Our financial information for fiscal 2022 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 Healthand Corporate. Dental and Animal Healthare 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 Healthis a leading, full-line distributor in North Americaand the U.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.
The operating margins of the animal health activity are lower than those of the dental activity. While operating expenses are lower in the animal health sector compared to the dental sector, gross margins in the animal health sector are generally lower due to the low margins recorded 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 2022 ended on
April 30, 2022and consisted of 53 weeks. Fiscal 2021 and 2020 ended on April 24, 2021and April 25, 2020, respectively, and both consisted of 52 weeks. Fiscal 2023 will end on April 29, 2023and 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 net sales adjusted to exclude the impact of foreign currency, changes in product selling relationships and contributions from recent acquisitions. Foreign currency impact represents the difference in results that is attributable to fluctuations in currency exchange rates the company uses to convert results for all foreign entities where the functional currency is not the U.S.dollar. The company calculates the impact as the difference between the current period results translated using the current period currency exchange rates and using the comparable prior period's currency exchange rates. The company believes the disclosure of net sales changes in constant currency provides useful supplementary information to investors in light of significant fluctuations in currency rates.
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. As part of our broad-based effort to respond to the COVID-19 pandemic, we implemented cost reduction measures, including temporary salary reductions, furloughs and reduced work hours across our workforce during the period from
May 1, 2020through July 31, 2020. Within our Dental segment, supply chain disruptions for PPE and an increased demand for these products initially resulted in backorders of PPE and a potential scarcity in raw materials to make PPE, causing substantial price increases. We had to prepay suppliers in order to obtain PPE for resale to our customers, and as manufacturing caught up to increased demand for PPE, prices dropped, impacting our margins and requiring us to write down certain inventory. However, in the Dental Segment, the effect became less significant during the first quarter of fiscal 2021, as dental offices began opening for elective procedures. In addition, we recorded increased sales of infection control products starting in the first quarter of fiscal 2021 within the Dental segment. The disruptions we experienced in our production animal business as a result of the pandemic became less significant after the first quarter of fiscal 2021. Gains on Vetsource Investment. In fiscal 2022, we sold a portion of our investment in Vetsource, with a carrying value of $25.8 million, for $56.8 million. We recorded a pre-tax gain of $31.0 millionin gains on investments in our consolidated statements of operations and other comprehensive income (loss) as a result of this sale. The cash received of $56.8 millionis reported within investing activities in our consolidated statements of cash flows. We also recorded a pre-tax non-cash gain of $31.0 millionto reflect the increase in the carrying value of the remaining 33
portion of our investment in Vetsource, which was based on the selling price of the portion of the investment we sold for
$56.8 million. This gain was recorded in gains on investments in our consolidated statements of operations and other comprehensive income (loss). Concurrent with the sale, we obtained rights that will allow us, under certain circumstances, to require another shareholder of Vetsource to purchase our remaining shares. We recorded a pre-tax non-cash gain of $25.8 millionin gains on investments in our consolidated statements of operations and other comprehensive income (loss) as a result of this transaction. The aggregate gains on investments of $87.8 millionare reported within operating activities in our consolidated statements of cash flows. Concurrent with obtaining this put option, we also granted rights to the same Vetsource shareholder that would allow such shareholder, under certain circumstances, to require us to sell our remaining shares at fair value. Gain on Vets Plus Investment. In fiscal 2022, we sold a portion of our investment in Vets Plus with a carrying value of $4.0 millionfor $17.1 million. We recorded a pre-tax gain of $13.1 millionin gains on investments in our consolidated statements of operations and other comprehensive income (loss) as a result of this sale. This $13.1 millionpre-tax gain is reported within operating activities in our consolidated statements of cash flows. The cash received of $17.1 millionis reported within investing activities in our consolidated statements of cash flows. Fiscal 2022 Legal Reserve. On August 27, 2021, we signed a memorandum of understanding to settle the federal securities class action complaint described in Note 17 to the Consolidated Financial Statements. Under the terms of the settlement, Pattersonagreed to pay $63.0 millionto resolve the case. Although we agreed to settle this matter, we expressly deny the allegations of the complaint and all liability. Our insurers consented to the settlement and contributed an aggregate of $35.0 millionto fund the settlement and to reimburse us for certain costs and expenses of the litigation. As a result of the foregoing, we recorded a pre-tax reserve of $63.0 millionin other accrued liabilities in the consolidated balance sheets in our Corporate segment during the first quarter of fiscal 2022 related to the probable settlement of this litigation (the "Fiscal 2022 Legal Reserve"). During the first quarter of fiscal 2022, we also recorded a receivable of $27.0 millionin prepaid expenses and other current assets in the consolidated balance sheets in our Corporate segment related to probable insurance recoveries, which amount was paid into the litigation settlement escrow as required by the memorandum of understanding. The net expense of $36.0 millionwas recorded in operating expenses in our consolidated statements of operations and other comprehensive income (loss). We recorded a gain of $8.0 millionduring the second quarter of fiscal 2022 in our Corporate segment to account for our receipt of carrier reimbursement of previously expended fees and costs. The parties filed a stipulation of settlement during the second quarter of fiscal 2022. On February 3, 2022, the District Court entered an order preliminarily approving the settlement and directing the claims administrator to mail a notice of settlement and claim form to all class members. On June 9, 2022, the District Court held a final settlement hearing to determine whether the settlement should be approved. On June 10, 2022, the District Court entered an order granting final approval to the settlement. Inventory Donation Charges. In fiscal 2022, we committed to donate certain personal protective equipment to charitable organizations to assist with COVID-19 recovery efforts. We recorded a charge of $49.2 millionwithin cost of sales in our consolidated statements of operations and other comprehensive income (loss) as a result ("Inventory Donation Charges") in the first quarter of fiscal 2022. These charges were driven by our intention to not sell these products, but rather to donate them to charitable organizations. Of the $49.2 millionexpense recorded, $47.2 millionand $2.0 millionwas recorded within our Dental and Animal Healthsegments, respectively. Goodwill Impairment. In fiscal 2020, we recorded non-cash pre-tax goodwill impairment charges totaling $675.1 millionin our Animal Healthsegment ("Goodwill Impairment"), which were not fully tax deductible. The decrease in the fair value of the Animal Healthreporting 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 reflected recent sales trends we had experienced. Future operating margins were expected to be lower based on then-current trends in our markets. These trends were driven by customer and vendor consolidation. We experienced a further decrease in the fair value of the Animal Healthreporting 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. In fiscal 2020, the animal health industry 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 in fiscal 2020 reflected the long-term impact of COVID-19. Gain on Investment. We recorded a pre-tax gain of $34.3 millionrelated 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. 34
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 millionduring fiscal 2020. This charge relates to the January 2014forward 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") in fiscal 2020 related to the then-probable settlement of litigation with the U.S. Attorney's Office for the Western District of Virginia, which were recorded within operating expenses in the consolidated statements of operations and other comprehensive income (loss) in our Corporate segment. The settlement amount was fully paid in fiscal 2020. Fiscal 2020 Legal Reserve. We incurred expenses of $17.7 million("Fiscal 2020 SourceOne Dental Legal Reserve") in fiscal 2020 related to the settlement of litigation with SourceOne Dental, Inc., which were recorded within operating expenses in the consolidated statements of operations and other comprehensive income (loss) in our Corporate segment. The settlement amount was fully paid in fiscal 2020. Receivables Securitization Program. We are a party to certain receivables purchase agreements with MUFG Bank, Ltd.("MUFG"), under which MUFG acts as an agent to facilitate the sale of certain Pattersonreceivables (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 DPP receivable is ultimately realized by Pattersonfollowing 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 used in operating activities within the consolidated statements of cash flows.
The following table summarizes our results as a percentage of net sales:
Fiscal Year Ended April 30, 2022 April 24, 2021 April 25, 2020 Net sales 100.0 % 100.0 % 100.0 % Cost of sales 80.2 79.6 78.2 Gross profit 19.8 20.4 21.8 Operating expenses 17.4 16.8 19.9 Goodwill impairment - - 12.3 Operating income (loss) 2.4 3.6 (10.4) Other income (expense), net 1.7 (0.2) (0.4) Income (loss) before taxes 4.1 3.4 (10.8) Income tax expense (benefit) 1.0 0.8 (0.1) Net income (loss) 3.1 2.6 (10.7) Net loss attributable to noncontrolling interests - - - Net income (loss) attributable to Patterson Companies, Inc. 3.1 % 2.6 % (10.7) %
Fiscal 2022 vs. Fiscal 2021
Net sales. Consolidated net sales in fiscal 2022 were
$6,499.4 million, an increase of 9.9% from $5,912.1 millionin fiscal 2021. Sales were positively impacted by an estimated 1.9% due to the extra week of results in the current year. Foreign exchange rate changes had a favorable impact of 0.7% on fiscal 2022 sales. Sales of certain products previously recognized on a gross basis were recognized on a net basis during fiscal 2022. This change in revenue recognition was driven by changes in contractual terms with certain suppliers in our Animal Healthsegment. The impact of this change in revenue recognition for certain products was partially offset by the impact of the acquisition of substantially all of the assets of Miller Vet on sales for fiscal 2022, resulting in a net decrease in sales of approximately 1.8%. 35 -------------------------------------------------------------------------------- Table of Contents Dental segment sales increased 8.1% to $2,516.1 millionin fiscal 2022 from $2,327.0 millionin fiscal 2021. Sales were positively impacted by an estimated 1.8% due to the extra week of results in the current year. Foreign exchange rate changes had a favorable impact of 0.5% on fiscal 2022 sales. Sales of consumables increased 8.4%, sales of equipment and software increased 9.5%, and sales of value-added services and other increased 3.4% in fiscal 2022. Dental segment sales growth in fiscal 2022 was driven by a recovery in the Dental end markets, compared to sales in fiscal 2021, which were negatively affected by the COVID-19 pandemic when dental offices were closed for elective procedures, particularly during the first quarter of our fiscal 2021. Animal Healthsegment sales increased 11.9% to $3,982.9 millionin fiscal 2022 from $3,560.0 millionin fiscal 2021. Sales were positively impacted by an estimated 2.0% due to the extra week of results in the current year. Foreign exchange rate changes had a favorable impact of 0.8% on fiscal 2022 sales. Sales of certain products previously recognized on a gross basis were recognized on a net basis during fiscal 2022. This change in revenue recognition was driven by changes in contractual terms with certain suppliers. The impact of this change in revenue recognition for certain products was partially offset by the impact of the acquisition of substantially all of the assets of Miller Vet on sales for fiscal 2022, resulting in a net decrease in Animal Healthsegment sales of approximately 3.0%. Sales were higher in fiscal 2022 as compared to fiscal 2021, driven by increased demand across all of our animal health businesses and geographies. Gross profit. Consolidated gross profit margin decreased 60 basis points from the prior year to 19.8%, driven primarily by the impact of the Inventory Donation Charges, unfavorable mix in sales among our segments due to faster growth in our Animal Healthsegment, and lower net sales in our Corporate segment due to the effect of rising interest rates on our customer financing portfolio. This interest rate impact was partially offset by a gain on associated interest rates swap agreements, which is reflected in other income, net in our consolidated statements of operations and other comprehensive income (loss). Operating expenses. Consolidated operating expenses for fiscal 2022 were $1,132.1 million, a 14.1% increase from the prior year of $992.5 million. We incurred higher operating expenses during fiscal 2022 primarily as a result of higher personnel costs, the impact of the Fiscal 2022 Legal Reserve and higher travel expenses. The higher personnel costs were primarily due to the salary reductions, reduced work hours, and furloughs we implemented as a response to the COVID-19 pandemic during the three months ended July 25, 2020. Travel expenses were higher in fiscal 2022 than in fiscal 2021 primarily due to COVID-19-related restrictions having a more significant impact in fiscal 2021. The consolidated operating expense ratio of 17.4% increased 60 basis points from the prior year period, which was also driven by these same factors. Operating income (loss). Fiscal 2022 operating income was $157.0 million, or 2.4% of net sales, as compared to $210.6 million, or 3.6% of net sales, in fiscal 2021. The decrease in operating income was primarily due to the impact of the Inventory Donation Charges, the Fiscal 2022 Legal Reserve and higher personnel costs. These impacts were partially offset by the growth in sales experienced in fiscal 2022.
Dental segment operating profit was
Animal Healthsegment operating income was $114.4 millionfor fiscal 2022, an increase of $26.3 millionfrom fiscal 2021. The increase was primarily driven by higher net sales during fiscal 2022, partially offset by higher personnel costs incurred during fiscal 2022. Corporate segment operating loss was $137.6 millionfor fiscal 2022, as compared to a loss of $78.8 millionfor fiscal 2021. The change was primarily driven by the impact of the Fiscal 2022 Legal Reserve, lower customer financing net sales recorded during fiscal 2022, and higher personnel costs incurred during fiscal 2022. The lower customer financing net sales were related to the effect of rising interest rates on our customer financing portfolio. Other income (expense). Net other income was $109.3 millionin fiscal 2022, compared to net other expense of $10.7 millionin fiscal 2021. The change was primarily driven by the Gains on Vetsource Investmentof $87.8 million, the Gain on Vets Plus Investmentof $13.1 millionand a larger gain on our interest rate swap agreements recorded during fiscal 2022. Income tax expense (benefit). The effective income tax rate for fiscal 2022 was 24.2%, compared to 22.4% for fiscal 2021. The increase was primarily due to provision to return adjustments in the prior year and a geographical shift in earnings, which was partially offset by excess tax benefits associated with stock-based compensation awards. 36 -------------------------------------------------------------------------------- Table of Contents Net income (loss) attributable to Patterson Companies, Inc.and earnings (loss) per share. Net income attributable to Patterson Companies Inc.was $203.2 millionin fiscal 2022, compared to $156.0 millionin fiscal 2021. Earnings per diluted share were $2.06in fiscal 2022, compared to $1.61in fiscal 2021. Weighted average diluted shares in fiscal 2022 were 98.5 million, compared to 96.7 million in fiscal 2021. The fiscal 2022 and fiscal 2021 cash dividend declared was $1.04per common share.
Fiscal 2021 vs. Fiscal 2020
See Item 7 of our 2021 Annual Report on Form 10-K filed
Cash and capital resources
Net cash used in operating activities was
$981.0 millionin fiscal 2022, compared to $730.5 millionin fiscal 2021 and $243.5 millionin fiscal 2020. Net cash used in operating activities in fiscal 2022 was primarily due to the impact of our Receivables Securitization Program and a net increase in inventory, inclusive of the impact of the $49.2 millionInventory Donation Charges, partially offset by an increase in accounts payable. Net cash used in operating activities in fiscal 2021 was primarily due to the impact of our Receivables Securitization Program, as well as an increase in accounts payable. 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. Net cash provided by investing activities was $1,239.0 millionin fiscal 2022, compared to $810.7 millionin fiscal 2021 and $499.1 millionin fiscal 2020. Collections of deferred purchase price receivables were $1,213.5 million, $834.0 millionand $540.9 millionin fiscal 2022, 2021 and 2020, respectively. In fiscal 2022, we recorded cash receipts of $75.9 millionfrom the sale of investments and used $19.8 millionto acquire Miller Vet. Capital expenditures were $38.3 million, $25.8 millionand $41.8 millionin fiscal 2022, 2021 and 2020, respectively. We expect to use a total of approximately $60 millionfor capital expenditures in fiscal 2023. Net cash used in financing activities in fiscal 2022 was $253.2 million, driven by $101.1 millionfor dividend payments, $100.8 millionfor payments on long-term debt, $35.0 millionin share repurchases and $24.0 millionattributed to payments on our revolving line of credit. Net cash used in financing activities in fiscal 2021 was $22.6 million, driven by $75.2 millionfor dividend payments, partially offset by $53.0 millionattributed to draws on our revolving line of credit. Net cash used in financing activities in fiscal 2020 was $271.2 million. Uses of cash consisted primarily of $460.8 millionfor the retirement of long-term debt and $100.4 millionfor dividend payments. In December 2019, we entered into a $300.0 millionsenior unsecured term loan facility, as described further below. In fiscal 2022 and fiscal 2021, a quarterly cash dividend of $0.26per share was declared each quarter, with payment occurring in the subsequent quarter. We currently expect to declare and pay quarterly cash dividends in the future, but any future dividends 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 in the future may also contain similar covenants. Accordingly, there can be no assurance that we will declare and pay dividends in the future at the same rate or at all. In fiscal 2021, we entered into an amendment, restatement and consolidation of certain credit agreements with various lenders, including MUFG Bank, Ltd, as administrative agent. This amended and restated credit agreement (the "Credit Agreement"), dated February 16, 2021, consists of a $700.0 millionrevolving credit facility and a $300.0 millionterm loan facility, and will mature no later than February 2024. We used the facilities to refinance and consolidate certain credit agreements in existence prior to the Credit Agreement being executed, pay the fees and expenses incurred therewith, and finance our ongoing working capital and other general corporate purposes. As of April 30, 2022, $300.0 millionwas outstanding under the Credit Agreement term loan at an interest rate of 1.89%, and $29.0 millionwas outstanding under the Credit Agreement revolving credit facility at an interest rate of 1.54%. As of April 24, 2021, $300.0 millionwas outstanding under the Credit Agreement term loan at an interest rate of 1.36%, and $53.0 millionwas outstanding under the Credit Agreement revolving credit facility at an interest rate of 1.34%.
$142.0 millionin cash and cash equivalents as of April 30, 2022, of which $85.8 millionis in foreign bank accounts. See Note 12 to the Consolidated Financial Statements for further information regarding our intention to permanently reinvest these funds. Included in cash and cash equivalents as of April 30, 2022is $39.1 millionof cash collected from previously sold customer financing arrangements that have not yet been settled with the third party. See Note 5 to the Consolidated Financial Statements for further information. We expect the collection of deferred purchase price receivables, existing cash balances and credit availability under existing debt facilities, less our funds used in operations, will be sufficient to meet our working capital needs and to finance our business over the next fiscal year. We expect to continue to obtain liquidity from the sale of equipment finance contracts. Pattersonsells 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 for Patterson. Pattersonis 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 Terms
As a convenience to our customers, we offer several different financing alternatives, including a third party program and a
Patterson-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 the Patterson-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 with MUFG 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 at April 30, 2022was $525 million. Second, we maintain an agreement with Fifth 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 at April 30, 2022was $100 million.
Our financing activities are further described in Note 5 to the consolidated financial statements.
A summary of our contractual obligations as of
April 30, 2022was as 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 $ 490,500$ - $ 450,500$ - $ 40,000Long-term debt interest 33,220 12,541 16,131 3,032 1,516 Operating leases 75,939 31,165 34,443 9,109 1,222 Total $ 599,659 $ 43,706 $ 501,074 $ 12,141 $ 42,738As of April 30, 2022our gross liability for uncertain tax positions, including interest and penalties, was $11.5 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. 38
For a more complete description of our contractual obligations, see notes 10 and 11 to the consolidated financial statements.
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 30, 2022 April 24, 2021 April 25, 2020 Days sales outstanding 25.2 25.9 29.1 Inventory turnover 6.6 6.1 5.4 Foreign Operations We derive foreign sales from Dental operations in
Canada, and Animal Healthoperations in Canadaand the U.K.Fluctuations in currency exchange rates have not significantly impacted earnings, as these fluctuations impact sales, cost of sales and operating expenses. Changes in exchange rates positively impacted net sales by $41.0 millionand $28.4 millionin fiscal 2022 and 2021, respectively, while they adversely affected net sales by $21.9 millionin fiscal 2020. Changes in currency exchange rates are a risk accompanying foreign operations, but this risk is not considered material with respect to our consolidated operations.
Significant Accounting Policies and Estimates
Pattersonhas adopted various accounting policies to prepare our consolidated financial statements in accordance with accounting principles generally accepted in the U.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 of Patterson'sassets 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 of Pattersonmay 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.
Sales of consumables, equipment, software and parts are recorded upon delivery, except where the terms of sale are FOB shipping point, in which case sales are recorded upon shipment. Technical services labor is accounted for as provided. Hardware and software support revenue is recognized on a pro rata basis over the period in which the support is provided.
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 39
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.
Pattersonhas 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 an intermediary for the collection and remittance of sales tax.
Patterson Advantage Loyalty Program - Patterson Dental provides a point-based awards program to qualifying customers involving the issuance of "
PattersonAdvantage 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 of April 30, 2022, 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 88.0% 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. Goodwilland Other Indefinite-Lived Intangible Assets - Goodwillrepresents 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 of April 30, 2022; 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. Pattersonconducts 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. In connection with the preparation of these financial statements in the fourth quarter of fiscal 2022, management completed its annual goodwill and other indefinite-lived intangible asset impairment tests using the beginning of our fiscal 2022 fourth quarter as the valuation date. We determined that there was no impairment of either goodwill or our indefinite-lived intangible asset. In connection with the preparation of these financial statements in the fourth quarter of fiscal 2021, management completed its annual goodwill and other indefinite-lived intangible asset impairment tests using the beginning of our fiscal 2021 fourth quarter as the valuation date. We determined that there was no impairment of either goodwill or our indefinite-lived intangible asset. 40 -------------------------------------------------------------------------------- Table of Contents In connection with the preparation of our fiscal 2020 Form 10-K 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 millionnon-cash pre-tax impairment charge of our Animal Healthreporting unit's goodwill. The decrease in the fair value of the Animal Healthreporting 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 reflected recent sales trends we had experienced. Future operating margins were expected to be lower based on then-current trends in our markets. These trends were driven by customer and vendor consolidation. Subsequent to the annual test being completed and in connection with the preparation of our fiscal 2020 Form 10-K in the fourth quarter of fiscal 2020, we experienced events and circumstances that indicated that the carrying amount of goodwill may have been 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 fiscal April 2020. This test resulted in no impairment to the Dental reporting unit's goodwill, and a $406.1 millionnon-cash pre-tax impairment charge of our Animal Healthreporting unit's goodwill. The decrease in the fair value of the Animal Healthreporting 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. In fiscal 2020, the animal health industry 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 in fiscal 2020 reflected the long-term impact of COVID-19. As of April 25, 2020, our Animal Healthreporting 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 7 to the Consolidated Financial Statements. Development Costs of Software to be Sold - At the end of each fiscal quarter, we compare the unamortized capitalized costs of software to be sold to its net realizable value. If the unamortized amount exceeds the net realizable value, an impairment is recorded for this amount of that asset shall be written off. If the unamortized capitalized costs are less than the net realizable value of that asset, then there is no impairment. Related Party Transactions - We have interests in a number of entities that are accounted for using the equity method. During fiscal 2022, 2021 and 2020 we made purchases of $128.5 million, $110.2 millionand $94.2 millionfrom these entities, respectively. During fiscal 2022, 2021 and 2020, we recorded net sales of $117.3 million, $93.6 millionand $110.3 millionto these entities, respectively. Income Taxes - We are subject to income taxes in the U.S.and numerous foreign jurisdictions. Significant judgments are required in determining the consolidated provision for income taxes. Changes in tax policy or interpretation of current tax law 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. 41
Valuation allowances are made for deferred tax assets if, after evaluating the available positive and negative evidence, it is more likely than not that the deferred tax asset will not be fully realized.
Pattersonis 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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