We lease twenty-seven facilities throughout the United States and Puerto Rico. Our corporate headquarters office, containing approximately 75,000 square feet, is located in Rockville, Maryland and accommodates our executive and corporate functions. We also have satellite offices in Alabama, Colorado, Florida, Georgia, Hawaii, Illinois, Iowa, Michigan, Minnesota, Mississippi, Missouri, Nevada, North Carolina, Ohio, Pennsylvania, Puerto Rico and Texas. We believe all of our facilities are well-maintained and in good operating condition and have adequate capacity to meet our current business needs.
The following selected financial data has been derived from the audited financial statements of the Company. We have completed a number of acquisitions over the past five years which may affect year-over-year comparisons of our selected financial data. The revenue and operating results related to acquisitions of companies are included from the respective acquisition dates. The selected financial data should be read in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” included as
Catalyst Health Solutions, Inc. is a full-service pharmacy benefit management, or PBM, company. We operate primarily under the brand name Catalyst Rx. We are built on strong, innovative principles in the management of prescription drug benefits and our client-centered philosophy contributes to our client retention rates. Our clients include self-insured employers; state and local governments; managed care organizations, or MCOs; unions; third-party administrators, or TPAs; hospices; and individuals who contract with us to administer the prescription drug component of their overall health benefit programs.
Catalyst Rx Health Initiatives, Inc. (formerly known as Walgreens Health Initiative, Inc.)
On June 13, 2011, we completed our acquisition of Catalyst Rx Health Initiatives, Inc., or “CHII”, formerly known as Walgreens Health Initiatives, Inc., or “WHI”, which was the PBM subsidiary of Walgreen Co., or “Walgreens”. The purchase price was $485.0 million in cash, subsequently adjusted by $48.6 million for net working capital adjustments, and up to $40.0 million in additional cash consideration payable upon the achievement of certain client retention milestones through March 31, 2014. The fair value of the contingent consideration at the acquisition date was approximately $36.7 million. The cash payment for this acquisition was funded from a combination of cash on hand and amounts drawn under our revolving credit facility. For the year ended December 30, 2011, we incurred approximately $12.2 million of transaction related costs, which were included in selling, general and administrative expenses in our consolidated statements of operations.
The value of identified intangibles reflect that we entered into a 10-year contract with Walgreens to provide PBM services for Walgreens’ 244,000 employees and retirees, as well as 10-year agreements to administer the Walgreens Prescription Savings Club, which has approximately 2.4 million members, and to provide certain administrative support services to on-going Walgreens businesses.
We determined the fair value of the contingent consideration using probability assessments of the expected future cash flows over the period in which the obligation is expected to be settled, and applied a discount rate that appropriately captures a market participant’s view of the risk associated with the obligation. Subsequent changes to the valuation are recorded through earnings. For the year ended December 31, 2011, there was a $1.0 million increase in the fair value of contingent consideration subsequent to acquisition which was recorded in selling, general and administrative expenses in the consolidated statements of operations.
The purchase price of NLBP was largely determined on the basis of management’s expectations of future earnings and cash flows, resulting in the recognition of goodwill. Management’s final allocation of the purchase price to the net assets acquired resulted in goodwill of $4.5 million, trade name intangibles of $0.2 million with an estimated useful life of 20 years, non-compete agreements of $0.6 million with an estimated life of 3 years, and acquired technology of $0.9 million with an estimated useful life of 5 years.
The acquisition was accounted for as a purchase, and accordingly, the results of NLBP operations are included in our consolidated financial statements since the date of acquisition. Goodwill related to this acquisition is deductible for tax purposes.
On September 13, 2010, we completed the acquisition of FutureScripts, LLC and FutureScripts Secure LLC (collectively, “FutureScripts”). FutureScripts, formed in 2006, was the PBM subsidiary of Independence Blue Cross or “IBC”. FutureScripts provides pharmacy benefit management services to approximately 1 million lives and manages over 14 million prescriptions annually. We manage these pharmacy benefits under the terms of a 10-year contract. Under the terms of the acquisition agreement, we maintain the FutureScripts brand and provide IBC a full complement of services, including: claims adjudication, member services, network administration, formulary management and rebate contracting, mail and specialty drug management, clinical services, data reporting and analytics, as well as client service and sales support.
Total consideration for the acquisition of FutureScripts consisted of cash payments on September 13, 2010 of $225.5 million. The purchase price of FutureScripts was largely determined on the basis of management’s expectations of future earnings and cash flows, resulting in the recognition of goodwill. The purchase price was funded from our cash on hand. In June 2011, we received approximately $1.0 million in cash as required for certain closing date net working capital adjustments. We incurred $1.5 million of acquisition related costs, which were included in selling, general and administrative expenses in our consolidated statement of operations for the year ended December 31, 2010.
Management’s allocation of the purchase price to the net assets acquired resulted in goodwill of $127.3 million, trade name intangibles of $16.2 million with an estimated useful life of 20 years, and customer contract intangibles of $81.4 million with an estimated useful life of 10 years. Goodwill related to this acquisition is deductible for tax purposes. The goodwill recognized is primarily attributable to the workforce of the acquired business and the operating synergies expected to be realized after our acquisition of FutureScripts.
On August 25, 2010, we acquired inPharmative, Inc. for a cash payment of $16.5 million and 100,000 common stock warrants valued at approximately $1.0 million using the Black-Scholes option pricing model. In March 2011, we paid an additional $0.7 million as required for certain closing date net working capital adjustments. InPharmative, which is based in Kansas City, MO, is a provider of rebate administration technology tools to PBMs, health plans, state Medicaid programs and group purchasing organizations.
The acquisition was accounted for as a purchase, and accordingly, the results of inPharmative operations are included in our consolidated financial statements since the date of acquisition.
In July 2009, we purchased Total Script, LLC, a pharmacy benefit management company with a strategic focus on the small- to mid-sized employer group markets. Total consideration for the acquisition of Total Script consisted of cash payments of $13.5 million. Additionally, the purchase agreement included contingent consideration payable over a three-year period based on the achievement of certain milestones and net new business contracted. The fair value of the net contingent consideration recognized on the acquisition date, which was determined using expected present value techniques, was approximately $13.4 million. During 2010, we made contingent consideration payments of $3.2 million based on the achievement of certain milestones and net new business acquired. Also, during 2011 and 2010, there were decreases of $3.0 million and $1.1 million, respectively, in the fair value of recognized amounts for the contingent consideration, primarily due to revised assumptions regarding net new business contracted. On December 15, 2011, we entered into an agreement with Total Script whereby we will pay $2.7 million in connection with full and final settlement of the remaining contingent consideration owed. Such cash payment was made on January 3, 2012. The adjustments to the fair value of recognized amounts for contingent consideration, including a $3.4 million adjustment at settlement, were included in selling, general and administrative expenses in the consolidated statements of operation for the respective periods.
For the year ended December 31, 2011, our revenue per claims processed, excluding ASO claims, increased by approximately 6% when compared to the same period in 2010. The increase in revenue per claims processed for 2011 was primarily caused by manufacturer-driven price inflation and increased use of specialty medications, offset by an increase in generic utilization. Additionally, the portion of manufacturer or third-party intermediary rebates due to clients is recorded as a reduction of revenue. For the years ended December 31, 2011 and 2010, adjustments made to these rebate payable estimates from prior periods increased revenue by $2.2 million and $3.5 million, respectively.
Interest Expense. Interest expense increased to $7.5 million for the year ended December 31, 2011 from $3.0 million in the comparable period in 2010. The increase was primarily attributable to the interest expense associated with our use of our credit facilities and the amortization of related financing costs.
Income Tax Expense. The effective income tax rates of 37.7% in 2011 and 37.9% in 2010 represent the percentage relationship of the provision for income taxes to the income before provision for income taxes. Our tax rate in 2011 was favorably impacted by a decrease in our overall state effective income tax rates.
Net Income Attributable to the Company. Our 2011 net income attributable to the Company excludes a $0.4 million of net loss attributable to a non-controlling interest. The decrease in our 2011 net income attributable to the Company over the same period in 2010 was primarily a function of increased selling, general and administrative expenses related to our recent acquisitions.
Direct Expenses. Direct expenses for the years ended December 31, 2010 and 2009 were approximately $3.5 billion and $2.7 billion, respectively. Direct expenses increased by $0.8 billion over the comparable period in 2009 primarily due to the $0.9 billion increase in revenue. Direct expenses for 2010 and 2009 represented 97.2% and 97.1% of total operating expenses for the respective periods. Rebates earned under arrangements with manufacturers or third-party intermediaries are recorded as a reduction of direct expenses. For the year ended December 31, 2010, adjustments made to these rebate receivable estimates from prior periods reduced direct expenses by $4.8 million.
Net Income Attributable to the Company. Net income attributable to the Company for the year ended December 31, 2010 increased by approximately $15.8 million over the same period in 2009 to $81.0 million. The increase in net income attributable to the Company was primarily a function of increased gross margin, reduced by an increase in selling, general and administrative expenses.
Our sources of funds are primarily cash flows from operating activities. We have in the past also raised funds by borrowing on bank debt and, most recently, through the proceeds of a public offering of shares of our common stock. During the last several years, we have generated positive cash flow from operations and anticipate similar results for 2012. At December 31, 2011, our cash and cash equivalents were $49.2 million. The net decrease of $108.6 million in our cash and cash equivalents since the end of fiscal 2010 resulted primarily from the cash provided by our operating activities and financing activities, offset by cash used in the acquisition of WHI.
On April 13, 2011, we consummated a public offering of 6,325,000 shares of our common stock, par value $0.01 per share, of which 4,500,000 shares were sold by the Company and 1,825,000 shares were sold by one of our stockholders, Principal Holding Company, LLC (“Principal”), at a public offering price of $53.00 per share. Total proceeds to the Company, net of underwriting fees, were $227.1 million.
Net Cash Provided by Operating Activities. Our operating activities generated $99.0 million of cash from operations in 2011, a $1.3 million increase from the $97.7 million generated in 2010. This $99.0 million in cash provided by operating activities in 2011 reflects $66.6 million in net income, plus $60.7 million in net non-cash charges and a $28.3 million net decrease in cash provided by changes in working capital and other assets and liabilities. This $28.3 million net decrease in cash provided by changes in working capital, net of effects from acquisitions, was primarily due to changes in accounts receivable of $57.4 million, rebates receivable of $72.1 million, income tax receivable of $13.0 million, other assets of $8.2 million and accrued expense and other liabilities of $2.8 million, offset by changes in inventory of $0.4 million, accounts payable of $103.4 million and rebates payable of $21.4 million. The change in accounts receivable and in rebates receivable reflects the impact of the timing of the collection of these receivables. The change in rebates payable and in accounts payable reflects the temporary benefit in the timing of payments of these liabilities.
Net Cash Used in Investing Activities. Net cash used in investing activities for the year ended December 31, 2011 was $550.6 million, compared to $240.3 million in 2010. The cash used in 2011 reflects expenditures of $462.1 million for business acquisitions, net of cash received for working capital adjustments, $40.0 million in business acquisition related restricted cash, $5.0 million in other restricted cash, $40.7 million in capital expenditures and other investing activities of $3.2 million, offset by $0.4 million cash from consolidation of our variable interest entity.
Net Cash Provided by Financing Activities. Net cash provided by financing activities for the year ended December 31, 2011 was $343.0 million compared to $148.4 million in 2010. In 2011, we received $227.1 million from an equity offering, $130.0 million from net borrowings on our revolving credit facility, $1.9 million from the exercise of stock options, $0.6 million in proceeds from issuance of common stock pursuant to our employee stock purchase plan, an income tax benefit of $6.8 million related to the exercise of stock options and restricted stock vesting, and other financing activities of $1.0 million. Additionally, we purchased $3.5 million of treasury stock during 2011, incurred $5.4 million in deferred financing cost related to our credit facilities, made scheduled repayments of $7.5 million on our term loan, and repaid obligations of $8.0 million related to the First Rx Specialty and Mail Services LLC arrangement.
Net cash provided by financing activities for the year ended December 31, 2010 was $148.4 million compared to $6.4 million in 2009. In 2010, we received $150.0 million in proceeds from a term loan, $3.6 million from the exercise of stock options, $0.3 million in proceeds from issuance of common stock pursuant to our employee stock purchase plan and had an income tax benefit of $6.0 million related to the exercise of stock options and restricted stock vesting. Additionally, we purchased $2.6 million of treasury stock during 2010, incurred $3.8 million in deferred financing cost related to our new credit facilities, made a repayment of $1.9 million on our term loan, and made a $3.2 million contingent consideration payment.
Net cash provided by financing activities for the year ended December 31, 2009 was $6.4 million compared to $15.7 million in 2008. In 2009, we received proceeds of $2.9 million from the exercise of stock options and $0.3 million in proceeds from issuance of common stock pursuant to the employee stock purchase plan, had an income tax benefit of $3.6 million related to the exercise of stock options and restricted stock vesting, and received proceeds of $1.0 million related to our First Rx Specialty and Mail Services, LLC arrangement. Additionally, we purchased $1.0 million of treasury stock and incurred $0.4 million in deferred financing cost during 2009.
(1) The interest expense for our term loan obligation is based on our December 31, 2011 LIBOR and applicable margin over LIBOR. Our actual interest payments will fluctuate with changes in LIBOR and in the margin over LIBOR we are required to pay. We have excluded from these interest payments the interest on our outstanding revolving credit facility as this interest is calculated based on the outstanding balance which may vary daily and is not pre-determinable. See “Note 8 - Financing” of our consolidated financial statements for further discussion.
(2) Total contractual obligations exclude (a) the potential future payments required in connection with possible contingent
At December 31, 2011, we had a $400.0 million revolving credit facility with $130.0 million in outstanding borrowings. For additional information regarding our credit facilities, deferred income taxes, and operating leases, see Notes 8, 9 and 12, respectively, of our consolidated financial statements.
Rebates earned under arrangements with manufacturers or third-party intermediaries are predominately recorded as a reduction of direct expenses. The portion, which in some cases may be the full amount, of such rebates due to clients is recorded as a reduction of revenue. Manufacturers’ or third-party intermediary rebates are based on estimates, which are subject to final settlement with the contracted party on an on-going basis.
Trade accounts receivable are recorded at the invoiced amount and do not bear interest. The allowance for accounts receivable is our best estimate of the amount of probable credit losses in our existing accounts receivable. We determine the allowance based on historical write-off experience by industry and regional economic data. We review our allowance for accounts receivable quarterly. Account balances are charged off against the allowance when we feel it is probable the receivable will not be recovered. We do not have any off-balance-sheet credit exposure related to our customers.
The Company qualitatively assesses the determination of the primary beneficiary of variable interest entities (“VIE”) based on whether we (1) have the power to direct matters that most significantly impact the activities of the VIE and (2) have the obligation to absorb losses or the right to receive benefits of the VIE that could potentially be significant to the VIE. We consolidate the VIEs for which we are the primary beneficiary.
We may, from time to time, be assessed interest or penalties by major tax jurisdictions, although any such assessments historically have been minimal and immaterial to our financial results. Our policy is that we recognize interest and penalties accrued on any unrecognized tax benefits as a component of income tax expense.
For a discussion of new accounting standards affecting us, refer to Note 3 of our Notes to Consolidated Financial Statements.
Our audited consolidated financial statements are contained in a separate section of this Annual Report on Form 10-K on pages through and Financial Statement Schedule on page S-1 attached hereto.