XNAS:PSSI Annual Report 10-K Filing - 3/30/2012

Effective Date 3/30/2012

Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

FORM 10-K

 

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

For the Fiscal Year Ended March 30, 2012

or

 

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

Commission file number 0-23832

 

 

 

LOGO

PSS WORLD MEDICAL, INC.

(Exact name of Registrant as specified in its charter)

 

FLORIDA   59-2280364
(State of incorporation)  

(I.R.S. Employer

Identification No.)

4345 Southpoint Boulevard
Jacksonville, Florida
  32216
(Address of principal executive offices)   (Zip Code)
 

Registrant’s telephone number, including area code (904) 332-3000

Securities registered pursuant to Section 12(b) of the Act:

 

Title of each class

     

Name of Exchange on which registered

Common Stock, $0.01 par value per share     NASDAQ GS Stock Market

Securities registered pursuant to Section 12(g) of the Act: None

 

 

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.

    Yes  x     No  ¨

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.    Yes  ¨    No  x

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    No  ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 229.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  x    No  ¨

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.    ¨

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

 

Large accelerated filer   x    Accelerated filer   ¨
Non-accelerated filer   ¨    Smaller reporting company   ¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

Yes  ¨    No  x

The aggregate market value of common stock held by non-affiliates, computed by reference to the closing price as reported on the NASDAQ GS, as of September 30, 2011 was approximately $999,962,086.

The number of shares of Common Stock, $0.01 par value, of the Registrant outstanding as of May 18, 2012, was 50,427,436.

 

 

 


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Document Incorporated by Reference

Portions of the Registrant’s Definitive Proxy Statement for the 2012 Annual Meeting of Stockholders, which will be filed with the Securities and Exchange Commission not later than 120 days after March 30, 2012, are incorporated by reference into Part III of this Annual Report on Form 10-K.


Table of Contents

TABLE OF CONTENTS

 

Item

       Page  
 

Cautionary Statements - Forward-Looking Statements

     1   
 

Part I

  
1.  

Business

     3   
1A.  

Risk Factors

     12   
1B.  

Unresolved Staff Comments

     23   
2.  

Properties

     23   
3.  

Legal Proceedings

     25   
4.  

Mine Safety Disclosures

     25   
 

Part II

  
5.  

Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

     25   
6.  

Selected Financial Data

     28   
7.  

Management’s Discussion and Analysis of Financial Condition and Results of Operations

     29   
7A.  

Quantitative and Qualitative Disclosures About Market Risk

     57   
8.  

Financial Statements and Supplementary Data

     F-1   
9.  

Changes in and Disagreements with Accountants on Accounting and Financial Disclosure

     59   
9A.  

Controls and Procedures

     59   
9B.  

Other Information

     61   
 

Part III

  
10.  

Directors, Executive Officers and Corporate Governance

     62   
11.  

Executive Compensation

     62   
12.  

Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters

     62   
13.  

Certain Relationships and Related Transactions, and Director Independence

     62   
14.  

Principal Accountant Fees and Services

     62   
 

Part IV

  
15.  

Exhibits and Financial Statement Schedules

     63   
 

Signatures

     68   


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CAUTIONARY STATEMENTS

Forward-Looking Statements

Management may from time-to-time make written or oral forward-looking statements with respect to the Company’s annual or long-term goals, including statements contained in this Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, reports to shareholders, press releases, and other communications. These statements are subject to risks and uncertainties that could cause actual results to differ materially from historical earnings and those currently anticipated or projected. Management cautions readers not to place undue reliance on any of the Company’s forward-looking statements, which speak only as of the date made.

Words such as “anticipates,” “expects,” “intends,” “plans,” “purpose,” “mission,” “believes,” “seeks,” “estimates,” “may,” “could,” and similar expressions identify forward-looking statements. Forward-looking statements contained in this Annual Report on Form 10-K involve risks and uncertainties include, but may not be limited to:

 

   

Management’s belief that the Company’s strategic restructuring will positively impact its financial results and better position the Company to participate among the fastest growing of the alternate-site healthcare market segments;

 

   

Management’s belief that the healthcare services industry will continue to be subject to extensive regulation at the federal, state, local and foreign levels and that enforcement activities will continue to increase;

 

   

Management’s belief that consolidation in the healthcare industry will continue among provider groups, long-term care facilities, and other alternate site providers, as well as health systems created through alliances between hospitals and long-term care facilities or physician practices;

 

   

Management’s belief that the outcome of legal proceedings or claims which are pending or known to be threatened will not have a material adverse effect on the Company’s consolidated financial position, liquidity, or results of operations;

 

   

Management’s expectation that the remaining federal and state net operating loss carryforwards will be utilized prior to their expiration date, that the Company’s deferred tax assets as of March 30, 2012 will be realizable to reverse deferred tax liabilities and offset a portion of projected future taxable income, and that the Company’s unrecognized tax benefits will not change significantly over the next twelve months;

 

   

Management’s expectation to make strategic business acquisitions to increase market share and leverage distribution capabilities;

 

   

Management’s expectation that future working capital needs, capital expenditures, and the overall growth in the business will be funded through a combination of cash flows from operating activities, borrowings under the revolving line of credit, cash proceeds from the sale of the businesses outlined in the Company’s strategic restructuring plan, proceeds from the Company’s debt offerings, capital markets, and/or other financing arrangements;

 

   

Management’s belief that the Company’s global sourcing initiative will continue to impact net operating working capital levels and will continue to positively impact the Company’s results of operations;

 

   

Management’s expectation that the reorganization of the Company’s global sourcing subsidiaries will have a sustained positive impact on the Company’s effective tax rate;

 

   

Management’s intention to permanently reinvest undistributed earnings attributable to foreign operations;

 

   

Management’s intention to retain earnings for the growth and development of the Company’s business and not declare cash dividends in the immediate future;

 

   

Management’s belief that the Company may seek to retire a portion of its outstanding equity through cash purchases and may also seek to issue additional equity to meet its future liquidity requirements;

 

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Management’s belief that the medical products distribution industry is expected to experience continued growth due to the aging U.S. population, increased healthcare awareness, the introduction of new medical technology, the development of new pharmacology treatments, and recently enacted health care reform legislation;

 

   

Management’s belief that the extended care market is expected to benefit from the increasing growth rate of the U.S. elderly population, the increased incidence of chronic conditions, the growing acceptance of and emphasis on lower-cost alternate site treatment and the increased treatment of higher acuity patients in nursing homes;

 

   

Management’s belief that the physician market is expected to grow, due, in part, to the shift of procedures and diagnostic testing away from acute care settings to lower cost settings, such as the physician’s office, and from increased consumption of healthcare products and services, resulting from an aging U.S. population and the expected increase in utilization from the implementation of health care reform in 2014, offset by slower growth in the near term due to economic conditions and unemployment rates;

 

   

Management’s intent to either renegotiate existing leases or execute new leases upon the expiration date of such agreements, except for those that may be exited through the Company’s restructuring plan;

 

   

Management’s estimation and expectation of future payouts of long-term incentive compensation;

 

   

Management’s expectation that near term sales growth rates, excluding acquisitions, will remain lower than historical growth rates, due to economic conditions and lower patient utilization;

 

   

Management’s expectation that government funded programs will become more prevalent and that, as a result, reimbursements may become more reliant on federal and state budgets; and

 

   

Management’s belief that the Company’s distribution infrastructure is adequate to carry on its business as currently conducted and that, if necessary, the Company could find additional and/or replacement facilities to lease without suffering a material adverse effect on its business.

In connection with the “safe harbor” provisions of the Private Securities Litigation Reform Act of 1995, management has identified important factors that could affect the Company’s financial performance and could cause actual results for future periods to differ materially from those expressed in any forward-looking statements, including the risks described or referred to in Item 1A. Risk Factors.

The Company cautions readers not to place undue reliance on any of these forward-looking statements, which speak only as of the date made. The Company undertakes no duty and is under no obligation to update or revise any forward-looking statements, whether as a result of new information, future events or otherwise.

Third-Party Statistical Data

This report contains estimates and other information concerning the Company’s industry, including market size and growth rates, which are based on industry publications, analyst reports, surveys and forecasts. These estimates involve a number of assumptions and limitations, and you are cautioned not to give undue weight to these estimates. Although the Company believes the information in these industry publications, surveys and forecasts is reliable, it has not been independently verified and therefore the accuracy or completeness of the information cannot be guaranteed.

 

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PART I

 

ITEM 1. BUSINESS

THE COMPANY

PSS World Medical, Inc. (the “Company” or “PSSI”), a Florida corporation, began operations in 1983. The Company is a national distributor of medical products and supplies, diagnostic equipment, healthcare information technology and pharmaceutical products, and provides professional and consulting services to the physician, long-term care, assisted living, home health care, and hospice markets. The Company has full service distribution centers strategically located to efficiently serve all 50 states throughout the United States.

The Company’s business decisions and strategies are guided by its Purpose and Mission. The Company’s stated Purpose is to strengthen the clinical success and financial health of caregivers by solving their biggest problems. The Company’s Mission is to improve caregivers’ financial performance by 20%.

The Company currently conducts business through two operating segments, the Physician Business and the Extended Care Business, which serve a diverse customer base. During the year ended March 30, 2012, the Company rebranded its Elder Care Business to the “Extended Care Business” to more appropriately align with its customer base. A third reporting segment, Shared Services, consists of departments that support the operating segments through the delivery of standardized service. For information on comparative segment revenue, segment profit and related financial information, refer to Footnote 18, Segment Information, of the consolidated financial statements.

PSSI is a market leader in the two alternate-site customer segments it serves as a result of a high-touch, differentiated business model; value-added, solutions-based marketing programs; a consultative sales force with extensive product, disease state, reimbursement, and supply chain knowledge; a successfully expanded product and service offering including unique arrangements with manufacturers and a full line of the Company’s store brands; innovative information systems and customer-facing technologies that serve its core markets; and a culture of performance.

During the first quarter of fiscal year 2013, the Company’s Board of Directors approved a strategic restructuring plan (“the restructuring plan”), designed to transform the Company by focusing on four lines of business – Physician, Laboratory, In-Office Dispensing, and Home Care and Hospice. The restructuring plan will include the sale of two business units serving skilled nursing facilities within the Extended Care Business and specialty dental practices within the Physician Business. Additionally, the restructuring plan includes the integration of warehouse operations into one common distribution infrastructure, as well as a redesign of the shared services function. These efforts are expected to reduce operating costs as a percentage of net sales, while streamlining decision making and improving service. The Company expects to complete the restructuring plan within the next several fiscal years. Except as otherwise noted, the information contained in this Form 10-K reflects Company information as of March 30, 2012, before the announcement and commencement of the strategic restructuring plan.

THE INDUSTRY

The Company’s business strategies focus on the alternate site healthcare provider market, which is comprised of the estimated $12 billion physician office market, the $4 billion long-term care and assisted living market, and the $11 billion home health and hospice markets, in each case as estimated in industry analyst reports. The Company targets approximately 212,000 sites in the physician office market and 40,000 sites in the extended care market.

The medical products distribution industry is expected to experience continued growth due to the aging U.S. population, increased healthcare awareness, the introduction of new medical technology, new pharmaceutical treatments, and recently enacted health care reform legislation, which includes expanded insurance coverage. The physician market is expected to grow, due, in part, to the shift of procedures and diagnostic testing away from acute care settings to lower cost settings, such as the physician’s office, and from increased consumption of healthcare products and services, resulting from an aging U.S. population and the expected increase in utilization from the

 

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implementation of health care reform legislation. This growth may be slowed somewhat in the near term due to general economic conditions. The extended care markets are also expected to benefit from the increasing growth rate of the U.S. elderly population, the increased incidence of chronic conditions, the growing acceptance of and emphasis on lower-cost alternate site treatment and the increased treatment of higher acuity patients in nursing homes. As of August 2008, the U.S. Bureau of the Census report estimated the U.S. elderly population will more than double by 2050, with Americans age 85 years and older, the population in the greatest need of extended care services, projected to more than triple during this period.

According to industry analyst reports, the physician office end market is expected to grow at a long-term rate of 5% to 7%, the long-term care market is expected to grow at a rate of 1% to 3%, and the home health care market is expected to grow at a rate of 5% to 7%.

In recent years, the healthcare industry has experienced consolidation among provider groups, long-term care facilities, and other alternate site providers, as well as health systems created through alliances between hospitals and long-term care facilities or physician practices. The Company expects such consolidation activities to continue.

THE PHYSICIAN BUSINESS

The Physician Business operates through the Company’s Physician Sales & Service division and is a leading distributor of medical supplies, diagnostic equipment, healthcare information technology, pharmaceutical products and provider of professional and consulting services, based on revenues, number of customers and number of sales professionals. The Physician Business serves alternate site healthcare providers, including independent physicians and physician groups, community health centers, urgent care facilities, health system affiliated practices and other non-hospital based caregivers. The Physician Business has approximately 850 sales professionals trained in solution-focused selling, disease state management, and diagnostic and therapeutic products used by healthcare providers.

Customers

The Physician Business distributes products and offers services to office-based physicians who specialize in internal medicine, family practice, primary care, pediatrics, OB/GYN, cardiology, orthopedics, general practice, and other specialties. The Physician Business’ target market consists of approximately 498,000 independent physicians practicing at approximately 212,000 offices in the United States.

The Physician Business also distributes products and offers services to office-based physicians operating under the ownership of private or public companies or acute care facilities that range in size from small hospitals to large integrated delivery network systems (collectively “health systems”). Physicians employed by health systems are generally concentrated in the same specialties as independent physicians.

Customer pricing for each product is generally either negotiated directly with the physician office or contracted through group purchasing organizations (“GPOs”). GPOs negotiate directly with medical product manufacturers and distributors on behalf of their members, establishing exclusive or multi-supplier relationships.

Distribution Infrastructure

As of March 30, 2012, the Physician Business operated a distribution network consisting of 33 full-service distribution centers, 39 break-freight locations, 2 other operations-related facilities, and 2 redistribution facilities, some of which are shared with the Extended Care Business, to serve customers throughout the United States. The operations of a full-service distribution center include sales support and certain administrative functions, such as customer billing and customer service, as well as general warehousing functions, inventory management, and product delivery. Inventory purchasing is centralized at the Company’s Shared Services segment in Jacksonville, Florida. Full-service distribution centers receive inventory directly from manufacturers and redistribution centers. The distribution centers deliver product to customers and break-freight locations on a daily basis via the Company’s fleet of leased vehicles or third party transportation providers. Break-freight locations are warehouse facilities that receive packaged customer orders from full-service distribution centers and distribute them directly to customers on a daily basis. The Physician Business provides service to its customers through myPSS.com, a customer and sales force internet ordering portal, and SmartScan, a handheld inventory management device that allows customers to order product electronically and provides basic inventory management functions.

 

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Products

The Physician Business distributes approximately 164,000 different products consisting of disposable supplies, pharmaceuticals, diagnostic equipment, and non-diagnostic equipment. Additionally, the Physician Business offers healthcare information technology solutions and physician dispensing solutions.

Branded Medical-Surgical Disposable Supplies. This product category includes a broad range of medical supplies, including paper goods, needles and syringes, gauze and wound dressings, surgical instruments, sutures, examination gloves, orthopedic soft goods, tongue blades and applicators, sterilization and intravenous solutions, specimen containers, reagents for diagnostic equipment, and diagnostic rapid test kits. The Physician Business offers a broad array of branded products sourced from various medical product manufacturers.

Store Brand Medical-Surgical Disposable Supplies and Equipment. The Company offers its own products in connection with its strategy of sourcing through global channels to drive enhanced customer satisfaction and profitability. This product category includes a broad range of medical supplies, including paper goods, needles and syringes, gauze and wound dressings, surgical instruments, sutures, examination gloves, orthopedic soft goods, tongue blades and applicators, sterilization products, specimen containers, reagents for diagnostic equipment, and diagnostic rapid test kits marketed under various Company brand names.

Pharmaceutical Products. This product category includes various vaccines, injectables, inhalants, topicals, ophthalmic ointments and solutions, otic solutions and oral analgesics, antacids and antibiotics, and controlled pharmaceutical products, which are used or administered in the physician’s office. Controlled pharmaceutical products include injectable anesthesia agents, narcotics, and pain management drugs.

Diagnostic Equipment. This product category includes various equipment lines such as blood chemistry analyzers, automated cell and differential counters, immunoassay analyzers, bone densitometers, electrocardiograph monitors and defibrillators, cardiac stress systems, cardiac and OB/GYN ultrasound, holter monitors, flexible sigmoidoscopy scopes, and microscopes. Sales of certain diagnostic equipment generate recurring orders of disposable diagnostic reagents and supplies consumed in the operation of the equipment.

Non-Diagnostic Equipment. This category includes all other equipment used in a medical practice such as aesthetic lasers, autoclaves, examination tables, medical scales, and furniture.

Healthcare Information Technology. This category includes healthcare information technology products and services designed to improve the accuracy, efficiency, and effectiveness of physician business practices.

Physician Dispensing Solutions. The Physician Business provides dispensing solutions to physician business practices which include repackaging of medical products, dispensing software, claims processing services, formulary consultation services and compliance necessary for such practices to dispense medical products to their patients on-site. Medical products provided include pharmaceuticals repackaged for patient dispensing and equipment such as transcutaneous electrical nerve stimulation units.

Competition

The Physician Business operates in a highly competitive industry where products and services are readily available to customers from a number of manufacturers, distributors, and suppliers. Competitors of the Physician Business include large, national, full-line distributors, many smaller regional and local distributors, and manufacturers who sell directly to customers. Competitive factors within the medical/surgical supply distribution and services industry include pricing, product availability, sales force capabilities, delivery time, electronic commerce capabilities and relationships with customers, as well as the ability to meet customer-specific requirements.

 

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THE EXTENDED CARE BUSINESS

The Extended Care Business operates through the Gulf South Medical Supply, Inc. subsidiary and is a national distributor of medical supplies and related products and solutions to the extended care industry in the United States. The Extended Care Business serves the skilled nursing home, assisted living, home health care and hospice markets. In addition, the Extended Care Business provides Medicare Part B and Medicaid billing services. The home health care industry refers to providers (companies, agencies, and care givers) of medical services, medical supplies, and equipment to patients in a residential setting. The Extended Care Business has approximately 170 sales professionals trained in solution-focused selling, disease state management and diagnostic and therapeutic products used in extended care settings.

Customers

The Extended Care Business’ target market consists of approximately 40,000 independent, regional, and national nursing home facilities, home health agencies, assisted living centers, hospices, and home medical equipment dealers. Approximately 16%, 16%, and 15%, of the Extended Care Business’ net sales for fiscal years 2012, 2011, and 2010, respectively, represent net sales to its largest five customers.

Distribution Infrastructure

As of March 30, 2012, the Extended Care Business operated a distribution network consisting of 18 full-service distribution centers, 10 break-freight locations, 2 other operations-related facilities, and 2 redistribution centers, some of which are shared with the Physician Business, to serve customers throughout the United States. The operations of a full-service distribution center include general warehousing functions such as inventory management, warehouse management, and product delivery directly to customers on a daily basis. Full-service distribution centers receive inventory directly from manufacturers and redistribution centers and distribute product to customers and break-freight locations. Break-freight locations receive packaged customer orders from full-service distribution centers and distribute them directly to customers on a daily basis. Product is delivered using either the Company’s fleet of leased delivery vehicles or third party transportation providers. Accounts receivable collections, cash application, customer billing, and inventory purchasing are centralized in the Company’s Shared Services segment in Jacksonville, Florida, while customer order processing, customer service, and sales support are centralized in Jackson, Mississippi. Coupled with a team of sales professionals, myGSOnline, an automated customer internet platform, and SmartScan, the Extended Care Business provides service to customers ranging from nursing homes to providers of home health, hospice, sub-acute, rehabilitation, and transitional care.

Products

The Extended Care Business distributes approximately 46,000 different medical and related products consisting of medical supplies, incontinent supplies and personal care items, enteral feeding supplies, point of care testing devices, advanced wound care, home medical equipment, and other supplies required to provide long-term care. The Extended Care Business offers a broad array of branded products from various manufacturers. In addition, the Company offers its own store brands, including Select Medical Products and other specialty brand products, in connection with its strategy of sourcing through global channels to drive enhanced customer satisfaction and profitability.

Services

The Extended Care Business, through its wholly-owned subsidiary, Proclaim, Inc., provides Medicare Part B and Medicaid billing services to the nursing home and assisted living markets. The Extended Care Business also provides consulting services to extended care providers through its noncontrolling interest in Pathway Health Services, Inc. (“Pathway”).

 

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Competition

The Extended Care Business operates in a highly competitive industry where products and services are readily available to customers from a number of manufacturers, distributors, suppliers, and service providers. Competitors of the Extended Care Business include large, multinational, full-line distributors, many smaller regional and local distributors, manufacturers who sell directly to customers, and Medicare Part B billing service providers. Competitive factors within the extended care industry include pricing, product availability, delivery time, electronic commerce capabilities, as well as the ability to meet customer-specific requirements.

SHARED SERVICES

The Company’s Shared Services segment consists of departments that support the Company’s operating segments through the delivery of standardized service. Shared Services includes executive and administrative services; accounting and finance; information technology development and support; shared operations management; legal and regulatory compliance; human resources; training and development; supplier management; and sourcing and procurement of inventory. Shared Services allocates a portion of its operating costs and interest expense to the operating segments. The allocation of these costs is generally proportionate to the revenues of each operating segment. Interest expense is allocated based on an internal carrying value of historical capital used to acquire or develop the operating segments’ operations.

SUPPLIER RELATIONSHIPS

Supplier relationships are an integral part of the Company’s businesses. Sales support, performance incentives, product literature, samples, demonstration units, training, marketing intelligence, distributor discounts and rebates, and new products are important elements of developing successful supplier relationships. The Company seeks to increase profitability by purchasing certain medical supplies, pharmaceutical products, and equipment at the lowest available price through volume discounts, rebates, and product category consolidation under contracts with terms negotiated by the Company’s supplier management professionals.

The Company pursues opportunities to market and sell medical equipment and supplies through unique or exclusive marketing arrangements. Manufacturers of medical supplies and diagnostic equipment often seek to optimize the number of distributors selling their products to end users in order to reduce the cost associated with marketing and field sales support. The Company has been successful in obtaining unique or exclusive arrangements to sell certain products based on the size of its sales force and the effectiveness of its marketing programs.

GLOBAL PRODUCT SOURCING

The Company’s global sourcing activities include identification of manufacturers in foreign locations, selection and specification of products to be manufactured, management of quality assurance programs and controls, and alignment of product availability and customer needs. The Company’s global sourcing team, located in U.S. and foreign locations, consists of fully dedicated functional experts in areas such as product development, global sourcing, logistics, supply chain design and management, supplier relations, product management, quality assurance, and quality control.

As of March 30, 2012, the Company had approximately $49.6 million of globally-sourced product inventory, which represented approximately 1,200 SKUs and 200 product categories. These products were sourced from approximately 72 manufacturers located in countries including Canada, China, India, Japan, Malaysia, Mexico, Philippines, Poland, South Korea, Taiwan, and the United Kingdom.

INFORMATION SYSTEMS

The Physician and Extended Care Businesses operate the Oracle JD Edwards XE platform as the primary enterprise resource planning (“ERP”) system.

 

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The Physician Business’ internet portal, myPSS.com, provides its customers and sales representatives with sales history, accounts receivable detail, available inventory and supports a number of ordering methods. The Physician Business’ laptop-based sales force automation application, known as “ICON”, carries customer order history and accounts receivable detail, reflects on-hand inventory quantities for the local distribution center, and transmits orders over a secure wireless network. During the fourth quarter of fiscal year 2012, the Company enhanced the myPSS.com internet portal to allow for sales force ordering and began to phase out ICON. Online order processing is supplemented in the Physician Business with SmartScan, the Company’s handheld inventory management device. Approximately 75% of customer orders in the Physician Business are electronic orders.

The Extended Care Business’ internet portal, myGSOnline.com, provides its customers and sales representatives with sales history, accounts receivable detail, available inventory, and supports a number of ordering methods. The Extended Care Business offers its customers a wide variety of electronic data interchange (“EDI”) services whereby orders, order acknowledgments, invoices, and other industry standard EDI transactions are available electronically. This improves efficiency and timeliness for the Company and its customers. Approximately 83% of customer orders in the Extended Care Business are electronic orders.

During fiscal year 2012, the Company continued its focus on increasing its internet, e-commerce and EDI capabilities to connect more effectively with customers and suppliers. Additionally, the Company continued the implementation of a warehouse management system to streamline warehouse management, enhance inventory controls, and improve customer service.

REGULATORY MATTERS

General

Federal, state, local, and foreign government agencies extensively regulate the distribution and sale of medical devices, medical supplies and pharmaceutical products, and the billing of government-sponsored healthcare programs. Applicable federal, state and foreign statutes and regulations require the Company to meet various standards relating to, among other things, licensure, personnel, physical security, maintenance of proper records, privacy of health information, maintenance and repair of equipment, and quality assurance programs.

The Company’s costs associated with complying with the various applicable federal and state statutes and regulations, as they now exist and as they may be modified, could be material. Although the Company intends to comply with all applicable laws and regulations, many of them have been recently enacted, are broadly worded, and have not been interpreted by regulators and the courts. Consequently, they have been and may continue to be interpreted or applied by governmental authorities in a manner that differs from the Company’s interpretation, which has required and could continue to require the Company to make changes in its operating procedures which may increase operating costs. Future allegations by a state or the federal government that the Company has not complied with these laws could have a material adverse impact on the Company. If it is determined that the Company has not complied with these laws, or if the Company enters into settlement agreements to resolve allegations of non-compliance, the Company could be required to make settlement payments, quarantine or destroy inventory, or be subject to civil and criminal penalties, including fines and the loss of licenses or its ability to participate in Medicare, Medicaid, and other federal and state healthcare programs. In addition, the enforcement of these laws and regulations has increased and is expected to increase in the future. Any of the foregoing could have a material adverse impact on the Company. The Company believes that the healthcare services industry will continue to be subject to extensive regulation and enforcement at the federal, state, local, and foreign levels.

Healthcare Fraud and Abuse Laws

The Company is subject to extensive state and federal laws and regulations relating to healthcare fraud and abuse. Federal and state governments continue to scrutinize potentially fraudulent practices in the healthcare industry in an attempt to minimize the cost that such practices have on Medicare, Medicaid, and other government healthcare programs. Under Medicare, Medicaid, and other government-funded healthcare programs, the federal government enforces a federal law called the Anti-Kickback Statute. The Anti-Kickback Statute, and the related regulations prohibits any person from offering, paying, soliciting or receiving anything of value to or from another person to

 

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induce the referral of business, including the sale or purchase of items or services covered by Medicare, Medicaid, or other federally subsidized programs. Many states also have similar anti-kickback statutes. The Federal False Claims Act provides that those who knowingly submit, or cause another person or entity to submit, false claims for payment of government funds are liable for three times the government’s damages, plus civil penalties.

The Patient Protection and Affordable Care Act (“PPACA”), enacted in March 2010, known as “The Health Care Reform Bill,” significantly strengthened the Federal False Claims Act, and the Anti-Kickback provisions, which could lead to increased whistleblower or related suits. The Physician Payment Sunshine Act, which is a provision of the PPACA, imposed new reporting and disclosure requirements for pharmaceutical, medical device, and medical supply distributors and manufacturers with regard to payments or other transfers of value made to physicians and teaching hospitals. The Centers for Medicare and Medicaid Services (“CMS”) has delayed the implementation of the reporting requirements to an unspecified date allowing for the review of comments resulting from the published interim rules. Additional implemented or pending state legislation surrounding payments or other transfers of value made to certain practitioners requires disclosure and reporting.

State and Federal Drug Pedigree Laws

There have been increasing efforts by various levels of government to regulate the pharmaceutical distribution system in order to prevent the introduction of counterfeit, adulterated, or misbranded pharmaceuticals into the distribution system. Several states have enacted or proposed laws and regulations designed to protect the integrity of the supply channel for the distribution of pharmaceutical products. For example, several states have implemented drug pedigree requirements that require prescription drugs to be distributed with records or information documenting the prior distribution of the drug back to the manufacturers. In addition, California has proposed legislation that will require the implementation of an electronic drug pedigree system that provides “track and trace” chain of custody technologies, such as radio frequency identification (“RFID”) technologies by January 1, 2016 for wholesale distributors and repackagers. At the federal level, the FDA issued final regulations pursuant to the Prescription Drug Marketing Act that became effective in December 2006. The regulations impose drug pedigree and other chain of custody requirements that increase the costs and/or burden of selling products and handling product returns. There is currently a case pending in the Federal District Court for the Eastern District Court of New York enjoining the implementation of some of the federal drug pedigree requirements, in response to a case initiated by secondary distributors. Moreover, the United States Food and Drug Administration Amendments Act of 2007 require the FDA to establish standards to provide for the development of a standardized numerical identifier and include track and trace or authentication technologies, such as RFID and other technologies. In the future, Congress may implement legislation that would revise and expand the federal pedigree requirements. If enacted, these pedigree requirements could preempt existing state pedigree requirements and the Company may have to adopt or modify its operations to initiate and transmit electronically-coded pedigree information concerning the purchase and transmittal of prescription drugs in all 50 states.

The Food, Drug and Cosmetic Act, Prescription Drug Marketing Act of 1987, Safe Medical Devices Act of 1990, Controlled Substances Act and Various State Regulations

The Company’s business is subject to regulation under the Federal Food, Drug and Cosmetic Act, the Prescription Drug Marketing Act of 1987, the Safe Medical Devices Act of 1990, and state laws and regulations applicable to the manufacture, importation, and distribution of medical devices and over-the-counter pharmaceutical products, as well as the distribution of prescription pharmaceutical products or dispensing of pre-packaged prescription pharmaceuticals products. In addition, the Company is subject to regulations issued by the United States Food and Drug Administration (“FDA”), the Drug Enforcement Administration (“DEA”), and comparable state agencies.

The Federal Food, Drug, and Cosmetic Act generally regulates the manufacture and importation of drugs and medical devices shipped via interstate commerce, including such matters as labeling, packaging, storage, and handling of such products. The Prescription Drug Marketing Act of 1987, which amended the Federal Food, Drug and Cosmetic Act, establishes certain requirements applicable to the wholesale distribution of prescription drugs, including the requirement that wholesale drug distributors be registered with the Secretary of Health and Human Services or be licensed in each state in which business is conducted in accordance with federally established guidelines on storage, handling, and records maintenance. The Safe Medical Devices Act of 1990 imposes certain reporting requirements on distributors in the event of an incident involving serious illness, injury, or death caused by a medical device. The Company is also required to maintain licenses and permits for the distribution of pharmaceutical products and medical devices under the laws of the states in which it operates.

 

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The Health Insurance Portability and Accountability Act of 1996

The Health Insurance Portability and Accountability Act of 1996 and its implementing regulations (collectively, “HIPAA”) establishes (i) national standards for some types of electronic health information transactions and the data elements used in those transactions, (ii) standards to protect the privacy of individually identifiable health information (“PHI”), and (iii) security standards to ensure the integrity and confidentiality of health information. Health plans, healthcare clearinghouses, and most healthcare providers, including the Company, are “Covered Entities” subject to HIPAA.

The Health Information Technology for Economic and Clinical Health Act of 2009 (“HITECH”), signed into law on February 17, 2009, expanded, among other things, (i) the scope of HIPAA to now apply directly to “business associates,” or independent contractors who receive or obtain PHI in connection with providing a service to a covered entity, including information exchange organizations, medical suppliers that ship to patient’s homes, and third-party billing service providers, (ii) substantive security and privacy obligations, including new federal security breach notification requirements to affected individuals of certain breaches of unsecured PHI, and (iii) the civil and criminal penalties that may be imposed for HIPAA violations. The HITECH Act may have a significant impact on the duties, responsibilities, and liabilities of the organization, particularly with regards to HIPAA compliance.

The United States Foreign Corrupt Practices Act of 1977

The Company conducts operations in a number of foreign countries making it subject to regulatory provisions under the United States Foreign Corrupt Practices Act (“FCPA”), as amended, and similar regulations in foreign jurisdictions. The FCPA prohibits U.S. and other business entities from making improper payments to foreign government officials, political parties, or political party officials for the purpose of furthering foreign business activities. In addition to anti-bribery laws, the Company is also subject to anti-corruption provisions under the FCPA which are enforced by the U.S. Department of Justice. The Securities and Exchange Commission requires strict observance and compliance with regulations set forth by the FCPA regarding certain accounting and internal control standards. Failure to comply with the provisions of the FCPA may result in severe penalties and other consequences for individual employees and/or the Company as a whole.

Government Procurement Contracts

The Company has multiple contracts with government entities. These contracts contain requirements and restrictions, that differ from those with commercial customers, and that could present significant risks if the Company does not maintain compliance. If the Company fails to comply with the terms of these contracts, penalties may be imposed including monetary damages and criminal and civil penalties. In addition contracts could be terminated and the Company could be prohibited from conducting future business with the governmental entity.

Other Laws

The Company is subject to various additional federal, state, and local laws and regulations in the United States, relating to the safe working conditions and the sales, use, and disposal of hazardous or potentially hazardous substances. In addition, laws that affect the Company’s foreign operations include U.S. and international import and export laws and regulations that require that the Company abide by certain standards relating to the importation and exportation of finished goods, raw materials, and supplies. Furthermore, the Department of Transportation regulates the conveyance of regulated materials, both in Company-leased delivery vehicles and via common carrier.

Impact of Changes in Healthcare Legislation

Federal, state, and foreign laws and regulations affecting the Company’s business are subject to change. The Company cannot predict what impact, if any, such changes might have on its business. Any new legislation or regulations, or new interpretations of existing statutes and regulations, governing the manner in which the Company conducts its business could have a material adverse impact on the Company and its results of operations.

 

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The extensive federal and state laws and regulations described above apply not only to the Company, but also to the manufacturers which supply the products distributed by the Company. For instance, medical product and device manufacturers are subject to design, manufacturing, labeling, promotion, and advertising standards imposed on, as well as registration and reporting requirements regarding their facilities and products. Likewise, pharmaceutical manufacturers are subject to development, manufacturing, and distribution regulation by the FDA, the DEA and other federal, state, and local authorities. Failure of a manufacturer to comply with these requirements, or changes in such requirements, could result in recalls, seizures, manufacturing suspensions, or other interruptions in the production, supply, and sale of its products. Such interruptions may result in a material adverse impact on the Company’s business. Similarly, changes in the extensive regulations or in their interpretation or enforcement applicable to the Company’s customers could adversely impact the Company’s business in ways which are difficult for the Company to predict.

See Item 1A “Risk Factors” for a discussion of additional regulatory developments that may affect the Company’s results of operations and financial condition.

PROPRIETARY RIGHTS

The Company has registered with the United States Patent and Trademark Office the marks PSS WORLD MEDICAL (and Design), PSS (and Design), GULF SOUTH MEDICAL (and Design), EXPERTISE DELIVERED, ANSWERS (and Design), SMARTSCAN, PHYSICIAN SELECT, NIGHTINGALE, SOUTHERN ANESTHESIA & SURGICAL, INC. (and Design), ADVANCE PLUS + by SOUTHERN ANESTHESIA & SURGICAL, INC. (and Design), GULF SOUTH MEDICAL SUPPLY (and Design), SELECT MEDICAL PRODUCTS (and Design) and SELECT MEDICAL PRODUCTS PSS GULF SOUTH MEDICAL SUPPLY (and Design), among others. The Company’s trademarks generally have a term of ten years. The Company believes that the PSS World Medical, Physician Sales & Service, and Gulf South Medical Supply names are well recognized in the medical supply industry and by healthcare providers and, therefore, are valuable assets of the Company.

EMPLOYEES

As of March 30, 2012, the Company employed approximately 4,100 full-time and part-time employees. The Company’s approximately 1,020 sales professionals are largely comprised of sales representatives. The Company believes ongoing employee training is critical to its success and, accordingly, invests significant resources in training, continuing professional education and leadership development. Management believes that relations with employees are strong and the Company’s long-term success depends upon its employees, including its sales professionals.

AVAILABLE INFORMATION

The Company files annual, quarterly and current reports, proxy statements, and other information with the Securities and Exchange Commission (“SEC”). Any documents that have been filed with the SEC may be read or copied, at prescribed rates contingent upon a written request, at its Public Reference Room located at 100 F Street, N.E., Washington, D.C. 20549. Information on the operation of the Public Reference Room may be obtained by calling the SEC at 1-800-SEC-0330. These documents are also filed with the SEC electronically and are accessible on the SEC’s internet website found at www.sec.gov. Copies of materials filed with the SEC may also be obtained free of charge from the Company’s internet website found at www.pssworldmedical.com as soon as reasonably practicable after such material is electronically filed with or furnished to the SEC.

The Company’s Code of Ethics, Audit Committee Charter, Corporate Governance Committee Charter, and Compensation Committee Charter are available to the public free of charge in the Investor Relations section of the Company’s website www.pssworldmedical.com or may be obtained by writing to: PSS World Medical, Inc., Investor Relations, 4345 Southpoint Blvd., Jacksonville, Florida 32216. The Company intends to post amendments to or waivers from its Code of Ethics (to the extent applicable to the Company’s principal executive officer, principal financial officer, or principal accounting officer) on its website.

 

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ITEM 1A. RISK FACTORS

The Company’s continued success depends on management’s ability to identify, prioritize, and appropriately manage a wide range of enterprise risk exposures. Readers should carefully consider each of the following risks and additional information set forth in this Annual Report on Form 10-K. These risks and other factors may affect forward-looking statements, including those made by the Company in this document or elsewhere. The risks and uncertainties described herein may not be the only ones facing the Company and are not organized in order of priority. Additional risks and uncertainties not presently known to management or that management currently believes to be immaterial may also adversely affect the Company’s business. If any of the following risks and uncertainties develop into actual events, it could affect the Company’s business, financial condition, or results of operations, cause the trading price of the Company’s common stock to decline, or cause actual results to differ materially from those expected.

The recently announced strategic restructuring plan is subject to a number of risks and uncertainties.

During the first quarter of fiscal year 2013 the Company’s Board of Directors adopted a strategic restructuring plan. The restructuring plan will include, among other things, the sale of two business units serving skilled nursing facilities and specialty dental practices, the integration of warehouse operations into one common distribution infrastructure, as well as a redesign of the shared services function. The restructuring is subject to a number of risks and uncertainties that could adversely impact the Company’s financial condition, results of operations, and cash flows, and may otherwise cause disruption to the Company’s business. These risks and uncertainties include, but are not limited to:

 

   

The Company may not be able to divest the business units on favorable terms, or at all;

 

   

The Company may not be able to retain key personnel (including sales representatives), customers, and suppliers during or after the restructuring;

 

   

The Company may not execute the restructuring plan in a timely or efficient manner;

 

   

The Company may experience a disruption to the Company’s IT systems;

 

   

The Company may not be able to find suitable acquisitions in the areas it has chosen to focus; and

 

   

The Company may incur substantial restructuring or impairment charges.

The Company may not be able to continue to successfully compete with other medical supply companies and direct manufacturers.

Consolidation within the healthcare industry has resulted in increased competition by direct manufacturers, large national distributors, and drug wholesalers, and may result in lower customer pricing and/or higher operating costs. Additionally, changes in ownership of physician practices may erode the Company’s customer base. Continued consolidation in the healthcare industry could result in the following:

 

   

potential new entrants to the markets the Company serves;

 

   

provider networks created through consolidation among physician provider groups, long-term care facilities, and other alternate site providers may shift purchasing decisions to entities or persons with whom the Company has no current relationship;

 

   

national hospital distributors, drug wholesale distributors, and healthcare manufacturers may focus their efforts more directly on the Company’s markets;

 

   

competitors obtaining exclusive rights to market products to the Company’s customers; and

 

   

hospitals forming alliances with long-term care facilities or physician practices to create health systems which may look to hospital distributors and manufacturers to supply their affiliates.

 

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The medical supply distribution market is highly competitive. The Company’s results of operations could be materially adversely affected if competitors offer products similar to those distributed by the Company at significantly lower prices. Principal competitors of the Company include full-line and full-service, multi-market medical distributors, internet distributors, and direct selling manufacturers, many of which have a national presence and significantly greater resources than the Company. The Company also faces significant competition from regional and local distributors, telemarketing firms, internet companies, and mail order firms. The Company’s competition may have the following strengths:

 

   

sales representatives that compete directly with the Company;

 

   

capability to market products directly to the Company’s customers;

 

   

exclusive access to unique products or services;

 

   

substantially greater financial resources than the Company; and

 

   

lower product and operating costs.

There can be no assurance the Company will maintain operating margins and customer relationships and avoid increased competition and significant pricing pressure in the future if medical supply distributor consolidations, acquisitions of the Company’s customers by hospitals, and other customer consolidations occur. If the Company is unable to compete successfully with other medical supply distributors and direct manufacturers, the Company’s business, financial condition, and results of operations may be materially adversely affected.

General economic conditions, including the current global economy may materially adversely impact the Company’s operating results.

Current and future economic conditions and other factors including consumer confidence, unemployment levels, interest rates, tax rates, consumer debt levels, the threat or outbreak of terrorism, fuel and energy costs, the availability of consumer credit, and the impact of state and federal budget deficits on Medicaid and Medicare reimbursement can reduce consumer spending or change consumer purchasing habits, having a negative impact on the purchasing power of the Company’s customers. The current global economy has and may continue to materially adversely affect consumer spending habits and the Company’s operating results.

Trends in healthcare spending, as well as the recently enacted health care reform legislation, may impact the Company’s results of operations.

A significant portion of medical costs in the United States are funded by government and private insurance programs, such as Medicare, Medicaid, and corporate health insurance plans. In recent years, government-imposed limits on reimbursement to hospitals, physicians, nursing homes, home health providers, and other healthcare providers have significantly impacted spending in certain markets within the medical products industry. Future changes in Medicare and state administered Medicaid programs may limit payments to providers and customers served by the Company. Significant reductions in reimbursement levels and adjustments, in combination with rising costs, may negatively impact customers’ financial health and liquidity and may negatively affect the Company’s results of operations. Additionally, the Company’s Medicare Part B billing services are subject to a competitive bidding process. The inability of the Company to successfully compete in this environment could impact the Company’s net sales and results of operations.

Health care reform is a key priority of the current Administration. The Health Care Reform Bill included increased availability of insurance, provisions for healthcare information technology, increased efficiencies in Medicare and Medicaid, and provisions for additional taxes on medical devices. In addition, the Health Care Reform Bill provides for changes in how healthcare may be delivered to patients in the future, such as accountable care organizations and the use of healthcare information technology, which may impact the Company’s business. It is unclear at this time what impact such laws and regulations will have on the purchasing patterns of the Company’s customers, and as a result, the Company’s financial condition, results of operations, and cash flows.

 

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Numerous factors, many of which cannot be controlled by the Company, may cause the Company’s net sales and results of operations to fluctuate, which may adversely affect the market price of the Company’s common stock.

The Company’s net sales and operating results may fluctuate as a result of many factors, some of which are out of the Company’s control, including:

 

   

general economic conditions;

 

   

demand for the products and services offered by the Company;

 

   

introduction of new products and services offered by the Company and its competitors;

 

   

seasonal and pandemic vaccine sales;

 

   

retention of sales representatives and other key employees;

 

   

acquisitions, dispositions, or other investments by the Company;

 

   

changes in manufacturers’ pricing policies, contract terms, and distribution strategies;

 

   

rapid or unexpected increases in product or operating costs;

 

   

changes in the Company’s business strategies, or those of its competitors;

 

   

product supply shortages;

 

   

product recalls by manufacturers;

 

   

changes in product mix;

 

   

fuel costs and third party shipping rates;

 

   

costs associated with the Company’s self-funded medical insurance program;

 

   

inclement weather;

 

   

disruptions resulting from implementing strategic business plans;

 

   

disruptions resulting from implementing ERP systems; and

 

   

changes by the government, including health care reform, changes in reimbursement rates to providers, regulatory requirements, and taxes related to the distribution of medical and pharmaceutical products.

Accordingly, management believes that period-to-period comparisons of the results of operations should not be relied upon as an indication of future performance because these factors may cause the Company’s results of operations to differ from analysts’ and investors’ expectations in certain future periods. This could materially and adversely affect the trading price of the Company’s common stock.

The Company may face increasing competitive pricing pressures on sales to its customers.

The Company’s business strategy may not mitigate the effect of pricing pressures, which could adversely impact the Company’s net sales, gross margins, and results of operations. As a result of the current economic environment, the Company has experienced increased pressure on the price of its products and services, which may continue into future periods.

Additionally, sales to large accounts and provider groups, especially in the extended care market, represent a significant portion of the Company’s revenue base. Competitive pricing pressures may increase due to:

 

   

change in ownership;

 

   

additional negotiating leverage of large customers;

 

   

supplier agreements containing volume discounts;

 

   

service specifications;

 

   

financial health of customers;

 

   

activity of competitors; and

 

   

activity of GPOs.

 

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The viability of the Company’s customers may be threatened by various factors.

The Company has been negatively impacted in the past, and could be negatively impacted in the future, when customers experience disruptions resulting from tighter capital and credit markets, changes in reimbursement, or a loss of patient revenue due to changes in the general economy. Customers have, and may continue to modify, delay, or cancel plans to purchase the Company’s products or services. Additionally, if customers’ operating and financial performance deteriorate, or if they are unable to make scheduled payments or obtain credit, customers may not be able to pay, or may delay payment of, accounts receivable owed to the Company. Any inability of customers to pay for products and services may adversely affect the Company’s results of operations and cash flow.

The Company’s customers are also impacted by increasing costs of malpractice claims and liability insurance. As a result, customer financial viability may adversely impact the Company’s financial condition, net sales, results of operations, and cash flows from operations.

The Company’s future operating results are affected by its relationships with its customers, sales representatives, and senior management team.

The Company’s ability to retain existing customers and attract new customers is dependent upon hiring and retaining sales representatives. Customer relationships are at risk if a sales representative ceases employment with the Company, particularly where the representative seeks employment with a competitor. The Company uses employment agreements containing restrictive covenants, which protect the Company’s legitimate business interests. However, these agreements have not been obtained for all sales representatives. In addition, the terms of these agreements, in certain jurisdictions, may not be fully enforceable. The inability to adequately hire or retain sales representatives could limit the Company’s ability to expand its business and increase sales.

The Company’s success in executing its strategic objectives depends largely on the efforts and abilities of senior management, particularly the executive management team, as well as operations and sales leaders at each distribution center, as local leaders have significant decision-making authority. Although the Company maintains key man life insurance for certain officers, the loss of services of one or more of its members of senior management, the inability of the current management team to successfully execute the Company’s strategies, or the inability of the Company to attract and retain key personnel through appropriately aligned compensation and benefit plans may adversely affect the Company’s business.

The Company relies extensively on its relationships, significant distribution agreements, and other purchasing arrangements with suppliers.

The Company has distribution agreements and other purchasing arrangements with a substantial majority of its suppliers. The Company relies on these suppliers to manufacture and/or supply products for and to the Company for resale to the Company’s customers. If any distribution agreement or other purchasing arrangement between the Company and a supplier expires or is terminated, if the Company fails to meet the minimum requirements under the agreement, or if the Company and any supplier otherwise cease conducting business with each other, then the Company’s net sales and results of operations may be materially adversely affected.

Since the Company does not manufacture many of the products it sells, it is dependent on vendors and manufacturers for the supply of products. The Company relies on suppliers to provide, among other things:

 

   

field sales representatives’ technical and selling support;

 

   

acceptable purchasing, pricing, and delivery terms;

 

   

sales performance and other financial incentives;

 

   

rebates for inventory purchases or sales volume;

 

   

support of sales and marketing programs;

 

   

promotional materials;

 

   

product availability; and

 

   

product indemnification on certain products.

There can be no assurance that the Company will be successful in maintaining good relations with its suppliers. The Company’s global sourcing strategy may threaten relations with certain suppliers and risk the loss of key branded products. Additionally, there can be no assurance that the Company will meet forecasted inventory purchases, sales volume, or other criteria required to obtain the benefits outlined in supplier agreements.

 

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Cost increases for the Company’s products may impact the Company’s results of operations.

The Company’s suppliers, both domestic and foreign, may increase costs for products distributed by the Company. While the Company takes steps to mitigate the effect of these cost increases, there can be no assurance that these cost increases will not materially adversely impact the Company’s net sales, gross margins, financial conditions, and results of operations.

Expansion of GPO or hospital purchasing power and the multi-tiered costing structure may place the Company at a competitive disadvantage.

The medical products industry is subject to a multi-tiered costing structure, which can vary by manufacturer and/or product. Under this structure, certain competitors can obtain more favorable prices for medical products than the Company. The multi-tiered costing structure continues to expand as many large health systems and others with significant purchasing power, such as GPOs, demand more favorable pricing terms. This may threaten the Company’s ability to compete effectively, which would in turn negatively impact the Company’s results of operations. Although the Company seeks to obtain similar terms from manufacturers and obtain access to lower prices demanded by GPO contracts or other contracts, management cannot assure such terms will be obtained or contracts will be executed.

The operating costs of the Company’s delivery fleet could increase due to fuel price fluctuations and/or service interruptions by third parties.

The Company delivers its products to customers through either its Company-leased delivery fleet or third party transportation providers. Significant fluctuations in the cost of fuel have had and may continue to have an adverse impact on the Company’s cost to deliver product to customers. In addition, the Company’s operations may be impacted by events and conditions outside of its control, including strikes or other service interruptions by third party transportation providers which may increase the Company’s operating expenses and adversely affect the Company’s ability to deliver products on a timely basis.

The Company’s strategy for growth may not result in additional net sales or operating income and may have an adverse effect on working capital, operating cash flow, and results of operations.

The Company seeks to increase revenues and operating income by:

 

   

developing innovative marketing and distribution programs;

 

   

expanding the sales force and increasing sales force productivity;

 

   

completing strategic acquisitions;

 

   

expanding e-commerce initiatives and development;

 

   

maintaining and expanding vendor incentive programs;

 

   

expanding product offerings;

 

   

expanding sales support services;

 

   

increasing healthcare information technology offerings; and

 

   

leveraging its infrastructure and information systems to improve sourcing, supply chain and distribution efficiency.

These business strategies for growth may result in increased costs and expenses. There can be no assurance that the Company’s business strategy for growth will result in additional net sales or operating income. In addition, the implementation of the Company’s business strategy for growth may have an adverse effect on working capital, operating cash flow, and results of operations.

Execution of Company’s acquisition strategy could adversely affect the Company’s results of operations and financial condition.

 

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An element of the Company’s strategy is to identify, pursue, and consummate acquisitions that either expand or complement the Company’s business. Future acquisitions or investments may be financed by the issuance of equity securities that would increase the number of outstanding common shares and may decrease earnings per share, and through incurring additional debt. Additionally, changes in generally accepted accounting principles and general economic and market conditions may affect the profitability of acquisitions.

The Company has made numerous acquisitions over the past two fiscal years. The integration of acquisitions involves a number of risks. The Company may be unable to successfully integrate the operations of acquired companies and realize anticipated economic, operational, and other benefits in a timely manner. Integration of an acquired company may be difficult when the acquired business is in a market in which the Company has limited expertise. If the operations of acquired companies are not successfully integrated, the Company may:

 

   

incur substantial unanticipated costs and delays;

 

   

experience operational, technical, or financial controls problems; and

 

   

damage relationships with key customers and employees.

As a result of these operational, financing, and environmental factors, the Company’s business, financial condition, results of operations, and market price of the Company’s common stock may be adversely affected.

The Company’s ability to execute its global sourcing strategy, which includes sourcing products from foreign markets subject to political, economic and legal uncertainties, may affect the Company’s overall profitability.

The Company continues to expand its globally sourced product offerings, which are marketed under various brand names (collectively known as “store brand” or “store brands”). The Company’s global sourcing strategy revolves around sustaining sourcing channels to drive enhanced customer satisfaction and profitability. To attain its strategic objectives, the Company has focused on:

 

   

expanding the store brand product offering;

 

   

strengthening the global sourcing infrastructure;

 

   

improving product sourcing processes and sourcing partner coordination;

 

   

ensuring the quality of store brand products;

 

   

supporting increases in volume of globally sourced products;

 

   

effectively marketing store brand products; and

 

   

providing appropriate incentives to its sales force in the form of commission and promotions.

The Company’s global sourcing strategy involves purchasing certain products directly from foreign manufacturers. The Company’s business, financial condition, and results of operations may be adversely affected by changes in the political, social, or economic environment of certain foreign countries. Changes in laws and regulations, or their interpretation, the imposition of surcharges or any material increase in tax rates, restrictions on currency conversion, imports and sources of supply, or the nationalization or other expropriation of private enterprises could have a material adverse effect on the Company’s ability to conduct business and its results of operations. Additional risks related to the Company’s global sourcing strategy include:

 

   

political unrest in certain regions;

 

   

intermittent supply interruptions with global manufacturers;

 

   

unfavorable changes in foreign currency exchange rates;

 

   

shipping disruptions due to transportation delays;

 

   

fluctuations in the cost of commodities;

 

   

fluctuations in labor costs;

 

   

potential quality issues;

 

   

shortages in facility capacity;

 

   

availability of raw materials;

 

   

increasing regulation of imports;

 

   

natural disasters in certain regions;

 

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regional tensions that adversely affect the development of ongoing agreements;

 

   

intellectual property violation claims; and

 

   

violations of the United States Foreign Corrupt Practices Act (“FCPA”).

The Company’s failure or inability to execute any of its strategic global sourcing initiatives could adversely impact its future profitability.

The Company may not be able to effectively respond to changes in its systems and product-related technology.

The use of technology and e-commerce by the Company and its customers is expanding. E-commerce is an efficient system for customer ordering and inventory management functions and the use of technology applications is becoming more prevalent in the Company’s customers’ businesses. The Company provides multiple e-commerce and other technology options in order to meet the demands of its customers. Advancements in technology and e-commerce will require the Company to enhance existing services and introduce new services to meet customer demands. If the Company does not address the changing demands of customers on a timely basis, the Company could experience adverse results.

The Company’s business is dependent on data processing systems critical to the business operations.

The Company is reliant on its information systems for centralized customer support, operating, and administrative processes. Management relies on the capability, accuracy, timeliness, and stability of its data processing systems to:

 

   

receive and ship customer orders, including those received electronically;

 

   

manage customer billings and collections;

 

   

provide accurate point-of-sale product cost information;

 

   

track and report third-party ancillary billing services;

 

   

provide product reporting, such as product purchases and sales by vendor and vendor incentives earned;

 

   

manage inventory procurement and processes;

 

   

track and report regulatory compliance related to certain pharmaceutical products and devices;

 

   

manage human resources information;

 

   

provide manufacturer rebate tracking, compliance, verification, and collection;

 

   

ensure payments to suppliers are made in accordance with negotiated terms;

 

   

ensure certain critical internal controls are operating properly;

 

   

prepare and present accurate financial statements and related information; and

 

   

integrate acquisitions.

The Company’s business, financial condition, and results of operations may be materially adversely affected if, among other things:

 

   

data errors are created by the information systems and remain undetected;

 

   

data processing capabilities are interrupted or fail to operate for an extended period of time;

 

   

the data processing system becomes unable to support the growth of the business;

 

   

data is lost or is unable to be restored;

 

   

data security is breached inadvertently or through malicious intent causing destruction or theft of the Company’s information;

 

   

problems occur with system upgrades and implementations, or such upgrades and implementations are not timely;

 

   

product maintenance and upgrades to the ERP system are no longer provided by suppliers; or

 

   

a revision is made to the estimated useful lives for certain computer software.

 

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The Company’s future results of operations could be adversely affected by operational disruptions due to natural disasters, particularly in regions susceptible to hurricanes.

A natural disaster such as a hurricane, tornado, earthquake, or flood could cause severe damage and disruption to the Company’s operations, property, inventory, and the operations of its customers.

The Company has developed disaster recovery plans, which include the use of third party back-up facilities for information system infrastructure. In addition, the Company maintains business interruption insurance for instances of catastrophic loss. There is a risk the Company may fail to execute its disaster recovery plans and incur losses that exceed insurance policy limits or are excluded from policy provisions. Furthermore, the Company may have difficulty obtaining business interruption insurance in the future or similar types of coverage may not be available in the markets in which it operates. The Company’s failure to execute or inability to execute any of its disaster recovery plans and obtain adequate insurance coverage could materially adversely impact the Company’s business and results of operations.

The terms of the Company’s indebtedness may impose restrictions on the ability to engage in certain business activities, limit its ability to obtain additional financing, and limit its flexibility to react to industry or economic conditions.

Revolving Line of Credit

The Company maintains an asset-based revolving line of credit (the “RLOC”), which permits maximum borrowings of up to $300.0 million and may be increased to $400.0 million at the Company’s discretion. Availability depends on a borrowing base calculation consisting of accounts receivable and inventory, subject to satisfaction of certain eligibility requirements, and certain other reserves. Any deterioration in the amount or valuation of these assets, including the execution of the Company’s restructuring plan, could reduce the availability of borrowings under the RLOC. Increases in the level of the Company’s indebtedness or changes in the Company’s debt rating could adversely affect the Company’s liquidity and reduce the Company’s ability to:

 

   

sell or transfer assets;

 

   

make certain permitted investments; and

 

   

incur additional indebtedness and liens.

Operating cash requirements are normally funded by cash flows from operating activities and borrowings under the RLOC, which expires in 2016. The Company expects that sources of capital to fund future growth in the business will be provided by a combination of cash flows from operating activities, borrowings under the RLOC, cash proceeds from the sale the businesses outlined in the Company’s restructuring plan, proceeds from the Company’s debt offerings, capital markets, and/or other financing arrangements. However, changes in capital markets or adverse changes to the Company’s operations may disrupt the Company’s ability to maintain adequate levels of liquidity, including its ability to renew its RLOC in 2016 on terms acceptable to the Company.

If the Company is unable to generate sufficient cash flow from operating activities, the Company may be forced to adopt strategies that may include the following:

 

   

sell assets;

 

   

restructure or refinance existing indebtedness;

 

   

seek additional equity capital; and

 

   

reduce or delay acquisitions and capital expenditures.

2012 Notes

On February 24, 2012, the Company issued $250.0 million aggregate principal of 6.375% senior notes, which mature on March 1, 2022 (the “2012 Notes”). The operating and financial restrictions and covenants governing the RLOC and the indenture that governs the 2012 Notes may adversely affect the Company’s ability to finance future operations or capital needs or to engage in other business activities. Under the 2012 Notes, the Company is required

 

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to comply with certain operating and financial covenants, and, in certain circumstances, to satisfy and maintain specified financial ratios and tests. In addition, the indenture governing the 2012 Notes contains financial and other covenants that limit the Company’s ability to engage in certain activities, some of which may be in the Company’s long-term best interests, including the ability to:

 

   

borrow money or sell preferred stock;

 

   

create liens;

 

   

pay dividends on or redeem or repurchase stock;

 

   

make certain types of investments, including acquisitions;

 

   

enter into agreements restricting the Company’s subsidiaries’ ability to pay dividends or make other payments to the Company;

 

   

enter into transactions with affiliates;

 

   

issue guarantees of debt; and

 

   

sell assets or merge with other companies.

The Company’s failure to comply with any of the restrictions or covenants in the indenture governing the 2012 Notes could result in an event of default, which, if not cured or waived, would result in the acceleration of all of the indebtedness under the Company’s debt agreements, including the indenture governing the 2012 Notes.

2008 Notes

The Company’s common stock experiences price and volume fluctuations. Trading prices of the Company’s common stock may be influenced by operating results, projections, and economic, financial, regulatory, and other factors. In addition, general market conditions, including the level of, and fluctuations in, the trading prices of stocks generally, could affect the price of the Company’s common stock.

In August 2008, the Company issued $230.0 million aggregate principal of 3.125% senior convertible notes (“2008 Notes”), which mature on August 1, 2014. The market price of the 2008 Notes is expected to be significantly affected by the market price of the Company’s common stock as well as the general level of interest rates and the Company’s credit quality. This may result in a significantly greater volatility in the trading value of the 2008 Notes than would be expected for nonconvertible debt securities the Company may issue.

The price of the Company’s common stock may also be affected by possible sales of the Company’s common stock by investors who view the 2008 Notes as a more attractive means of equity participation in the Company and by hedging or arbitrage activity involving the Company’s common stock as a result of the issuance of the 2008 Notes. The hedging or arbitrage activity, in turn, could affect the trading prices of the 2008 Notes and common stock.

The Company faces potential litigation and liability exposure for product liability and other claims against the Company.

The Company is a distributor of medical products, equipment, and pharmaceutical products. As a result, there is a risk that injury or other liability arising from the use or transportation of the products may occur and result in litigation against the Company. Accordingly, the Company maintains various insurance policies, including product liability insurance, to cover such exposure at amounts that management considers adequate. However, there can be no assurance the coverage maintained by the Company under various insurance policies is sufficient to cover future claims or will be available in adequate amounts at a reasonable cost. In many cases, the manufacturer of the product for any product liability claims may indemnify the Company; however, these agreements may not apply to products sourced through alternate channels. Additionally, there can be no assurance that indemnification agreements provided by manufacturers will adequately protect the Company, particularly the enforceability of indemnification provisions provided by overseas suppliers for globally-sourced products. These risks increase as more of the Company’s sales relate to globally sourced products and products purchased through alternate channels. A successful claim brought against the Company in excess of available insurance or indemnification agreements, or any claim that results in significant adverse publicity against the Company, could harm the Company’s business, reputation, and results of operations.

 

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In addition to product liability claims, the Company is subject to various legal and administrative proceedings and claims arising in the normal course of business, which are described in Footnote 19, Commitments and Contingencies, of the consolidated financial statements included elsewhere in this Annual Report on Form 10-K. The outcomes of such proceedings or claims that are unasserted, pending, or known to be threatened could have a material adverse effect on the Company’s consolidated financial position, liquidity, or results of operations.

The Company faces risk that its proprietary rights may infringe on the rights of third parties and that the protection offered by its proprietary rights may not be adequate.

The Company relies on a combination of patent, copyright and trademark laws, nondisclosure and other contractual provisions to protect a number of its products, services, and intangible assets. These proprietary rights are important to the Company’s ongoing operations. There can be no assurance these protections will provide meaningful protection against competitive products or services or otherwise be commercially viable or the Company will be successful in obtaining additional intellectual property or enforcing its intellectual property rights against unauthorized users.

From time-to-time, outside parties may assert infringement claims against the Company. If the Company was found to be infringing on other’s rights, the Company may be required to pay substantial damage awards, obtain a license, or cease selling the products that contain the infringing property. Such actions may be significant and result in material losses to the Company.

Failure to comply with existing and future regulatory and legal requirements could adversely affect the Company’s results of operations and financial condition.

General

The healthcare industry is highly regulated and the Company is subject to various federal, state, local, and foreign laws and regulations, which include the DEA, the FDA, various state boards of pharmacy, state health departments, the United States Department of Health and Human Services (“HHS”), the Occupational Safety and Health Administration (“OSHA”), the CMS, various State Attorneys General, State Medicaid fraud units, and other comparable agencies. Certain of the Company’s distribution service centers may be required to register for permits and/or licenses with, and comply with operating and security standards of the DEA, the FDA, HHS, and various state boards of pharmacy, state health departments, and/or comparable state agencies as well as certain accrediting bodies depending upon the type of operations and location of product distribution, manufacturing, and sale. Enforcement activity with regards to these laws and regulations has increased recently and the Company expects it to continue to increase. In addition, the Company’s vehicle fleet is subject to extensive regulation by the Department of Transportation. Although the Company believes it is in compliance, in all material respects, with applicable laws and regulations, any non-compliance could have a material adverse effect on the Company.

The noncompliance by the Company with applicable laws and regulations or the failure to maintain, renew, or obtain necessary permits and licenses could have an adverse effect on the Company’s results of operations and financial condition. In addition, if changes were to occur to the laws and regulations applicable to the Company’s businesses, such changes could adversely affect many of the Company’s regulated operations or could otherwise restrict the Company’s existing operations, limit the expansion of the Company’s businesses, apply regulations to previously unregulated businesses, or otherwise affect the Company adversely. The costs associated with complying with federal and state regulations may be significant and failure to comply with any such laws and regulations could have a material adverse effect on the Company, including criminal and civil penalties, administrative sanctions, quarantine and destruction of inventory, fines, and other adverse actions.

The manufacture, distribution, and marketing of certain of the Company’s products are subject to extensive ongoing regulation by the FDA. Failure to comply with the requirements of the FDA could result in warning letters, product recalls or seizures, monetary sanctions, injunctions to halt manufacture and distribution of products, civil or criminal sanctions, refusal of the government to grant approvals, restrictions on operations, or withdrawal of existing approvals. Any of these actions could cause a loss of customer confidence in the Company and its products which could adversely affect the Company’s sales. In addition, third parties may file claims against the Company in connection with these issues.

 

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Laws relating to physician dispensing

Certain physician medication dispensing solutions could be adversely affected by legislation that would provide restrictions and /or limitations that could affect profitability. In addition, the Company expects that an increase in enforcement activity of the laws and regulations surrounding this type of business activity will continue and could potentially inhibit or eliminate this business, impairing the Company’s goodwill balance.

Laws relating to healthcare fraud

The Company is subject to extensive and frequently changing federal and state laws and regulations relating to healthcare fraud. The federal government continues to increase enforcement of practices involving healthcare fraud. The Company’s relationships with manufacturers and healthcare providers subject the business to laws and regulations on fraud and abuse which, among other things, (i) prohibit persons from soliciting, offering, receiving, or paying any remuneration in order to induce the referral of a patient for treatment or to induce the ordering, purchasing, leasing, or arranging for or recommending ordering, purchasing or leasing of items or services that are in any way paid for by government-sponsored healthcare programs, and (ii) impose a number of restrictions upon referring physicians and providers of designated health services under government healthcare programs. While the Company believes that it is substantially compliant with all applicable laws, many of the applicable regulations are vague or indefinite and have not been interpreted by regulators or the courts. They may be interpreted or applied in a manner that could require changes in operations. In addition, the Federal False Claims Act creates a financial incentive for private individuals to bring suit on behalf of the government to recover funds paid pursuant to a false claim, which may include failure to comply with technical requirements for claim submission, coding, and billing. If the Company fails to comply with applicable laws and regulations, it could suffer civil and criminal penalties, including substantial fines or penalties, and other sanctions, including exclusion from participation in any federal healthcare program.

Laws affecting the Company’s foreign operations

The Company is subject to the FCPA, which generally prohibits United States companies from engaging in bribery or prohibited payments to foreign officials for the purpose of obtaining or retaining business. FCPA enforcement has increased significantly in recent years. The Company has implemented safeguards to prevent and discourage violations of the FCPA. There is no assurance, however, that these safeguards will be effective. If employees or other agents are found to have violated the FCPA, the Company could suffer severe penalties and other consequences that may have a material adverse effect on the Company’s business, financial condition, and results of operations.

Tax legislation initiatives and audits by tax authorities could adversely affect the Company’s net earnings and tax liabilities

The Company is subject to the tax laws and regulations of the United States federal, state, and local governments and certain foreign governments. Various legislative initiatives may be proposed, including those to alter the taxation of the Company’s earnings from foreign operations, which could adversely affect the Company’s tax positions. There can be no assurance that the Company’s effective tax rate will not be adversely affected by these initiatives. In addition, United States federal, state, and local tax laws and regulations are extremely complex and subject to varying interpretations. Although the Company believes that its historical tax positions are sound and consistent with applicable laws, regulations, and existing precedent, there can be no assurance that the Company’s tax positions will not be challenged by relevant tax authorities or that the Company would be successful in any such challenge.

From time to time the Company is audited by United States federal, state, local and foreign tax authorities. If these audits result in assessments different from recorded reserves, the Company’s future results may include unfavorable adjustments to tax liabilities.

See Item 1 “Business – Regulatory Matters” for additional information.

 

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ITEM 1B. UNRESOLVED STAFF COMMENTS

The Company has received no written comments regarding its periodic or current reports from the staff of the Securities and Exchange Commission that were issued 180 days or more preceding the end of fiscal year 2012 and that remain unresolved.

 

ITEM 2. PROPERTIES

The Company leases warehouse and office space for its full-service distribution centers, break-freight locations, redistribution facilities, and other operations-related facilities in various locations across the United States. In the normal course of business, management regularly assesses its business needs and makes changes to the capacity and location of these leased facilities. As of March 30, 2012, the Company believes its distribution infrastructure is adequate to carry on its business as currently conducted and that, if necessary, it could find additional and/or replacement facilities to lease without suffering a material adverse effect on its business.

 

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The following tables identify the full-service distribution centers, break-freight locations, redistribution facilities, and other operations-related facilities for each operating segment:

 

Physician Business

  

Full-Service Distribution Center Locations

   Aiea, HI    Fullerton, CA    Madison, TN    Santa Ana, CA
   Birmingham, AL    Gainesville, GA    Memphis, TN    Schertz, TX *
   Auburn, WA *    Grand Prairie, TX    New Hyde Park, NY    St. Rose, LA
   Charlotte, NC *    Houston, TX *    Olathe, KS *    Wareham, MA
   Colonial Heights, VA    Kennesaw, GA    Orlando, FL    West Columbia, SC
   Denver, CO    Kennesaw, GA    Phoenix, AZ    West Sacramento, CA
   Elgin, IL    Leetsdale, PA    Rochester, NY   
   Flowood, MS    Louisville, KY    Rogers, MN   
   Fairfield, NJ *    Lubbock, TX    Salt Lake City, UT   
  

Break-Freight Locations

   Albany, NY    Fresno, CA    Mesquite, TX *    Southfield, MI
   Baton Rouge, LA    Gahanna, OH *    Middletown, PA *    St. Charles, MO
   Big Bend, WI    Gresham, OR    Morrisville, NC *    St. Petersburg, FL
   Bloomfield, CT    Jacksonville, FL *    Nashville, TN    Tallahassee, FL
   Chatsworth, CA    Knoxville, TN    Newark, CA    Trussville, AL
   Chattanooga, TN    Lafayette, LA    Omaha, NE *    Tulsa, OK
   Chesapeake, VA    Lanham, MD    Pompano Beach, FL    Tyler, TX
   Cincinnati, OH *    Las Vegas, NV    Ridgeland, MS *    Warminster, PA *
   Columbia, SC    Macedonia, OH    Roanoke, VA    West Babylon, NY
   Fredericksburg, VA    Maumelle, AR *    San Diego, CA   
  

Redistribution Facilities

   Fullerton, CA *    Jacksonville, FL *      
  

Other

   Boise, ID    Channahon, IL      

Extended Care Business

  

Full-Service Distribution Center Locations

   Auburn, WA *    Gahanna, OH *    Omaha, NE *    Spokane, WA
   Augusta, GA    Londonderry, NH    Ontario, CA    Vancouver, WA
   Austell, GA    Mesquite, TX *    Orlando, FL    Windsor, WI
   Evanston, IL    Middletown, PA *    Ridgeland, MS *   
   Fort Lauderdale, FL    Morrisville, NC *    Sacramento, CA   
  

Break-Freight Locations

   Charlotte, NC *    Fairfield, NJ *    Maumelle, AR *    Warminster, PA *
   Cincinnati, OH *    Houston, TX *    Olathe, KS *   
   Eau Claire, WI    Indianapolis, IN    Schertz, TX *   
  

Redistribution Facilities

   Fullerton, CA *    Jacksonville, FL *      
  

Other

   Birmingham, AL    Redmond, WA      

 

* Facilities shared by Physician Business and Extended Care Business.

 

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The Company’s Shared Services locations consist of approximately 150,000 square feet of leased office space located at 4345 Southpoint Boulevard and 4190 Belfort Road, Jacksonville, Florida 32216.

The Company also retains additional space for the purpose of providing support services to segment locations described in the previous table. These offices are located in the following cities: Charlotte, NC; Franklin, TN; Jacksonville, FL; Lake Forest, IL; Shanghai, China; and Woodstock, GA.

In the aggregate, the Company’s locations consist of approximately 2.9 million square feet of leased space. The lease agreements have expiration dates ranging from May 2012 to June 2021 and facilities ranging in size from approximately 1,000 square feet to 169,000 square feet.

 

ITEM 3. LEGAL PROCEEDINGS

From time to time the Company is a party to various legal and administrative proceedings and claims arising in the normal course of business. While any litigation contains an element of uncertainty, the Company believes that the outcome of such other proceedings or claims which are pending or known to be threatened will not have a material adverse effect on the Company’s consolidated financial position, liquidity, or results of operations.

 

ITEM 4. MINE SAFETY DISCLOSURES

Not applicable.

PART II

 

ITEM 5. MARKET FOR THE REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES

Market Information

Shares of the Company’s common stock are quoted on Nasdaq Stock Market, Inc.’s Global Select Market (“NASDAQ GS”) under the ticker symbol “PSSI.” The following table presents, for the periods indicated, the range of high and low sale prices per share of the Company’s common stock as reported on NASDAQ GS:

 

Quarter Ended

   High      Low  

Fiscal year ended March 30, 2012:

     

July 1, 2011

   $ 29.47      $ 26.55  

September 30, 2011

   $ 28.87      $ 19.14  

December 30, 2011

   $ 25.05      $ 18.51  

March 30, 2012

   $ 25.99      $ 22.67  

Fiscal year ended April 1, 2011:

     

July 2, 2010

   $ 24.45      $ 20.51  

October 1, 2010

   $ 21.79      $ 18.15  

December 31, 2010

   $ 24.11      $ 20.50  

April 1, 2011

   $ 27.36      $ 22.47  

Cash Dividends

Since inception, the Company has neither declared nor paid cash dividends, and intends to continue to retain earnings for the growth and development of the Company’s business; therefore, does not anticipate the declaration of a cash dividend in the immediate future. The Company’s revolving line of credit agreement contains certain covenants that limit the amount of cash dividends that may be declared by the Company.

 

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Holders of Common Stock

As of May 18, 2012, there were approximately 1,372 holders of record of the Company’s common stock.

Performance Graph

The graph below compares the cumulative total stockholder return on $100 invested, assuming reinvestment of dividends, if any, on March 30, 2007, the last trading day before the beginning of the Company’s fiscal year 2008 through the end of fiscal year 2012, with the cumulative return on $100 invested for the same period in the Nasdaq Stock Market (U.S. Companies) Composite Index.

The graph also compares the cumulative stockholder return to an index of companies management believes comprise the Company’s peer group, which includes the following: Amerisourcebergen Corporation, Baxter International, Inc., Cardinal Health, Inc., McKesson Corporation, Owens & Minor, Inc., Patterson Companies, Inc., and Henry Schein, Inc.

COMPARISON OF 5 YEAR CUMULATIVE TOTAL RETURN*

Among PSS World Medical, Inc., The NASDAQ Composite Index

And A Peer Group

 

LOGO

 

FISCAL YEAR ENDED MARCH 30, 2012

 
     March 30,      March 28,      March 27,      April 2,      April 1,      March 30,  
     2007      2008      2009      2010      2011      2012  

PSS World Medical, Inc.

     100.00        78.81        67.88        111.21        128.25        119.87  

NASDAQ Composite

     100.00        94.11        63.12        99.02        114.84        127.66  

Peer Group

     100.00        94.12        71.30        100.38        108.70        117.20  

 

* Information presented above assumes $100 invested on March 30, 2007 and that dividends were reinvested.

 

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Issuer Purchases of Equity Securities

From time to time, the Company’s Board of Directors authorizes the purchase of its outstanding common shares. The Company is authorized to repurchase a determined amount of its total common stock. Repurchases can be made in the open market, privately negotiated transactions, and other transactions publicly disclosed through filings with the SEC. The Company’s stock repurchase programs do not have an expiration date.

The following table summarizes the common stock repurchases and Board of Directors authorizations during the period from April 1, 2011 to March 30, 2012.

 

(in thousands)    Shares  

Shares available for repurchase as of April 1, 2011

     3,352  

Additional shares authorized for repurchase

     2,680  

Shares repurchased

     (5,595
  

 

 

 

Shares available for repurchase as of March 30, 2012

     437  
  

 

 

 

During fiscal year 2012, the Company repurchased approximately 5.6 million shares of common stock under these programs at an average price of $25.10 per common share for approximately $140.4 million.

The following table summarizes the Company’s repurchase activity during the three months ended March 30, 2012.

 

Period

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

January 2—January 30

     444      $ 24.20        444        1,456,296  

January 31—February 29

     329,406        24.55        329,406        1,126,890  

March 1—March 30

     689,696        24.04        689,696        437,194  
     

 

 

       

 

 

    

Total fourth quarter

     1,019,546      $ 24.21        1,019,546        436,750  
     

 

 

       

 

 

    

 

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ITEM 6. SELECTED FINANCIAL DATA

The selected financial data for fiscal years 2008 through 2012 have been derived from the Company’s consolidated financial statements, which give retroactive effect to the restatement related to adoption of the Financial Accounting Standards Board’s (“FASB”) Accounting Standards Codification (“ASC”) 470-20, Debt –Debt with Conversion and Other Options. The selected financial data below should be read in conjunction with the Company’s financial statements and the notes thereto and Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations.

 

     Fiscal Year Ended  
     2012      2011      2010      2009      2008  
     (Dollars in thousands, except per share data)   

Statement of Operations Data:

              

Net sales

   $ 2,102,002      $ 2,034,789      $ 2,055,171      $ 1,952,691      $ 1,855,791  

Net income attributable to PSS World Medical, Inc.

   $ 74,319      $ 74,485      $ 69,363      $ 51,486      $ 53,133  

Earnings per share:

              

Basic

   $ 1.43      $ 1.35      $ 1.20      $ 0.86      $ 0.82  

Diluted

   $ 1.38      $ 1.32      $ 1.18      $ 0.85      $ 0.80  

Weighted average shares outstanding:

              

Basic

     51,998        54,996        58,029        59,937        64,703  

Diluted

     53,989        56,546        58,943        60,696        66,184  

Ratio of earnings to fixed charges (a)

     5.1        5.7        4.2        3.3        4.5  

Balance Sheet Data:

              

Working capital (b)

   $ 485,365      $ 345,402      $ 355,606      $ 323,545      $ 97,454  

Total assets

   $ 1,155,970      $ 951,672      $ 872,066      $ 858,624      $ 813,236  

Long-term liabilities (b)

   $ 564,832      $ 305,942      $ 277,994      $ 241,684      $ 65,198  

 

(a) For the purpose of calculating the ratio of earnings to fixed charges, earnings consist of income from operations before provision for income taxes, plus fixed charges, less capitalized interest. Fixed charges consist of interest, whether expensed or capitalized, amortization of debt issuance costs, and the portion of rental expense estimated by management to be attributable to interest.
(b) Fiscal year 2008 working capital and long-term liabilities reflect a reclassification of $150 million of 2.25% senior convertible notes from long-term to current liabilities made during fiscal year 2009.

 

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ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

THE COMPANY

PSS World Medical, Inc. (the “Company” or “PSSI”), a Florida corporation, began operations in 1983. The Company is a national distributor of medical products and supplies, diagnostic equipment, healthcare information technology and pharmaceutical products, and provides professional and consulting services to the physician, long-term care, assisted living, home health care, and hospice markets. The Company has full service distribution centers strategically located to efficiently serve all 50 states throughout the United States.

The Company’s business decisions and strategies are guided by its Purpose and Mission. The Company’s stated Purpose is to strengthen the clinical success and financial health of caregivers by solving their biggest problems. The Company’s Mission is to improve caregivers’ financial performance by 20%.

The Company currently conducts business through two operating segments, the Physician Business and the Extended Care Business, which serve a diverse customer base through full-service distribution centers, in all 50 states throughout the U.S. During the year ended March 30, 2012, the Company rebranded its Elder Care Business to the “Extended Care Business” to more appropriately align with its customer base. A third reporting segment, Shared Services, consists of departments that support the operating segments through the delivery of standardized service. For information on comparative segment revenue, segment profit and related financial information, refer to Footnote 18, Segment Information, of the consolidated financial statements.

PSSI is a market leader in the two alternate-site customer segments it serves as a result of a high-touch, differentiated business model; value-added, solutions-based marketing programs; a consultative sales force with extensive product, disease state, reimbursement, and supply chain knowledge; a successfully expanded product and service offering including unique arrangements with manufacturers and a full line of the Company’s store brands; innovative information systems and customer-facing technologies that serve its core markets; and a culture of performance.

During the first quarter of fiscal year 2013, the Company’s Board of Directors approved a strategic restructuring plan designed to transform the Company by focusing on four lines of business – Physician, Laboratory, In-Office Dispensing, and Home Care and Hospice. The restructuring plan will include the sale of two business units serving skilled nursing facilities within the Extended Care Business and specialty dental practices within the Physician Business. Additionally, the plan includes the integration of warehouse operations into one common distribution infrastructure, as well as a redesign of the shared services function. These efforts are expected to reduce operating costs as a percentage of net sales, while streamlining decision making and improving service. The Company expects to complete the restructuring plan within the next several fiscal years. Except as otherwise noted, the information contained in this Form 10-K reflects Company information as of March 30, 2012, before the announcement and commencement of the strategic restructuring plan.

THE COMPANY’S STRATEGY

The Company’s objective is to be the leading distributor and marketer of medical products and services to select customer segments in the U.S., with a goal to grow revenues at twice the market growth rate in the markets it serves. The key components of the Company’s strategy to achieve its Purpose and Mission include:

Reach and Strengthen: Grow sales through differentiated marketing programs, innovative products and services and new customer acquisitions. The Company believes its sales professionals, which consists of approximately 1,020 employees, and their customer relationships and knowledge are strategic competitive advantages. The Company has developed tailored sales force training focused on developing and building unique relationships with customers and providing solutions though innovative marketing programs, exclusive products, and new product and technology offerings that strengthen its customers’ clinical outcomes and financial health. The Company plans to continue to make fold-in acquisitions and grow its sales force through its sales representative expansion initiative.

 

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Our Health: Optimize the Company’s product offering and profitability. The Company has developed and implemented programs to increase its profitability at the product and customer level. The Company continues to develop its domestic and global product sourcing capabilities to optimize its product offering by integrating sourcing and branding initiatives with customer, product and Company strategies to increase profitability. The Company intends to broaden its reach and breadth of products by (i) expanding its store brand product offerings, which generally have higher margins, (ii) increasing product quality and category management, and (iii) leveraging its sourcing capabilities, both foreign and domestic.

LEAN: Simplify and improve business activities to provide only what our customers value. The Company is making significant investments in its distribution infrastructure, information systems, process reengineering, and training to simplify its distribution and administrative infrastructure, develop easy to use scalable processes and systems that enable growth, reduce costs to serve, and achieve the Company’s commitment to providing superior customer service. LEAN process improvement initiatives focus on process redesign, investments in automation and organizational commitments to customer service in the most efficient manner. During fiscal year 2012, the Company continued to leverage its existing infrastructure investments and process improvements resulting in operating efficiencies, improved customer service levels and operating margins.

Identify, develop and retain leaders capable of managing a growing corporation. The Company is committed to the effective recruitment, hiring and promotion of employees with outstanding performance, culture and leadership abilities. The Company provides leadership development opportunities, individual leadership assessment and development plans, education and coaching programs to its employees. The Company’s goal is to develop a diverse group of individuals capable of leading a growing corporation.

Conduct business in a legal and ethical manner. The Company believes each employee is responsible for personal integrity and the consequences of actions, and is expected to follow the highest standards of ethics, honesty, fairness and compliance with the law. The Company provides health, safety, and regulatory education training programs and a safe and positive work environment for its employees.

Be the employer of choice within the industry. The Company believes its management, sales force and employees are its most valuable assets. The Company seeks to foster a culture of performance and execution by designing employee incentive programs aligned with the Company’s Purpose and Mission, business strategies and objectives. The Company strives to be the employer of choice in the markets it serves, in terms of benefits offered to employees, availability of health and wellness programs, professional competency, growth opportunities, and personal development training.

Strategic acquisitions. The Company expects to continue to make strategic acquisitions to reach new customers, complement or expand its product offerings, leverage existing infrastructure and increase its market share and profitability.

EXECUTIVE OVERVIEW

During fiscal year 2012, the Company continued to grow sales despite continued low economic growth and weak utilization trends. Consolidated net sales increased 3.3% during fiscal year 2012 when compared to the prior year.

Consolidated income from operations decreased approximately $0.2 million, or 0.3% during the fiscal year ended March 30, 2012, and operating margins as a percentage of sales declined. The results for fiscal year 2012 were largely impacted by operating costs associated with acquired companies and acquisition-related expenses, partially offset by management’s focus on improving selling margin and reducing operating costs as a percentage of net sales through its LEAN strategies, strategic acquisitions, and continued leverage of its distribution infrastructure. Additionally, net sales decreased during the year ended March 30, 2012 due to a historically light influenza season which resulted in an approximate $12.0 million to $16.0 million decline in net sales of influenza-related products.

Cash flows from operating activities during fiscal year 2012 was $128.3 million which, along with available cash balances, borrowings on its revolving line of credit, and proceeds from the issuance of its 6.375% senior notes, funded the Company’s stock repurchase program, investments in capital projects, and acquisitions during the fiscal year.

 

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The following significantly impacted the Company’s financial and operating results during fiscal years 2012, 2011, and 2010:

Acquisitions

During fiscal year 2012, the Company made a total of eight strategic acquisitions in both the Physician Business and Extended Care Business, with combined net sales of $16.6 million recorded in the Company’s Consolidated Statements of Operations as of March 30, 2012. Cash paid for acquisitions made during fiscal year 2012, 2011, and 2010 was $65.1 million, $65.9 million, and $14.8 million, respectively. Refer to Footnote 4, Purchase Business Combinations, for additional information.

Revolving Line of Credit

On November 16, 2011, the Company amended and restated the credit agreement related to its revolving line of credit (the “RLOC”) with the following features and key terms: (i) a five-year term, maturing on November 16, 2016; (ii) a facility size of $300.0 million, with increased borrowing capacity of $100.0 million via an accordion feature; and (iii) conditional covenants based on the Company’s borrowing availability and fixed charge coverage ratio requirements. See Footnote 12, Debt for additional information regarding the features and terms under the new RLOC.

Issuance of Senior Notes

On February 24, 2012, the Company issued $250.0 million aggregate principal 6.375% senior notes, which mature on March 1, 2022 (the “2012 Notes”). See Footnote 12, Debt for additional information regarding the features and terms of the 2012 Notes.

Global Sourcing Initiative

The Company’s global sourcing strategy involves purchasing products directly from contracted manufacturers and is a key initiative for the Company. Milestones reached during fiscal year 2012, 2011 and 2010 included (i) expanding the Company’s global sourcing resources in Asia and Europe, (ii) increasing the capacity of the redistribution infrastructure in the United States; (iii) expanding the store brand product offering, and (iv) designing and implementing a security assessment program for global manufacturers in compliance with the U.S. Customs Trade Partners Against Terrorism Act. As of March 30, 2012 and April 1, 2011, the Company had approximately $49.6 million and $46.0 million of globally-sourced product inventory, respectively. Management believes this initiative will continue to positively impact the Company’s results of operations in future years.

During fiscal year 2012, the Company completed a reorganization of its non-U.S. global sourcing subsidiaries. This reorganization increased the responsibilities and contributions of the non-U.S. subsidiaries, proportionally increasing their income and reducing the income of the U.S. subsidiaries. As the non-U.S. subsidiaries are generally subject to tax at rates lower than the U.S. subsidiaries, changes in the proportion of the Company’s taxable earnings originating outside the U.S. favorably impacts the effective tax rate. The Company expects this reorganization to continue to have a sustained positive impact on its effective tax rate; however, the Company cannot determine what impact, if any, the restructuring plan may have on the tax rate in future periods.

Change in Long-Term Incentive Compensation Estimate

During fiscal year 2012, the Company decreased its estimation of estimated achievement of performance targets related to long-term corporate incentive compensation plans based on actual and expected future financial performance. The change in estimate decreased Performance Share Units outstanding by approximately 98,000 shares. As a result of the change in performance estimate, stock based compensation expenses decreased $1.5 million.

 

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There were no material changes in estimates during fiscal year 2011.

During fiscal year 2010, management raised its estimation of expected achievement of performance targets related to long-term corporate incentive compensation plans. Due to the change in estimate, the Company recognized additional long-term incentive-based compensation expense of $11.4 million, offset by a decrease of $4.4 million in accruals for long-term incentive compensation related to the departure of the Company’s former Chairman and Chief Executive Officer.

See Footnote 15, Incentive and Stock-Based Compensation, for additional information.

Convertible Debt Transactions

During fiscal year 2009, the Company issued $230.0 million principal amount of 3.125% senior convertible notes (“2008 Notes”). As of March 30, 2012, April 1, 2011 and April 2, 2010, the Company was required to include shares underlying the 2008 Notes in its diluted weighted average shares outstanding, as the average stock price per share for the period exceeded $21.22 (the conversion price for the 2008 Notes). Prior to conversion, the purchased options from the convertible note hedge transaction are considered to be anti-dilutive. Refer to Footnote 12, Debt, for additional information.

H1N1 Influenza Pandemic

During fiscal year 2010, the Physician Business experienced increased sales of influenza test kits, surgical masks, medical gloves and hand sanitizers, and other product categories related to the H1N1 influenza pandemic. As a result, the Company recognized approximately $52.5 million in additional net sales during fiscal year 2010, which did not reoccur in fiscal year 2012 or 2011.

Investment in athenahealth, Inc.

During fiscal year 2010, the Company sold its investment in athenahealth, Inc. (“athena”), resulting in a gain of approximately $3.6 million ($2.3 million, net of tax). Refer to Footnote 7, Equity Investment, for additional information.

Subsequent Event—Restructuring Plan

During the first quarter of fiscal year 2013, the Company’s Board of Directors approved a strategic restructuring plan designed to transform the Company by focusing its efforts and investments on what it believes will be the fastest growing segments of non-acute, alternate site healthcare in the U.S. Specifically, the Company will focus on physician, laboratory, in-office dispensing, and the home care and hospice markets.

The restructuring plan will include the sale of two business units serving skilled nursing facilities and specialty dental practices, the integration of warehouse operations into one common distribution infrastructure, and a redesign of its shared services function. As such, current results of operations may not be indicative of future results.

 

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RESULTS OF OPERATIONS

FISCAL YEAR ENDED MARCH 30, 2012 VERSUS FISCAL YEAR ENDED APRIL 1, 2011

NET SALES

 

     For the Fiscal Year Ended         
     March 30, 2012      April 1, 2011         
(dollars in millions)    Amount      Average Daily
Net Sales
     Amount      Average Daily
Net Sales
     Percent
Change
 

Physician Business

   $ 1,512.7      $ 6.0      $ 1,425.0      $ 5.6        6.2 

Extended Care Business

     587.4        2.3        607.8        2.4        (3.4

Shared Services

     1.9        —           2.0        —           (6.5
  

 

 

    

 

 

    

 

 

    

 

 

    

Total Company

   $ 2,102.0      $ 8.3      $ 2,034.8      $ 8.0        3.3 
  

 

 

    

 

 

    

 

 

    

 

 

    

Selling days

     253           253        

Physician Business

Management evaluates the Physician Business by product category. The following table summarizes the growth rate by product category period over period.

 

     For the Fiscal Year Ended         
(dollars in millions)    March 30, 2012      April 1, 2011      Percent Change  

Branded (a)

   $ 743.1      $ 751.5        (1.1 )% 

Store brand products and services (b)

     229.9        208.1        10.5  

Pharmaceutical products

     330.8        310.5        6.5  

Equipment (c)

     117.7        112.1        5.0  

Physician dispensing solutions

     84.3        36.9        128.5  

Other

     6.9        5.9        17.3  
  

 

 

    

 

 

    

Total

   $ 1,512.7      $ 1,425.0        6.2 
  

 

 

    

 

 

    

Selling days

     253        253     

 

(a) Branded products are comprised of disposables and lab diagnostics from branded manufacturers.
(b) Store brand products and services are comprised of the Company’s brands of disposables, lab diagnostics, equipment, and laboratory consulting services.
(c) Equipment from branded manufacturers.

Overall, net sales during the fiscal year ended March 30, 2012 were positively impacted by revenue from acquisitions contributing to the physician dispensing solutions product category and continued success with the Company’s Reach initiative resulting in the addition of new accounts during the period.

Net sales of branded products decreased during the year ended March 30, 2012 due to a historically light influenza season which resulted in an approximate $12.0 million to $16.0 million decline in net sales of influenza lab diagnostic test kits and other influenza-related products.

Net sales of store brand products and services increased during the year ended March 30, 2012 due to continued focus on the expansion of the store brands product category, resulting in new customer sales, as well as customer conversions from branded products to the Company’s store brands.

 

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Net sales of pharmaceutical increased during the fiscal year ended March 30, 2012 as a result of an existing manufacturer’s shift from a direct sales structure to a distribution-based structure, partially offset by a decrease in influenza vaccine and controlled pharmaceutical product sales compared to the prior fiscal year due to a historically light influenza season.

Net sales of equipment increased during the year ended March 30, 2012 due to increased demand, as prior fiscal year sales were negatively impacted by a decrease in discretionary spending, economic conditions, and tight credit markets which impacted the ability of physicians to obtain financing and delayed equipment purchases.

During fiscal years 2011 and 2012, the Physician Business made several strategic acquisitions of companies providing physician pharmaceutical dispensing products and services, establishing a new product category, physician dispensing solutions, which contributed approximately $84.3 million in net sales during the year ended March 30, 2012.

During the first quarter of fiscal year 2013, the Company announced a strategic restructuring plan, which includes the sale of a business serving specialty dental practices representing approximately $46.5 million and $44.6 million of net sales as of March 30, 2012 and April 1, 2011, respectively.

Extended Care Business

Management evaluates the Extended Care business by customer category. During fiscal year 2012, certain customers were reclassified within these categories to better align with standard industry classifications. As a result, prior periods were recast to be consistent with current year presentation. The following table summarizes the change in net sales by customer segment period over period.

 

     For the Fiscal Year Ended         
(dollars in millions)    March 30, 2012      April 1, 2011      Percent Change  

Nursing home and assisted living facilities

   $ 346.7      $ 356.4        (2.7 )% 

Hospice and home health care agencies

     178.2        187.0        (4.7

Billing services

     10.5        12.0        (11.8

Other

     52.0        52.4        (0.7
  

 

 

    

 

 

    

Total

   $ 587.4      $ 607.8        (3.4 )% 
  

 

 

    

 

 

    

Selling days

     253        253     

Net sales during the fiscal year ended March 30, 2012 compared to the prior year decreased approximately $20.4 million. Net sales in the nursing home and assisted living facilities and the hospice and home health care customer categories were negatively impacted by the loss of several regional and national chain customers.

Billing services net sales were negatively impacted by contractual billing adjustments related to Medicare and Medicaid billings and accounts lost due to competitive bidding.

Net sales of store brand products increased 7.3% during fiscal year 2012 when compared to fiscal year 2011 as a result of continued focus on the expansion of the store brands product category, resulting in new customer sales as well as customer conversions from branded products to the Company’s store brands.

During the first quarter of fiscal year 2013, the Company announced a strategic restructuring plan, which includes the sale of a business serving skilled nursing facilities, representing a portion of the net sales within the Nursing home and assisted living facilities and Billing services customer categories. As of the filing date, the Company could not determine the impact of the potential sale on future periods.

 

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GROSS PROFIT

Physician Business

Gross profit dollars for the Physician Business increased $44.2 million and gross margins increased 106 basis points during fiscal year 2012. The increase in gross profit dollars and gross margin was a result of growth in the Company’s store brand products and acquisitions in the physician dispensing solutions product category, which generally have higher gross margins than the Company’s other product categories.

Extended Care Business

Gross profit dollars in the Extended Care Business decreased $5.7 million while gross margin increased 4 basis points during fiscal year 2012. Gross profit dollars were negatively impacted by the reduction in net sales and competitive pricing pressures, while increased sales of store brand products positively impacted gross margin.

GENERAL AND ADMINISTRATIVE EXPENSES

 

     For the Fiscal Year Ended  
     March 30, 2012     April 1, 2011  
(dollars in millions)    Amount      % of Net
Sales
    Amount      % of Net
Sales
 

Physician Business (a)

   $ 229.6        15.2    $ 203.0        14.2 

Extended Care Business (a)

     124.4        21.2       119.5        19.7  

Shared Services (b)

     39.0        1.9       42.2        2.1  
  

 

 

      

 

 

    

Total Company (b)

   $ 393.0        18.7    $ 364.7        17.9 
  

 

 

      

 

 

    

 

(a) General and administrative expenses as a percentage of net sales are calculated based on reportable segment net sales.
(b) General and administrative expenses as a percentage of net sales are calculated based on consolidated net sales.

General and administrative expenses are impacted by (i) compensation and employee benefit costs; (ii) cost to deliver, which represents all costs associated with the warehousing, transportation and delivery of products to customers; (iii) shared services overhead costs; and (iv) general and administrative expenses of acquired companies and acquisition-related costs.

Physician Business

General and administrative expenses increased $26.6 million during the fiscal year ended March 30, 2012, when compared to the prior fiscal year. This increase was attributable to (i) an increase in payroll and payroll-related expenses of $13.7 million, $10.1 million of which was the result of the physician dispensing solutions acquisitions; (ii) an increase in depreciation and amortization expense of $4.4 million due to the addition of property and equipment and intangible assets related to acquisitions; (iii) an increase in cost to deliver of $3.0 million due to an increase in warehouse expense related to the growth in net sales during the year, and additional expenses from physician dispensing solutions acquisitions; (iv) an increase in consulting fees of $1.6 million related to acquired companies; and (v) an increase in allocated corporate expenses of $1.5 million, partially offset by a decrease in accrued incentive compensation expense of $2.2 million related to payout estimates based on performance.

Extended Care Business

General and administrative expenses increased $4.9 million during the fiscal year ended March 30, 2012, when compared to the prior fiscal year. The increase was attributable to (i) an increase in payroll and payroll-related expenses of $2.9 million due to acquisitions and the timing of the Company’s consolidation of Pathway; and (ii) an increase in corporate allocated expenses of $1.1 million, partially offset by a decrease in accrued incentive compensation expense of $0.7 million related to payout estimates based on performance.

 

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Shared Services

General and administrative expenses decreased $3.2 million during fiscal year 2012, when compared to the prior fiscal year. The decrease was attributable to (i) a decrease in accrued incentive and stock-based compensation expense of $11.4 million related to payout estimates based on performance; and (ii) a decrease in business insurance costs of $1.8 million, partially offset by (i) an increase in payroll and payroll-related expenses of $5.4 million; and (ii) and increase in consulting fees of $2.8 million.

SELLING EXPENSES

 

     For the Fiscal Year Ended  
     March 30, 2012     April 1, 2011  
(dollars in millions)    Amount      % of Net
Sales
    Amount      % of Net
Sales
 

Physician Business

   $ 127.4        8.4    $ 116.7        8.2 

Extended Care Business

     20.5        3.5       20.8        3.4  
  

 

 

      

 

 

    

Total Company

   $ 147.9        7.0    $ 137.5        6.8 
  

 

 

      

 

 

    

Selling expenses are principally driven by commission expenses, which are generally paid to sales representatives based on gross profit dollars and gross margin. The increase in Physician Business selling expenses was due to the impact of its sales representative expansion initiative, while the change in selling expenses as a percentage of net sales for the Physician Business and Extended Care Business was consistent with the change in gross profit dollars and gross margin year over year.

INCOME FROM OPERATIONS

 

     For the Fiscal Year Ended  
     March 30, 2012     April 1, 2011  
(dollars in millions)    Amount     % of Net
Sales
    Amount     % of Net
Sales
 

Physician Business

   $ 144.8       9.6    $ 138.0       9.7 

Extended Care Business

     27.6       4.7       37.8       6.2  

Shared Services

     (39.0     —          (42.2     —     
  

 

 

     

 

 

   

Total Company

   $ 133.4       6.3    $ 133.6       6.6 
  

 

 

     

 

 

   

Income from operations for each business segment changed due to the factors discussed above. Business simplification and LEAN strategies, in conjunction with the successful integration of the Company’s strategic acquisitions, are expected to partially offset the effects of the lower net sales growth.

During the first quarter of fiscal year 2013, the Company announced a strategic restructuring plan. The restructuring plan will include the sale of two business units serving: (i) specialty dental practices, representing approximately $7.0 million and $6.1 million of income from operations within the Physician Business during the fiscal years 2012 and 2011, respectively, and (ii) skilled nursing facilities within the Extended Care Business. Additionally, the restructuring plan includes the integration of warehouse operations into one common distribution infrastructure, and a redesign of its shared services function. As of the filing date, the Company could not determine the impact of the potential sale within the Extended Care Business and additional restructuring activities on future periods.

 

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INTEREST EXPENSE

The Company’s debt structure during fiscal year 2012 consisted of its 2012 Notes, 2008 Notes, and variable rate borrowings under its RLOC. The following table summarizes the various components of total interest expense and interest rates applicable to the borrowings outstanding under the RLOC:

 

     For the Fiscal Year Ended     Increase
(Decrease)
 
(dollars in millions)    March 30, 2012     April 1, 2011    

Components of interest expense:

      

Interest on borrowings

   $ 20.0     $ 16.7     $ 3.3  

Debt issuance costs

     1.1       0.9       0.2  

Less: Capitalized interest

     (0.9     (0.5     (0.4
  

 

 

   

 

 

   

 

 

 

Total interest expense

   $ 20.2     $ 17.1     $ 3.1  
  

 

 

   

 

 

   

 

 

 

Weighted average interest rate-RLOC (a)

     2.27     2.37     (0.10 )% 

Average daily borrowings under the RLOC

   $ 44.4     $ 3.8     $ 40.6  

 

(a) Weighted average interest rate excludes debt issuance costs and unused line fees.

Interest expense increased during the fiscal year ended March 30, 2012 as average daily borrowings under the RLOC were higher, due to an increase in acquisition and share repurchase activity. In addition, approximately $1.3 million of the increase was a result of having both the 2008 Notes and 2012 Notes outstanding during fiscal year 2012, while only the 2008 Notes were outstanding during fiscal year 2011.

OTHER INCOME

 

     For the Fiscal Year Ended               
(dollars in millions)    March 30, 2012      April 1, 2011      Decrease     Percent
Change
 

Total Company

   $ 2.1      $ 2.5      $ (0.4     (16.8 )% 

Other income during the fiscal year ended March 30, 2012 remained relatively consistent with prior year and is mainly attributable to customer finance charges.

PROVISION FOR INCOME TAXES

 

     For the Fiscal Year Ended  
     March 30, 2012     April 1, 2011  
(dollars in millions)    Amount      Effective
Rate
    Amount      Effective
Rate
 

Total Company

   $ 41.1        35.6   $ 44.6        37.4

The effective rate for the twelve months ended March 30, 2012 was impacted by a reorganization of the Company’s non-U.S. global sourcing subsidiaries. This reorganization increased the responsibilities and contributions of the non-U.S. subsidiaries, proportionally increasing their income and reducing the income of the U.S. subsidiaries. As the non-U.S. subsidiaries are generally subject to tax at rates lower than the U.S. subsidiaries, changes in the proportion of the Company’s taxable earnings originating outside the U.S. favorably impacts the effective tax rate. The Company expects this reorganization to continue to have a sustained positive impact on its effective tax rate; however, the Company cannot determine what impact, if any, the restructuring plan may have on the tax rate in future periods.

 

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RESULTS OF OPERATIONS

FISCAL YEAR ENDED APRIL 1, 2011 VERSUS FISCAL YEAR ENDED APRIL 2, 2010

NET SALES

 

     For the Fiscal Year Ended               
     April 1, 2011      April 2, 2010               
(dollars in millions)    Amount      Average Daily
Net Sales
     Amount      Average Daily
Net Sales
     Total
Percent
Change
    Average
Daily Net
Sales
Percent
Change
 

Physician Business

   $ 1,425.0      $ 5.6      $ 1,437.8      $ 5.6        (0.9 )%      1.1 

Extended Care Business

     607.8        2.4        614.9        2.4        (1.2     0.8  

Shared Services

     2.0        —           2.5        —           (15.9     (14.2
  

 

 

    

 

 

    

 

 

    

 

 

      

Total Company

   $ 2,034.8      $ 8.0      $ 2,055.2      $ 8.0        (1.0 )%      1.0
  

 

 

    

 

 

    

 

 

    

 

 

      

Physician Business

Management evaluates the Physician Business by product category. The following table summarizes the growth rate by product category period over period.

 

     For the Fiscal Year Ended         
(dollars in millions)    April 1, 2011      April 2, 2010      Percent
Change
 

Branded (a)

   $ 751.5      $ 803.2        (6.4 )% 

Store brand products and services (b)

     208.1        199.3        4.4  

Pharmaceutical products

     310.5        312.8        (0.7

Equipment

     112.1        118.8        (5.6

Physician dispensing solutions

     36.9        —           —     

Other

     5.9        3.7        53.8  
  

 

 

    

 

 

    

Total

   $ 1,425.0      $ 1,437.8        (0.9 )% 
  

 

 

    

 

 

    

Selling days

     253        258     

 

(a) Branded products are comprised of disposables and lab diagnostics from branded manufacturers.
(b) Store brand products and services are comprised of the Company’s brands of disposables, lab diagnostics, equipment and laboratory consulting services.

Net sales growth during the fiscal year ended April 1, 2011 decreased as a result of (i) fiscal year 2010 H1N1 related sales, (ii) five fewer selling days, (iii) the state of the overall economy resulting in decreased physician office visits, offset by (iv) sales from fiscal year 2011 acquisitions. During the fiscal year ended April 1, 2011, the Company continued to make strategic acquisitions in the Physician Business. Net sales from fiscal year 2011 acquisitions were $41.9 million, of which $36.9 million related to acquisitions in the physician dispensing solutions line of business. During the fiscal year ended April 2, 2010, the Physician Business increased sales in influenza test kits, surgical masks, medical gloves, hand sanitizer, and other products related to the H1N1 pandemic, recording approximately $52.5 million in additional sales across the branded and store brand product categories.

Store brand product sales increased 4.4% due to the Company’s continued focus on promoting its globally sourced products, which resulted in new customer sales as well as customer conversions from other manufacturer branded products to store brand products.

Equipment sales decreased as a result of general economic conditions and lower availability of credit for physician practices.

 

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During the first quarter of fiscal year 2013, the Company announced a strategic restructuring plan, which includes the sale of a business serving specialty dental practices representing approximately $44.6 million and $38.1 million of revenue as of April 1, 2011 and April 2, 2010, respectively.

Extended Care Business

Management evaluates the Extended Care business by customer category. During fiscal year 2012, certain customers were reclassified amongst these categories to better align with standard industry classifications. As a result, prior periods were recast to be consistent with current year presentation. The following table summarizes the change in net sales by customer segment period over period.

 

     For the Fiscal Year Ended         
(dollars in millions)    April 1, 2011      April 2, 2010      Percent Change  

Nursing home and assisted living facilities

   $ 356.4      $ 377.7        (5.3 )% 

Hospice and home health care agencies

     187.0        180.6        4.1  

Billing services

     12.0        13.3        (9.6

Other

     52.4        43.3        13.7  
  

 

 

    

 

 

    

Total

   $ 607.8      $ 614.9        (1.2 )% 
  

 

 

    

 

 

    

Selling days

     253        258     

Net sales during the fiscal year ended April 1, 2011 compared to the prior year decreased approximately $7.1 million, resulting from 5 fewer selling days. Net sales in the nursing home and assisted living customer segment was also negatively impacted by the loss of a few large regional nursing home customers, offset by continued growth in independent nursing homes and assisted living facilities.

Net sales growth in the hospice and home health care customer segments reflected the continued successful execution of strategies to diversify its customer base through expansion in the home health care market and other non-facility based care as well as net sales of approximately $9.3 million attributed to an acquisition made during fiscal year 2010, offset by five fewer selling days during fiscal year 2011. The Company’s net sales in billing services were negatively impacted by decreased Medicare and Medicaid reimbursements and accounts lost due to competitive bidding.

Net sales of store brand products increased 1.5% during fiscal year 2011, when compared to fiscal year 2010, due to the Company’s focus on promoting its globally sourced products which resulted in additional sales to new and existing customers.

During the first quarter of fiscal year 2013, the Company announced a strategic restructuring plan, which includes the sale of a business serving skilled nursing facilities, representing a portion of the net sales within the Nursing home and assisted living facilities and Billing services customer categories. As of the filing date, the Company could not determine the impact of the potential sale on future periods.

GROSS PROFIT

Physician Business

Gross profit dollars for the Physician Business increased $6.9 million and gross margins increased 77 basis points during fiscal year 2011. The increase in gross profit was due to margin improvement initiatives, higher growth in the Company’s brand of products, and additional sales from the Company’s entry into the physician dispensing solutions market, which have higher margins than the Company’s existing product offerings.

Extended Care Business

Gross profit dollars in the Extended Care Business increased $1.4 million and gross margin increased 57 basis points during fiscal year 2011. The increase in gross profit was impacted by the consolidation of Pathway Healthcare Services, a consulting business consolidated as a variable interest entity, and gross margin improvement initiatives, including increased sales of store brand products.

 

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GENERAL AND ADMINISTRATIVE EXPENSES

 

     For the Fiscal Year Ended  
     April 1, 2011     April 2, 2010  
(dollars in millions)    Amount      % of Net
Sales
    Amount      % of Net
Sales
 

Physician Business (a)

   $ 203.0        14.2   $ 198.2        13.8

Extended Care Business (a)

     119.5        19.7       118.1        19.2  

Shared Services (b)

     42.2        2.1       54.6        2.7  
  

 

 

      

 

 

    

Total Company (b)

   $ 364.7        17.9   $ 370.9        18.0
  

 

 

      

 

 

    

 

(a) General and administrative expenses as a percentage of net sales are calculated based on reportable segment net sales.
(b) General and administrative expenses as a percentage of net sales are calculated based on consolidated net sales.

General and administrative expenses are impacted by (i) compensation and employee benefit costs; (ii) cost to deliver, which represents all costs associated with the warehousing, transportation and delivery of products to customers; and (iii) shared services overhead costs.

Physician Business

General and administrative expenses increased $4.8 million during the fiscal year ended April 1, 2011, when compared to the prior year. This increase was mainly attributable to (i) an increase in allocated corporate expenses of $3.8 million; (ii) an increase in depreciation expense of $1.0 million due to the addition of new assets; and (iii) an increase in general and administrative expenses of $6.9 million as a result of the DSI and Linear acquisitions partially offset by a reduction in incentive compensation expense of $8.4 million based on reduced achievement of performance targets.

Extended Care Business

General and administrative expenses increased $1.4 million during the fiscal year ended April 1, 2011, when compared to fiscal year 2010. This increase was mainly attributable to (i) an increase in allocated corporate expenses of $2.3 million; and (ii) an increase in insurance costs of $1.0 million, partially offset by a reduction in bad debt expense of $1.9 million.

Shared Services

General and administrative expenses decreased $12.4 million during fiscal year 2011 due to (i) decreased incentive and stock-based compensation expense of $7.3 million related to payout estimates based on performance; (ii) a reduction in separation expenses of $2.9 million, related to the departure of the Company’s former Chairman and Chief Executive Officer during fiscal year 2010; (iii) an increase in corporate expense allocations of $7.1 million, offset by (iv) an increase in business insurance of $1.4 million; and (v) an increase in payroll and payroll-related costs of $1.5 million related to general merit and benefit increases and a reduction in capitalized salaries related to internally developed software projects.

 

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SELLING EXPENSES

 

     For the Fiscal Year Ended  
     April 1, 2011     April 2, 2010  
(dollars in millions)    Amount      % of Net
Sales
    Amount      % of Net
Sales
 

Physician Business (a)

   $ 116.7        8.2    $ 115.1        8.0 

Extended Care Business (a)

     20.8        3.4       20.7        3.4  
  

 

 

      

 

 

    

Total Company (b)

   $ 137.5        6.8    $ 135.8        6.6 
  

 

 

      

 

 

    

 

(a) Selling expenses as a percentage of net sales are calculated based on divisional net sales.
(b) Selling expenses as a percentage of net sales are calculated based on consolidated net sales.

Selling expenses are principally driven by commission expenses, which are generally paid to sales representatives based on gross profit dollars and gross profit as a percentage of net sales. The change in selling expenses for the Physician Business and Extended Care Business was consistent with the increases in gross profit and gross margin year over year.

INCOME FROM OPERATIONS

 

     For the Fiscal Year Ended  
     April 1, 2011     April 2, 2010  
(dollars in millions)    Amount     % of Net
Sales
    Amount     % of Net
Sales
 

Physician Business

   $ 138.0       9.7    $ 137.3       9.5 

Extended Care Business

     37.8       6.2       38.0       6.2  

Shared Services

     (42.2     —          (54.3     —     
  

 

 

     

 

 

   

Total Company

   $ 133.6       6.6    $ 121.0       5.9 
  

 

 

     

 

 

   

Income from operations for each business segment changed due to the factors discussed above. Business simplification and LEAN strategies, in conjunction with the successful integration of the Company’s strategic acquisitions are expected to continue to offset the effects of the lower sales growth, resulting in continued growth in income from operations, as a percentage of revenues.

During the first quarter of fiscal year 2013, the Company announced a strategic restructuring plan. The restructuring plan will include the sale of two business units serving: (i) specialty dental practices, representing approximately $6.1 million and $4.6 million of income from operations within the Physician Business during the fiscal years 2011 and 2010, respectively, and (ii) skilled nursing facilities within the Extended Care Business. Additionally, the restructuring plan includes the integration of warehouse operations into one common distribution infrastructure, and a redesign of its shared services function. As of the filing date, the Company could not determine the impact of the potential sale within the Extended Care Business and additional restructuring activities on future periods.

INTEREST EXPENSE

The Company’s debt structure during fiscal year 2011 consisted of variable rate borrowings under its revolving line of credit (“RLOC”) agreement and its 2008 Notes. The Company adopted a new accounting pronouncement during fiscal year 2010, ASC 470-20, Debt – Debt with Conversion and Other Options and, as required by this new standard, the Company retrospectively applied this change in accounting to all prior periods for which the Company had applicable outstanding convertible debt. See Footnote 12, Debt, for additional information.

The following table summarizes the various components of total interest expense and interest rates applicable to the borrowings outstanding under the RLOC.

 

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     For the Fiscal Year Ended        
(dollars in millions)    April 1, 2011     April 2, 2010     Decrease  

Components of interest expense:

      

Interest on borrowings

   $ 16.7     $ 17.4     $ (0.7

Debt issuance costs

     0.9       1.1       (2.0

Less: Capitalized interest

     (0.5     (1.2     0.7  
  

 

 

   

 

 

   

 

 

 

Total interest expense

   $ 17.1     $ 17.3     $ (0.2
  

 

 

   

 

 

   

 

 

 

Weighted average interest rate-RLOC (a)

     2.37     4.02     (1.65 )% 

Average daily borrowings under the RLOC

   $ 3.8     $ 44.2     $ (40.4

 

(a) Weighted average interest rate excludes debt issuance costs and unused line fees.

During fiscal year 2008, the Company entered into a two-year $50.0 million variable-to-fixed interest rate swap, (“Swap Agreement”), which effectively fixed the interest rate on all or a portion of the borrowings under the RLOC at 3.95% (consisting of a fixed interest rate of 2.70% and a credit spread of 1.25%) for a notional amount of $50.0 million. The Swap Agreement expired on February 19, 2010.

During fiscal year 2010, as required by the Swap Agreement, the Company maintained a minimum balance of $50.0 million drawn on the RLOC. After expiration, the balance on the RLOC was paid down, resulting in the average daily balance decreasing to $3.8 million for the year ended April 1, 2011.

OTHER INCOME

 

     For the Fiscal Year Ended               
(dollars in millions)    April 1, 2011      April 2, 2010      Decrease     Percent
Change
 

Total Company

   $ 2.5      $ 6.1      $ (3.6     (58.7 )% 

The Company sold its investment in athena during fiscal year 2010, recognizing a gain of $3.6 million. Excluding the gains on the sale of athena stock, Other income during fiscal year 2011 remained consistent with prior year and is mainly attributable to customer finance charges. See Footnote 7, Equity Investment, for further information relating the Company’s investment in athena.

PROVISION FOR INCOME TAXES

 

     For the Fiscal Year Ended  
     April 1, 2011     April 2, 2010  
(dollars in millions)    Amount      Effective
Rate
    Amount      Effective
Rate
 

Total Company

   $ 44.6        37.4   $ 40.8        37.0

The increase in the provision for income taxes year over year is attributable to an increase in pre-tax income. The increase in the effective rate relates to a decrease in the proportion of income earned by the Company’s non-U.S. subsidiaries, which are generally subject to tax at rates lower than the United States.

 

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LIQUIDITY AND CAPITAL RESOURCES

Liquidity and Capital Resources Highlights

Cash flows from operations are impacted by profitability and changes in operating working capital. Management monitors operating working capital through the following metrics:

 

     Fiscal Year Ended  
     2012     2011     2010  

Days Sales Outstanding: (a)

      

Physician Business

     40.7       38.7       38.3  

Extended Care Business

     46.3       47.3       48.4  

Days On Hand: (b)

      

Physician Business

     53.7       54.8       53.6  

Extended Care Business

     66.8       62.7       54.4  

Days in Accounts Payable: (c)

      

Physician Business

     37.2       37.5       37.3  

Extended Care Business

     24.6       21.3       22.6  

Cash Conversion Days: (d)

      

Physician Business

     57.3       56.0       54.6  

Extended Care Business

     88.4       88.7       80.2  

Inventory Turnover: (e)

      

Physician Business

     6.7x        6.6x        6.7x   

Extended Care Business

     5.4x        5.7x        6.6x   

Return on Committed Capital: (f)

      

Total Company

     34.8     35.5     33.5

 

(a) Days sales outstanding (“DSO”) is average accounts receivable divided by average daily net sales. Average accounts receivable is the sum of accounts receivable, net of the allowance for doubtful accounts, at the beginning and end of the most recent four quarters divided by five. Average daily net sales are net sales for the most recent four quarters divided by 360.
(b) Days on hand (“DOH”) is average inventory divided by average daily cost of goods sold (“COGS”). Average inventory is the sum of inventory at the beginning and end of the most recent four quarters divided by five. Average daily COGS is COGS for the most recent four quarters divided by 360.
(c) Days in accounts payable (“DIP”) is average accounts payable divided by average daily COGS. Average accounts payable is the sum of accounts payable at the beginning and end of the most recent four quarters divided by five.
(d) Cash conversion days is the sum of DSO and DOH, less DIP.
(e) Inventory turnover is 360 divided by DOH.
(f) ROCC is defined as return divided by average committed capital. Return is calculated as net income less (i) provision for income taxes, (ii) amortization, (iii) interest expense, and (iv) interest and investment income. Committed capital is calculated as total assets less (i) cash, (ii) goodwill and intangibles, and (iii) liabilities, excluding current and long-term debt.

 

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In addition to the cash flow metrics described above, the Company monitors and manages other components of liquidity, including the following:

 

     As of  
(dollars in thousands)    March 30, 2012     April 1, 2011  

Capital Structure:

    

Revolving line of credit (a)

   $ —        $ —     

2012 Notes (a)

     250,000       —     

2008 Notes (a)

     204,916       195,643  

Other debt (a)

     —          780  

Cash and cash equivalents

     (163,152     (29,348
  

 

 

   

 

 

 

Net debt

     41,764       167,075  

Total equity

     390,811       446,526  
  

 

 

   

 

 

 

Total capital

   $ 432,575     $ 613,601  
  

 

 

   

 

 

 

Operating Working Capital:

    

Accounts receivable, net

   $ 257,700     $ 247,229  

Inventories

     213,586       213,211  

Accounts payable

     (146,533     (128,057
  

 

 

   

 

 

 
   $ 324,753     $ 332,383  
  

 

 

   

 

 

 

 

(a) Outstanding debt is presented in order of seniority.

Cash Flows from Operating Activities

The primary components cash flows from operating activities consist of net income adjusted to reflect the effect of non-cash expenses and changes in operating working capital. Net cash provided by operating activities during fiscal years 2012, 2011, and 2010 was impacted by net income adjusted for (i) depreciation of property and equipment and amortization of intangible assets of $35.8 million, $31.4 million, and $27.1 million, respectively, (ii) amortization of debt discount and issuance costs of $10.3 million, $9.4 million, and $8.9 million, respectively, (iii) operational working capital sources of approximately $13.0 million, and needs of $3.1 million and $14.6 million, respectively, and (iv) noncash compensation expense of $7.3 million, $10.2 million, and $12.8 million, respectively. The Company’s net operating working capital levels were impacted in fiscal years 2012, 2011, and 2010 by its sourcing initiatives, including global sourcing, which generally require longer supply chain lead times and different payment terms. Management expects to increase its global sourcing activities, which may be offset by the restructuring plan. The Company continues to focus on efforts to increase cash collections from customers, improve inventory turns without impacting customer service levels, and manage the cash disbursements process.

Cash flows from operating activities during fiscal years 2012, 2011, and 2010 reflect the Company’s utilization of $0.6 million (tax-effected), $0.9 million (tax-effected), and $1.1 million (tax-effected), respectively, of net operating loss (“NOL”) carryforwards to offset cash payments due for federal and state tax liabilities based on estimated taxable income. Cash flows from operating activities were also impacted by cash payments made to, and refunds received from, federal and state taxing authorities. During fiscal years 2012, 2011, and 2010, the Company paid taxes, net of refunds, of approximately $42.2 million, $36.4 million and $42.6 million, respectively, which related to federal and state tax payments.

As of March 30, 2012, the Company had a deferred income tax liability of $17.3 million (tax-effected) related to interest deductions taken for tax purposes on its 2.25% senior convertible notes issued in 2004 (“2004 Notes”). The liability will be fully deferred for five years and paid ratably from fiscal year 2014 to fiscal year 2018 in accordance with the American Recovery and Reinvestment Act of 2009.

During fiscal year 2012, the IRS completed an examination of the Company’s federal income tax return for the fiscal year ended March 27, 2009. As a result, no changes were made to the Company’s taxable income.

 

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During fiscal year 2010, the IRS completed an examination of the Company’s federal income tax return for the fiscal years ended March 28, 2008, March 30, 2007, and March 31, 2006. As a result, the Company agreed to minor adjustments to its taxable income that did not have a material impact on the Company’s financial condition or results of operations.

Cash Flows from Investing Activities

Payments for business acquisitions, net of cash acquired, were $65.1 million, $65.9 million, and $14.8 million during fiscal years 2012, 2011, and 2010, respectively. During fiscal years 2012 and 2010 the Company made acquisitions not deemed significant for individual disclosure. Refer to Footnote 4, Purchase Business Combinations, for further discussion. The Company expects to continue to make strategic business acquisitions in future periods to grow market share and leverage its existing distribution capabilities, which will impact cash flows from investing activities.

Capital expenditures totaled $23.9 million, $18.2 million, and $25.9 million, during fiscal years 2012, 2011, and 2010, respectively, of which approximately $17.9 million, $12.2 million, and $20.2 million, respectively, related to the development and enhancement of the Company’s ERP and supply chain systems, electronic commerce platforms, and internal productivity software. Capital expenditures related to distribution center expansions and enhancements were approximately $1.4 million, $1.4 million, and $0.9 million, during fiscal years 2012, 2011, and 2010, respectively. Prior to the announcement of the Company’s strategic restructuring plan, capital expenditures were estimated to be approximately $24.5 million during fiscal year 2013. The Company is currently unable to make a good faith estimate of the impact the strategic restructuring plan will have on the capital expenditure plan. Such expenditures are expected to be funded by existing cash balances, cash flows from operating activities, or borrowings under the Company’s RLOC.

During fiscal year 2011, the Company purchased a $3.3 million convertible note issued by Pathway. See Footnote 5, Variable Interest Entity, for further discussion.

During fiscal year 2010, the Company sold its investment in athenahealth, Inc. (“athena”), resulting in a gain of approximately $3.6 million ($2.3 million, net of tax) recorded in Other income, net on the Consolidated Statement of Operations. Cash proceeds of $10.7 million were received in fiscal year 2010. Refer to Footnote 7, Equity Investment, for additional discussion.

Cash Flows from Financing Activities

During fiscal years 2012, 2011, and 2010, the Company repurchased approximately $140.4 million, $54.8 million and $57.2 million of the Company’s common stock, respectively. The share repurchases represented approximately 5.6 million, 2.7 million, and 2.8 million shares, respectively. As of March 30, 2012, approximately 0.4 million common shares were available for repurchase under authorized share repurchase programs. Refer to Footnote 14, Equity, for additional discussion.

The Company recognized excess tax benefits from stock-based compensation arrangements of $2.1 million, $3.2 million, and $2.5 million during fiscal years 2012, 2011, and 2010, respectively. The increase in recognized excess tax benefits, defined as the amount by which the actual tax deduction exceeds recognized compensation expense, is due to increases in the Company’s stock price and timing of stock option exercises.

The Company issued $250.0 million of 6.375% senior notes during fiscal year 2012. In conjunction with the offering, the Company paid debt issuance costs of approximately $4.7 million. In addition, the Company paid approximately $1.8 million in debt issuance costs related to the amendment and restatement of the credit agreement for its RLOC during fiscal year 2012.

During fiscal years 2012 and 2011, the Company paid $9.5 million and $0.9 million in contingent consideration related to earn-outs from acquisitions, respectively.

 

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During fiscal years 2012, 2011, 2010, the Company used proceeds from borrowings on its RLOC to fund a portion of the Company’s share repurchases, acquisition activities, investment strategies, and operating activities during the periods.

Capital Resources

The Company closely monitors the capital and credit markets. While market conditions have improved, volatility remains that may restrict access to capital and the costs associated with issuing or refinancing debt may increase relative to the Company’s current position. While the Company believes it is well positioned, there can be no guarantee the recent disruptions in the overall economy and the financial markets will not adversely impact the business and results of operations.

The Company finances its business through cash from operating activities, the proceeds from the 2012 Notes and 2008 Notes offerings, and the $300.0 million RLOC. The ability to generate sufficient cash from operating activities is dependent on the continued demand for the Company’s products and services and its access to those products and services from suppliers. The Company’s capital structure provides the financial resources to support the Company’s core business strategies of customer service and revenue growth. The RLOC, which is an asset-based agreement, is collateralized by the Company’s accounts receivable and inventory. The Company’s long-term priorities for use of its capital include programs to grow sales, make fold-in and strategic acquisitions, and repurchase of its common stock.

As the Company’s business grows, its cash and working capital requirements are expected to increase. The Company expects the overall growth in the business will be funded through a combination of cash flows from operating activities, borrowings under the RLOC, cash proceeds from the sale of the businesses outlined in the Company’s strategic restructuring plan, proceeds from the issuance of its 2012 Notes, capital markets, and/or other financing arrangements.

The Company has not provided for U.S. income taxes on accumulated and undistributed earnings attributable to foreign operations as the Company intends to permanently reinvest these undistributed earnings. These earnings relate to ongoing operations and were $20.2 million and $10.5 million as of March 30, 2012 and April 1, 2011, respectively.

As of March 30, 2012, the Company has not entered into any material working capital commitments that require funding, other than the items discussed below and the obligations included in the future minimum obligation table.

Based on prevailing market conditions, liquidity requirements, contractual restrictions, and other factors, the Company may seek to retire a portion of its outstanding equity through cash purchases and/or reduce its debt. The Company may also seek to issue additional equity to meet its future liquidity requirements. Such transactions may occur in the open market, privately negotiated transactions, or otherwise. The amounts involved could be material.

2012 Notes

On February 24, 2012, the Company issued $250.0 million aggregate principal of 6.375% senior notes, which mature on March 1, 2022. Interest on the notes is payable semi-annually in arrears on March 1 and September 1, beginning September 1, 2012. The 2012 Notes are fully and unconditionally guaranteed on a joint and several basis by certain of the Company’s domestic subsidiaries (the “Guarantor Subsidiaries”). Refer to Footnote 22, Condensed Consolidating Financial Information, for further information regarding the Guarantor Subsidiaries.

The Company used a portion of the net proceeds of the offering to repay borrowings under the RLOC in the amount of $127.3 million. Remaining proceeds will be used to partially fund the retirement of the 2008 Notes, as well as for general corporate purposes, including potential acquisitions and share repurchases.

As of March 30, 2012, the fair value of the 2012 Notes was approximately $257.5 million. Refer to Footnote 12, Debt, for a detailed discussion regarding the 2012 Notes.

 

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2008 Notes

In August 2008, the Company issued $230.0 million principal amount of 3.125% senior convertible notes, which mature on August 1, 2014. Interest on the notes is payable semiannually in arrears on February 1 and August 1 of each year. The notes will be convertible into cash up to the principal amount of the notes and shares of the Company’s common stock for any conversion value in excess of the principal amount under the following circumstances: (i) if the Company has called the notes for redemption; (ii) in the event of a Fundamental Change, as defined in the indenture, such as a merger, acquisition, or liquidation; (iii) on or after May 1, 2014 and prior to the close of business on the second scheduled trading day immediately preceding August 1, 2014; (iv) prior to May 1, 2014, during the five consecutive business day period following any five consecutive trading day period in which the trading price for a note for each day of that trading period is less than 98% of the closing sale price of the Company’s common stock on such corresponding trading day multiplied by the applicable conversion rate; (v) prior to May 1, 2014, during any calendar quarter after September 30, 2008 in which the closing sale price of the Company’s common stock for at least 20 of the 30 consecutive trading days ending the day prior to such quarter is greater than 130% of the applicable conversion price of $21.22 per share (“Contingent Conversion Trigger”); or (vi) upon specified corporate events as discussed in the indenture governing the notes.

The ability of note holders to convert is assessed on a quarterly basis and is dependent on the trading price of the Company’s stock during the last 30 trading days of each quarter. The Contingent Conversion Trigger was not met during the three months ended March 30, 2012; therefore, the notes may not be converted during the Company’s first quarter of fiscal year 2013.

The Company used a portion of the net proceeds of the offering to repurchase approximately $35.0 million of its common stock in privately negotiated transactions with institutional investors concurrently with this offering. The Company also used $101.7 million of the net proceeds during fiscal year 2009, when holders of the 2004 Notes required the Company to redeem $149.98 million of the outstanding notes. Remaining proceeds have been used for general corporate purposes.

As of March 30, 2012, the fair value of the 2008 Notes was approximately $323.8 million. Refer to Footnote 12, Debt, for a detailed discussion regarding the 2008 Notes.

Convertible Note Hedge Transactions

In connection with the offering of the 2008 Notes, the Company also entered into convertible note hedge transactions with respect to its common stock (the “purchased options”) with a major financial institution, (the “counterparty”). The Company paid an aggregate amount of $54.1 million to the counterparty for the purchased options. The purchased options cover, subject to anti-dilution adjustments substantially identical to those in the notes, approximately 10.8 million shares of common stock at a strike price that corresponds to the initial conversion price of the notes, also subject to adjustment, and are exercisable at each conversion date of the notes. The purchased options will expire upon the earlier of (i) the last day the notes remain outstanding or (ii) the second scheduled trading day immediately preceding the maturity date of the notes.

The purchased options are intended to reduce the potential dilution upon conversion of the notes in the event that the market value per share of the common stock, as measured under the notes, at the time of exercise is greater than the conversion price of the notes.

The purchased options are separate transactions, entered into by the Company with the counterparty, and are not part of the terms of the notes. Holders of the notes will not have any rights with respect to the purchased options.

Warrant Transactions

The Company also entered into warrant transactions (the “warrants”), whereby the Company sold to the counterparty warrants in an aggregate amount of $25.4 million to acquire, subject to anti-dilution adjustments, up to 10.8 million shares of common stock at a strike price of $28.29 per share of common stock, also subject to adjustment. The warrants will expire after the purchased options in approximately ratable portions on a series of expiration dates commencing on November 3, 2014.

 

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The warrants are separate transactions, entered into by the Company with the counterparties, and are not part of the terms of the notes. Holders of the notes do not have any rights with respect to the warrants.

The purchased options will generally have the effect of increasing the conversion price of the 2008 Notes to approximately $28.29 per share, representing a 68.5% premium based on the closing sale price of the Company’s common stock of $16.79 per share on August 4, 2008.

Impact on Diluted Weighted Average Shares

In accordance with ASC 260, Earnings Per Share, and the Company’s stated policy of settling the principal amount in cash, the Company was required to include shares underlying the 2008 Notes in its diluted weighted average shares outstanding since the average stock price per share for the period exceeded $21.22 (the conversion price for the senior convertible notes). Only the number of shares that would be issuable under the treasury stock method of accounting for share dilution was included, which was based upon the amount by which the average stock price exceeded the conversion price. If the average stock price of the Company’s common stock exceeds $28.29 per share, it will also include the effect of the additional potential shares that may be issued related to the warrants, which may negatively impact the Company’s diluted weighted average shares and diluted earnings per share.

The purchased options are not included in the calculation of diluted earnings per share prior to the conversion of the 2008 Notes, as their effect is considered anti-dilutive. As of March 30, 2012, the purchased options were “in the money” and would have been convertible into approximately 1.9 million shares of the Company’s common stock. The exercise of the purchased options is restricted to each conversion date of the 2008 Notes.

Revolving Line of Credit

During fiscal year 2012, the Company amended and restated the credit agreement related to its RLOC, increasing the facility size to $300.0 million, with increased borrowing capacity of $100.0 million via an accordion feature. See Footnote 12, Debt for additional information regarding the features and terms under the new credit agreement.

The Company had no outstanding borrowings under the revolving line of credit as of March 30, 2012. After reducing availability for outstanding borrowings and letter of credit commitments, the Company has sufficient assets based on eligible accounts receivable and inventory to borrow $269.1 million (excluding the additional increase of $100.0 million) under the RLOC as of March 30, 2012. The average daily interest rate, excluding debt issuance costs and unused line fees, for the fiscal years ended March 30, 2012, April 1, 2011, and April 2, 2010 was 2.27%, 2.37%, and 4.02%, respectively. Refer to Footnote 12, Debt, for a detailed discussion regarding the RLOC.

During the first quarter of fiscal year 2013, the Company’s Board of Directors approved a strategic restructuring plan. The restructuring plan will include the sale of two business units serving skilled nursing facilities within the Extended Care Business and specialty dental practices within the Physician Business. The sale of the businesses are expected to increase the Company’s available cash balances, while reducing the Company’s assets used to calculate its borrowing base under the RLOC. The Company estimates availability under the RLOC would be approximately $201.1 million as of March 30, 2012 as adjusted for the sale of these two businesses.

Debt Rating

The Company maintains relationships with two nationally recognized debt rating agencies: Standard & Poor’s Ratings Services (“S&P”) and Moody’s Investor Services (“Moody’s). Companies that have assigned ratings at the top end of the range have, in the opinion of the rating agency, the strongest capability for repayment of debt or payment of claims, while companies at the bottom end of the range have the weakest capacity.

 

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In conjunction with the issuance of the 2012 Notes, the Company sought an updated corporate rating and a new issuance rating from S&P and re-established its ratings relationship with Moody’s. The 2012 Notes require that the Company maintain ratings from two nationally recognized debt ratings services.

On February 10, 2012, S&P affirmed its corporate credit rating of “BB+” and outlook of Stable. Additionally, it initiated a rating of “BB-” on the 2012 Notes and downgraded the 2008 notes from “BB” to “BB-.”

Also on February 10, 2012, Moody’s initiated ratings coverage with the following ratings: Long Term Issuer Rating (Corporate Family) of Ba3 with an outlook of Stable; Senior Unsecured Issue Rating for the 2012 Notes of Ba3. Moody’s does not provide ratings coverage for the 2008 Notes.

Subsequent to March 30, 2012, in response to the Company’s announcement of its strategic restructuring plan, S&P affirmed its existing “BB+” corporate credit rating and “BB-” senior unsecured debt rating, and revised its outlook to Negative. Also in response to the strategic restructuring plan announcement, Moody’s affirmed its Long Term Issuer Rating (Corporate Family) of Ba3 with an outlook of Stable and its Senior Unsecured Issue Rating for the 2012 Notes of Ba3.

Agency ratings are subject to change, and there can be no assurance that a ratings agency will continue to rate the Company or its debt, and/or maintain its current ratings. Management cannot predict the effect that a change in debt ratings will have on the Company’s liquidity.

Off-Balance Sheet Arrangements

The Company’s most significant off-balance sheet financing arrangements as of March 30, 2012 are non-cancelable operating lease agreements for warehouse space and equipment rentals, and outstanding letters of credit. As of March 30, 2012, future minimum obligations under operating lease agreements are $72.0 million. The Company had no open letters of credit outstanding as of March 30, 2012. The Company does not participate in any off-balance sheet arrangements involving unconsolidated subsidiaries that provide financing or potentially expose the Company to unrecorded financial obligations.

 

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Future Contractual Obligations

In the normal course of business, the Company enters into obligations and commitments that require future contractual payments. The following table presents, in aggregate, scheduled payments under contractual obligations for the Physician Business, the Extended Care Business, and Shared Services:

 

Contractual Obligation

   Payment Due By Fiscal Years  
(in thousands)    2013      2014      2015      2016      2017      Thereafter      Total  

Revolving line of credit (a)

   $ 750      $ 750      $ 750      $ 750      $ 469      $ —         $ 3,469  

Senior unsecured notes (b)

     15,938        15,938        15,938        15,938        15,938        273,904        353,594  

Convertible senior notes (b), (c)

     7,188        7,188        233,593        —           —           —           247,969  

Operating lease obligations (d)

     24,935        19,232        11,542        5,912        3,530        6,813        71,964  

Purchase commitments (e)

     812        —           —           —           —           —           812  

Obligations from acquisitions (f)

     2,159        1,620        1,188        —           —           —           4,967  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total (g)

   $ 51,782      $ 44,728      $ 263,011      $ 22,600      $ 19,937      $ 280,717      $ 682,775  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

(a) Amounts represent unused line fees on the revolving line of credit under the RLOC, which expires in November 2016.
(b) Amounts include interest expense.
(c) Under the terms of the convertible note agreement, the notes are convertible during any calendar quarter in which the closing sale price of the Company’s common stock for a certain number of days is greater than $27.59 per share. The 2008 Notes would be classified as a current liability during any such quarter. The 2008 Notes are discussed further in Footnote 12, Debt.
(d) Amounts represent contractual obligations for operating leases of the Company as of March 30, 2012. Currently, it is management’s intent to either renegotiate existing leases or execute new leases upon the expiration date of such agreements, except for those that may be exited through the Company’s restructuring plan.
(e) Amounts represent estimated obligations to be paid related to various shipping contracts and future purchases of certain vaccines. If a supply agreement for store brand products between a vendor and the Company were to be terminated, then the Company may be required to purchase from the vendor all remaining finished and unfinished products and product-materials held by the vendor. As of March 30, 2012, the Company had no material obligation to purchase remaining products or materials due to a termination of a supply agreement with a vendor who supplies store brand products to the Company.
(f) Amounts represent estimated obligations to be paid to sellers of previously acquired businesses for contingent consideration, interest, and funds held to secure any adjustments or claims that may arise.
(g) As of March 30, 2012, the Company had gross unrecognized tax benefits of $1.4 million. This amount is excluded from the table above as the Company cannot reasonably estimate the period of cash settlement with the respective taxing authorities. Additionally, the Company has a liability of $94.4 million related to a deferred compensation program recorded in Other noncurrent liabilities in the accompanying Consolidated Balance Sheets. The amount is excluded from the table above as the Company cannot reasonably estimate the period of cash settlement and the liability is offset by the cash surrender value of corporate-owned life insurance policies recorded in Other assets in the accompanying Consolidated Balance Sheets.

CRITICAL ACCOUNTING ESTIMATES

In preparing the consolidated financial statements in conformity with U.S. generally accepted accounting principles (“GAAP”), management is required to make certain estimates, judgments, and assumptions that affect the reported amounts of assets and liabilities, including the disclosure of contingent assets and liabilities, at the date of the financial statements and the reported amounts of revenues and expenses during the periods presented. The Company periodically evaluates the accounting policies and estimates it uses to prepare its financial statements, which are then reviewed by the Company’s audit committee. Management’s estimates are based on historical experience and other assumptions considered reasonable with the relevant facts and circumstances. Based on the uncertainty inherent in such estimates, actual results may differ.

The critical accounting estimates are those estimates that require the Company’s management to make assumptions about matters that are highly uncertain at the time the estimate is made and could have a material impact on the Company’s results due to changes in the estimates or the use of different estimates that could reasonably have been used. Additionally, the Company includes those accounting estimates whose initial application had a material impact on the Company’s financial presentation, unless the application resulted solely from the issuance of new accounting literature. The discussion below applies to each of the Company’s reportable segments (Physician Business, Extended Care Business, and Shared Services), unless otherwise noted.

 

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Allowance for Doubtful Accounts

The Company maintains allowances for doubtful accounts for estimated losses on trade receivables resulting from the inability to collect outstanding amounts due from its customers. The allowances include estimates of specific amounts for those accounts that are likely to be uncollectible, such as bankruptcies, and general allowances for those accounts that management currently believes to be collectible but may later become uncollectible. Management believes the estimates used in determining the allowance for doubtful accounts are critical accounting estimates because changes in credit worthiness and economic conditions, including bankruptcies, have had a material impact on operations in previous fiscal years and could have a material impact on the Company’s results from operations in the future.

The estimates used to determine the allowances for doubtful accounts are based on historical collection experience, current economic trends, credit-worthiness of customers, and changes in customer payment terms. The percentage of each aging category that is reserved is determined by analyzing historical write-offs and current trends in the credit quality of the customer base. Adjustments to credit limits and allowances for bad debts are made based upon payment history and the customer’s current credit worthiness. If the financial condition of the Company’s customers were to deteriorate or improve, allowances may be adjusted, impacting general and administrative expenses and the accounts receivable balance.

Physician Business

During fiscal years 2009 through 2011, the Physician Business’ allowance for doubtful accounts was reduced by customer deductions and write-offs ranging from $1.3 million to $2.3 million and was increased by additional provisions ranging from $1.5 million to $1.9 million. During fiscal year 2012, the Physician Business’ allowance for doubtful accounts was reduced by $2.1 million for customer deductions and write-offs and was increased by additional provisions of $2.3 million, remaining relatively consistent with prior years. During fiscal years 2009 through 2011, the Company’s allowance for doubtful accounts has represented between 1.6% and 1.9% of the Physician Business’ trade receivable balance. If management were to assume its reserve percentages as of March 30, 2012 were based on the fiscal year 2009 through 2011 historic ranges noted above, the allowance for doubtful accounts as of March 30, 2012 would range between $3.2 million and $3.8 million. As of March 30, 2012 the allowance for doubtful accounts for this business segment was $3.2 million.

Extended Care Business

During fiscal years 2009 through 2011, the Extended Care Business’ allowance for doubtful accounts was reduced by customer deductions and write-offs ranging from $0.9 million to $2.2 million, and was impacted by provisions ranging from a decrease of $0.1 million to an increase of $2.1 million. During fiscal year 2012, the Extended Care Business’ allowance for doubtful accounts was increased by $0.4 million for customer deductions and write-offs and was increased by additional provisions of $0.6 million. During fiscal years 2009 through 2011, the Company’s allowance for doubtful accounts represented between 3.5% and 4.7% of the Extended Care Business’ trade receivable balance. If management were to assume its reserve percentages as of March 30, 2012 were based on the fiscal year 2009 through 2011 historic ranges noted above, the allowance for doubtful accounts as of March 30, 2012 would range between $2.9 million and $3.9 million. As of March 30, 2012, the allowance for doubtful accounts for this business segment was $3.0 million.

Although the Company believes its judgments, estimates and/or assumptions related to allowances for doubtful accounts are reasonable, making material changes to such judgments, estimates and/or assumptions, and changes in customer’s credit worthiness could materially affect the Company’s financial results.

 

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Inventories

In order to state inventories (medical products, medical equipment, and other related products) at the lower of cost (determined using the first-in, first-out (“FIFO”) method) or market (net realizable value), the Company adjusts for excess or slow moving inventory based on the expectation that certain inventory will become obsolete, sold for less than cost, or become unsellable altogether. The adjustments are estimated based on factors such as historical trends, current market conditions, and management’s assessment of when the inventory would likely be sold and the quantities and prices at which the inventory would likely be sold in the normal course of business. Changes in product specifications, customer product preferences, or the loss of a customer may result in an unanticipated impairment in net realizable value that may have a material impact on cost of goods sold, gross margin, and net income. Obsolete or damaged inventory is disposed of or written down to net realizable value on a periodic basis. Additional adjustments, if necessary, are made based on management’s specific review of inventory on-hand. Management believes the estimates used in determining adjustments for excess and slow moving inventory are critical accounting estimates as changes in the estimates for both segments could have a material impact on net income and the estimates involve a high degree of judgment.

Inventory adjustments ranged from 1.3% to 1.8% of gross inventory for the Physician Business and 1.8% to 2.1% of gross inventory for the Extended Care Business during fiscal years 2009 through 2011. If management were to assume inventory adjustments were based on the fiscal years 2009 through 2011 historical ranges noted above, adjustments for excess and slow moving inventory as of March 30, 2012 would range from $2.0 million to $2.7 million for the Physician Business and $1.5 million to $1.8 million for the Extended Care Business, impacting the Company’s Inventory balance and Gross profit. As of March 30, 2012, management estimated adjustments for excess or slow moving inventory to be approximately $3.8 million and $2.8 million for the Physician Business and Extended Care Business, respectively. The increase in Physician Business inventory adjustments above the expected range relates to additional adjustments related to fiscal year 2012 acquisitions.

Although the Company believes its judgments, estimates and/or assumptions related to inventory adjustments are reasonable, making material changes to such judgments, estimates and/or assumptions could materially affect the Company’s financial results.

Vendor Rebates

The Company receives transaction-based rebates from third party suppliers. Such rebates are classified as a reduction to cost of goods sold in the accompanying statements of operations.

Transaction-based rebates are generally associated with a specific customer contract and are recognized as a reduction to cost of goods sold at the time the transaction occurs. Management establishes a reserve for uncollectible transaction-based vendor rebates based on management’s judgment after considering the status of current outstanding rebate claims, historical denial experience with suppliers, and any other pertinent available information. Management believes the estimates used in determining the reserve for uncollectible transaction-based vendor rebates are critical accounting estimates because changes in the estimates could have a material impact on net income and the estimates involve a high degree of judgment.

Reserves for transaction-based rebates for the fiscal years ended March 30, 2012 and April 1, 2011 were $1.1 million and $1.5 million, respectively. Reserves ranged from 13.2% to 23.6% of rebates receivable during fiscal years 2009 through 2011. If management were to assume its reserve percentages as of March 30, 2012 were based on the fiscal year 2009 through 2011 historical ranges noted above, the transaction-based rebate reserve as of March 30, 2012 would range from $1.5 million to $2.7 million, impacting the Company’s Prepaid and other current assets balance and Gross profit. The fiscal year 2012 transaction-based rebate reserve fell below the Company’s historical ranges. During fiscal year 2010, the Company implemented a contracts and rebates administration system which provided enhanced the accuracy of rebate filings and reduced rebate denials during fiscal years 2011 and 2012.

 

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Although the Company believes its judgments, estimates and/or assumptions related to vendor rebates are reasonable, making material changes to such judgments, estimates and/or assumptions could materially affect the Company’s financial results.

Contractual Billing Adjustments

The Company provides medical claim billing services on a fee-for-service or a full-assignment basis and records claims receivable due from insurance carriers. A claim may become uncollectible in full due to denial or partially due to discounts taken. Contractual billing adjustments are estimated to record net revenues and claims receivables at their net realizable values. Management estimates contractual billing adjustments based on historical collection experience, and also considers voided claims and claims written off. Contractual billing adjustments are recorded as a reduction to Accounts receivable, net and Net sales. Management believes the estimates used in determining contractual billing adjustments are critical accounting estimates because changes in the estimates could have a material impact on net income and the estimates involve a high degree of judgment.

Physician Business

Contractual billing adjustments recorded to Physician Business claims receivables for the fiscal years ended March 30, 2012 and April 1, 2011 were $13.2 million and $2.9 million, respectively. Adjustments were 57.9% and 24.1% of gross claims receivable during the fiscal years ended March 30, 2012 and April 1, 2011, respectively. The increase in contractual billing adjustments in fiscal year 2012 as compared to prior year relates to increased internal claims adjudication which increased the claims receivable and related adjustments and physician dispensing acquisitions consummated during the year.

Extended Care Business

Contractual billing adjustments recorded to Extended Care Business claims receivables for the fiscal years ended March 30, 2012 and April 1, 2011 were $2.3 million and $3.1 million, respectively. Adjustments were 34.5% and 29.7% of gross claims receivable during the fiscal years ended March 30, 2012 and April 1, 2011, respectively. The increase in contractual billing adjustments in fiscal year 2012 as compared to prior year relates to additional adjustments on Medicare and Medicaid billings.

Although the Company believes its judgments, estimates and/or assumptions related to contractual billing adjustments are reasonable, making material changes to such judgments, estimates and/or assumptions could materially affect the Company’s financial results.

Income Taxes

The Company uses the asset and liability method for determining its provision for income taxes and deferred tax assets and liabilities. Under this method, the amount of deferred tax assets and liabilities at the end of each period are determined using the tax rate expected to be in effect when taxes are actually paid or recovered. Valuation allowances are established to reduce deferred tax assets when it is more likely than not that some portion or all of the deferred tax assets will not be realized. In determining the need for valuation allowances, significant judgment and estimates are used as management considers short- and long-term forecasts of future taxable income as well as prudent and feasible tax planning strategies. These judgments and estimates include some degree of uncertainty and changes to these estimates could require management to adjust the valuation allowances for deferred tax assets.

The Company had gross deferred income tax assets of $75.6 million and $72.7 million as of March 30, 2012 and April 1, 2011, respectively. There were no valuation allowances as of March 30, 2012 and April 1, 2011, as management believes it will fully utilize the Company’s deferred tax assets before their expiration.

The Company has not provided for U.S. income taxes on accumulated and undistributed earnings attributable to foreign operations as the Company intends to permanently reinvest these undistributed earnings. These earnings relate to ongoing operations and were $20.2 million and $10.5 million as of March 30, 2012 and April 1, 2011, respectively.

 

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The Company’s tax filings are periodically subject to review by the Internal Revenue Service (“IRS”) and other taxing authorities, which may result in assessments of additional tax. Resolution of these assessments, either with the taxing authority or the courts, inevitably includes some degree of uncertainty; accordingly, the Company provides taxes only for the amounts management believes will ultimately result from these proceedings. Management’s experience has been that the estimates and assumptions used to provide for future tax assessments have proven to be appropriate. However, past experience is only a guide, and the potential exists, however limited, that adjustments resulting from the resolution of current and potential future tax controversies may differ materially from the amount accrued.

Current standards of accounting for uncertainty in income taxes provides that a tax benefit from an uncertain tax position may be recognized when it is more likely than not that the position will be sustained upon examination, including resolutions of any related appeals or litigation processes. This standard requires management to make significant judgments while assessing the probability of possible outcomes of future tax examinations. As of March 30, 2012 and April 1, 2011, the liability for uncertain tax positions was $1.4 million and $1.5 million, respectively. Management does not expect the amount of unrecognized tax benefits to change significantly over the next twelve months.

If the estimates or judgments described above were to change, a hypothetical 1% change in the Company’s effective tax rate would impact consolidated income from continuing operations by approximately $1.2 million in fiscal year 2012.

Valuation of Intangible Assets, Other Long-lived Assets, and Goodwill

Acquisitions

The Company allocates the purchase price of acquired companies to the tangible and intangible assets acquired and liabilities assumed based on estimated fair values. Such valuations require management to make significant estimates and assumptions. Critical estimates in the valuation of acquired assets include, but are not limited to: (i) expected future cash flows from existing customer contracts and relationships; (ii) assumptions relating to the impact of noncompete agreements on business operations; (iii) assumptions related to the impact on the timing of expected future cash flows; (iv) retention of customers and key business leaders; and (v) the risk inherent in investing in intangible assets. These estimates are inherently uncertain and unpredictable. Assumptions may be incomplete or inaccurate, and unanticipated events and circumstances may occur which may affect the accuracy or validity of such assumptions, estimates, or other actual results. For these reasons, management believes the estimates used in determining the fair value of assets acquired through an acquisition are critical accounting estimates.

During fiscal years 2009 through 2011, the Company made acquisitions with initial purchase prices totaling $84.4 million. During fiscal year 2012, the Company made acquisitions with initial, unadjusted purchase price totaling $70.0 million. Adjustments to the valuation of acquired assets and liabilities subsequent to the date of purchase based on changes in management’s original estimates were immaterial to the current and previous three fiscal years.

Impairment

Under ASC 350, Intangibles – Goodwill and Other (“ASC 350”), goodwill and indefinite-lived intangible assets are not amortized, but instead tested for impairment annually or whenever events or changes in circumstances indicate the carrying amount may be impaired. Goodwill and indefinite-lived intangible assets are reviewed for impairment at each reporting unit annually on the last day of each fiscal year.

The impairment and disposal of long-lived assets is accounted for in accordance with ASC 360-10, Property, Plant, and Equipment—Overall, (“ASC 360-10”). ASC 360-10 requires that long-lived assets, such as property and equipment and intangible assets subject to amortization, be reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. In the event that the carrying value of assets are determined to be unrecoverable, the Company would estimate the fair value of the assets or reporting unit and record an impairment charge for the excess of the carrying value over the fair value. In

 

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conducting the impairment analysis, the Company determines the fair value of its reporting units using valuation techniques which may include discounted cash flow analyses requiring management to make certain assumptions regarding estimated future cash flows, revenues, earnings, and other factors, including discount rates, to determine the fair value of these respective assets. The application of different assumptions about such matters as estimated future cash flows or discount rates, or the testing for impairment at a different level of the organization or on a different organizational structure, may produce materially different results. For these reasons, management believes the estimates used in evaluating the Company’s goodwill, indefinite-lived intangible assets, and long-lived assets are critical accounting estimates. Based on management’s review, goodwill, intangible assets, and other long-lived assets were not impaired during fiscal years 2011, 2010, and 2009. As of March 30, 2012 and April 1, 2011, the Company’s intangible asset, other long-lived asset, and goodwill balances totaled $357.4 million and $311.4 million, respectively.

Based on management’s review, goodwill, intangible assets, and other long-lived assets were not impaired during fiscal year 2012 and management does not believe there were any circumstances which indicated the carrying value of an asset might not be recoverable in the future. Additionally, a hypothetical 1% change in the discount rate utilized in the Company’s discounted cash flow analysis would not have indicated impairment for any of the Company’s reporting units.

Long-Term Incentive Compensation

Equity Incentive Plans

As of March 30, 2012, the Company has outstanding grants of nonqualified stock options, time-based restricted stock and performance-based restricted stock outstanding.

Estimates are required to determine the number of stock-based awards which will ultimately vest, and, in the case of performance-based restricted stock, estimates of the Company’s future performance. Changes in the estimated forfeiture rates and changes in estimates regarding the Company’s performance can have material effects on stock-based compensation expense. Accordingly, management has determined that the estimates used to determine equity-based compensation expense are critical accounting estimates.

When estimating forfeitures, the Company considers termination behaviors as well as trends of actual equity-based awards forfeited. Management periodically re-assesses the estimated forfeiture rate established upon grant date. Such estimates are revised if they differ materially from actual forfeitures. As required, forfeiture estimates are adjusted to reflect actual forfeitures when an award vests. Actual forfeitures in future reporting periods could be materially higher or lower than management’s current estimates, which could have a material impact on equity-based compensation expense recognized in future years.

When estimating the Company’s earnings per share goals for performance-based restricted stock, the Company reviews historical performance, internal plans and goals, economic conditions, and other performance metrics. These future performance estimates are re-assessed throughout the service period. Such estimates are revised, if necessary, if they differ materially from the original assessment and may have an impact on the vesting of an award. If actual performance differs significantly from management’s estimates, it could have a material impact on equity-based compensation expense recognized in future years.

During the fiscal year ended March 30, 2012, the Company changed its estimate of the number of shares to be delivered on its performance based awards. This change reflected a decrease in estimated achievement of performance conditions based on actual and expected future financial performance. The change in estimate decreased Performance Share Units outstanding by approximately 98,000 shares. As a result of the change in performance estimate, stock based compensation expenses decreased $1.5 million ($0.9 million, net of tax), or $0.02 per diluted share during the year ended March 30, 2012.

Based on the financial results during fiscal year 2010, management revised its assessment for probable achievement of performance conditions related to long-term incentive compensation plans. Management reviewed the fiscal year results impacted by: (i) the impact of revenue growth programs, (ii) the impact of implemented cost savings initiatives, (iii) the increase in sales of H1N1 related products, and (iv) the gain on sale of shares in athena. It was

 

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determined the cumulative impact of these events required the Company to adjust its estimates and adjust the accruals to these plans based on those estimates. The change in estimate for these awards resulted in an increase in stock-based compensation expense of $9.1 million ($5.6 million, net of tax), or $0.10 per diluted share during fiscal year 2010, offset by a decrease in expense of $4.4 million related to the departure of the Company’s former Chairman and Chief Executive Officer.

Total stock-based compensation expense during the fiscal years ended March 30, 2012, April 1, 2011, and April 2, 2010, was $6.4 million, $9.2 million, and $12.2 million, respectively. Current forfeiture rates average 1.0% per quarter, with actual rates ranging from 0.1% to 3.9% per quarter for fiscal years 2009-2011. If management had used the low and high end of these actual ranges during fiscal year 2012, equity-based compensation expense, included in general and administrative expenses, would have been $6.5 million and $6.4 million, respectively. Holding forfeiture rates static, if management had estimated the Company’s future performance at the minimum and maximum earnings per share ranges, since inception of the awards, equity-based compensation expense would have been $5.8 million and $8.4 million, respectively, during the fiscal year ended March 30, 2012. Refer to Footnote 15, Incentive and Stock-Based Compensation, for additional information.

Cash-based incentive plans

The Company maintains cash-based long-term incentive plans, the Shareholder Value Plans (“SVP”), for certain employees. The SVP provides incentive to enhance shareholder value through the achievement of cumulative earnings per share goals.

Estimates are required to determine the Company’s expected future performance and cumulative earnings per share at the end of the three-year performance period. Changes in estimates regarding the Company’s performance can have a material effect on cash-based incentive compensation expense. For this reason, management has determined that the performance estimates used for long-term cash-based compensation expense are critical accounting estimates.

When estimating the Company’s earnings per share goals for the SVP, the Company reviews historical performance, internal plans and goals, economic conditions, and other performance metrics. These future performance metrics are re-assessed throughout the service period. Such estimates are revised, if necessary, if they differ materially from the original assessment. If actual performance differs significantly from management’s estimates, it could have a material impact on cash-based compensation expense recognized in future years.

During fiscal year 2012, the Compensation Committee approved the 2011 Shareholder Value Plan (“2011 SVP”), a cash based performance award program for certain officers and management under the 2006 Incentive Plan. The performance period under the 2011 SVP is the 36-month period from April 1, 2011 to March 28, 2014. Target awards under the 2011 SVP were calculated as three times the participant’s base salary times an award factor ranging from 15% to 40% and performance goals were based on planned cumulative earnings per share. Due to a reduction in payout estimates based on performance, the Company has no accrued compensation cost related to the 2011 SVP recorded as of March 30, 2012.

During fiscal year 2009, the Compensation Committee approved the 2008 Shareholder Value Plan (“2008 SVP”). The performance period under the 2008 SVP was the three year period from March 31, 2008 to April 1, 2011. Based upon current results and expected future results as discussed above, the Company recognized an additional $2.3 million in corporate compensation expense during fiscal year 2010 related to the 2008 SVP due to a change in estimate. There were no material changes in estimates during fiscal year 2011. The Company accrued approximately $10.7 million of compensation cost related to the 2008 SVP, recorded in Other current liabilities in the accompanying Consolidated Balance Sheets as of April 1, 2011, which was paid in June 2011.

Recent Accounting Pronouncements

In October 2009, the FASB issued an Accounting Standards Update (“ASU”) for multiple deliverable revenue arrangements. The update requires entities to allocate revenue in an arrangement using estimated selling prices of the delivered goods and services based on a selling price hierarchy. The update eliminates the residual method of revenue allocation and requires revenues to be allocated using the relative selling price method. The Company

 

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adopted this update prospectively for revenue arrangements entered into or materially modified beginning in the first quarter of fiscal year 2012. The Company has evaluated this standard and determined it did not have a material effect on the Company’s statements of financial condition or results of operations.

In May 2011, the FASB issued an ASU with amendments to achieve common fair value measurement and disclosure requirements in GAAP. The amendments in this update clarified the language used to describe many of the requirements in GAAP for measuring fair value and for disclosing information about fair value measurements. The following areas were impacted by this ASU: (i) application of the highest and best use and valuation premise concepts; (ii) measuring the fair value of an instrument classified in shareholders’ equity; and (iii) additional quantitative disclosures regarding unobservable inputs used in Level 3 fair value measurements. The amendments are effective during interim and annual periods beginning after December 15, 2011, or the Company’s fourth quarter of fiscal year 2012. The Company has evaluated this standard and determined that, other than requiring additional disclosures, it will not have a material impact on the Company’s statements of financial condition or results of operations.

In June 2011, the FASB issued new guidance on the presentation of comprehensive income that requires changes in stockholders’ equity to be presented either (i) in a single continuous statement of comprehensive income, or (ii) in two separate consecutive statements. The ASU requires retrospective application and is effective for fiscal years, and interim periods within those years, beginning after December 15, 2011, or the Company’s fiscal year 2013. In December 2011, the FASB indefinitely deferred the effective date for amendments pertaining to the presentation of reclassification adjustments by component. The Company has evaluated this standard and determined it will not have a material effect on the Company’s statements of financial condition or results of operations.

In September 2011, the FASB issued amended guidance to simplify the method in which entities test goodwill for impairment. This ASU allows an entity to assess qualitative factors to determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying amount as a basis for determining whether it is necessary to perform the two-step goodwill impairment test. Additional disclosure requirements were included with this update, including an explanation of qualitative factors used in the goodwill analysis. The amendments in this update are effective for annual and interim goodwill impairment tests performed for fiscal years beginning after December 15, 2011, or the Company’s fiscal year 2013. The Company has evaluated this standard and determined it will not have an effect on the Company’s statements of financial condition or results of operations.

 

ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Market Risk. The Company’s objective in managing market risk exposures is to identify and limit the potential impact of changes in interest rates, commodity availability, and access of capital on earnings and cash flow. The following assessment of the Company’s market risk does not include uncertainties that are either nonfinancial or nonquantifiable, such as political uncertainty, economic uncertainty, impact of future tax legislation, and credit risks.

Interest Rate Risk. The Company’s primary interest rate exposure relates to cash and cash equivalents and fixed and variable rate debt. During fiscal year 2012, the Company’s debt obligations consisted of (i) $250.0 million senior notes with a fixed rate of 6.375%, (ii) $230.0 million senior convertible notes with a fixed rate of 3.125%, and (iii) variable rate borrowings under the revolving line of credit, which bear interest at the bank’s base rate or at LIBOR plus an applicable margin.

Changes in interest rates affect interest payments under the Company’s variable rate revolving line of credit agreement. During fiscal year 2012, the Company had average daily variable rate borrowings under its line of credit of $44.4 million. A hypothetical 1% increase/decrease in prevailing interest rates as of March 30, 2012, would result in a corresponding increase/decrease in interest expense of less than $0.1 million.

During fiscal year 2011, the Company had average daily variable rate borrowings under its line of credit of $3.8 million. A hypothetical 1% increase/decrease in prevailing interest rates as of April 1, 2011, would result in a corresponding increase/decrease in interest expense of less than $0.1 million.

 

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Changes in interest rates also affect rates of return on the Company’s cash equivalents and short-term investments, which generally consist of money market accounts.

Currency Risk. The Company’s currency rate exposures relate to products that are globally sourced from manufacturers in Southeast Asia. Currently, the Company has negotiated settlement of payments to manufacturers in U.S. dollars. However, over time, local country currency fluctuations may increase or decrease the negotiated cost that the Company must pay for these products. In addition, the Company may in future periods negotiate settlement of payments to manufacturers in the local currency of the country providing a product which would then subject the Company to foreign currency risk.

Commodity Risk. The Company’s primary commodity exposures relate to fluctuations in the price of gasoline and diesel fuel and the procurement of certain medical supplies in which the product cost is dependent upon the price of raw materials, which may fluctuate significantly.

The Company’s direct fuel exposure relates to fluctuations in fuel costs that affect the Company-leased delivery fleet or third-party delivery charges. Significant increases in the cost of gasoline and diesel fuel may impact the Company’s gross margin, cost to deliver, and the operating costs of third party transportation providers. Common carriers have passed these increases through to the Company in the form of a fuel surcharge, which may adversely affect the Company’s results of operations. Beginning in fiscal year 2006, the Company implemented a fuel surcharge to its customers to pass on a portion of the increased cost of gasoline and diesel fuel with adjustments to the amount of surcharge based on market conditions. There can be no assurance that the Company will be able to fully pass along further significant increases in fuel costs to its customers due to the competitive nature of the medical supply distribution industry.

As of March 2012 and March 2011, the U.S. national average for unleaded gasoline was $3.98 and $3.74/gallon, respectively, and the U.S. national average for diesel fuel was $4.14 and $3.98/gallon, respectively. With respect to the Company’s direct fuel purchases, a hypothetical 10% increase/decrease in diesel and unleaded fuel costs during fiscal years 2012 and 2011 would have resulted in a corresponding increase/decrease in fuel expense of approximately $0.8 million and $0.6 million, respectively.

The Company purchases latex and vinyl gloves through agreements in which the pricing of gloves is based on the price of latex as traded on the Malaysian Rubber Exchange and the weighted price of the raw materials Poly Vinyl Chloride (“PVC”), Dioctylphthalate (“DOP”), and Nitrile Butadiene (“NDR”). Latex, PVC, DOP, and NDR in their raw form are only a few of many components used in the manufacture of gloves. Based on estimates of component mix, the following table presents the change in product cost of a hypothetical 10% increase/decrease in the underlying raw material cost during fiscal years 2012 and 2011:

 

     Hypothetical Change in Product Cost of 10%  
     For the Fiscal Year Ended  
     March 30, 2012      April 1, 2011  
(dollars in millions)    Amount (+/-)      Amount (+/-)  

Latex gloves

   $ 1.4      $ 0.9  

Vinyl gloves

     1.7        1.1  

Nitrile gloves

     0.7        0.3  

 

58


Table of Contents
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

INDEX TO THE CONSOLIDATED FINANCIAL STATEMENTS

 

     Page  

Report of Independent Registered Public Accounting Firm

     F-2   

Consolidated Balance Sheets - March 30, 2012 and April 1, 2011

     F-3   

Consolidated Statements of Operations for the Years Ended March 30, 2012, April  1, 2011 and April 2, 2010

     F-4   

Consolidated Statements of Equity and Comprehensive Income for the Years Ended March 30, 2012,  April 1, 2011 and April 2, 2010

     F-5   

Consolidated Statements of Cash Flows for the Years Ended March 30, 2012, April  1, 2011 and April 2, 2010

     F-6   

Notes to Consolidated Financial Statements

     F-7   

Schedule II - Valuation and Qualifying Accounts for the Years Ended March 30, 2012, April  1, 2011 and April 2, 2010

     F-52   

 

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Table of Contents

Report of Independent Registered Public Accounting Firm

The Board of Directors and Shareholders

PSS World Medical, Inc.:

We have audited the accompanying consolidated balance sheets of PSS World Medical, Inc. and subsidiaries (the Company) as of March 30, 2012 and April 1, 2011, and the related consolidated statements of operations, equity and comprehensive income and cash flows for each of the years in the three-year period ended March 30, 2012. In connection with our audits of the consolidated financial statements, we also have audited the financial statement schedule. These consolidated financial statements and financial statement schedule are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements and financial statement schedule based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of PSS World Medical, Inc. and subsidiaries as of March 30, 2012 and April 1, 2011, and the results of their operations and their cash flows for each of the years in the three-year period ended March 30, 2012, in conformity with U.S. generally accepted accounting principles. Also, in our opinion, the related financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly, in all material respects, the information set forth therein.

We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), PSS World Medical Inc.’s internal control over financial reporting as of March 30, 2012, based on criteria established in Internal Control – Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO), and our report dated May 25, 2012 expressed an unqualified opinion on the effectiveness of the Company’s internal control over financial reporting.

/s/ KPMG LLP

May 25, 2012

Jacksonville, Florida

Certified Public Accountants

 

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Table of Contents

PSS WORLD MEDICAL, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

MARCH 30, 2012 AND APRIL 1, 2011

(Dollars in Thousands)

 

ASSETS

  

     2012      2011  

Current Assets:

     

Cash and cash equivalents

   $ 163,152      $ 29,348  

Accounts receivable, net

     257,700        247,229  

Inventories

     213,586        213,211  

Deferred tax assets, net

     16,962        20,533  

Prepaid expenses and other current assets

     34,292        34,285  
  

 

 

    

 

 

 

Total current assets

     685,692        544,606  

Property and equipment, net

     101,036        102,401  

Other Assets:

     

Goodwill

     201,752        167,094  

Intangibles, net

     54,600        41,879  

Other assets

     112,890        95,692  
  

 

 

    

 

 

 

Total assets (a)

   $ 1,155,970      $ 951,672  
  

 

 

    

 

 

 

LIABILITIES AND EQUITY

  

Current Liabilities:

     

Accounts payable

   $ 146,533      $ 128,057  

Accrued expenses

     41,753        37,175  

Current portion of long-term debt

     —           761  

Other current liabilities

     12,041        33,211  
  

 

 

    

 

 

 

Total current liabilities

     200,327        199,204  

Revolving line of credit and long-term debt, excluding current portion

     454,916        195,662  

Other noncurrent liabilities

     109,916        110,280  
  

 

 

    

 

 

 

Total liabilities (a)

     765,159        505,146  
  

 

 

    

 

 

 

Commitments and contingencies (Notes 2, 11, 12, 14, 15, 16, 17 and 19)

     

Equity:

     

PSS World Medical Inc. shareholders’ equity:

     

Preferred stock, $0.01 par value; 1,000,000 shares authorized, no shares issued and outstanding

     —           —     

Common stock, $0.01 par value; 150,000,000 shares authorized, 50,312,323 and 55,465,600 shares issued and outstanding as of March 30, 2012 and April 1, 2011, respectively

     495        546  

Additional paid-in capital

     —           122,912  

Retained earnings

     386,633        319,468  
  

 

 

    

 

 

 

Total PSS World Medical, Inc. shareholders’ equity

     387,128        442,926  

Noncontrolling interest

     3,683        3,600  
  

 

 

    

 

 

 

Total equity

     390,811        446,526  
  

 

 

    

 

 

 

Total liabilities and equity

   $ 1,155,970      $ 951,672  
  

 

 

    

 

 

 

 

(a) See Footnote 5, Variable Interest Entity, for discussion of the assets and liabilities related to the Company’s consolidated variable interest entity.

The accompanying notes are an integral part of these consolidated financial statements.

 

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PSS WORLD MEDICAL, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS

FOR THE YEARS ENDED MARCH 30, 2012, APRIL 1, 2011 AND APRIL 2, 2010

(In Thousands, Except Per Share Data)

 

     2012     2011     2010  

Net sales

   $ 2,102,002     $ 2,034,789     $ 2,055,171  

Cost of goods sold

     1,427,799       1,399,018       1,427,476  
  

 

 

   

 

 

   

 

 

 

Gross profit

     674,203       635,771       627,695  

General and administrative expenses

     392,990       364,749       370,871  

Selling expenses

     147,857       137,466       135,843  
  

 

 

   

 

 

   

 

 

 

Income from operations

     133,356       133,556       120,981  
  

 

 

   

 

 

   

 

 

 

Other (expense) income:

      

Interest expense

     (20,148     (17,121     (17,295

Interest income

     173       284       376  

Other income, net

     2,084       2,506       6,068  
  

 

 

   

 

 

   

 

 

 

Other expense, net

     (17,891     (14,331     (10,851
  

 

 

   

 

 

   

 

 

 

Income before provision for income taxes

     115,465       119,225       110,130  

Provision for income taxes

     41,063       44,561       40,767  
  

 

 

   

 

 

   

 

 

 

Net income

     74,402       74,664       69,363  

Net income attributable to noncontrolling interest

     83       179       —     
  

 

 

   

 

 

   

 

 

 

Net income attributable to PSS World Medical, Inc.

   $ 74,319     $ 74,485     $ 69,363  
  

 

 

   

 

 

   

 

 

 

Earnings per common share attributable to

      

PSS World Medical, Inc.:

      

Basic

   $ 1.43     $ 1.35     $ 1.20  

Diluted

   $ 1.38     $ 1.32     $ 1.18  

Weighted average common shares outstanding:

      

Basic

     51,998       54,996       58,029  

Diluted

     53,989       56,546       58,943  

The accompanying notes are an integral part of these consolidated financial statements.

 

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PSS WORLD MEDICAL, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF EQUITY AND COMPREHENSIVE INCOME

FOR THE YEARS ENDED MARCH 30, 2012, APRIL 1, 2011 AND APRIL 2, 2010

(Dollars in Thousands, Except Share Data)

 

    Shares     Amount     Additional
Paid-In
Capital
    Retained
Earnings
    Accumulated
Other
Comprehensive
(Loss) Income
    Total PSS World
Medical, Inc.
Shareholders’
Equity
    Noncontrolling
Interest
    Total Equity  

Balance as of March 27, 2009

    58,301,253     $ 583     $ 200,175     $ 175,620     $ 1,652     $ 378,030     $ —        $ 378,030  

Net income

    —          —          —          69,363       —          69,363       —          69,363  

Unrealized holding gains on available-for-sale investments, net of taxes of $33

    —          —          —          —          56       56       —          56  

Reclassification adjustment for gains on available-for-sale investments included in net income, net of taxes of $1,375

    —          —          —          —          (2,260     (2,260     —          (2,260

Impact of interest rate swap, net of taxes of $339

    —          —          —          —          552       552       —          552  
           

 

 

   

 

 

   

 

 

 

Total comprehensive income

              67,711       —          67,711  
           

 

 

   

 

 

   

 

 

 

Repurchases and retirement of common stock

    (2,767,093     (28     (57,148     —          —          (57,176     —          (57,176

Exercise of stock options

    547,823       6       4,483       —          —          4,489       —          4,489  

Stock-based compensation

    —          —          11,887       —          —          11,887       —          11,887  

Vesting of restricted stock

    90,354       1       (1     —          —          —          —          —     

Excess tax benefit from stock-based compensation

    —          —          2,516       —          —          2,516       —          2,516  

Employee benefits and other

    27,256       —          557       —          —          557       —          557  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Balance as of April 2, 2010

    56,199,593     $ 562     $ 162,469     $ 244,983     $ —        $ 408,014     $ —        $ 408,014  

Net income

    —          —          —          74,485       —          74,485       179       74,664  
           

 

 

   

 

 

   

 

 

 

Total comprehensive income

    —          —          —          —          —          74,485       179       74,664  
           

 

 

   

 

 

   

 

 

 

Acquisition of variable interest entity

    —          —          —          —          —          —          3,421       3,421  

Repurchases and retirement of common stock

    (2,728,300     (27     (54,734     —          —          (54,761     —          (54,761

Exercise of stock options

    337,853       3       2,075       —          —          2,078       —          2,078  

Stock-based compensation

    —          —          9,285       —          —          9,285       —          9,285  

Vesting of restricted stock

    802,005       8       (8     —          —          —          —          —     

Excess tax benefit from stock-based compensation

    —          —          3,187       —          —          3,187       —          3,187  

Employee benefits and other

    23,892       —          638       —          —          638       —          638  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Balance as of April 1, 2011

    54,635,043     $ 546     $ 122,912     $ 319,468     $ —        $ 442,926     $ 3,600     $ 446,526  

Net income

    —          —          —          74,319       —          74,319       83       74,402  
           

 

 

   

 

 

   

 

 

 

Total comprehensive income

    —          —          —          —          —          74,319       83       74,402  
           

 

 

   

 

 

   

 

 

 

Repurchases and retirement of common stock

    (5,594,668     (56     (133,229     (7,154     —          (140,439     —          (140,439

Exercise of stock options

    170,961       1       1,382       —          —          1,383       —          1,383  

Stock-based compensation

    —          —          6,430       —          —          6,430       —          6,430  

Vesting of restricted stock

    301,581       4       (4     —          —          —          —          —     

Excess tax benefit from stock-based compensation

    —          —          2,057       —          —          2,057       —          2,057  

Employee benefits and other

    26,021       —          452       —          —          452       —          452  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Balance as of March 30, 2012

    49,538,938     $ 495     $ —        $ 386,633     $ —        $ 387,128     $ 3,683     $ 390,811  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

The accompanying notes are an integral part of these consolidated financial statements.

 

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Table of Contents

PSS WORLD MEDICAL, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

FOR THE YEARS ENDED MARCH 30, 2012, APRIL 1, 2011 AND APRIL 2, 2010

(Dollars in Thousands)

 

     2012     2011     2010  

Cash Flows From Operating Activities:

      

Net income

   $ 74,402     $ 74,664     $ 69,363  

Adjustments to reconcile net income to net cash provided by operating activities:

      

Depreciation

     26,847       25,065       21,940  

Amortization of intangible assets

     8,930       6,378       5,121  

Amortization of debt discount and issuance costs

     10,289       9,447       8,852  

Noncash compensation expense

     7,302       10,227       12,772  

Provision for doubtful accounts

     2,858       1,741       3,795  

(Benefit) provision for deferred income taxes

     (1,284     3,251       (8,264

Provision for deferred compensation

     1,165       1,423       1,530  

(Gain) loss on sales of property and equipment

     (102     19       81  

Gain on sale of available for sale securities

     —          —          (3,635

Changes in operating assets and liabilities, net of effects from business combinations:

      

Accounts receivable, net

     85       (7,257     221  

Inventories

     4,096       12,265       (9,718

Prepaid expenses and other current assets

     833       (6,433     (5,710

Other assets

     (10,885     (7,973     (4,685

Accounts payable

     8,828       (8,153     (5,129

Accrued expenses and other liabilities

     (5,080     1,664       15,867  
  

 

 

   

 

 

   

 

 

 

Net cash provided by operating activities

     128,284       116,328       102,401  
  

 

 

   

 

 

   

 

 

 

Cash Flows From Investing Activities:

      

Payments for business combinations, net of cash acquired

     (65,131     (65,934     (14,802

Capital expenditures

     (23,918     (18,227     (25,923

Payment for investment in variable interest entity, net of cash

     —          (3,277     —     

Proceeds from sale of available for sale securities

     —          —          10,681  

Other

     (163     (668     (541
  

 

 

   

 

 

   

 

 

 

Net cash used in investing activities

     (89,212     (88,106     (30,585
  

 

 

   

 

 

   

 

 

 

Cash Flows From Financing Activities:

      

Proceeds from issuance of debt

     250,000       —          —     

Proceeds from borrowings on the revolving line of credit

     405,056       106,400       5,350  

Repayments on the revolving line of credit

     (405,056     (106,400     (55,350

Purchase and retirement of common stock

     (140,439     (54,761     (57,176

Payment of contingent consideration on business acquisitions

     (9,500     (862     —     

Payment for debt issue costs

     (6,467     —          —     

Excess tax benefits from stock-based compensation arrangements

     2,057       3,187       2,516  

Proceeds from exercise of stock options

     1,383       2,079       4,489  

Payments under capital lease obligations

     (779     (834     (925

Other

     (1,523     (434     —     
  

 

 

   

 

 

   

 

 

 

Net cash provided by (used in) financing activities

     94,732       (51,625     (101,096
  

 

 

   

 

 

   

 

 

 

Net increase (decrease) in cash and cash equivalents

     133,804       (23,403     (29,280

Cash and cash equivalents, beginning of period

     29,348       52,751       82,031  
  

 

 

   

 

 

   

 

 

 

Cash and cash equivalents, end of period

   $ 163,152     $ 29,348     $ 52,751  
  

 

 

   

 

 

   

 

 

 

The accompanying notes are an integral part of these consolidated financial statements.

 

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PSS WORLD MEDICAL, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

MARCH 30, 2012, APRIL 1, 2011 AND APRIL 2, 2010

(Dollars in Thousands, Except Per Share Data, Unless Otherwise Noted)

1. NATURE OF OPERATIONS

PSS World Medical, Inc. (the “Company” or “PSSI”), a Florida corporation, began operations in 1983. The Company is a national distributor of medical products and supplies, diagnostic equipment, healthcare information technology and pharmaceutical products, and provides professional and consulting services to the physician, long-term care, assisted living, home health care, and hospice markets. The Company has full-service distribution centers strategically located to efficiently serve all 50 states throughout the United States.

The Company currently conducts business through two operating segments, the Physician Business and the Extended Care Business, which serve a diverse customer base. A third reporting segment, Shared Services, consists of departments that support the operating segments through the delivery of standardized service.

The Physician Business, or the Physician Sales & Service division, is a leading distributor of medical supplies, diagnostic equipment, pharmaceutical-related products, healthcare information technology, professional and consulting services and physician dispensing solutions to alternate site healthcare providers in the U.S. The Physician Business currently operates 33 full-service distribution centers, 39 break-freight locations, 2 service centers, and 2 redistribution facilities, some of which are shared with the Extended Care Business, serving physician offices in all 50 states.

The Extended Care Business, or the Gulf South Medical Supply division, is a national distributor of medical supplies and related products and solutions to the extended care industry in the United States. The Extended Care Business serves the skilled nursing home, assisted living, home health care, and hospice markets. In addition, the Extended Care Business also provides Medicare Part B billing services, either on a fee-for-service or a full-assignment basis and Medicaid billing services to the assisted living market. The Extended Care Business currently operates 18 full-service distribution centers, 10 break-freight locations, 2 service centers, and 2 redistribution facilities, some of which are shared with the Physician Business, serving independent and regional skilled nursing facilities, assisted living centers, home health care, and hospice providers in all 50 states.

2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Basis of Presentation

The accompanying consolidated financial statements have been prepared in accordance with U.S. generally accepted accounting principles (“GAAP”) and include the accounts of PSS World Medical, Inc. and its wholly-owned subsidiaries. All significant intercompany balances and transactions have been eliminated in consolidation.

The Company reports its year-end financial position, results of operations, and cash flows on the Friday closest to March 31. Fiscal years 2012 and 2011 each consisted of 52 weeks and 253 selling days and fiscal year 2010 consisted of 53 weeks or 258 selling days.

Use of Estimates

The preparation of financial statements in accordance with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Significant items subject to such estimates and assumptions include the carrying amount of inventories, property and equipment, goodwill, and intangibles; allowances for doubtful accounts receivables, contractual billing adjustments and vendor rebate receivables; valuation allowances for deferred income taxes; liabilities for loss contingencies; incentive and stock-based compensation expense; and valuations associated with business combinations. Actual results could differ from the estimates and assumptions used in preparing the consolidated financial statements.

 

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Fair Value of Financial Instruments

The carrying amounts of the Company’s current financial instruments, including cash and cash equivalents, short-term trade receivables, and accounts payable, approximate their fair values due to the short-term nature of these assets and liabilities. The gross carrying value of the Company’s 6.375% unsecured senior notes issued in 2012 as of March 30, 2012 was $250,000 and the fair value, estimated using a third party valuation model, was approximately $257,500. The gross carrying value of the Company’s 3.125% senior convertible notes issued in 2008 as of March 30, 2012 and April 1, 2011 was $230,000 and the fair value, estimated using a third party valuation model, was approximately $302,174 and $323,800, respectively.

Cash and Cash Equivalents

Cash and cash equivalents generally consist of demand deposits with financial institutions and highly liquid investment grade instruments having maturities of three months or less at the date of purchase. Cash and cash equivalents are stated at cost, which approximates market value.

Outstanding checks in excess of cash balances available for a legal right of offset are reclassified to Accounts payable on the Consolidated Balance Sheets. Amounts reclassified to accounts payable were $10,069 and $13,425 as of March 30, 2012 and April 1, 2011, respectively.

Accounts Receivable

Trade accounts receivable consists of amounts owed to the Company and is stated net of allowances, which approximates fair value due to the short-term nature of the asset. The Company’s outstanding accounts receivable balances are exposed to credit risk and valuation allowances are established for estimated losses resulting from non-collection of outstanding amounts due from customers. The valuation allowances include specific amounts for those accounts that are deemed likely to be uncollectible, such as disputed amounts and customers in bankruptcy, and general allowances for accounts that management currently believes to be collectible but that may later become uncollectible. Estimates are used to determine the valuation allowances and are generally based on historical collection results, current economic trends, credit-worthiness of customers, and changes in customer payment terms. Cash flows related to changes in accounts receivable balances are classified as operating activities within the Consolidated Statements of Cash Flows.

The Physician Business’ trade accounts receivable consists of many individual accounts, none of which is individually significant to the Company. The Physician Business had allowances for doubtful accounts of approximately $3,167 and $2,934 as of March 30, 2012 and April 1, 2011, respectively. During fiscal years 2012, 2011, and 2010, bad debt expense was less than 1% of net sales.

The Extended Care Business’ trade accounts receivable has a number of large customer accounts that are significant to its business. Approximately 16%, 16%, and 15%, of the Extended Care Business’ net sales for the fiscal years ended March 30, 2012, April 1, 2011, and April 2, 2010, respectively, represent net sales to its largest five customers. As of March 30, 2012 and April 1, 2011, the outstanding accounts receivable balances of these customers represented approximately 10% of accounts receivable, net of allowance for doubtful accounts, respectively. The Extended Care Business had allowances for doubtful accounts of approximately $3,047 and $2,875 as of March 30, 2012 and April 1, 2011, respectively. During fiscal years 2012, 2011, and 2010, bad debt expense was less than 1% of net sales.

Over the past three years, the Company’s average allowance for doubtful accounts has represented 2% of the Physician Business’ gross accounts receivable balance, and 4% of the Extended Care business’ gross accounts receivable balance.

 

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Table of Contents

Contractual Billing Adjustments

The Company provides medical claim billing services on a fee-for-service or a full-assignment basis and records claims receivable due from insurance carriers. A claim may become uncollectible in full due to denial, or partially uncollectable due to discounts taken. Management estimates contractual billing adjustments based on historical collection experience, and also considers voided claims and claims written off. Contractual billing adjustments are recorded as a reduction to Net sales on the Consolidated Statements of Operations.

Inventories

Inventories consist of medical products, medical equipment, and other related products and are stated at the lower of cost or market. Cost is determined using the first-in, first-out (“FIFO”) method. Market is defined as net realizable value. The net realizable value of excess and slow moving inventory is determined using judgment as to when inventory will be sold and the quantities and prices at which inventory will be sold in the normal course of business. Obsolete or damaged inventory is disposed of or written down to net realizable value on a quarterly basis. Additional adjustments, if necessary, are made based on management’s specific review of inventory on-hand. Cash flows related to changes in inventory are classified as operating activities within the Consolidated Statements of Cash Flows.

Property and Equipment

Property and equipment are stated at cost. Depreciation is computed using the straight-line method over the following estimated useful lives of the respective classes of assets:

 

     Useful Life

Equipment

   2 to 10 years

Computer hardware and software

   3 to 15 years

Capitalized internal-use software costs

   5 to 15 years

Leasehold improvements are amortized over the shorter of the lease term or the estimated useful life. Management is required to use judgment in determining the estimated useful lives of such assets. Changes in circumstances such as technological advances, changes to the Company’s business model, changes in the Company’s business strategy, or changes in the planned use of property and equipment could result in the actual useful lives differing from the Company’s current estimates. In those cases where the Company determines the useful life of property and equipment should be shortened or extended, the Company depreciates the net book value in excess of the estimated salvage value over its revised remaining useful life.

The Company capitalizes the following costs associated with developing internal-use computer software: (i) external direct costs of materials and services consumed in developing or obtaining internal-use computer software; (ii) certain payroll and payroll-related costs for Company employees who are directly associated with the development of internal-use software, to the extent of time spent directly on the project; and (iii) interest costs incurred while developing internal-use computer software. According to ASC 835-20, Interest-Capitalization of Interest, interest cost may be capitalized as a part of the historical cost of acquiring certain assets, such as assets that are constructed or produced for a company’s own use. The amount of capitalized interest during fiscal years 2012, 2011, and 2010 was $897, $511, and $1,182, respectively.

Gains or losses upon retirement or disposal of property and equipment are recorded in Other income, net in the accompanying Consolidated Statements of Operations. Normal repair and maintenance costs that do not substantially extend the life of property and equipment are expensed as incurred.

Goodwill

Goodwill represents the future economic benefits and synergies arising from other assets acquired in a business combination that are not individually identified and separately recognized. In accordance with the provisions of ASC 350-20, Intangibles – Goodwill and Other – Goodwill, goodwill is reviewed for impairment annually as of the

 

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last day of the fiscal year. An interim review is performed between annual tests whenever events or changes in circumstances indicate the carrying amount of the goodwill may be impaired. Because the estimated fair value of the reporting units exceeded the carrying amount of the goodwill, there was no impairment as of March 30, 2012 and April 1, 2011.

Intangibles

ASC 350-30, Intangibles – Goodwill and Other – General Intangibles Other Than Goodwill, requires intangible assets with finite useful lives be amortized over their respective estimated useful lives. Amortization is computed using the straight-line method.

Certain sales representatives employed by the Physician and Extended Care Businesses have executed employment agreements in exchange for a cash payment (“Nonsolicitation Agreements”). These employment agreements include nonsolicitation covenants, which state that the sales representative can neither solicit nor accept business from certain of the Company’s customers for a stated period of time subsequent to the date the sales representative ceases employment with the Company. The costs associated with these Nonsolicitation Agreements are capitalized and amortized on a straight-line basis over their estimated useful lives, plus the stated nonsolicitation period. If a sales representative terminates employment prior to the end of the estimated useful life of the agreement, the remaining net book value of the asset is amortized over the stated nonsolicitation period.

During the period the sales representatives remain employed with the Company, the nonsolicitation intangible asset is evaluated for impairment in accordance with the provisions of ASC 360-10, Property, Plant, and Equipment – Overall. This standard requires the Company to test for impairment whenever events or changes in circumstances indicate that the carrying amount of the asset may not be recoverable. Certain factors which may indicate an impairment exists include, but are not limited to: (i) a change in a state’s legal system that would impact any legal opinion relied upon when assessing enforceability of the nonsolicitation covenants, (ii) a decline in gross profit or sales volume, (iii) death, or (iv) full retirement by the sales representative. In the event the carrying value of the assets were to be determined unrecoverable, the Company would estimate the fair value of the assets and record an impairment charge for the excess of the carrying value over the fair value. There were no impairments as of March 30, 2012 or April 1, 2011.