent to our annual goodwill impairment test, which was caused by additional reductions in management's estimates of future cash flows, driven by reduced sales volumes, as well as reduced EBITDA multiples of comparable companies. These estimates and market multiples were negatively affected by COVID-19. The animal health industry has experienced a reduction in sales volume as a result of stay at home and shelter in place orders, as well as a result of meat packing plant closures. Our future cash flow estimates for this business unit reflect the long-term impact of COVID-19. Receivables Securitization Program. In fiscal 2019 and fiscal 2020, we entered into receivables purchase agreements withMUFG Bank, Ltd. ("MUFG"). Under these agreements, MUFG acts as an agent to facilitate the 41 -------------------------------------------------------------------------------- Table of Contents sale of certainPatterson receivables (the "Receivables") to certain unaffiliated financial institutions (the "Purchasers"). The proceeds from the sale of these Receivables comprise a combination of cash and a deferred purchase price ("DPP") receivable. The initial transaction in fiscal 2019 was a sale of$237.6 million of net receivables. From this sale, we received$171.0 million of cash. The proceeds from the initial sale were primarily used to reduce debt. The transaction in fiscal 2020 reduced our net receivables by$120.1 million and increased cash by$29.0 million as ofJanuary 25, 2020 . As ofApril 25, 2020 , the maximum available under the receivables purchase agreements was$200.0 million , of which$200.0 million was utilized. The DPP receivable was$117.3 million as ofApril 25, 2020 . The DPP receivable is ultimately realized byPatterson following the collection of the underlying Receivables sold to the Purchasers. The collection of the DPP receivable is recognized as an increase to net cash provided by investing activities within the consolidated statements of cash flows, with a corresponding reduction to net cash provided by operating activities within the consolidated statements of cash flows. Gain on Investment. We recorded a pre-tax gain of$34.3 million related to one of our investments ("Gain on Investment") in fiscal 2020. This gain was based on the selling price of preferred stock in this investment that is similar to the preferred stock we own, and was adjusted for differences in liquidation preferences. Early Repayment of Debt. In fiscal 2020, we repaid certain indebtedness totaling$373.8 million ("Early Repayment of Debt"). As a result, we recorded a pre-tax non-cash charge of$9.0 million during fiscal 2020. This charge relates to theJanuary 2014 forward interest rate swap agreement and accelerated amortization of debt issuance costs. Fiscal 2020 U.S. Attorney's Office Legal Reserve. We incurred costs and expenses of$58.3 million ("Fiscal 2020 U.S. Attorney's Office Legal Reserve") during the second quarter of fiscal 2020 related to the then-probable settlement of an investigation by theU.S. Attorney's Office for the Western District of Virginia . See "Part I, Item 3. Legal Proceedings" for additional information. Fiscal 2020 Legal Reserve. We incurred expenses of$17.7 million during the first quarter of fiscal 2020 related to the settlement of litigation withSourceOne Dental, Inc. Fiscal 2019 Legal Reserve. InSeptember 2018 , we signed an agreement to settle the litigation entitled In re Dental Supplies Antitrust Litigation. Under the terms of the settlement, we paid$28.3 million into escrow upon preliminary court approval. Such funds were to be released to the settlement fund administrator upon final court approval of the settlement, which was granted at the fairness hearing held onJune 24, 2019 . We established a pre-tax reserve of$28.3 million during the first quarter of fiscal 2019 to account for the settlement of this matter.U.S. Tax Reform. InDecember 2017 , theU.S. government enacted comprehensive tax legislation commonly referred to as the Tax Act. The Tax Act significantly revised the future ongoingU.S. federal corporate income tax by, among other things, loweringU.S. federal corporate tax rates and implementing a territorial tax system. EffectiveJanuary 1, 2018 , the Tax Act reduced theU.S. federal corporate tax rate from 35.0% to 21.0%. For our fiscal year endingApril 28, 2018 , we utilized a blended rate of approximately 30.5%. For fiscal 2018, these impacts resulted in a provisional discrete net tax benefit of$76.6 million , which included provisional amounts of$81.9 million of tax benefit onU.S. deferred tax assets and liabilities,$4.0 million of tax expense for a one-time transition tax on unremitted foreign earnings and$1.2 million in withholding taxes paid on current year distributions. Results of Operations The following table summarizes our results as a percent of net sales: 42
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Table of Contents Fiscal Year Ended April 25, 2020 April 27, 2019 April 28, 2018 Net sales 100.0 % 100.0 % 100.0 % Cost of sales 78.2 78.6 78.1 Gross profit 21.8 21.4 21.9 Operating expenses 19.9 18.9 17.9 Goodwill impairment 12.3 - - Operating (loss) income (10.4) 2.5 4.0 Other expense, net (0.4) (0.6) (0.7) (Loss) income before taxes (10.8) 1.9 3.3 Income tax (benefit) expense (0.1) 0.4 (0.4) Net (loss) income (10.7) 1.5 3.7 Net loss attributable to noncontrolling interests - - - Net (loss) income attributable to Patterson Companies, Inc. (10.7) % 1.5 % 3.7 % Fiscal 2020 Compared to Fiscal 2019 Net sales. Consolidated net sales in fiscal 2020 were$5,490.0 million , a decrease of 1.5% from$5,574.5 million in fiscal 2019. Foreign exchange rate changes had an unfavorable impact of 0.4% on fiscal 2020 sales. Dental segment sales decreased 4.1% to$2,101.9 million in fiscal 2020 from$2,191.8 million in fiscal 2019. Foreign exchange rate changes had an unfavorable impact of 0.1% on fiscal 2020 sales. Sales of consumables decreased 6.5%, sales of equipment and software decreased 2.5%, and sales of other services and products increased 2.2% in fiscal 2020. Dental segment sales were negatively affected by the COVID-19 pandemic during the fourth quarter of fiscal 2020 due to mandated and recommended closures after theAmerican Dental Association announced onMarch 16, 2020 that dentists nationwide postpone elective procedures in response to the spread of COVID-19 across the country.Animal Health segment sales decreased 0.5% to$3,336.3 million in fiscal 2020 from$3,354.5 million in fiscal 2019. Foreign exchange rate changes had an unfavorable impact of 0.6% on fiscal 2020 sales. Sales of certain products previously recognized on a gross basis were recognized on a net basis during fiscal 2020, resulting in an estimated 0.3% unfavorable impact to sales.Animal Health segment sales were also negatively affected by COVID-19 during the fourth quarter of fiscal 2020. The animal health industry has experienced a reduction in sales volume as a result of stay at home and shelter in place orders. Gross profit. Consolidated gross profit margin increased 40 basis points from the prior year to 21.8%. Gross profit margin rates increased in both theDental and Animal Health segment. In addition, a greater percentage of sales came from our Corporate segment sales, resulting in a higher consolidated gross profit margin rate. Operating expenses. Consolidated operating expenses for fiscal 2020 were$1,094.5 million , a 4.0% increase from the prior year of$1,053.1 million . We incurred higher operating expenses during fiscal 2020 primarily as a result of legal fees and settlements in fiscal 2020 being$40.9 million higher than those incurred in fiscal 2019.Goodwill impairment. In fiscal 2020, we recorded goodwill impairment charges totaling$675.1 million in ourAnimal Health segment. Operating (loss) income. The consolidated operating loss was$572.1 million in fiscal 2020, compared to operating income of$137.7 million , or 2.5% of sales, in fiscal 2019. The change in operating (loss) income from fiscal 2019 was driven by the Goodwill Impairment and higher legal fees and settlements in fiscal 2020. Dental segment operating income was$168.3 million for fiscal 2020, a decrease of$10.9 million from fiscal 2019. The decrease was driven primarily by lower net sales, partially offset by lower operating expenses.Animal Health segment operating loss was$594.7 million for fiscal 2020, as compared to operating income of$81.5 million for fiscal 2019. The change was primarily driven by the Goodwill Impairment in fiscal 2020. 43 -------------------------------------------------------------------------------- Table of Contents Corporate segment operating loss was$145.7 million for fiscal 2020, as compared to a loss of$123.0 million for fiscal 2019. The change was driven primarily by higher legal fees and settlements, partially offset by higher net sales recorded during fiscal 2020. Other income (expense), net. Net other expense was$18.3 million in fiscal 2020, compared to$31.5 million in fiscal 2019. Net other expense was lower during fiscal 2020 due to the Gain on Investment, partially offset by losses incurred on interest rate swap agreements we utilize to hedge against interest rate fluctuations that impact the amount of net sales we record related to our customer financing contracts. In addition, interest expense was higher in fiscal 2020, driven by the Early Repayment of Debt, partially offset by lower long-term debt. Income tax (benefit) expense. For fiscal 2020, the income tax benefit was$1.0 million on a loss before taxes of$590.4 million . The Goodwill Impairment and the Fiscal 2020 U.S. Attorney's Office Legal Reserve were not fully deductible. The effective income tax rate for fiscal 2019 was 22.0%. Net (loss) income attributable toPatterson Companies, Inc. and (loss) earnings per share. Net loss attributable toPatterson Companies Inc. was$588.4 million in fiscal 2020, compared to net income attributable toPatterson Companies Inc. of$83.6 million in fiscal 2019. The loss per diluted share was$6.25 in fiscal 2020, compared to earnings per diluted share of$0.89 in fiscal 2019. Weighted average diluted shares in fiscal 2020 were 94,154,000, compared to 93,484,000 in fiscal 2019. The fiscal 2020 and fiscal 2019 cash dividend was$1.04 per common share. Fiscal 2019 Compared to Fiscal 2018
See Item 7 in our 2019 Annual Report on Form 10-K filed
Liquidity and Capital Resources
Net cash (used in) provided by operating activities was$(243.5) million in fiscal 2020, compared to$48.2 million in fiscal 2019 and$178.9 million in fiscal 2018. Net cash used in operating activities in fiscal 2020 was primarily due to the impact of our Receivables Securitization Program, partially offset by a reduction in working capital, which was driven mainly by an increase in accounts payable. The net cash provided by operating activities in fiscal 2019 was primarily driven by a reduction in working capital, partially offset by the impact of our Receivables Securitization Program. In fiscal 2018, our cash flows from operating activities were primarily driven by net income. Net cash provided by investing activities was$499.1 million in fiscal 2020, compared to$340.7 million in fiscal 2019 and$17.0 million in fiscal 2018. Collections of deferred purchase price receivables were$540.9 million ,$402.4 million and$49.7 million in fiscal 2020, 2019 and 2018, respectively. Capital expenditures were$41.8 million ,$60.7 million and$43.3 million in fiscal 2020, 2019 and 2018, respectively. Capital expenditures in fiscal 2019 included a$14.9 million investment to convert leased property into owned property. We expect to use a total of approximately$50 million for capital expenditures in fiscal 2021. Net cash used in financing activities in fiscal 2020 was$271.2 million . Uses of cash consisted primarily of$460.8 million for the retirement of long-term debt and$100.4 million for dividend payments. InDecember 2019 , we entered into a$300.0 million senior unsecured term loan facility, as described further below. Net cash used in financing activities in fiscal 2019 was$355.2 million . Uses of cash consisted primarily of$249.5 million for the retirement of long-term debt and$99.5 million for dividend payments. Net cash used in financing activities in fiscal 2018 was$230.2 million . Uses of cash consisted primarily of$164.8 million for the retirement of long-term debt,$99.2 million for dividend payments and$87.5 million for share repurchases. InMarch 2018 , we issued fixed-rate senior notes with an aggregate principal amount of$150.0 million , due fiscal 2028. The proceeds were used to repay$150.0 million of senior notes that came due inMarch 2018 , which is included in the$164.8 million of debt retirement noted above. In fiscal 2020, a quarterly cash dividend of$0.26 per share was paid throughout the year. We currently expect to pay quarterly cash dividends in the future, but any future dividend payments will be subject to approval by our Board of Directors, which will depend on our earnings, capital requirements, operating results and financial condition, as well as applicable law, regulatory constraints, industry practice and other business considerations that our Board considers relevant. We are also subject to various financial covenants under our debt agreements including the maintenance of leverage and interest coverage ratios. The terms of agreements governing debt that we may incur 44 -------------------------------------------------------------------------------- Table of Contents in the future may also contain similar covenants. Accordingly, there can be no assurance that we will pay dividends in the future at the same rate or at all. In fiscal 2017, we entered into an amended credit agreement ("Amended Credit Agreement"), consisting of a$295.1 million term loan and a$750.0 million revolving line of credit. InMarch 2019 , we permanently reduced the capacity under the revolving line of credit to$500.0 million . Interest on borrowings is variable and is determined as a base rate plus a spread. This spread, as well as a commitment fee on the unused portion of the facility, is based on our leverage ratio, as defined in the Amended Credit Agreement. During the quarter endedOctober 26, 2019 , we repaid the remaining$81.6 million outstanding under the unsecured term loan. As ofApril 25, 2020 , no amount was outstanding under the Amended Credit Agreement unsecured term loan or revolving line of credit. AtApril 27, 2019 ,$87.1 million was outstanding under the Amended Credit Agreement unsecured term loan at an interest rate of 3.73%, and no amount was outstanding under the Amended Credit Agreement revolving line of credit. The term loan and revolving line of credit mature no later thanJanuary 2022 . InDecember 2019 , we entered into a senior unsecured term loan facility agreement (the "Term Facility Agreement"), consisting of a$300.0 million term loan. Interest on borrowings is variable and is determined as a base rate plus a spread. This spread is based on our leverage ratio, as defined in the Term Facility Agreement. The proceeds were used to repay certain existing indebtedness, pay fees and expenses incurred in connection with the Term Facility Agreement, and finance our ongoing working capital and other general corporate purposes. The Term Facility will mature no later thanDecember 20, 2022 . As ofApril 25, 2020 ,$300.0 million was outstanding under the Term Facility at an interest rate of 1.87%.
During the quarter ended
On
We have$77.9 million in cash and cash equivalents as ofApril 25, 2020 , of which$46.8 million is in foreign bank accounts. See Note 11 to the Consolidated Financial Statements for further information regarding our intention to permanently reinvest these funds. Included in cash and cash equivalents as ofApril 25, 2020 is$21.8 million of cash collected from previously sold customer financing arrangements that have not yet been settled with the third party. See Note 7 to the Consolidated Financial Statements for further information. We expect funds used in operations, the collection of deferred purchase price receivables, existing cash balances and credit availability under existing debt facilities will be sufficient to meet our working capital needs and to finance our business over the next fiscal year. InMay 2020 , we requested draws on our Amended Credit Agreement revolving line of credit, resulting in a total of$450 million outstanding under the revolving credit facility, representing 90% of the full amount available. The Company elected to drawdown the revolving line of credit to increase its cash position and provide financial flexibility in light of current economic conditions and uncertainties arising in connection with the COVID-19 pandemic. The proceeds are being used for working capital and other general corporate purposes. As part of our broad-based effort to respond to the COVID-19 pandemic, we implemented cost reduction measures, including base salary reductions for employees at the level of manager through our executive officers of between 10% and 35% during the period fromMay 1, 2020 throughJuly 31, 2020 . We expect to continue to obtain liquidity from the sale of equipment finance contracts.Patterson sells a significant portion of our finance contracts (see below) to a commercial paper funded conduit managed by a third party bank, and as a result, commercial paper is indirectly an important source of liquidity forPatterson .Patterson is allowed to participate in the conduit due to the quality of our finance contracts and our financial strength. Cash flows could be impaired if our financial strength diminishes to a level that precluded us from taking part in this facility or other similar facilities. Also, market conditions outside of our control could adversely affect the ability for us to sell the contracts. Customer Financing Arrangements As a convenience to our customers, we offer several different financing alternatives, including a third party program and aPatterson -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 thePatterson - 45 -------------------------------------------------------------------------------- Table of Contents sponsored program, equipment purchased by creditworthy customers may be financed up to a maximum of$1 million . 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. First, we operate under an agreement to sell a portion of our equipment finance contracts to commercial paper conduits withMUFG Bank, Ltd. ("MUFG") serving as the agent. We utilize 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 to MUFG. The capacity under the agreement with MUFG atApril 25, 2020 was$525 million . Second, we maintain an agreement withFifth Third Bank ("Fifth Third") whereby Fifth Third purchases customers' financing contracts. PDC Funding II, a consolidated, wholly owned subsidiary, sells financing contracts to Fifth Third. We receive the proceeds of the contracts upon sale to Fifth Third. The capacity under the agreement with Fifth Third atApril 25, 2020 was$100 million . Our financing business is described in further detail in Note 8 to the Consolidated Financial Statements. Contractual Obligations A summary of our contractual obligations as ofApril 25, 2020 follows (in thousands): Payments due by year Less than More than Total 1 year 1-3 years 3-5 years 5 years Long-term debt principal$ 591,250 $ -$ 400,750 $ 150,500 $ 40,000 Long-term debt interest 59,834 16,158 26,684 12,444 4,548 Operating leases 84,919 33,195 41,710 9,137 877 Total$ 736,003 $ 49,353 $ 469,144 $ 172,081 $ 45,425 As ofApril 25, 2020 our gross liability for uncertain tax positions, including interest and penalties, was$13.7 million . We are not able to reasonably estimate the amount by which the liability will increase or decrease over an extended period of time or whether a cash settlement of the liability will be required. Therefore, these amounts have been excluded from the schedule of contractual obligations. For a more complete description of our contractual obligations, see Notes 7 and 11 to the Consolidated Financial Statements. Outlook The COVID-19 pandemic and measures taken in response thereto have had a significant impact on our businesses. InMarch 2020 , based upon the recommendations of theAmerican Dental Association , theAmerican Veterinary Medical Association and such organizations' state-level counterparts, various dental and veterinary offices announced that they were performing only emergency or limited procedures, and rescheduled wellness exams and other elective procedures. In addition, many states and countries imposed restrictions on business operations to protect public health. As ofJune 2020 , these measures have been lifted in some areas that we serve, sometimes subject to social distancing and capacity restrictions. However, future closures may be mandated or recommended by health authorities in some states, cities, or counties depending on the progress of the pandemic. In addition, even if dental and veterinary offices are open for business in their area, some consumers may continue to delay elective visits. In addition, the pandemic has also negatively impacted consumer spending and business spending habits due to increased unemployment and economic uncertainty, all of which may become heightened concerns upon a second wave of infection or future developments. The animal health industry has also experienced a reduction in sales volume as a result of stay at home and shelter in place orders, as well as due to meat packing plant closures. We cannot accurately estimate how long and to what extent COVID-19 will continue to impact our business. Although we have experienced reduced demand, we are unable to predict how significantly the pandemic will reduce future demand for services provided by dentists and veterinarians, the effect of such decreased demand on the demand for the dental and companion animal products and services we distribute, or the impact of the pandemic on the overall healthcare infrastructure and economic outlook inthe United States ,Canada or theUnited Kingdom . 46 -------------------------------------------------------------------------------- Table of Contents In addition to the impact on procedure volumes, we are experiencing and may experience other disruptions as a result of the COVID-19 pandemic. For example, disruptions or potential disruptions include restrictions on the ability of our personnel to travel and access customers for sales, service and other support; supplier disruptions; and additional government requirements to "shelter at home" or other incremental mitigation efforts that may further impact our capacity to sell and service the products we distribute. Furthermore, the economic effects of the pandemic and other governmental actions could reduce the demand for food animal products, thereby adversely affecting our production animal supply business. The total impact of these disruptions could have a material impact on our financial condition, cash flows and results of operations. However, we continue to believe in the long-term fundamentals of our business and our compelling value proposition to customers. Working Capital Management The following table summarizes our average accounts receivable days sales outstanding and average annual inventory turnover for the past three fiscal years: Fiscal Year Ended April 25, 2020 April 27, 2019 April 28, 2018 Days sales outstanding 29.1 36.5 53.1 Inventory turnover 5.4 5.3 5.2 Foreign Operations We derive foreign sales from Dental operations inCanada , andAnimal Health operations inCanada and theU.K. Fluctuations in currency exchange rates have not significantly impacted earnings, as these fluctuations impact sales, cost of sales and operating expenses. However, changes in exchange rates adversely affected net sales by$21.9 million and$24.3 million in fiscal 2020 and 2019, respectively, while they positively impacted net sales by$29.5 million in fiscal 2018. Changes in currency exchange rates are a risk accompanying foreign operations, but this risk is not considered material with respect to our consolidated operations. Critical Accounting Policies and EstimatesPatterson has adopted various accounting policies to prepare our consolidated financial statements in accordance with accounting principles generally accepted in theU.S. Management believes that our policies are conservative and our philosophy is to adopt accounting policies that minimize the risk of adverse events having a material impact on recorded assets and liabilities. However, the preparation of financial statements requires the use of estimates and judgments regarding the realization of assets and the settlement of liabilities based on the information available to management at the time. Changes subsequent to the preparation of the financial statements in economic, technological and competitive conditions may materially impact the recorded values ofPatterson's assets and liabilities. Therefore, the users of the financial statements should read all the notes to the Consolidated Financial Statements and be aware that conditions currently unknown to management may develop in the future. This may require a material adjustment to a recorded asset or liability to consistently apply to our significant accounting principles and policies that are discussed in Note 1 to the Consolidated Financial Statements. The financial performance and condition ofPatterson may also be materially impacted by transactions and events that we have not previously experienced and for which we have not been required to establish an accounting policy or adopt a generally accepted accounting principle. Revenue Recognition - Revenues are generated from the sale of consumable products, equipment and support, software and support, technical service parts and labor, and other sources. Revenues are recognized when or as performance obligations are satisfied. Performance obligations are satisfied when the customer obtains control of the goods or services. Consumable, equipment, software and parts sales are recorded upon delivery, except in those circumstances where terms of the sale are FOB shipping point, in which case sales are recorded upon shipment. Technical service labor is recognized as it is provided. Revenue derived from equipment and software support is recognized ratably over the period in which the support is provided. 47 -------------------------------------------------------------------------------- Table of Contents In addition to revenues generated from the distribution of consumable products under arrangements (buy/sell agreements) where the full market value of the product is recorded as revenue, we earn commissions for services provided under agency agreements. The agency agreement contrasts to a buy/sell agreement in that we do not have control over the transaction, as we do not have the primary responsibility of fulfilling the promise of the good or service and we do not bill or collect from the customer in an agency relationship. Commissions under agency agreements are recorded when the services are provided. Estimates for returns, damaged goods, rebates, loyalty programs and other revenue allowances are made at the time the revenue is recognized based on the historical experience for such items. The receivables that result from the recognition of revenue are reported net of related allowances. We maintain a valuation allowance based upon the expected collectability of receivables held. Estimates are used to determine the valuation allowance and are based on several factors, including historical collection data, economic trends and credit worthiness of customers. Receivables are written off when we determine the amounts to be uncollectible, typically upon customer bankruptcy or non-response to continuous collection efforts. The portions of receivable amounts that are not expected to be collected during the next twelve months are classified as long-term.Patterson has a relatively large, dispersed customer base and no single customer accounts for more than 10% of consolidated net sales. In addition, the equipment sold to customers under finance contracts generally serves as collateral for the contract and the customer provides a personal guarantee as well. Net sales do not include sales tax as we are considered a pass-through conduit for collecting and remitting sales tax. Patterson Advantage Loyalty Program - Patterson Dental provides a point-based awards program to qualifying customers involving the issuance of "Patterson Advantage dollars" which can be used toward equipment and technology purchases. Patterson Advantage dollars earned during a program year expire one year after the end of the program year. The cost and corresponding liability associated with the program is recognized as contra-revenue. As ofApril 25, 2020 , we believe we have sufficient experience with the program to reasonably estimate the amount of Patterson Advantage dollars that will not be redeemed and thus have recorded a liability for 92.0% of the maximum potential amount that could be redeemed. We recognize the expected breakage amount as revenue in proportion to the pattern of rights exercised by the customer, and we recognize the estimated value of unused Patterson Advantage dollars as redemptions occur. Breakage recognized was immaterial to all periods presented. Inventory and Reserves - Inventory consists primarily of merchandise held for sale and is stated at the lower of cost or market. Cost is determined using the last-in, first-out ("LIFO") method for all inventories, except for foreign inventories and manufactured inventories, which are valued using the first-in, first-out ("FIFO") method. We continually assess the valuation of inventories and reduce the carrying value of those inventories that are obsolete or in excess of forecasted usage to estimated realizable value. Estimates are made of the net realizable value of such inventories based on analyses and assumptions including, but not limited to, historical usage, future demand and market requirements.Goodwill and Other Indefinite-Lived Intangible Assets -Goodwill represents the excess of cost over the fair value of identifiable net assets of businesses acquired. Impairment testing for goodwill is done at the reporting unit level, with all goodwill assigned to a reporting unit. We have two reporting units as ofApril 25, 2020 ;Dental and Animal Health . Our Corporate reportable segment's assets and liabilities, and net sales and expenses, are allocated to the two reporting units. We assess goodwill for impairment annually and whenever an event occurs or circumstances change that would indicate that the carrying amount may be impaired. Any goodwill impairment is measured as the amount by which a reporting unit's carrying value exceeds its fair value, not to exceed the carrying value of goodwill. The determination of fair value involves uncertainties because it requires management to make assumptions and to apply judgment to estimate industry and economic factors and the profitability of future business strategies.Patterson conducts impairment testing based on current business strategy in light of present industry and economic conditions, as well as future expectations. Additionally, in assessing goodwill for impairment, the reasonableness of the implied control premium is considered based on market capitalizations and recent market transactions. Our indefinite-lived intangible asset is a trade name, which is assessed for impairment by comparing the carrying value of the asset with its fair value. If the carrying value exceeds fair value, an impairment loss is recognized in an amount equal to the excess. The determination of fair value involves assumptions, including projected revenues and gross profit levels, as well as consideration of any factors that may indicate potential impairment. 48
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In connection with the preparation of these financial statements in the fourth quarter of fiscal 2020, management completed its annual goodwill and other indefinite-lived intangible asset impairment tests using the beginning of our fiscal 2020 fourth quarter as the valuation date. We determined that there was no impairment of our indefinite-lived intangible asset. Our annual goodwill impairment test resulted in no impairment to the Dental reporting unit's goodwill, and a$269.0 million non-cash pre-tax impairment charge of ourAnimal Health reporting unit's goodwill. The decrease in the fair value of theAnimal Health reporting unit below its carrying value was mainly the result of a reduction in management's estimates of future cash flows. Future cash flows were affected by a reduction in future sales volume and operating margins. The sales volume estimate is a reflection of recent sales trends we've experienced. Future operating margins are expected to be lower based on current trends in our markets. These trends are driven by customer and vendor consolidation. Subsequent to the annual test being completed and in connection with the preparation of these financial statements, we experienced events and circumstances that indicated that the carrying amount of goodwill may be further impaired. These events and circumstances included a decline in our projected future earnings and a sustained decrease in our share price. As such, we tested our goodwill for impairment as of the beginning of our fiscalApril 2020 . This test resulted in no impairment to the Dental reporting unit's goodwill, and a$406.1 million non-cash pre-tax impairment charge of ourAnimal Health reporting unit's goodwill. The decrease in the fair value of theAnimal Health reporting unit subsequent to the annual goodwill impairment test was caused by additional reductions in management's estimates of future cash flows, driven by reduced sales volumes, as well as reduced EBITDA multiples of comparable companies. These estimates and market multiples were negatively affected by COVID-19. The animal health industry has experienced a reduction in sales volume as a result of stay at home and shelter in place orders, as well as a result of meat packing plant closures. Our future cash flow estimates for this business unit reflect the long-term impact of COVID-19. As ofApril 25, 2020 , ourAnimal Health reporting unit had no remaining goodwill as a result of the total goodwill impairment charges recorded in fiscal 2020 of$675.1 million . Long-Lived Assets - Long-lived assets, including definite-lived intangible assets, are evaluated for impairment whenever events or changes in circumstances indicate that the carrying amount of the assets may not be recoverable through the estimated undiscounted future cash flows derived from such assets. Our definite-lived intangible assets primarily consist of customer relationships, trade names and trademarks. When impairment exists, the related assets are written down to fair value using level 3 inputs, as discussed further in Note 9 to the Consolidated Financial Statements. Related Party Transactions - We have interests in a number of entities that are accounted for using the equity method. During fiscal 2020, 2019 and 2018 we made purchases of$94.2 million ,$87.9 million and$84.2 million from these entities, respectively. During fiscal 2020, 2019 and 2018, we recorded net sales of$110.3 million ,$74.5 million and$19.7 million to these entities, respectively. Income Taxes - We are subject to income taxes in theU.S. and numerous foreign jurisdictions. Significant judgments are required in determining the consolidated provision for income taxes. Changes in interpretation of the Tax Act could create potential added uncertainties. During the ordinary course of business, there are many transactions and calculations for which the ultimate tax determination is uncertain. As a result, we recognize tax liabilities based on estimates of whether additional taxes and interest will be due. These tax liabilities are recognized when, despite our belief that our tax return position is supportable, we believe that certain positions may not be fully sustained upon review by tax authorities. We believe that our accruals for tax liabilities are adequate for all open audit years based on our assessment of many factors including past experience and interpretations of tax law. This assessment relies on estimates and assumptions and may involve a series of complex judgments about future events. To the extent that the final tax outcome of these matters is different than the amounts recorded, such differences will impact income tax expense in the period in which such determination is made and could materially affect our financial results. Valuation allowances are established for deferred tax assets if, after assessment of available positive and negative evidence, it is more likely than not that the deferred tax asset will not be fully realized. 49
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Table of Contents Self-insurance -Patterson is self-insured for certain losses related to general liability, product liability, automobile, workers' compensation and medical claims. We estimate our liabilities based upon an analysis of historical data and actuarial estimates. While current estimates are believed reasonable based on information currently available, actual results could differ and affect financial results due to changes in the amount or frequency of claims, medical cost inflation or other factors. Historically, actual results related to these types of claims have not varied significantly from estimated amounts. Stock-based Compensation - We recognize stock-based compensation based on certain assumptions including inputs within valuation models, estimated forfeitures and estimated performance outcomes. These assumptions require subjective judgment and changes in the assumptions can materially affect fair value estimates. Management assesses the assumptions and methodologies used to estimate forfeitures and to calculate estimated fair value of stock-based compensation on a regular basis. Circumstances may change, and additional data may become available over time, which could result in changes to these assumptions and methodologies and thereby materially impact the fair value determination or estimates of forfeitures. If factors change and we employ different assumptions, the amount of compensation expense associated with stock-based compensation may differ significantly from what was recorded in the current period.
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