The following selected consolidated financial data have been derived from the consolidated financial statements of the Company contained elsewhere in this Annual Report on Form 10-K and the Company’s Annual Report on Form 10-K for the fiscal years ended December 31, 2012 and 2011. The selected consolidated financial data should be read in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and the consolidated financial statements, including the notes thereto.
The Company completed its acquisition of MedfusionRx on December 28, 2010. The purchase price for MedfusionRx was $101.5 million in cash with an additional $5.5 million potential earn-out payment subject to the achievement of certain financial performance targets through 2012.
On October 1, 2013, the Company completed the acquisition of Restat, LLC, a privately held pharmacy benefit manager based in Milwaukee, Wisconsin, for a purchase price of $409.5 million in cash subject to certain customary post-closing adjustments. The purchase price was funded from Catamaran’s existing cash balance and $350.0 million in borrowings under the Revolving Facility. The acquisition provides the Company the opportunity to bring Catamaran's full-suite of technology and clinical services to Restat's clients, including mail and specialty pharmacy services.
This Management's Discussion and Analysis (“MD&A”) of Catamaran Corporation (the “Company” or "Catamaran") should be read in conjunction with the consolidated financial statements of the Company and the related notes thereto included in Item 8 of this Annual Report on Form 10-K. This MD&A also contains forward-looking statements and should be read in conjunction with the risk factors described in Item 1A “Risk Factors.”
Certain statements included in this MD&A, including those that express management's objectives and the strategies to achieve those objectives, as well as information with respect to the Company's beliefs, plans, expectations, anticipations, estimates and intentions, constitute “forward-looking statements” within the meaning of applicable securities laws. Forward-looking statements are necessarily based upon a number of estimates and assumptions that, while considered reasonable by management at this time, are inherently subject to significant business, economic and competitive uncertainties and contingencies. We caution that such forward-looking statements involve known and unknown risks, uncertainties and other risks that may cause our actual financial results, performance, or achievements to be materially different from our estimated future results, performance or achievements expressed or implied by those forward-looking statements. Numerous factors could cause actual results to differ materially from those in the forward-looking statements, including without limitation, our ability to achieve increased market acceptance for our product offerings and penetrate new markets; our ability to compete successfully; our dependence on, and ability to retain, key customers; customer demands for enhanced services levels or loss or unfavorable modification with our customers; the risks and challenges associated with our PBM partnering agreement with Cigna Corporation due to the size of the client and the complexity and term of the agreement; consolidation in the healthcare industry; our ability to identify and complete acquisitions, manage our growth, integrate acquisitions and achieve expected synergies from acquisitions; changes in industry pricing benchmarks and continuing market and economic challenges; our ability to maintain our relationships with pharmacy providers, pharmaceutical manufacturers, third-party rebate administrators and suppliers; compliance with existing laws, regulations and industry initiatives and future change in laws or regulations in the healthcare industry; our ability to maintain our relationships with suppliers; the outcome of any legal or tax proceeding that has been or may be instituted against us; the existence of undetected errors or similar problems in our software products; potential liability for the use of incorrect or incomplete data; interruption of our operations due to outside sources and breach of our security by third parties; our dependence on the expertise of our senior management and other personnel; maintaining our intellectual property rights and litigation involving intellectual property rights; our ability to obtain, use or successfully integrate third-party licensed technology; our ability to accurately forecast our financial results; our level of indebtedness and the covenants and restrictions in the agreements governing our outstanding indebtedness; our access to sufficient capital to fund our future requirements; potential write-offs of goodwill or other intangible assets; and the material weakness identified in our internal control over financial reporting.
The mail pharmacies provide members flexibility, privacy, and easy access to their maintenance medications while offering significant plan savings to the customer. These pharmacies provide high quality service, member support and convenient, easy-to-use mail service delivery
Revenue primarily consists of sales of prescription drugs, together with any associated administrative fees, to customers and participants, through the Company’s nationwide network of participating pharmacies or the Company's own mail and specialty pharmacies. Revenue related to the sales of prescription drugs is recognized when the claims are adjudicated and the prescription drugs are shipped. Claims are adjudicated at the point-of-sale using a real-time processing system.
Under the Company’s customer contracts, the pharmacy is solely obligated to collect the co-payments from the participants. As such, the Company does not include participant co-payments paid to non-Company owned pharmacies in revenue or cost of revenue. During 2013, 2012 and 2011, pharmacies, excluding the Company's internally owned mail and specialty locations, collected approximately $2.9 billion, $1.8 billion, and $0.7 billion, respectively, in co-payments from the participants. If we had included these co-payments collected at non-Company owned pharmacies in our reported revenue and direct expenses, our operating and net income would not have been affected.
Profitability of the HCIT business depends primarily on revenue derived from transaction processing services, software license sales, hardware sales, maintenance, and professional services. Recurring revenue remains a cornerstone of the Company’s business model and consists of transaction processing services and maintenance. Growth in revenue from recurring sources has been driven primarily by growth in the Company’s transaction processing business in the form of claims processing for its payor customers. Through the Company’s transaction processing business, where the Company is generally paid based on the volume of transactions processed, the Company continues to benefit from the growth in pharmaceutical drug use in the United States. The Company believes that aging demographics and increased use of prescription drugs will continue to benefit the transaction processing business. In addition to benefiting from this industry growth, the Company continues to focus on increasing recurring revenue in the transaction processing area by adding new transaction processing customers to its existing customer base. The recognition of revenue depends on various factors including the type of service provided, contract parameters, and any undelivered elements.
The Company’s operating expenses primarily consist of cost of revenue, selling, general and administrative (“SG&A”) costs, depreciation, and amortization. Cost of revenue includes the costs of drugs dispensed as well as costs related to the products and services provided to customers and costs associated with the operation and maintenance of the transaction processing centers. These costs include salaries and related expenses for professional services personnel, transaction processing centers’ personnel, customer support personnel and depreciation expense related to data center operations. SG&A costs relate to selling expenses, commissions, marketing, network administration and
The complex environment in which the Company operates presents it with opportunities, challenges, and risks. The Company’s clients are paramount to its success; the retention of existing and winning of new clients and members poses the greatest opportunity, and the loss thereof represents an ongoing risk. The preservation of the Company’s relationships with pharmaceutical manufacturers and the Company's network of participating pharmacies is very important to the execution of its business strategies. The Company’s future success will depend in part on its ability to drive volume at its mail and specialty pharmacies and increase generic dispensing rates in light of the significant brand-name drug patent expirations expected to occur over the next several years. The Company’s ability to continue to provide innovative and competitive clinical and other services to clients and patients, including the Company’s active participation in the Medicare Part D benefit and the rapidly growing specialty pharmacy industry, also will play an important part in the Company’s future success.
The Company’s business model allows its customers the flexibility to operate the Company’s systems themselves (with or without taking advantage of the Company’s significant customization, consulting and systems implementation services) on a fee-per-transaction or subscription basis through ASP processing from the Company’s data center. In other cases, the Company fully manages a customer's pharmacy benefit program from claims adjudication through clinical programs and consulting.
Leading technology and platform: The Company’s technology is robust, scalable, and web-enabled. The platform is able to cross-check multiple processes, such as reviewing claim eligibility, adverse drug reaction and properly calculating member, pharmacy and payor payments on a real-time basis. The Company’s technology is built on flexible, database-driven rule sets and broad functionality applicable for most any type of business. The Company believes it has one of the most comprehensive claims processing platforms in the market.
The Company reported net income attributable to the Company of $262.2 million, or $1.27 per share (fully-diluted), for the year ended December 31, 2013, an increase of $145.5 million or 124.7% compared to $116.7 million, or $0.70 per share (fully-diluted), in 2012. Net income attributable to the Company is higher for the year ended December 31, 2013 as compared to 2012 as a result of a full year of the Catalyst book of business, the addition of the Restat book of business and other new customer contract implementations during the year, as well as a decrease
in the transaction and integration costs related to the Company's Merger with Catalyst that closed in Q3 2012. These positive impacts to net income attributable to the Company were offset by an increase in operating expenses as discussed above, as well as an increase in interest expense of $13.3 million as a result of the Company's borrowings utilized to partially finance the Merger with Catalyst being outstanding for a full year, as well as additional borrowings utilized to help finance in part the acquisition of Restat.
Earnings per share attributable to the Company (fully-diluted) increased $0.57 or 81.4% to $1.27 for the year ended December 31, 2013 as compared to $0.70 for the year ended December 31, 2012, primarily due to the increase in net income attributable to the Company as previously noted as well as a decrease in the transaction and integration costs as discussed above.
Strong operational results and strong attention to cash management yielded cash flow from operations of $475.4 million in 2013, an increase of $225.7 million from 2012.
Revenue increased $5.0 billion, or 99.8%, to $9.9 billion during 2012 as compared to 2011, primarily due to the Merger with Catalyst, which was completed on July 2, 2012 and contributed $3.2 billion to 2012 revenues, new customer starts during 2012 and an increase in new
PBM services sold to several existing HCIT customers as a result of synergies between the HCIT and PBM segments, which allowed the Company to focus on offering a broader array of products and services to the Company's customers.
Gross profit increased $423.9 million, or 137.0%, to $733.4 million during 2012 as compared to 2011, mostly due to incremental PBM revenues. Gross profit percentage increased from 6.2% of revenue for the year ended December 31, 2011 to 7.4% of revenue for the year ended December 31, 2012. The PBM segment's gross profit percentage increased due to the synergies realized from the Company's acquisitions.
SG&A costs for the year ended December 31, 2013 were $440.8 million compared to $369.5 million and $145.8 million for the years ended December 31, 2012 and 2011, respectively. SG&A costs consist primarily of employee costs in addition to professional services costs, facilities and costs not related to cost of revenue. SG&A costs have increased $71.3 million, or 19.3%, from 2012 to 2013 due to having a full year of costs to support and integrate the business acquired from Catalyst that were only present for half of the year in 2012. Additionally, operating costs increased related to the acquisition of Restat and certain lease exit costs incurred during 2013 that were not present during 2012, along with increased costs as a result of organic increases in SG&A in order to support the growth of the PBM segment, specifically related to the new Cigna contract announced in June 2013 for which the Company has already began investing in additional personnel and infrastructure to support the implementation of that contract.
Depreciation expense relates to property and equipment used in all areas of the Company except for those depreciable assets directly related to the generation of revenue, which is included in the cost of revenue in the consolidated statements of operations. Depreciation expense increased $21.2 million to $37.9 million for the year ended December 31, 2013 from $16.7 million for the same period in 2012, driven by an additional half of year of depreciation from the assets acquired in the Merger with Catalyst, the acquisition of Restat, along with new asset purchases in 2013 to support the continued growth in the Company's business. Depreciation expense will continue to increase in 2014 as a result of a full year of depreciation of Restat assets, along with an increase due to new asset purchases in 2013.
Depreciation expense for the year ended December 31, 2012 increased $10.0 million from $6.7 million in 2011 as a result of new asset purchases made during 2012, plus the additional depreciation related to the assets acquired in the Merger with Catalyst and the acquisition of HealthTran.
Amortization expense for the year ended December 31, 2012 was $130.1 million compared to $16.4 million for the year ended December 31, 2011. The increase was driven mainly by the amortization of intangible assets acquired in the Merger with Catalyst and acquisition of HealthTran in 2012. Amortization expense also increased in 2012 due to an $8 million adjustment to the useful life to the trade name intangible asset the Company carried from its acquisition of Medfusion in 2010. The adjustment to the useful life was triggered as a result of the Company re-branding its specialty business as BriovaRx in October 2012 and ceasing the use of the Medfusion name.
Interest and other expense, net increased $14.9 million to $41.6 million for the year ended December 31, 2013 from $26.7 million in 2012. The increase is driven by an increase in the interest expense of $13.3 million to $39.1 million for the year ended December 31, 2013 from $25.8 million in 2012. The increase in interest expense is a result of a full year of outstanding borrowings under the Company's credit facility used to partially finance the Merger with Catalyst and an additional $350.0 million utilized to partially finance the acquisition of Restat. Refer to Note 9 - Long - Term Liabilities in the notes to the consolidated financial statements for more information related to the Company's credit facility. Interest expense, increased $23.9 million to $25.8 million for the year ended December 31, 2012 compared to 2011, primarily due to interest related to the $1.4 billion utilized under the Company's credit facility to partially finance the Merger with Catalyst during 2012.
The Company manages its business in two segments: PBM and HCIT, and evaluates segment performance based on revenue and gross profit. Information about the Company’s reportable segments for the years ended December 31, 2013, 2012 and 2011 is presented below:
PBM revenue increased by $4.8 billion, or 49.5% to $14.6 billion for the year ended December 31, 2013 as compared to $9.8 billion in 2012. The increase in revenue is primarily due to a full year of revenue contribution from Catalyst, the acquisition of Restat, which was completed on October 1, 2013, as well as organic growth as a result of the implementation of new customer contracts in 2013. As a result of these customer additions, adjusted prescription claim volume for the PBM segment increased 48.8% to 296.0 million from 198.9 million during 2012.
For the year ended December 31, 2012, compared to 2011, cost of revenue increased $4.5 billion, or 98.6%. The increase was in line with the increase in PBM revenues during this period. As a percentage of revenue, cost of revenue was 93.4% and 94.7% for the years ended December 31, 2012 and 2011, respectively. The decrease in the cost of revenue as a percentage of revenue was primarily due to the synergies realized as a result of the Merger as well as the increased use of lower cost generic drugs and higher utilization of the Company's owned mail and specialty pharmacies.
Cost of revenue increased $4.8 million or 7.3% to $70.5 million for the year ended December 31, 2013 as compared to $65.7 million for the year ended December 31, 2012. Cost of revenue increased $2.4 million or 3.7% to $65.7 million for the year ended December 31, 2012 as compared to $63.3 million for the same period in 2011. Cost of revenue includes the direct support costs for the HCIT business as well as depreciation expense of $4.3 million, $3.5 million and $2.7 million for the years ended December 31, 2013, 2012 and 2011, respectively. In addition, cost of revenue includes stock-based compensation expense of $1.4 million for the year ended December 31, 2013 and $0.7 million for the years ended December 31, 2012 and 2011. Cost of revenue increased during 2013 as compared to 2012 mainly due to investments in our systems. The Company's HCIT costs do not always directly correlate with changes in revenue. Most of the increased revenues of 2012 were related to transaction processing, which often do not incur cost increases when volumes rise due to the scalability of the Company's systems.
Gross profit increased $36.4 million, or 68.8%, to $89.3 million for the year ended December 31, 2012 as compared to $52.9 million in 2011, and gross profit percentage was 57.6% for the year ended December 31, 2012, as compared to 45.5% in 2011. The increases in gross profit and gross profit percentage are attributable to the mix of the Company's HCIT revenue moving to more transaction processing as a percentage of total revenues. This reduced the percentage of revenues attributable to professional services, which carry the lowest gross profit percentage in the Company's HCIT segment due to the direct labor costs associated with professional services.
The following is a reconciliation of the Company's reported net income to EBITDA for the years ended December 31, 2013, 2012 and 2011.
EBITDA increased $288.4 million for the year ended December 31, 2013 compared to 2012, primarily due to an increase in sales within the PBM segment as a result of the Merger with Catalyst, the recent acquisition of Restat as well as organic growth from new customer contract implementations. This was partially offset by increased costs incurred to support the Company's business growth and recent acquisitions.
Adjusted EPS for the year ended December 31, 2013 was $2.00 as compared to $1.19 in 2012. The increase in Adjusted EPS is mainly due to an increase in net income attributable to the Company which was driven by an increase in the PBM revenue along with a decrease in the transaction costs incurred to complete the Merger with Catalyst. This was partially offset by increased costs incurred to support the Company's business growth and recent acquisitions.
The Company’s sources of liquidity have primarily consisted of cash provided by operating activities, proceeds from its public offerings, proceeds from credit facilities and stock option exercises. On October 1, 2013, the Company completed the acquisition of Restat for a purchase price of $409.5 million in cash, which was funded from Catamaran’s existing cash balance and $350.0 million in borrowings under the Revolving Facility. Due to the borrowings from the Credit Agreement used to complete the Merger of Catalyst and the acquisition of Restat the Company incurred a significant increase in its interest expense as compared to prior years and expects this expense and the related principal payments to continue throughout the term of the Credit Agreement. As of December 31, 2013, the Company had approximately $1.3 billion of outstanding debt under its Credit Agreement and approximately $500 million of available borrowing capacity thereunder. Refer to Note 9 - Long-Term Liabilities in the notes to the consolidated financial statements for more information regarding the Credit Agreement, including the amendment executed in 2013.
At December 31, 2013 and 2012, the Company had cash and cash equivalents totaling $387.2 million and $370.8 million, respectively. The Company believes that its cash on hand, together with cash generated from operating activities, and the amount available under its Credit Agreement, will be sufficient to support planned operations for the foreseeable future. At December 31, 2013, cash and cash equivalents consist of cash on hand, deposits in banks and bank term deposits with original maturities of 90 days or less.
As of December 31, 2013, goodwill and other intangible assets were $4.7 billion and $1.2 billion, respectively. Goodwill increased by $242.2 million from December 31, 2012 to December 31, 2013 mainly due to the acquisition of Restat, while intangible assets were flat during this period due to an increase in intangible asset amortization offset by intangible assets recorded from the Restat acquisition. Please refer to Note 7 - Goodwill and Other Intangibles Assets for future amortization expense as of December 31, 2013.
For the year ended December 31, 2013, the Company used $0.5 billion of cash for investing activities, a decrease of $1.1 billion as compared to the year ended December 31, 2012 . This decrease was driven by the cash consideration paid to acquire Catalyst and HealhTran in 2012 causing the use of approximately $1.6 billion in cash offset by $388.9 million primarily cash used to acquire Restat in 2013. Additionally, the Company used $128.8 million for purchases of property and equipment to support increased transaction volume and invest in systems to effectively and efficiently integrate the operations of recent acquisitions. The cash used was partially offset by proceeds from restricted cash of $20.0 million. As the Company grows, it continues to purchase capital assets to support increases in its information technology network capacity and personnel. The Company monitors and budgets these costs to ensure the expenditures aid in the strategic growth of the Company.
For the year ended December 31, 2012, the Company used $1.6 billion of cash for investing activities, an increase of $1.5 billion, which consisted primarily of cash used to acquire HealthTran and Catalyst. Additionally, the Company used $40.2 million for purchases of property and equipment to support increased transaction volume and invest in systems to effectively and efficiently integrate the operations of recent acquisitions.
For the year ended December 31, 2013, the Company generated $38.8 million of cash from financing activities as compared to $1.4 billion for the year ended December 31, 2012. The decrease during this period is primarily due to the Company's approximately $1.5 billion borrowings in 2012 to finance the Merger. During the year ended December 31, 2013 the Company's financing activities consisted primarily of borrowings of $0.5 billion used primarily to fund the acquisition of Restat offset by $0.4 billion of repayments on the Company's Credit Agreement, as well as payments of contingent purchase price consideration related to certain acquisitions and the distribution of its share of earnings in respect of a non-controlling interest.
Outstanding amounts under the Credit Agreement are due on the Credit Agreement's maturity date, July 2, 2018. The amount noted includes the amount borrowed by the Company under the Term Loan and the Revolving Facility as of December 31, 2013, which will fluctuate based on the principal amounts outstanding under the Term Loan and Revolving Facility.
The earn-out payment relates to the Walgreens Health Initiatives (acquired by Catalyst in 2011) acquisition and is subject to the achievement of certain performance targets during measurement periods that range from 2012 to 2013.
The preparation of financial statements 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 dates of the financial statements and the reported amounts of revenue and expenses during the period. Significant items subject to such estimates and assumptions include revenue recognition, purchase price allocation in connection with acquisitions, the carrying amount of property and equipment, the value of intangible assets acquired and related amortization periods, impairment of goodwill, rebates, contingencies, the valuation allowances for receivables and future income taxes and accruals for income tax uncertainties. Actual results could differ from those estimates. Note 2 - Significant Accounting Policies to the Company’s 2013 consolidated financial statements includes a Summary of Significant Accounting Policies. The understanding of the accounting policies used to prepare the consolidated financial statements is important to understanding the Company’s results of operations and financial condition.
The Company’s goodwill and long-lived assets (including property and equipment, and purchased intangibles subject to amortization) are subject to periodic impairment testing. Pursuant to the accounting standards update in 2011 related to the testing of goodwill impairment, the Company performed a qualitative assessment to determine if indicators of impairment were present. See Note 2 - Significant Accounting Policies in the notes to the consolidated financial statements for additional information on the Company's 2013 goodwill impairment test. Long-lived assets are only required to be tested for impairment when events or circumstances indicate that the net carrying amount of the asset may not be recoverable. Both asset impairment tests and considerations are impacted by various estimates and judgments made by management. Events that may cause a potential impairment in the Company's goodwill or long-lived assets would be the loss of a significant customer or group of customers, a fundamental change in the structure of the healthcare industry, including the method and manner in which pharmacy benefit managers are compensated or a significant decline in future expected profitability.
The annual qualitative assessment for goodwill is impacted by management’s assessment of reporting units, allocation of the consolidated Company’s assets and liabilities to each reporting unit, management’s estimate of future operating results, and a selection of peers to establish a comparable market group. The annual impairment test completed for 2013 did not indicate any impairment of the Company’s two reporting units, and did not reveal that an impairment would be reasonably likely in the near future.
assets. No events or other circumstances occurred in 2013, 2012 or 2011 that caused management to conclude any of its long-lived assets may not be recoverable. In October 2012, the Company launched its new specialty brand BriovaRx, formerly known as Medfusion and Ascend, delivering personalized, holistic care to patients with complex chronic and conditions to improve health outcomes. As a result of the re-branding of the specialty business, the Company concluded that the useful life of the intangible asset that the Company recorded for the MedfusionRx trade name should be reduced since the name would no longer be used by the Company, which was the asset's highest and best use. Before adjusting the useful life of the asset, the Company considered whether the asset had any value as a defensible asset which would extend its useful life. The Company determined that the MedfusionRx trade name had an insignificant value as a defensible asset, and the asset's useful life should be shortened due to the name change of the business. As a result, the Company recorded an additional $8.0 million in amortization expense during 2012.
In assessing the valuation of the allowance for doubtful accounts, management reviews the collectability of accounts receivable in aggregate and on an individual account-basis. Delinquency is assessed based primarily on contractual terms, and management’s judgment is used as the basis for allowances required. Management reviews the accounts receivable on an individual customer-basis to determine if events such as subsequent collections, discussions with management of the debtor companies, or other activities lead to the conclusion to either increase or decrease the calculated allowance. Factors considered when reviewing accounts receivable in the aggregate include the overall age of receivables, macro-economic issues impacting classes of customers and recent collection trends. The conclusions and estimates made are further impacted by changes in economic and market conditions as well as changes to the customers’ financial condition. Changes in estimates for the allowance of doubtful accounts have not had a significant impact on the results of the Company during 2013, 2012, or 2011.
From time to time in connection with its operations, the Company is named as a defendant in actions for damages and costs allegedly sustained by the plaintiffs. Management also considers other areas of the Company’s business that may be subject to litigation and liability for damages arising from errors in processing the pricing of prescription drug claims, failure to meet performance measures within certain contracts relating to its services performed or its ability to obtain certain levels of discounts or rebates on prescription purchases from participating pharmacies, drug manufacturers and third-party administrators or other actions or omissions. Reserves for contingencies are based upon the Company’s consideration of these proceedings and disputes. Management assesses the probability that these contingencies will be realized, and whether the outcome is reasonably estimable. The Company’s estimates for reserves recorded may be impacted by the history of similar claims, the limitations of any insurance coverage, advice from outside counsel, and management’s strategy with regard to the settlement or defense against such claims and obligations.
We have audited the accompanying consolidated balance sheets of Catamaran Corporation and subsidiaries (the Company) as of December 31, 2013 and 2012, and the related consolidated statements of operations, comprehensive income, cash flows and shareholders’ equity for each of the years in the three-year period ended December 31, 2013. These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the Company’s internal control over financial reporting as of December 31, 2013, based on criteria established in Internal Control - Integrated Framework (1992) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO), and our report dated March 3, 2014 expressed an adverse opinion on the effectiveness of the Company’s internal control over financial reporting.
We have audited Catamaran Corporation’s (the Company) internal control over financial reporting as of December 31, 2013, based on criteria established in Internal Control - Integrated Framework (1992) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management’s Report on Internal Control over Financial Reporting appearing under Item 9A of the Company’s December 31, 2013 annual report on Form 10-K. Our responsibility is to express an opinion on the Company’s internal control over financial reporting based on our audit.
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the Company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.
In July 2012, following the completion of its merger (the “Merger”) with Catalyst Health Solutions, Inc. (“Catalyst”), SXC Health Solutions Corp. changed the name and brand for the combined company to Catamaran Corporation. The Company's common shares trade on the Nasdaq Stock Market under the ticker symbol "CTRX" and on the Toronto Stock Exchange under ticker symbol “CCT.”
Transaction processing revenue: Revenue from transaction processing includes ASP and switching services. ASP services consist primarily of hosting, claims adjudication, customer support, financial reporting, data storage, and rebate administration services. The Company earns a transaction fee for each transaction processed. The Company recognizes revenue at the time the transaction is processed, with the exception of any undelivered elements.
Professional services revenue: Professional services revenues are recognized as the services are performed, generally on a time and material basis. Professional services revenues attributed to fixed price arrangements are recognized over the service period based on a proportionate performance method whereby the performance is estimated utilizing direct labor hours incurred to date as a percentage of total estimated direct labor hours to complete the project.
Restricted cash balances at December 31, 2013 and 2012 are restricted as to use and relate primarily to cash on deposit for contingent consideration, minimum cash balances required in accordance with various state statutes, and contractual terms with customers.
Other assets and liabilities held by the Company deemed as financial instruments and required to be carried at fair value include cash and cash equivalents, accounts receivable, rebates receivable, accounts payable, accrued liabilities (current portion), pharmacy benefit management rebates payable and pharmacy benefit claim payments payable. The estimated fair values of these financial instruments approximate their carrying amounts due to the short-term nature of their maturities.
The cost of a group of intangible assets acquired in a transaction, including those acquired in a business combination that meet the specified criteria for recognition apart from goodwill, is recorded to the individual assets acquired based on their fair values. Intangible assets acquired individually or as part of a group of other assets are initially recognized and measured at cost.
The Company administers a rebate program through which it receives rebates and administrative fees from pharmaceutical manufacturers and third-party administrators that are shared with a majority of the Company’s customers. The rebates earned for the administration of the program are recorded as a reduction of cost of revenue and the portion of the rebate payable to customers, if applicable, is treated as a reduction of revenue. Rebates receivable include billed and unbilled PBM receivables from pharmaceutical manufacturers and third-party administrators. The Company records the gross rebate receivable and the related payable to the customers based on estimates, which are subject to final settlement due to the required validation of claims data submitted to the pharmaceutical manufacturers and third-party administrators, as well as contingent items contained in the total calculation for rebates earned. The estimates are based upon claims submitted and the Company’s rebate contracts, and are adjusted as additional information becomes available. Upon billing the pharmaceutical manufacturer or third-party administrator, any difference between the Company’s estimate and the actual amount of the rebate receivable is recorded to cost of revenue, net of the estimated impact to the Company’s customers. The Company generally pays rebates to its customers on a quarterly basis, or as agreed upon with its customers. There are certain instances where the Company pays rebates to its customers on a more accelerated basis. As of December 31, 2013 and 2012, total unbilled pharmaceutical manufacturer rebates receivable amounted to $54.6 million and $14.6 million, respectively.
In February 2013, the FASB issued an update on the reporting of amounts reclassified from accumulated other comprehensive income. An entity is required to present either parenthetically on the face of the financial statements or in the notes, significant amounts reclassified from each component of accumulated other comprehensive income and the income statement line items affected by the reclassification. However, an entity would not need to show the income statement line item affected for certain components that are not required to be reclassified in their entirety to net income, such as amounts amortized into net periodic pension cost. The standard is effective prospectively for public entities for fiscal years, and interim periods with those years, beginning after December 15, 2012. The Company adopted this standard on January 1, 2013; however, the implementation of the amendments did not have a significant impact on its financial results or in the presentation and disclosure of its financial statements.
No other new accounting standards have been adopted during the year ended December 31, 2013.
The acquisition was accounted for under the acquisition method of accounting with the Company treated as the acquiring entity. Accordingly, the consideration paid by the Company to complete the acquisition has been recorded to the assets acquired and liabilities assumed based upon their estimated fair values as of the date of acquisition. The carrying values for current assets and liabilities were deemed to approximate their fair values due to the short-term nature of their maturities. Fair values for acquired amortizable intangible assets were determined as follows: customer relationships were valued using an excess earnings model based on expected future revenues derived from the customers acquired, non-compete agreements were valued using discounted cash flow models based on expected future results of Restat, trademarks/tradenames were valued using a royalty savings model based on future projected revenues of Restat and applicable market royalty rates and licenses utilized a replacement cost approach. The excess of the purchase price over the estimated fair values of the net assets acquired was recorded as goodwill.
On July 2, 2012, the Company completed its merger with Catalyst, a full-service PBM. Each share of Catalyst common stock outstanding immediately prior to the effective time of the Merger (other than shares owned by the Company or Catalyst or any of their respective wholly-owned subsidiaries) was converted in the Merger into the right to receive 1.3212 (0.6606 prior to split adjustment) of a Company common share and $28.00 in cash. This resulted in the Company issuing approximately 66.8 million common shares, issuing 0.5 million warrants, and paying $1.4 billion in cash to Catalyst stockholders to complete the Merger. The results of Catalyst have been included in the Company's results since July 2, 2012.
All of the assets and liabilities recorded for the Merger are included within the Company's PBM segment. Goodwill of $525 million related to the Catalyst Merger is tax deductible. The goodwill recognized by the Company represents many of the synergies and business growth opportunities that the Company anticipates may be realized from the Merger. The synergies include improved pricing from the Company's suppliers due to the increased volume of prescription drug purchases, pull through opportunities of the combined companies' mail and specialty service offerings, and a more efficient leveraging of resources to achieve operating profits.
The purchase price of the acquired Catalyst operations was comprised of the following (in thousands):
Valued based on the number of outstanding shares issued in the Merger multiplied by the closing market price of Catamaran shares on July 2, 2012.
(b) These measurement period adjustments from the acquisition date through December 31, 2012 and were recorded to reflect changes in the estimated fair values of the associated assets acquired and liabilities assumed based on factors existing as of the acquisition date.
(c) These represent measurement period adjustments during 2013 through the end of the measurement period and were recorded to reflect changes in the estimated fair values of the associated assets acquired and liabilities assumed based on factors existing as of the acquisition date.
During the year ended December 31, 2013, the Company recognized $166.1 million of amortization expense from intangible assets acquired in the Merger. The estimated fair value of the customer relationship intangible asset was $1.2 billion at the date of acquisition with a useful life of 9 years. The intangible asset acquired will not have any residual value at the end of the amortization period. There were no in-process research and development assets acquired.
In January 2012, the Company completed the acquisition of all of the outstanding equity interests of HealthTran LLC (“HealthTran”), a full-service PBM, in exchange for $250.0 million in cash, subject to certain customary post-closing adjustments, in each case upon the terms and subject to the conditions contained in the HealthTran purchase agreement. HealthTran was an existing HCIT client and utilizes a Company platform for its claims adjudication services. The acquisition provides the opportunity to create new revenues from HealthTran's customer base and generate cost savings through purchasing and SG&A synergies. The results of HealthTran have been included in the Company's results since January 1, 2012. Costs related to the HealthTran acquisition of $0.9 million were included in SG&A expenses for the year ended December 31, 2011.
(b) These measurement period adjustments were recorded to reflect an additional $1.0 million paid to the former HealthTran owners for the working capital reconciliation and changes in the estimated fair values of the associated assets acquired and liabilities assumed based on factors existing as of the acquisition date.
The following unaudited pro forma financial information presents the combined historical results of operations of the Company and its acquisitions of Restat and Catalyst as if the acquisitions had each occurred on the first day of the fiscal year prior to fiscal year each respective acquisition was completed. The unaudited pro forma financial information includes certain adjustments related to the acquisitions, such as increased amortization from the fair value of intangible assets acquired recorded as part of the purchase accounting, the elimination of transactions between the Company and the acquired entities, and related income tax effects.
Net property and equipment was made up of the following at December 31, 2013 and 2012:
Adjustments to goodwill for transactions entered into and executed by Catalyst prior to the Merger deemed to have future benefit to the Company and not recorded as part of purchase accounting.
On June 3, 2013, the Company entered into an Amendment (the “Amendment”) to the Credit Agreement. Pursuant to the Amendment, the following key terms of the Credit Agreement were modified:
In connection with the Amendment, the Company made a $100.0 million prepayment on the Term Loan Facility to reduce its outstanding balance to $1.0 billion from $1.1 billion. In addition, the Company made principal repayments of $6.3 million in July 2013 and $6.3 million in December 2013 on the Term Loan Facility leaving the Company with $987.5 million outstanding as of December 31, 2013.
The Company utilized funds from the Revolving Facility to make the prepayment in connection with the Amendment, leaving the Company with $700.0 million of remaining available borrowing capacity under the Revolving Facility at the time of the Amendment execution. On October 1, 2013, the Company utilized $350.0 million under the Revolving Facility to partially fund the acquisition of Restat. In June and December 2013, the Company repaid $50.0 million and $100.0 million, respectively, of the amount borrowed under the Revolving Facility, leaving the Company with approximately $500.0 million of borrowing capacity under the Revolving Facility as of December 31, 2013.
In connection with executing the Amendment, the Company paid $2.3 million in direct lender fees to the syndication of banks providing credit to the Company. The fees consisted of a $1.3 million debt discount related to the Term Loan Facility and $1.0 million of debt issuance costs related to the Revolving Facility. The $1.3 million debt discount incurred in connection with the Amendment is presented on the consolidated balance sheet as a reduction to long-term debt, along with the $24.1 million of unamortized debt discount incurred in connection with the execution of the Credit Agreement. The debt discount amounts are being amortized to interest expense over the amended life of the Term Loan Facility. The Company uses the straight-line method to amortize the debt discount as it does not result in a materially different amount of interest expense than the effective interest rate method. The additional $1.0 million debt issue cost incurred in connection with the execution of the Amendment related to the Revolving Facility, along with $16.6 million of unamortized debt issuance costs incurred in connection with the execution of the Credit Agreement are presented on the consolidated balance sheet as other assets. The debt issuance costs are being amortized to interest expense over the amended life of the Revolving Facility using the straight-line method. The amortization related to financing costs and debt discounts totaled $9.1 million for the year ended December 31, 2013.
As a result of executing the Amendment, the Company assessed whether the modifications to the Credit Agreement were substantial and should be accounted for using extinguishment accounting. The Company made its assessment both on a total basis of all lenders and on an individual basis for each member of the syndication. The Company performed separate assessments for the Term Loan Facility and the Revolving Facility. As a result of the assessments, the Company recorded an additional interest expense charge of $0.4 million from unamortized debt discount and debt issuance costs during the year ended December 31, 2013.
As previously disclosed, the Credit Agreement prior to giving effect to the Amendment required the Company to maintain a consolidated leverage ratio at all times less than or equal to 3.75 to 1 initially, with step-downs to (i) 3.50 to 1 beginning with the fiscal quarter ending December 31, 2012, (ii) 3.25 to 1 beginning with the fiscal quarter ending December 31, 2013 and (iii) 3.00 to 1 beginning with the fiscal quarter ending
December 31, 2014. The Credit Agreement, as effected by the Amendment, requires the Company to maintain a consolidated leverage ratio at all times less than or equal to 4.00 to 1 and a consolidated senior secured leverage ratio at all times less than or equal to 3.25 to 1. The Company's consolidated leverage ratio is defined as the ratio of (1) consolidated total debt to (2) consolidated EBITDA (with add-backs permitted to consolidated EBITDA for (a) fees and expenses related to the Merger, the closing of the Credit Agreement, a specified historic acquisition and future permitted acquisitions, (b) synergies projected by the Company in good faith to be realized as a result of the Merger in an aggregate amount not to exceed a specified threshold and (c) fees and expenses and integration costs related to historical acquisitions by Catalyst in an aggregate amount not to exceed a specified threshold). The Company's new consolidated senior secured leverage ratio is defined as the ratio of (1) (a) consolidated total debt minus (b) any portion of consolidated total debt that is subordinated or not secured by a lien upon the assets of the Company or its subsidiaries to (2) consolidated EBITDA (subject to the permitted add-backs noted above). The Amendment continues to require the Company to maintain an interest coverage ratio greater than or equal to 4.00 to 1. The interest coverage ratio is defined as the ratio of (1) consolidated EBIT (subject to the permitted add-backs noted above) to (2) consolidated interest expense, tested at the end of each fiscal quarter for the rolling four fiscal quarter period then most recently ended. As of December 31, 2013, the Company was in compliance with the covenants of the Credit Agreement, as amended by the Amendment.
The Credit Agreement also contains a number of covenants that, among other things, restrict, subject to certain exceptions, the ability of the Company and its subsidiaries to: incur additional indebtedness; create liens; make investments, loans, advances or guarantees; sell or transfer assets; pay dividends and distributions or repurchase its own capital stock; prepay certain indebtedness; engage in mergers, acquisitions or consolidations (subject to exceptions for certain permitted acquisitions); change its lines of business or enter into new lines of business; engage in certain transactions with affiliates; enter into agreements restricting the ability to grant liens in favor of the collateral agent for the benefit of the secured parties; engage in sale and leaseback transactions; or enter into swap, forward, future or derivative transaction or option or similar agreements. In addition, the Credit Agreement includes various (i) customary affirmative covenants and other reporting requirements and (ii) customary events of default, including, without limitation, payment defaults, violation of covenants, material inaccuracy of representations or warranties, cross-defaults to other material agreements evidencing indebtedness, bankruptcy events, certain ERISA events, material judgments, invalidity of guarantees or security documents and change of control. Drawings under the Revolving Facility are subject to certain conditions precedent, including material accuracy of representations and warranties and absence of default.
Effective on March 11, 2009, the Board of Directors of the Company adopted the Catamaran Corporation Long-Term Incentive Plan (“LTIP”), which was approved by the shareholders of the Company at the Annual and Special Meeting of Shareholders on May 13, 2009. The LTIP provides for the grant of stock option awards, stock appreciation rights, restricted stock awards, restricted stock unit ("RSU") awards, performance awards and other stock-based awards to eligible persons, including executive officers and directors of the Company. The purpose of the LTIP is to advance the interests of the Company by attracting and retaining high caliber employees and other key individuals who perform services for the Company, a subsidiary or an affiliate; align the interests of the Company’s shareholders and recipients of awards under the LTIP by increasing the proprietary interest of such recipients in the Company’s growth and success; and motivate award recipients to act in the best long-term interest of the Company and its shareholders. The LTIP replaced the previous stock option plan, and no further grants or awards will be issued under the previous stock option plan. The maximum common shares of the Company allowed to be issued under the LTIP was increased by 3.6 million on May 11, 2011, after the Company’s shareholders approved an amendment to the LTIP at the Annual and Special Meeting of Shareholders of the Company. In July 2012, the maximum common shares of the Company allowed to be issued under the LTIP was increased by 5.0 million. Any full-value awards (i.e., any awards other than stock options or stock appreciation rights) granted under the LTIP are counted against this share limit as 1.79 shares for every one share granted. There were 6,196,313 stock-based awards available for grant under the LTIP as of December 31, 2013.
During the year ended December 31, 2013, there were 45,574 stock options denominated in Canadian dollars that were exercised with a weighted average exercise price of $3.53. As of the year ended December 31, 2013, there were no stock options denominated in Canadian dollar outstanding.
The aggregate intrinsic value and remaining contractual term of exercisable stock options at December 31, 2013 was $15.2 million and 3.59 years, respectively. The aggregate intrinsic value and remaining contractual term of all vested options and options that are expected to vest are $24.9 million and 4.59 years, respectively. The total fair value of stock options which vested during the years ended December 31, 2013, 2012, and 2011 was approximately $3.5 million, $2.8 million, and $2.5 million, respectively.
On May 16, 2007, shareholders of the Company approved the creation of the Employee Stock Purchase Plan (“ESPP”) which allows eligible employees to withhold annually up to a maximum of 15% of their base salary, or $25,000, subject to U.S. Internal Revenue Service limitations, for the purchase of the Company’s common shares. Common shares will be purchased on the last day of each offering period at a discount of 5% of the fair market value of the common shares on such date. The aggregate number of common shares that may be awarded under the ESPP may not exceed 400,000 common shares. Common shares available for purchase under the ESPP are drawn from reacquired common shares purchased on behalf of the Company in the open market. During 2013, 2012, and 2011, the Company delivered 33,728, 14,697, and 13,544 common shares, respectively, under the ESPP.
During 2013, the Company granted time-based RSUs and performance based RSUs to its employees and non-employee directors under both the LTIP and the Assumed Plans. Time-based RSUs vest on a straight-line basis over a range of three to four years. During 2012 and 2013, the Company also granted time-based RSUs that cliff vest after a three to four year period. Performance-based RSUs cliff vest based upon reaching agreed upon three-year performance conditions. The number of outstanding performance-based RSUs as of December 31, 2013 stated below assumes the associated performance targets will be met at the maximum level. The table below summarizes the number of time-based and performance-based RSUs that were granted and outstanding under both plans for the year ended December 31, 2013:
The total grant date fair value of RSUs that vested during 2013, 2012, and 2011 was $27.3 million, $18.0 million, and $4.8 million, respectively. The weighted average grant date fair value of awards granted during 2013, 2012, and 2011 was $55.99, $38.49, and $25.30, respectively.
The following table summarizes the information about RSUs for the year ended December 31, 2013 under the plans:
For the years ended December 31, 2013, 2012, and 2011, the Company recorded stock-based compensation expense of $25.6 million, $17.7 million, and $9.4 million, respectively. At December 31, 2013, there was $29.7 million and $8.8 million unrecognized compensation cost related to RSUs under the LTIP and Assumed Plans, which is expected to be recognized over a weighted-average period of 2.19 and 3.00 years, respectively.
The total income tax benefit, using the Company’s statutory tax rates, recognized in the statements of operations for stock-based compensation arrangements for years ended December 31, 2013, 2012, and 2011 was $9.5 million, $6.5 million, and $3.5 million, respectively.
The Black-Scholes-Merton option-pricing model was used to estimate the fair value of the options at grant date for the years ended December 31, 2013, 2012, and 2011, based on the following assumptions:
The expected life assumption is based on historical exercise patterns. The options issued to employees typically have a longer expected life of 4.5 to 5 years due to the vesting schedules, whereas options issued to directors have a shorter expected life of 1 to 2.5 years due to the shorter vesting period of some director options.
At December 31, 2013, the Company had gross deferred tax assets (“DTAs”) totaling $98.9 million compared to $61.3 million at December 31, 2012. Of the $98.9 million, $18.1 million of DTAs related to its Canadian operations compared to $5.0 million at December 31, 2012. The Company also had deferred tax liabilities which decreased to $338.7 million at December 31, 2013 from $363.2 million at December 31, 2012.
The balance of the valuation allowance was $18.4 million at December 31, 2013 compared to $5.8 million at December 31, 2012. The valuation allowance arising from the Canadian operations was $17.1 million at December 31, 2013 and $4.8 million at December 31, 2012. The Canadian valuation allowance increased during the year as a result of a loss from operations. The amount of this valuation allowance is subject to adjustment by the Company in future periods based upon its assessment of evidence supporting the degree of probability that DTAs will be realized.
Accounting guidance for uncertain tax positions prescribes a recognition threshold and measurement attribute criteria for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. As of December 31, 2013, the Company has an accrued liability in the consolidated balance sheet of $28.9 million. As of December 31, 2012 and 2011, the Company had an accrued liability of $18.8 million and $0.6 million, respectively. The increase is primarily the result of matters related to the Catalyst Merger. This liability related to various uncertain federal and state income tax matters, the resolution of all of which would not have a material impact on the Company’s effective tax rate.
The Company recognizes interest and penalties related to uncertain tax positions in income tax expense. Accrued interest and penalties at December 31, 2013 and 2012 was $4.7 million and $0.5 million, respectively. It is reasonably possible that the total amount of unrecognized tax benefits will increase or decrease within twelve months of December 31, 2013. The Company currently estimates that such increases or decreases will not be material.
In August 2013, the Company executed a plan to exit a portion of space it had leased in Maryland and entered into a sub-lease agreement with a third-party tenant that was coterminous with the Company's remaining lease term. As a result of this exit, the Company recorded an approximately $5.6 million charge in SG&A expense and corresponding lease loss accrual equal to the present value of the amount by which the net future lease obligations exceed the remaining rent-related deferred balances. The net future lease obligations were calculated by taking the remaining contractual rent obligation less the amount the Company will receive from the sub-lease agreement and recorded at its present value based on the Company's credit adjusted riskfree interest rate.
The following table sets forth the computation of basic and diluted EPS for the years ended December 31, 2013, 2012, and 2011 (in thousands, except share and per share data):
(b) Cash paid / received for income taxes and interest was as follows for the years ended December 31, 2013, 2012, and 2011 (in thousands):
Aggregate future minimum payments in respect of non-cancellable operating lease agreements as of December 31, 2013, which extend until 2025, are as follows (in thousands):
The total rental expense under operating leases for the years ended December 31, 2013, 2012, and 2011 was $35.4 million, $17.1 million, and $6.4 million, respectively. The lease renewal terms have not been factored into the commitments noted above as not renewing these leases would not have a detrimental impact on the Company.
The Company provides routine indemnification to its customers against liability if the Company’s products infringe on a third-party’s intellectual property rights. The maximum amount of these indemnifications cannot be reasonably estimated due to their uncertain nature. Historically, the Company has not made payments related to these indemnifications.
During the year ended December 31, 2013, one customer accounted for 23% of total revenue. During the year ended December 31, 2012, one customer accounted for 31% of total revenue. During the year ended December 31, 2011, one customer accounted for 40% of total revenue. In 2013, 2012 and 2011, these major customers were included in the PBM segment.
The Company used variable rate debt to assist in financing its Merger with Catalyst and acquisition of Restat. The Company is subject to interest rate risk related to the variable rate debt. When interest rates increase, interest expense could increase. Conversely, when interest rates decrease, interest expense could also decrease.
Fair value measurement guidance defines a hierarchy to prioritize the inputs to valuation techniques used to measure fair value into three broad levels, with Level 1 considered the most reliable. For assets and liabilities measured at fair value on a recurring basis in the consolidated balance sheet, the table below categorizes fair value measurements across the three levels as of December 31, 2013 (in thousands):
During 2013 and 2012, there were no movements of fair value measurements between levels 1, 2 and 3.