Overview

Our fiscal 2012 financial information is summarized in this Management's Discussion and Analysis, Consolidated Financial Statements, and related Notes. The following background is essential to more fully understand our Company's financial information.

Patterson operates a distribution business in three complementary markets:
dental supply, veterinary supply and rehabilitation supply. Historically our strategy for growth focused on internal growth and the acquisition of smaller distributors and businesses offering related products and services to the dental market. In fiscal 2002, we expanded our strategy to take advantage of a parallel growth opportunity in the veterinary supply market by acquiring the assets of J.
A. Webster, Inc. on July 9, 2001. Patterson added a third component to our business platform in fiscal 2004 when it entered the rehabilitation supply market with the acquisition of AbilityOne Products Corp. ("AbilityOne") on September 12, 2003. AbilityOne is now known as Patterson Medical.

Operating margins of the veterinary business are considerably lower than the dental and rehabilitation supply businesses. While operating expenses run at a lower rate in the veterinary business, their gross margin is substantially lower.

There are several important aspects of Patterson's business that are useful in analyzing it, including: (1) market 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.

There are two matters that have an overriding impact on our financial results for fiscal 2012. First, we operate with a 52-53 week accounting convention with our fiscal year ending on the last Saturday in April. Fiscal year 2011 included 53 weeks, with an additional, or fourteenth, week included in the first quarter ended July 31, 2010. Fiscal 2012 ending April 28, 2012 included 52 weeks, and the first quarter operations included thirteen weeks of activity compared to the prior year period which contained 14 weeks. It is difficult to precisely quantify the impact of the extra week, but estimates have been provided in those areas where it is possible to make reasonable approximations. We estimate that the impact of the extra week reduced sales growth by one or two percentage points in fiscal 2012 as compared to fiscal 2011.

The second matter involves the level of expense associated with our Employee Stock Ownership Plan ("ESOP"). For the past twenty years allocations of shares to employees have been made almost entirely from shares of Company stock acquired by the ESOP in 1990 ("the 1990 Shares"). Although the accounting standards in effect in 1990 were subsequently revised, the accounting for the 1990 shares was grandfathered under the revised standards and called for the expensing of the shares released for allocation to employees to be based on the original cost of the shares.

The revised standards require the expensing of shares released to be based on fair value of the shares at the time they are committed to be released and since the revision of the accounting standards, the ESOP has acquired approximately 4.5 million additional shares, nearly all of which are still held for future allocation to employees. As the final allocation of the 1990 shares was made at the end of fiscal 2011, the ESOP shares that have been subsequently acquired will be released and allocated to employees in fiscal 2012 and beyond. When these shares are committed to be released to employees, it will result in a non-cash expense equal to the average fair value of the shares committed to be released.

The ESOP expense increased our operating expenses by approximately $24 million and $0.13 per diluted share in fiscal 2012 as compared to fiscal 2011. This change from historical cost to fair value in recognizing ESOP expense creates a comparability discrepancy between our past and foreseeable future operating results.

The following table presents the ESOP expense reconciliation for comparability purposes:

                                                 Three Months Ended              Twelve Months Ended
                                             April 28,        April 30,       April 28,       April 30,
                                               2012             2011             2012            2011
Net Income                                  $    62,143      $    62,707      $  212,815      $  225,385
Incremental ESOP expense                          3,496               -           13,867              -

Adjusted Net Income (non-GAAP)              $    65,639      $    62,707      $  226,682      $  225,385

Diluted Earnings Per Share                  $      0.58      $      0.53      $     1.92      $     1.89
Incremental ESOP expense                           0.03               -             0.13              -

Adjusted Earnings Per Share (non-GAAP)      $      0.61      $      0.53      $     2.05      $     1.89

In fiscal 2012, we made a cash contribution of approximately $24 million to the ESOP, which was then used by the ESOP to acquire shares through open market purchases. We instructed the ESOP trustee to hold these shares in suspense for allocation to employees at the end of the current ESOP fiscal year. Since the fiscal 2012 contribution to the ESOP was made in cash as opposed to using shares previously acquired by the ESOP, the expense for the current fiscal year will be a cash expense to us.

During fiscal 2012, we repurchased approximately 12 million shares of our common stock at a cost of approximately $361 million. Through these repurchases and the cash dividends, we returned nearly $400 million of value to our shareholders.

Results of Operations

The following table summarizes our consolidated results of operations over the past three fiscal years as a percent of sales:

                                        2012         2011         2010
                 Net sales               100.0 %      100.0 %      100.0 %
                 Cost of sales            67.1 %       66.5 %       66.3 %

                 Gross margin             32.9 %       33.5 %       33.7 %
                 Operating expenses       22.8 %       22.5 %       22.7 %

                 Operating income         10.1 %       11.0 %       11.0 %
                 Other income, net         0.1 %        0.2 %        0.3 %
                 Interest expense          0.9 %        0.8 %        0.8 %

                 Income before taxes       9.3 %       10.4 %       10.5 %
                 Income taxes              3.3 %        3.8 %        3.9 %

                 Net income                6.0 %        6.6 %        6.6 %

Fiscal 2012 Compared to Fiscal 2011

As described in the Overview section above, the first quarter of fiscal 2011 included an extra week due to the Company's fiscal year convention. Accordingly, the fiscal year ended April 30, 2011 included 53 weeks while the fiscal year ended April 28, 2012 included 52 weeks. As noted above, we estimate that the impact of the extra week reduced sales growth by one to two percentage points in fiscal 2012 as compared to fiscal 2011.

Net Sales. Consolidated net sales in fiscal 2012 were $3,535.7 million, an increase of 3.5%, from $3,415.7 million in fiscal 2011. The growth in sales includes a 0.6% contribution from acquisitions and a 0.2% favorable impact of changes in foreign currency translation rates. Excluding the impact of the extra week, consolidated sales grew an estimated 5.1%.

Dental segment sales in fiscal 2012 rose 3.7% to $2,287.9 million from $2,236.1 million in fiscal 2011. The impact of currency translation rates was a favorable 0.1%. Consumable sales increased 2.6%, although they remained sluggish due to continuing weak general economic trends, low consumer confidence and high unemployment.

Dental equipment and software sales increased 5.3% in fiscal 2012 to $768.6 million. Sales of technology oriented equipment, including digital radiography and CAD/CAM products, accounted for the growth. Revenues from the sale of basic dental equipment infrastructure, primarily consisting of chairs, power units and cabinetry, continued to be soft in fiscal 2012, as practitioners focused purchases on products that they believed gave them higher returns in the near term.

Other dental sales, consisting primarily of technical service parts and labor, software support services and artificial teeth, increased 4.1% in fiscal 2012.

Webster sales grew 12.6% to $734.4 million. Sales of consumables were 10.9% higher in fiscal 2012 and equipment and software sales of $38.3 million represented an increase of 13.4% compared to fiscal 2011. Acquisitions added 1.5% to sales in fiscal 2012. Consumable sales in this segment have benefited from a higher percentage of pharmaceutical sales made under buy-sell versus agency distribution agreements, and an earlier and more severe flea and tick season. We have been investing in the Veterinary segment's equipment and technical service offering to expand this unit's full-service platform.

Patterson Medical sales of $513.3 million were 3.3% higher than fiscal 2011. Acquisitions, contributed 2.3% of sales growth. The positive impact from foreign currency translation rates was 0.6% in fiscal 2012. The capital equipment portion of this segment was negatively impacted by uncertainty in the market caused by regulatory changes in healthcare

Gross Margin. Consolidated gross margin was 32.9% in fiscal 2012 and 33.5% in fiscal 2011.

The Dental segment's gross margin decreased 30 basis points to 36.2% in fiscal 2012. This decrease is mainly due to sales mix as equipment growth outpaced consumable growth during the year.

Gross margin of the Veterinary unit was 18.3%, a decrease of 100 basis points from 19.3% in fiscal 2011. Sales mix was the primary factor in the decline as a higher percentage of revenue came from pharmaceutical sales, which have a lower margin.

Patterson Medical's gross margin declined 10 basis points to 39.0%. This was driven by a slight decrease in point of sale margin and an increase in freight rates, both domestically and internationally.

Operating Expenses. The consolidated operating expense ratio in fiscal 2012 was 22.8%, or 30 basis points higher than fiscal 2011. On a comparable basis, after adjusting for the increase in the ESOP expense discussed above, the operating expense ratio would have been 22.1%, or a decrease of nearly 40 basis points.

The Dental unit's operating expense ratio increased 110 basis points as this unit absorbs the majority of the ESOP expense. In addition, this segment was investing in training of sales personnel and deploying a new order entry system.

The ratio of the Veterinary unit's operating expenses as a percent of sales decreased 80 basis in the current year largely due to leverage of the higher sales levels.

Patterson Medical's operating expense ratio decreased 100 in fiscal 2012. The segment benefited from further integration of recent acquisitions and aggressive expense management.

Operating Income. Operating income was $358.0 million in fiscal 2012, compared to $376.0 million in fiscal 2011. Adjusting for the ESOP expense impact, operating income would have increased year-over-year.

Interest Expense. Interest expense was $30.3 million in fiscal 2012 compared to $25.8 million in fiscal 2011. This increase is due to the issuance of $325 million of debt in the third quarter of the current year. The Company made the decision to raise additional debt capital to take advantage of the favorable rate environment.

Other Income, net. Other income, net of other expenses, was $2.1 million in fiscal 2012 compared to $5.7 million in fiscal 2011. Interest income totaled $4.9 million in fiscal 2012, compared to $8.2 million in fiscal 2011. During fiscal 2011 the Company carried higher average balances of finance contracts while we modified agreements with our funding sources in the period.

Income Taxes. The effective income tax rate was 35.5% in fiscal 2012 as compared to 36.7% in fiscal 2011. The effective tax rate decreased in fiscal 2012 as compared to fiscal 2011 primarily due to an increase in the deductible dividends paid on shares held by our Employee Stock Ownership Plan and the release of reserves resulting from expiring statute of limitations.

Net Income and Earnings Per Share. Net income decreased 6.0% to $212.8 million in fiscal 2012 due primarily to the increase in operating expense as discussed above. Adjusting for the impact of the extra week on fiscal 2011 and the incremental ESOP expense in fiscal 2012, net income would have increased approximately 3%. Earnings per diluted share and dilutive shares outstanding were $1.92 and 110.8 million, respectively, in fiscal 2012 and $1.89 and 119.1 million, respectively, in fiscal 2011.

Fiscal 2011 Compared to Fiscal 2010

Net Sales. Consolidated net sales in fiscal 2011 were $3,415.7 million, an increase of 5.5% from $3,237.4 million in fiscal 2010. The growth in sales includes a 2.1% contribution from acquisitions and a 0.4% favorable impact of changes in foreign currency translation rates. Fiscal 2011 also included an additional or fifty-third week due to our fiscal year convention of ending on the last Saturday in April. It is difficult to quantify the exact impact of this additional week, but estimates have been provided in those areas where it is possible to make reasonable approximations. The impact of the extra week on consolidated sales is estimated to have been approximately one and a half percent.

Dental segment sales in fiscal 2011 rose 3.2% to $2,236.1 million from $2,167.5 million in fiscal 2010. Acquisitions added 0.1% to sales and the impact of currency translation rates was a favorable 0.7%. Consumable sales increased 3.2%, although they were affected by uneven patient demand for dental services as a result of the weak economy. While the economic recovery has been slow, it is believed the fundamentals of the North American dental market continued to strengthen as fiscal 2011 progressed.

Dental equipment and software sales increased 3.6% in fiscal 2011 to $734.7 million. Sales of basic dental equipment and software grew 5.4%, led by sales of digital sensors and cone beam and panoramic imaging systems. Sales of CEREC dental systems declined 2.4%.

As market fundamentals have started to improve, dentists are believed to have gradually become more confident about investing in their practices. In addition, additional marketing programs were implemented at the beginning of the fourth quarter of fiscal 2011. These two factors helped in reaching sales growth of 11.2% in the fourth quarter.

Other dental sales, consisting primarily of technical service parts and labor, software support services and artificial teeth, increased 2.0% in fiscal 2011.

Webster Veterinary sales grew 4.9% to $674.9 million. Sales of consumables were 4.0% higher in fiscal 2011 and equipment and software sales of $34.3 million represented an increase of 16.8% compared to fiscal 2010. The Veterinary equipment business has been growing at solid rates in recent quarters, and we intend to

continue investing in this relatively new portion of Webster's operation that has expanded the unit's full-service platform.

Patterson Medical sales of $504.7 million were 18.4% higher than fiscal 2010. Acquisitions, primarily that of the health care business of DCC plc, contributed 15.3% of sales growth. Internally generated sales growth, which excludes the contribution of acquisitions and a 0.4% negative impact from foreign currency translation rates, was 3.5% in fiscal 2011.

Gross Margin. Consolidated gross margin was 33.5% in fiscal 2011 and 33.7% in fiscal 2010.

The Dental segment's gross margin decreased 30 basis points to 36.5% in fiscal 2011. Lower vendor rebates and a higher level of promotional activities as compared to fiscal 2010 contributed to the decline.

Gross margin of the Veterinary unit was 19.3%, a decrease of 20 basis points from 19.5% in fiscal 2010. Price increases on a line of pharmaceutical products by a manufacturer and lower vendor rebates were primary factors in the decline in gross margin.

Patterson Medical's gross margin of its historical operations expanded during fiscal 2011; however, these improvements were offset by the lower gross margins of the DCC Healthcare acquisitions. For the year, gross margin declined 10 basis points to 39.1%.

Operating Expenses. The consolidated operating expense ratio in fiscal 2011 was 22.5%, or 20 basis points lower than fiscal 2010.

The Dental unit's operating expense ratio decreased 30 basis points, reflecting expense controls and leverage gained from higher sales on fixed costs.

The ratio of the Veterinary unit's operating expenses as a percent of sales decreased 80 basis points, due to leverage on higher sales and cost savings from the integration of the October, 2008 Columbus Serum acquisition. Those integration activities were completed in fiscal 2010.

Patterson Medical's operating expense ratio increased 80 basis points in fiscal 2011 due to the cost structure of the DCC acquisition. Integration of the DCC entities has progressed throughout the year and is largely complete.

Operating Income. Operating income was $376.0 million in fiscal 2011, or 5.8% higher compared to $355.3 million in fiscal 2010. Operating margin was 11.0% in fiscal years 2011 and 2010, respectively.

Interest Expense. Interest expense was $25.8 million in fiscal 2011 compared to $25.7 million in fiscal 2010.

Other Income, net. Other income, net of other expenses, was $5.7 million in fiscal 2011 compared to $9.4 million in fiscal 2010. The decrease was due to losses related to the Veterinary unit's equity interest in VetSource. Interest income totaled $8.2 million in fiscal 2011, compared to $8.6 million in fiscal 2010.

Income Taxes. The effective income tax rate was 36.7% in fiscal 2011 as compared to 37.4% in fiscal 2010. A portion of the dividends paid on shares held by our Employee Stock Ownership Plan are deductible on our income tax return. As there were more dividends paid in fiscal 2011 than in fiscal 2010, the deductible amount was larger, resulting in a lower effective income tax rate in fiscal 2011.

Net Income and Earnings Per Share. Net income increased 6.2% to $225.4 million in fiscal 2011 due primarily to the increase in operating income as discussed above. Earnings per diluted share and dilutive shares outstanding were $1.89 and 119.1, respectively, in fiscal 2011 and $1.78 and 119.2 million, respectively, in fiscal 2010.

Liquidity and Capital Resources

Patterson's operating cash flow has been our principal source of liquidity in the last three fiscal years. During fiscal 2012, we used our revolving credit facility periodically as a source of liquidity in addition to operating cash flow.

Operating activities generated cash of $321.2 million in fiscal 2012, compared to $262.6 million in fiscal 2011 and $265.5 million in fiscal 2010. In fiscal 2012, 2011 and 2010, we invested in financing programs to support marketing efforts directed at the equipment product lines, particularly in the Dental segment.

Capital expenditures were $29.7, $36.9 and $29.8 million in fiscal years 2012, 2011 and 2010, respectively. Significant expenditures in these years included the purchase and expansion of distribution facilities to accommodate multiple business units, the construction of a new facility for the Patterson Technology Center, the expansion of the general office building and continuing investments in information systems. In fiscal 2012, a project to build-out a purchased building in Indiana was completed, the building serves as a distribution facility used by all three business units. This facility is replacing several smaller distribution facilities. In addition, the Patterson Technology Center facility in Illinois was completed in fiscal 2012. This 100,000 square foot state-of-the-art facility replaced a nearby leased location and opened in the second quarter of fiscal 2012.

We expect to invest approximately $23 million in capital expenditures during fiscal 2013, our main investment is in information systems.

Cash used for acquisitions and equity investments totaled $22.6 million in fiscal 2012, $52.2 million in fiscal 2011 and $53.7 million in fiscal 2010. The majority of the cash used for acquisitions in fiscal 2012 related to the acquisitions of AVSC and Surgical Synergies. The Medical segment's acquisition of the healthcare assets of DCC plc. accounted for the majority of the cash used in fiscal 2011, while the acquisition of the rehabilitation business of Empi Therapy Solutions and the investment in Strategic Pharm-dba VetSource accounted for the majority of the cash used in fiscal 2010.

In fiscal 2012 we entered in to a new debt agreement for $325 million; see Note 7 of the Consolidated Financial Statements, "Long-term Debt." footnote for further information. There were neither issuances of, nor payments on, debt during fiscal 2011. In fiscal 2010, Patterson fully paid the $22 million that was outstanding under a revolving credit facility at the end of fiscal 2009. A maximum of $300 million is available under this facility, which expires in fiscal 2013.

In the fourth quarter of fiscal 2010, we declared and paid an initial quarterly cash dividend of $0.10 per share, which was increased to $0.12 per share in the fourth quarter of fiscal 2011 and the dividend continued at this rate through the third quarter of fiscal 2012. The dividend was increased to $0.14 per share in the fourth quarter of fiscal 2012. Total dividends paid in fiscal 2012 and fiscal 2011 were $54.7 million and $50.0 million, respectively. We expect to continue to pay a quarterly cash dividend for the foreseeable future. In addition, during fiscal 2012 we repurchased approximately 12.0 million shares of common stock for approximately $361 million. In fiscal 2011 we repurchased approximately 3.3 million shares of common stock for approximately $99 million. Under a share repurchase plan authorized by the board of directors, as of April 28, 2012, Patterson may repurchase up to an additional 11 million shares of its common stock. This authorization remains in effect through March 15, 2016.

Management expects funds generated from operations and existing cash to be sufficient to meet our working capital needs for the next fiscal year. We have approximately $189 million in foreign bank accounts. None of which are subject to any withdrawal restrictions. See Note 11, "Income Taxes" for further information regarding our intention to permanently reinvest these funds. We expect to continue to obtain liquidity from the sale of equipment finance contracts. Patterson's existing debt facilities are believed to be adequate as a supplement to internally generated cash flows to fund anticipated expansion plans and strategic initiatives, including acquisitions.

Patterson sells a significant portion of our finance contracts 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. Patterson is allowed to participate in the conduit due to the quality of our finance contracts and our financial strength. Cash flow 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

Patterson is a party to two arrangements under which we have sold finance contracts received from our customers to outside financial institutions. These arrangements provide sources of liquidity for us that would have to be replaced should any of the current financial institutions be unable or unwilling to continue under them.

In December 2010, the Receivables Purchase Agreement was amended to make The Bank of Tokyo-Mitsubishi UFJ, Ltd. ("BTMU") the managing agent. As of April 28, 2012, the capacity under this agreement is $500 million, $300 million with BTMU and the remainder with Royal Bank of Canada [RBC]. In August 2011, Fifth Third Bank [FTB] replaced U.S. Bank National Association as the agent under the Contract Purchase Agreement, which has a capacity of $75 million as of April 28, 2012. Our financing business is described in further detail in Note 6 of the Notes to the Consolidated Financial Statements in Item 8 of this Form 10-K. Note 6, "Customer Financing", discusses the nature and business purpose of the arrangements and the activity under each arrangement during fiscal 2012, including the amount of finance contracts sold and the holdback receivable owed to us.

Contractual Obligations

A summary of Patterson's contractual obligations as of April 28, 2012 follows
(in thousands):



                                                            Payment due by year
                                                Less than                                       More than
Contractual Obligations            Total          1 year        1-3 years       3-5 years        5 years
Long-Term Debt                   $ 850,000      $  125,000      $  250,000         000,000         475,000
Interest on Long-Term Debt         210,639          36,592          65,967          40,117          67,963
Operating Leases                    71,119          18,392          25,392          16,511          10,824

Patterson is unable to determine its contractual obligations by year related to the provisions of ASC Topic 740, "Income Taxes", as the ultimate amount or timing of settlement of its reserves for income taxes cannot be reasonably estimated. The total liability for unrecognized tax benefits including interest and penalties at April 28, 2012, is $20.7 million.

For a more complete description of Patterson's contractual obligations, see Notes 7 and 10 to the Consolidated Financial Statements in Item 8 of this Form 10-K.

Outlook

Over the last ten years, we have been able to grow revenue and earnings through our strategy of emphasizing value-added, full-service capabilities, using technology to enhance customer service, continuing to improve operating efficiencies, and growing through internal expansion and acquisitions. While the weakness in the general economy that has existed during much of fiscal 2012 and 2011 is expected to continue to affect our performance for at least the near term, Patterson's strategy will continue to focus on these key elements. With strong operating cash flow and available credit capacity, we are confident that we will be able to financially support our future growth. We believe that the strategic initiatives that we have implemented in the past several years, as well as those that will be implemented in fiscal 2013 and beyond, will strengthen our operational

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