The Company’s principal business operations are conducted from a 116,712 square foot leased office facility located at 2441 Warrenville Road, Suite 610 in Lisle, Illinois (outside of Chicago). This lease expires in January 2018. The Company’s mail and specialty pharmacies, which support the delivery of medications to individuals, are principally located in Alabama, Maine, and Florida, with additional facilities mostly located in the southeastern states of the U.S. Additionally, the Company maintains operations in several other leased locations in the U.S. and Canada, including operations in Ontario (Milton), Arizona, Hawaii, Georgia, Arkansas, Massachusetts, Colorado, Pennsylvania and Texas. The Company believes these properties are adequate for its current operations.
The following selected consolidated financial data has 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, 2010, 2009 and 2008. 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 acquisitions of PTRX and SaveDirectRx on October 3, 2011. The aggregate purchase price for the acquisitions
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 dependence on, and ability to retain, key customers; our ability to achieve increased market acceptance for our product offerings and penetrate new markets; consolidation in the healthcare industry; the existence of undetected errors or similar problems in our software products; our ability to identify and complete acquisitions, manage our growth, integrate acquisitions and achieve expected synergies from acquisitions; our ability to compete successfully; potential liability for the use of incorrect or incomplete data; the length of the sales cycle for our healthcare software solutions; interruption of our operations due to outside sources; maintaining our intellectual property rights and litigation involving intellectual property rights; our ability to obtain, use or successfully integrate third-party licensed technology; compliance with existing laws, regulations and industry initiatives and future change in laws or regulations in the healthcare industry; breach of our security by third parties; our dependence on the expertise of our key personnel; our access to sufficient capital to fund our future requirements; potential write-offs of goodwill or other intangible assets; and the outcome of any legal proceeding that has been or may be instituted against us. This list is not exhaustive of the factors that may affect any of our forward-looking statements and is subject to change. For additional information with respect to certain of these and other factors, refer to the risk factors described in Item 1A of this Annual Report on Form 10-K.
When relying on forward-looking information to make decisions, investors and others should carefully consider the foregoing factors and other uncertainties and potential events. In making the forward-looking statements contained in this MD&A, the Company does not assume any future significant acquisitions, dispositions or one-time items. It does assume, however, the renewal of certain customer contracts. Every year, the Company has major customer contracts that come up for renewal. In addition, the Company also assumes new customer contracts. In this regard, the Company is pursuing large opportunities that present a very long and complex sales cycle which substantially affects its forecasting abilities. The Company has assumed certain timing for the realization of these opportunities which it thinks is reasonable but which may not be achieved. Furthermore, the pursuit of these larger opportunities does not ensure a linear progression of revenue and earnings since they may involve significant up-front costs followed by renewals and cancellations of existing contracts. The Company has assumed certain revenues which may not be realized. The Company has also assumed that the material factors referred to in the previous paragraph will not cause such forward-looking information to differ materially from actual results or events. There can be no assurance that such assumptions will reflect the actual outcome of such items or factors. Accordingly, investors are cautioned not to put undue reliance on forward-looking statements
The Company provides comprehensive PBM services to customers, which include managed care organizations, local governments, unions, corporations, HMOs, employers, workers' compensation plans, third party health care plan administrators, and federal and state government programs through its network of licensed pharmacies throughout the United States. The PBM services include electronic point-of-sale pharmacy claims management, retail pharmacy network management, access to the Company's mail and specialty pharmacies, Medicare Part D services, benefit design consultation, preferred drug management programs, drug review and analysis, consulting services, data access and reporting and information analysis. The Company also owns and operates a network of mail and specialty pharmacies.
The Company's specialty pharmacy offering provides customers the ability to control spending on specialty medications and ensure patients receive the necessary, personalized support for complex medications in one of the fastest growing sectors of pharmaceutical spending through its specialty pharmacy locations. The Company’s specialty therapy medication management program uses a highly-trained and specialized
clinical staff organized in disease pods, a patient-centric approach, and evidence based clinical treatment protocols. The patient care team communicates with the patient, patient’s physician, and other caregivers as needed to obtain a complete medical and pharmacy history and then craft an individualized treatment plan, including patient education, counseling and expected therapy outcomes. Plan savings are achieved as the cost for specialty medication using this program is generally lower than retail pricing. In addition, the Company is a national provider of drug benefits to its customers under the federal government’s Medicare Part D program.
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. If we had included co-payments collected at non-Company owned pharmacies in our reported revenue and direct expenses, our operating and net income, consolidated balance sheets and statements of cash flows would not have been affected.
The PBM and pharmacy industries are intensely competitive, generally resulting in continuous pressure on gross profit as a percentage of total revenue. In recent years, industry consolidation and dramatic growth in managed healthcare have led to increasingly aggressive pricing of PBM services. Given the pressure on all parties to reduce healthcare costs, the Company expects this competitive environment to continue for the foreseeable future. In order to remain competitive, the Company looks to continue to drive purchasing efficiencies of pharmaceuticals
The Company’s business model allows its large customers to license the Company’s products and operate the Company’s systems themselves (with or without taking advantage of the Company’s significant customization, consulting and systems implementation services) and allows its other customers to utilize the Company’s systems’ capabilities on a fee-per-transaction or subscription basis through ASP processing from the Company’s data center.
Leading technology and platform: The Company’s technology is robust, scalable, and web-enabled. The Company’s payor offerings efficiently supported over 558 million transactions in 2011. The platform is able to instantly cross-check multiple processes, such as reviewing claim eligibility, adverse drug reaction and properly calculating member, pharmacy and payor payments. 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.
Our results for the year ended December 31, 2011 reflect the successful execution of our business model, which emphasizes the alignment of our financial interests with those of our clients through greater use of generics, low-cost brands and mail and specialty pharmacies. The positive trends we saw in 2010, including lower drug purchasing costs and increased generic usage, have continued to offset the negative impact of various marketplace forces affecting pricing and plan structure, among other factors, and thus we were able to continue to generate improvements in our results of operations. Additionally, as the regulatory environment evolves, we will continue to make significant investments designed to keep us ahead of the competition.
We successfully implemented our largest customer, HealthSpring, at the beginning of 2011, and have continued to fully integrate our recent acquisitions of MedfusionRx, LLC ("MedfusionRx"), MedMetrics Health Partners, Inc. ("Medmetrics"), PTRX, Inc. ("PTRX") and SaveDirectRx, Inc. ("SaveDirectRx") into our business. These events have helped drive overall growth in our top line revenue as well as in our overall operating results. We also continue to benefit from better management of ingredient costs through increased competition among generic manufacturers. The average generic dispensing rate ("GDR"), or the number of generic prescriptions as a percentage of the total number of prescriptions dispensed, for SXC clients reached 78% in 2011, a 2% trend increase from 2010. This increase was achieved through a broad range of plan design solutions, helped considerably by a continuing wave of major generic releases.
customers. The acquisition has also helped increase and expand the Company's footprint in the northeastern part of the U.S.
On December 28, 2010, the Company completed its acquisition of MedfusionRx, a specialty pharmacy provider with expertise in providing clinical services to patients with complex chronic conditions. The purchase price for MedfusionRx was $101.5 million in cash, with an opportunity for the former owners of MedfusionRx to earn an additional $5.5 million in cash, subject to the satisfaction of certain performance targets in the 2012 fiscal year, upon the terms and subject to the conditions contained in the MedfusionRx Purchase Agreement. The acquisition has helped transform the Company's specialty pharmacy business by expanding its presence and enhancing its capabilities in the rapidly growing specialty sector of the pharmacy industry.
On December 16, 2011, the Company entered into a Credit Agreement (the “Credit Agreement”) with JPMorgan Chase Bank, N.A. (“JPMCB”), as a lender and as administrative agent, Bank of America, N.A., SunTrust Bank, Fifth Third Bank, PNC Bank, N.A. and The Toronto-Dominion Bank, as lenders and co-syndication agents, Barclays Bank PLC, Morgan Stanley Bank, N.A., Credit Suisse AG, Cayman Islands Branch, The Northern Trust Company, PNC Bank Canada Branch, U.S. Bank National Association and U.S. Bank National Association, Canadian Branch, as lenders, other lenders from time to time party thereto (collectively the "Lenders") and J.P. Morgan Securities LLC, as sole bookrunner and sole lead arranger, with respect to a new five-year senior unsecured revolving credit facility (the “Revolving Credit Facility”). The Credit Agreement provides that, upon the terms and subject to the conditions set forth therein, the Lenders will make loans to the Company from time to time, with an initial aggregate revolving commitment of $350 million, subject to increase from time to time up to a maximum aggregate revolving commitment of $450 million. The Company will use the proceeds from the Revolving Credit Facility for general corporate purposes. On January 3, 2012, the Company borrowed $0 million under the Revolving Credit Facility to pay a portion of the consideration in connection with the acquisition of HealthTran and certain transaction fees and expenses related to the acquisition.
Revenue increased $3.0 billion, or 155.4%, to $5.0 billion during 2011 from $1.9 billion in 2010, primarily due to the implementation of the previously announced HealthSpring contract on January 1, 2011, recent acquisitions and organic growth from increased sales efforts, and other new customer starts during 2011. As a result of the increased business, the Company's adjusted prescription claim volume increased 91.0% to 91.7 million from 48.0 million during 2010.
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 $95.4 million, or 44.6%, to $309.5 million during 2011, mainly due to an increase in PBM gross profit of $96.9 million, or 60.7%, which was generated from the increased adjusted prescription claim volume from the implementation of the HealthSpring contract, recent acquisitions as well as other new customer starts. Consolidated gross profit percentage decreased from 11.0% of revenue for the year ended December 31, 2010 to 6.2% of revenue for the year ended December 31, 2011, as a result of the reduced gross profit percentage of the PBM segment. The PBM segment's gross profit percentage decreased due to the low gross profit percentage generated by the HealthSpring contract. While the gross profit percentage of the HealthSpring contract is lower than the Company's historical gross profit percentage, it brings a large volume of business to the Company. Additionally, the Company continues to increase the percentage of its revenues that are derived from the PBM segment as compared to the HCIT segment. Producing a greater percentage of the Company's total gross profit from PBM lowers the Company's consolidated gross profit percentage since these revenues carry a lower gross profit percentage as compared to HCIT revenues. As PBM revenues grow as a percentage of the Company's total revenues and gross profit, gross profit as a percentage of revenue will decrease.
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 $0.7 million to $6.7 million for the year ended December 31, 2011 from $6.0 million for the same period in 2010, and depreciation expense for the year ended December 31, 2010 increased $0.2 million from $5.8 million for the same period in 2009. The increases in 2011 and 2010 were primarily due to purchases related to the Company’s expansion of its data centers and information technology equipment to expand network capacity.
to $9.7 million for the year ended December 31, 2009. The decrease from 2009 to 2010 was due to many of the intangibles being amortized at a declining rate using a future economic benefit model instead of a straight- line methodology.
The effective tax rate increased to 33.6% during the year ended December 31, 2010 compared to 32.3% for the same period in 2009, primarily due to the diminishing impact of the income tax benefit related to certain acquisitions, as well as an increase in taxable income and changes in the proportion of overall income among jurisdictions.
Revenue increased $505.6 million, or 37.8%, for the year ended December 31, 2010 as compared to the same period in 2009 due to new customer starts during 2010, as well as an increase in PBM services sold to several HCIT customers during 2010. As contracts with these existing customers were renewed or renegotiated to provide for additional PBM services, revenue derived from these customers' contracts was moved from the HCIT segment to the PBM segment.
For the year ended December 31, 2010, compared to the same period in 2009, cost of revenue increased $484.2 million, or 40.4%. The increase was in line with the increase in PBM revenues during this period. As a percentage of revenue, cost of revenue was 91.3% and 89.7% for the years ended December 31, 2010 and 2009, respectively. The increase in the cost of revenue as a percentage of revenue was due to lower margins earned on new customer starts in 2010.
Gross profit was $256.6 million for the year ended December 31, 2011, compared to $159.7 million for the same period in 2010. Gross profit increased $96.9 million, or 60.7%, due to growth in the customer base in 2011 compared to the same period in 2010. Gross profit percentage was 5.3% and 8.7% for the years ended December 31, 2011 and 2010, respectively. Gross profit percentage decreased during 2011 as compared to 2010 due to newer business being added at lower margins, driven by the implementation of the HealthSpring contract in 2011, which carries a significantly lower gross profit percentage than the Company's historical book of business.
During the year ended December 31, 2010, gross profit increased $21.5 million, or 15.5%, compared to gross profit for the same period in 2009. This growth was primarily due to expansion of the customer base in 2010 compared to the same period in 2009. Gross profit percentage
Cost of revenue decreased 3.5% to $52.4 million for the year ended December 31, 2010 from $54.3 million for the year ended December 31, 2009. Included in the costs for the HCIT segment was depreciation expense of $2.4 million and $2.2 million for the years ended December 31, 2010 and 2009, respectively, as well as stock-based compensation expense of $0.7 million in each of the years ended December 31, 2010 and 2009. Cost of revenue decreased during 2010 as compared to 2009 mainly due to the continued focus by the Company to contain costs, as well as the conversion of some HCIT customers' contracts to the PBM segment, which transferred the associated revenue and costs to support these customers into the PBM segment.
Gross profit decreased $1.5 million, or 2.7%, to $52.9 million for the year ended December 31, 2011 as compared to $54.4 million for the same period in 2010. Gross profit percentage was 45.5% for the year ended December 31, 2011, as compared to 50.9% for the same period in 2010. Gross profit and gross profit percentage decreased for the year ended December 31, 2011, compared to the same period in 2010, due to the change in revenue mix.
Gross profit increased $6.0 million, or 12.4%, to $54.4 million for the year ended December 31, 2010 as compared to $48.4 million for the same period in 2009, and gross profit percentage was 50.9% for the year ended December 31, 2010, as compared to 47.1% for the same period in 2009. Gross profit and gross profit percentage increased for the year ended December 31, 2010, compared to the same period in 2009, due to changes in the revenue mix within HCIT as well as additional revenues earned for meeting certain contractual performance conditions during 2010.
The Company reports its financial results in accordance with GAAP, but Company management also evaluates and makes operating decisions using EBITDA, Adjusted EBITDA and Adjusted EPS. The Company's management believes that these measures provide useful supplemental information regarding the performance of business operations and facilitates comparisons to its historical operating results. The Company also uses this information internally for forecasting and budgeting as it believes that the measures are indicative of the Company's core operating performance. Note however, that these items are performance measures only, and do not provide any measure of the Company's cash flow or liquidity. Non-GAAP financial measures should not be considered as a substitute for measures of financial performance in accordance with GAAP, and investors and potential investors are encouraged to review the reconciliations of EBITDA, Adjusted EBITDA and Adjusted EPS that are included below.
The following is a reconciliation of the Company's reported net income to EBITDA and adjusted EBITDA for the years ended December 31, 2011, 2010 and 2009.
EBITDA and Adjusted EBITDA increased $51.6 million and $55.2 million, respectively, for the year ended December 31, 2011 compared the same period of 2010, primarily due to an increase in sales within the PBM segment, driven by he implementation of the HealthSpring contract on January 1, 2011, recent acquisitions and other new contract starts during the year.
Adjusted EPS for the year ended December 31, 2011 was $1.63 as compared to $1.11 in the same period of 2010. Increased gross profit earned from the expansion of the Company's PBM business, as well as recent acquisitions of MedfusionRx and PTRX, helped improve the Company's adjusted EPS during 2011. This was partially offset by increased costs incurred to support the Company's increased business, as well as the increase in the number of diluted shares outstanding during 2011 as compared to 2010.
At December 31, 2011, cash and cash equivalents consist of cash on hand, deposits in banks and bank term deposits with original maturities of 90 days or less. During the first quarter of 2010, the Company repositioned its funds previously placed in money market funds and moved the funds into cash on deposit accounts. The Company assessed that it would earn a greater return from cash on deposit accounts due to the historically low rates paid on the U.S. money market funds. Further, the Company reduced expenses by moving the funds to cash on deposit accounts as the fees charged for those accounts are lower than for U.S. money market fund accounts.
Accounts receivable are made up of trade accounts receivable from our customers. Accounts receivable increased $118.3 million to $240.4 million at December 31, 2011 from $122.2 million at December 31, 2010, driven by increases in revenue of $3.0 billion during the year ended December 31, 2011, as a result of increased PBM revenue from new customer starts in 2010, as well as additional sales generated at the mail and specialty pharmacies driven by the acquisition of MedfusionRx. The accounts receivable balance is impacted by changes in revenues, as well as the timing of collections, and is continually monitored by the Company to ensure timely collections and to assess the need for any changes to the allowance for doubtful accounts.
The accounts payable balance of $19.7 million represents amounts owed to the Company's suppliers for prescription drugs at the mail and specialty pharmacy locations, as well as amounts due to vendors for general operating expenses. As of December 31, 2011, the accounts payable balance has decreased $11.3 million from $30.9 million at December 31, 2010, mainly due to the timing of payments made for purchases of prescriptions drugs from the Company's suppliers.
For the year ended December 31, 2011, the Company generated $94.7 million of cash through its operations. Cash provided by operating activities has decreased slightly by $1.6 million compared to the same period in 2010. Operating cash flow consists mainly of net income which increased $27.1 million from $64.7 million for 2010. This increase is attributed to the increased transaction volume, and associated increase in gross profit, in the PBM segment propelled by new customer starts during 2011, as well as the additional business generated as a result of the Company's recent acquisitions. Cash from operations decreased due to an increase in accounts receivable of $110.5 million as a result of the increase in pharmacy transactions in the PBM segment from new customer starts during 2011 and the timing of when the Company received
Changes in non-cash items such as depreciation and amortization are caused by the purchase and acquisition of capital and intangible assets. In addition, as assets become fully depreciated or amortized, the related expenses will decrease.
For the year ended December 31, 2009, the Company generated $166.2 million of cash from financing activities, which consisted of $203.1 million in net proceeds from the public offering of 10,350,000 common shares in September 2009. In addition to the cash generated from the public offering, cash inflows from financing activities included proceeds from the exercise of stock options of $6.3 million and a $4.5 million tax benefit on the exercise of stock options. These were partially offset by the repayment of all of the Company's long term debt of $47.6 million.
The Company’s future capital requirements depend on many factors, including its product development programs. The Company expects to fund its operating and working capital needs, and business growth requirements through cash flow from operations, its cash and cash equivalents on hand and its Revolving Credit Facility. See Note 8 - Long-Term Liabilities to the consolidated financial statements for more information on the Company's Revolving Credit Facility. The Company expects that purchases of property and equipment will remain consistent with prior years. The Company cannot provide assurance that its actual cash requirements will not be greater than expected as of the date of this Annual Report. In order to meet business growth goals, the Company will, from time to time, consider the acquisition of, or investment in, complementary businesses, products, services and technologies, which might impact liquidity requirements or cause the issuance of additional equity or debt securities. Any issuance of additional equity or debt securities may result in dilution to shareholders, and the Company cannot be certain that additional public or private financing will be available in amounts or on terms acceptable to the Company, or at all.
The above table excludes $0.6 million related to the Company’s accrued liability for uncertain tax positions; the Company is unable to reliably estimate the period of cash settlement, if any, with the respective taxing authorities. In addition, on December 16, 2011, the Company entered into a Credit Agreement with respect to a new five-year senior unsecured Revolving Credit Facility with an initial aggregate revolving commitment of $350 million, subject to increase from time to time up to a maximum aggregate revolving commitment of $450 million. The Company will use the proceeds from borrowings under the Revolving Credit Facility for general corporate purposes. As of December 31, 2011, no amount was outstanding under the Revolving Credit Facility. In January 2012 the Company borrowed $100 million under its Revolving Credit Facility to finance in part the purchase price for the HealthTran acquisition. See Note 8 - Long-Term Liabilities to the consolidated financial statements for more information regarding the Company's Revolving Credit Facility.
As of January 31, 2012, the Company had 62,384,161 common shares outstanding, 1,249,873 options outstanding and 609,909 restricted stock units (“RSUs”) outstanding. The options are exercisable on a one-for-one basis into common shares. The outstanding RSUs are subject to time-based and performance-based vesting restrictions. The number of outstanding RSUs as of January 31, 2012 assumes the associated performance targets will be met at the maximum level for the performance-based RSUs. Once vested, RSUs convert on a one-for-one basis into common shares.
The Company completed its acquisition of PTRX and SaveDirectRx on October 3, 2011. The aggregate purchase price for PTRX and SaveDirectRx was $77.2 million in cash, subject to customary working capital adjustments, with an additional $4.5 million potential earn-out payment, subject to the achievement of certain performance targets in the 2012 fiscal year.
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 2011 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 administers rebate programs through which it receives rebates and administrative fees from pharmaceutical manufacturers and third party administrators that are shared with customers. The Company recognizes rebates when the Company is entitled to them, and when the amounts of the rebates are determinable. The amount recorded for rebates earned by the Company from the pharmaceutical manufacturers, third party administrators, and from administrative fees are recorded as a reduction of cost of sales. Rebates owed to the Company’s customers are recorded as a reduction of revenue. The Company determines the amount of rebates to record based on the number and types of
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 new accounting standards update related to the testing of goodwill impairment in 2011 the Company performed a qualitative assessment to determine if indicators of impairment were present. In addition, the Company also performed a quantitative assessment of the carrying value of goodwill as of October 31, 2011. See Note 2 - Significant Accounting Policies to the consolidated financial statements for additional information on the Company's 2011 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 2011 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.
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, 2011, 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 February 24, 2012 expressed an unqualified opinion on the effectiveness of the Company’s internal control over financial reporting.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets of the Company as of December 31, 2011 and 2010, and the related consolidated statements of operations, comprehensive income, cash flows and shareholders’ equity for the three-year period ended December 31, 2011, and our report dated February 24, 2012 expressed an unqualified opinion on those consolidated financial statements.
Effective with the quarter ended September 30, 2009, the Company adopted the Financial Accounting Standards Board's ("FASB") Accounting Standards Codification (“the Codification”), which is now the exclusive authoritative reference for nongovernmental U.S. GAAP. Where applicable, titles and references to accounting standards have been updated to reflect the Codification.
The Company's revenue is derived from prescription drug sales along with transaction processing services, maintenance, professional services, and systems sales (including software license and hardware sales).
When the Company enters into arrangements with multiple deliverables involving software, the Company applies the American Institute of Certified Public Accountant’s ("AICPA") accounting guidance for software. The entire arrangement fee is allocated to each element in the arrangement based on the respective VSOE of fair value of each element.
Typically, software license agreements are multiple element arrangements as they may also include professional services, related maintenance, hardware, and implementation services fees. Arrangements that include non-software elements are evaluated to determine whether those services are considered essential to the functionality of the software. In general, the software sold by the Company is not essential to the functionality of the non-software elements, including tangible products, sold by the Company; accordingly, all software elements in multiple element arrangements are recognized under accounting guidance for software.
The Company’s cost of revenue includes the cost of pharmaceuticals dispensed, either directly dispensed at its mail and specialty pharmacy locations, or indirectly through its nationwide network of participating pharmacies. Cost of revenue is reduced for rebates earned from pharmaceutical manufacturers and third party administrators. Cost of revenue also includes the cost of personnel to support the Company’s transaction processing services, system sales, maintenance, and professional services. In addition, the Company includes in cost of revenue an amount of depreciation expense that is related to property and equipment used to provide services to customers.
Restricted cash balances at December 31, 2011 are restricted as to use and relate primarily to minimum cash balances required in accordance with various state statutes, contractual terms with customers and other customer restrictions related to the Company’s PBM business.
The fair value of the contingent purchase price liability associated with the acquisitions of MedfusionRx and SaveDirectRx are based upon probability weighted discounted cash flow models, utilizing the Company's expectation of the amounts to be paid in the future to settle the contingent purchase price. The inputs utilized in calculating the fair value of the contingent purchase price liabilities are not observable in the market place. The fair value of the Company’s interest rate contracts is based upon observable market-based inputs that reflect the current value of the difference between the fixed rate payments the Company will make to the counter party, and the future variable rate receipts from the counterparty.
During the current year the Company adopted the amendment to the goodwill impairment testing standard that allows the Company to perform a qualitative analysis to determine whether further impairment testing is necessary. The Company performed the qualitative goodwill impairment assessment, as well as the quantitative test to create a baseline assessment to utilize in future qualitative tests. Neither the qualitative or quantitative tests indicated an impairment to the Company's goodwill balances was present and an impairment in the near future is not considered reasonably likely. The Company previously completed impairment tests in 2010 and 2009 and concluded no impairments existed.
Intangible assets with finite useful lives are amortized over their estimated useful lives on either a straight-line basis or in proportion to the economic benefits expected to be consumed. Customer relationships acquired with the acquisitions are amortized based on projected cash flows associated with existing customers at the acquisition date and typically have a life of 5 to 8 years. The Company's remaining intangible assets are amortized on a straight-line basis over 1 to 15 years.
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, 2011 and 2010, total unbilled pharmaceutical manufacturer rebates receivable amounted to $8.9 million and $9.3 million, respectively.
The Company accounts for derivative instruments pursuant to the FASB’s derivative and hedge accounting guidance. The guidance requires that all derivative instruments are recorded on the balance sheet at their respective fair values. Changes in the fair value of the Company’s derivative instruments not deemed cash flow hedges are recorded in the statements of operations each reporting period. The Company records the change in the fair value of its derivative instruments deemed as cash flow hedges through other comprehensive income in each reporting period.
Effective September 15, 2011, the Company adopted the amendment to the goodwill impairment testing standard. The updated accounting guidance provides entities with an option to perform a "qualitative" assessment to determine whether further impairment testing is necessary.
The goodwill recognized by the Company represents many of the synergies and business growth opportunities that may be realized from these acquisitions. The opportunity to bring SXC's full suite of PBM services to PTRX and SaveDirectRx clients is a significant driver of the goodwill created. In addition, there are cost saving opportunities through adding PTRX and SaveDirectRx into the Company's pharmacy and purchasing networks.
During the year ended December 31, 2011, the Company recognized $1.4 million of amortization expense from intangible assets acquired. Amortization for 2012 is expected to be $4.8 million.
On December 28, 2010, the Company, through its direct wholly owned subsidiary SXC Health Solutions, Inc. (“SXC Inc.”), completed the acquisition of MedfusionRx, L.L.C. and certain affiliated entities and certain assets of Medtown South, L.L.C (collectively, "MedfusionRx"), a specialty pharmacy provider with significant expertise in providing clinical services to patients with complex chronic conditions. The purchase price for MedfusionRx was $101.5 million in cash, subject to a customary post-closing working capital adjustment, and an opportunity for the former owners of MedfusionRx to earn an additional $5.5 million in cash, subject to the satisfaction of certain performance targets in the 2012 fiscal year, in each case based upon the terms and subject to the conditions contained in the Purchase Agreement. MedfusionRx's results of operations from the date of acquisition through December 31, 2010 were not material to the Company’s results of operations for 2010.
The purchase price of the acquired MedfusionRx operations was comprised of the following (in thousands):
The MedfusionRx purchase agreement includes contingent purchase price consideration in the form of an earn-out payment of up to $5.5 million contingent upon the MedfusionRx book of business meeting or exceeding certain gross profit targets for the year ended December 31, 2012. The $4.9 million fair-value of the contingent purchase price was accrued at the date of acquisition as part of the total consideration transferred. The Company utilized a probability weighted discounted cash flow method, with expected future performance of MedfusionRx, and its ability to meet the target performance objectives as the main driver of the valuation, to arrive at the fair value of the contingent consideration. In determining the fair value of the contingent purchase price, the Company considered the impact of the potential legal matters that may arise in connection with the recent proceedings involving certain of MedfusionRx's former owners and employees as noted in Note 14-Commitments and Contingencies. Currently, the Company does not believe the potential legal matters will impact the likelihood or amount of additional purchase price that will be paid.
from this acquisition. The opportunity to pull through more specialty sales to the Company's existing customer base is a significant driver of
During the year ended December 31, 2011, the Company recognized $7.0 million of amortization expense from intangible assets acquired. Amortization for 2012 is expected to be $4.9 million.
The estimated fair values and useful lives of intangible assets acquired are as follows (dollars in thousands):
On June 1, 2011, the Company completed the acquisition of substantially all of the assets of MedMetrics Health Partners, Inc. (“MedMetrics”), the full-service PBM subsidiary of Public Sector Partners, Inc., which is affiliated with a major medical school. MedMetrics' results of operations are included in the 2011 consolidated statements of operations commencing June 1, 2011. Prior to the acquisition, MedMetrics was a customer of the Company and its associated revenue was accounted for in the PBM segment. Due to the previous contractual relationship between the Company and MedMetrics, there were pre-existing transactions between the two entities which resulted in approximately $10.6 million in accounts receivable due to the Company from MedMetrics for PBM services provided. No gain or loss was generated from the subsequent settlement of these pre-existing balances.
The acquisition of MedMetrics is consistent with the Company's strategy to acquire assets that currently utilize the Company's technology platform which facilitates the integration into the Company's business and will allow the Company the opportunity to sell additional services, such as mail and specialty services, to MedMetrics' customers. The acquisition will also help extend the Company's footprint in the northeastern part of the U.S.
Depreciation expense, including property and equipment acquired under capital leases, totaled $9.5 million, $8.4 million, and $8.0 million for the years ended December 31, 2011, 2010, and 2009, respectively. Of the total depreciation expense, $2.7 million, $2.4 million, and $2.2 million was related to the data center operations and allocated to cost of revenue for the years ended December 31, 2011, 2010 and 2009, respectively.
The changes in the carrying amounts of goodwill by reportable segment for the years ended December 31, 2011 and 2010 are as follows (in thousands):
(3) Represents the acquisitions of Medmetrics, PTRX and SaveDirectRx in 2011.
Future amortization associated with intangible assets recorded as of December 31, 2011 is estimated to be $17.3 million in 2012, $14.5 million in 2013, $12.6 million in 2014, $9.8 million in 2015, $4.9 million in 2016, and $10.7 million for years after 2016. These amounts do not include estimated amortization for the recently completed HealthTran acquisition.
The interest rates applicable to the Revolving Credit Facility are based on a fluctuating rate of interest measured by reference to either, at the Company's option, (i) a base rate, plus an applicable margin, or (ii) an adjusted London interbank offered rate (adjusted for maximum reserves) (“LIBOR”), plus an applicable margin. The initial applicable margin for all borrowings is 0.375% per annum with respect to base rate borrowings and 1.375% per annum with respect to LIBOR borrowings. The applicable margin, in each case, will be adjusted from time to time based on the Company's consolidated leverage ratio for the previous fiscal quarter. During an event of default, default interest is payable at a rate that is 2% higher than the rate otherwise applicable. The Company may voluntarily, at any time and from time to time, prepay any loans outstanding in whole or in part without premium or penalty, subject to prior notice to JPMCB, as administrative agent, in accordance with the terms and provisions of the Credit Agreement.
All existing and future, direct and indirect, material subsidiaries are required to become guarantors of all of the Company's obligations under the Credit Agreement. Pursuant to a Subsidiary Guaranty dated December 16, 2011, among the guarantors party thereto and JPMCB, as administrative agent, certain material direct and indirect subsidiaries guarantee all obligations of the Company under the Credit Agreement.
Effective on March 11, 2009, the Board of Directors of the Company adopted the SXC Health Solutions Corp. 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 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 1,800,000 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. There were 2,138,470 stock-based awards available for grant under the LTIP as of December 31, 2011.
The following table summarizes activity related to stock options denominated in U.S. dollars for the year ended December 31, 2011. The Company began issuing these stock options subsequent to May 2007:
U.S. dollar options granted during 2011, were primarily subject to a graded vesting schedule of four years. U.S. dollar options granted expire seven years from the grant date.
The following table summarizes certain information about the U.S. dollar stock options outstanding at December 31, 2011:
and 1.89 years, respectively. The aggregate intrinsic value and remaining contractual term of all vested options and options that are expected to vest are $42.5 million and 3.31 years, respectively. The intrinsic value of options exercised during 2011, 2010 and 2009 was $23.3 million, $17.5 million, and $2.5 million, respectively. The total fair value of stock options which vested during the years ended December 31, 2011, 2010, and 2009 was approximately $2.5 million, $2.3 million, and $1.6 million, respectively.
During the first quarter of 2009, the ESPP was amended so that the common shares available for purchase under the ESPP are drawn from reacquired common shares purchased on behalf of the Company in the open market. Prior to the amendment in 2009, the common shares available for purchase under the ESPP were drawn from either authorized but previously un-issued common shares or from reacquired common shares, including those purchased by the Company in the open market. During 2011, 2010, and 2009, the Company delivered 6,772, 7,072, and 12,396 common shares, respectively, under the ESPP.
During 2011, the Company granted 116,046 time-based RSUs and 104,662 performance based RSUs to its employees and non-employee directors with an average grant date fair value of $50.61. Time-based RSUs vest on a straight-line basis over a range of three to four years and 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, 2011 stated above assumes the associated performance targets will be met at the maximum level.
For the years ended December 31, 2011, 2010, and 2009, the Company recorded stock-based compensation expense of $9.4 million, $5.9 million, and $3.7 million, 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, 2011, 2010, and 2009 was $3.5 million, $2.2 million, and $1.4 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, 2011, 2010, and 2009, 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 immediate vesting of some of their options.
At December 31, 2011, the Company had gross deferred tax assets (“DTAs”) totaling $20.5 million compared to $15.6 million at December 31, 2010. Of the $20.5 million, $4.0 million of DTAs related to its Canadian operations compared to $4.4 million at December 31, 2010. The Company also had deferred tax liabilities which increased to $25.1 million at December 31, 2011 from $19.7 million at December 31, 2010.
The balance of the valuation allowance was $3.6 million at December 31, 2011 compared to $3.7 million at December 31, 2010. The valuation allowance arising from the Canadian operations was $3.4 million at December 31, 2011 and $3.5 million at December 31, 2010. The Canadian valuation allowance decreased during the year as a result of changes in exchange rates. 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.
At December 31, 2011, the Company had a DTA of $0.3 million related to state NOLs that are available to reduce future years’ taxable income and expire beginning in 2014. A valuation allowance of $0.2 million has been established against a portion of the NOLs related to one of the Company’s prior acquisitions.
The Company has unused investment tax credits of approximately $0.5 million, which can be offset against Canadian federal income taxes payable in future taxation years. These investment tax credits expire in varying amounts from 2026 up to 2029.
Income from U.S. operations before income taxes was $137.3 million, $92.6 million, and $66.8 million for the years ended December 31, 2011, 2010 and 2009, respectively. Income from Canadian operations before income taxes, including taxable income attributable to intercompany debt, was $1.0 million, $5.0 million, and $1.3 million for the years ended December 31, 2011, 2010 and 2009, respectively.
U.S. GAAP 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, 2011 and 2010, the Company has an accrued liability in the consolidated balance sheets of $0.6 million, respectively, while as of December 31, 2009 the Company had an accrued liability of $0.5 million. 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 following table sets forth the computation of basic and diluted EPS for the years ended December 31, 2011, 2010, and 2009 (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, 2011, 2010, and 2009 (in thousands):
Aggregate future minimum payments in respect of non-cancellable operating lease agreements as of December 31, 2011, which extend until 2018, are as follows (in thousands):
In addition, 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. The Company has considered these proceedings and disputes in determining the necessity of any reserves for losses that are probable and reasonably estimable. In addition, various aspects of the Company’s business may subject it 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, its ability to obtain certain levels of discounts or rebates on prescription purchases from retail pharmacies and drug manufacturers or other actions or omissions. The Company’s recorded reserves are based on estimates developed with consideration given to the potential merits of claims or quantification of any performance obligations. The Company takes into account its history of claims, the limitations of any insurance coverage, advice from outside counsel, and management’s strategy with regard to the settlement or defense of such claims and obligations. While the ultimate outcome of those claims, lawsuits or performance obligations cannot be predicted with certainty, the Company believes, based on its understanding of the facts of these claims and performance obligations, that adequate provisions have been recorded in the accounts where required.
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.
At December 31, 2011, one customer accounted for 16.0% of the total accounts receivable balance. At December 31, 2010, no individual customer accounted for more than 10% of the total accounts receivable balance.
To manage credit risks, the Company selects counterparties based on credit assessments, limits overall exposure to any single counterparty, and monitors the market position with each counterparty. The Company assesses interest rate cash flow risk by continually identifying and monitoring changes in interest rate exposures that may adversely impact expected future cash flows and by evaluating hedging opportunities. The Company does not enter into derivative instruments for any purpose other than hedging identified exposures. That is, the Company does not speculate using derivative instruments and has not designated any instruments as fair value hedges or hedges of the foreign currency exposure of a net investment in foreign operations.
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, 2011 (in thousands):
On October 3, 2011, the Company completed the acquisition of SaveDirectRx, the exclusive mail-order pharmacy provider for PTRX, based in San Antonio, Texas. The purchase agreement includes contingent purchase price consideration in the form of an earn-out payment of up to $4.5 million contingent upon the SaveDirectRx book of business meeting or exceeding certain gross profit and revenue targets for the 2012 fiscal year. The $4.2 million fair-value of the contingent purchase price was accrued at the date of acquisition as part of the total consideration transferred. The fair value of the contingent purchase price consideration was $4.3 million as of December 31, 2011. The change in the value of the contingent purchase price of $0.1 million from October 3, 2011 was recorded to interest expense representing the change in the present value of the amount expected to be paid in the future for the contingent purchase price consideration. The Company utilized a probability weighted discounted cash flow method to arrive at the fair value of the contingent consideration based on the expected results and considering the performance targets of SaveDirectRx in 2012. As of December 31, 2011, the contingent purchase price consideration is classified as other liabilities in the consolidated balance sheet.
The Company has classified derivative liabilities as accrued liabilities as of December 31, 2010. The reported fair value was estimated based on quoted prices from a financial institution which are derived from movements in the underlying interest rate markets. The total change in fair value was $0.3 million for the year ended December 31, 2010, and was mostly recognized as other (income) expense in the consolidated statement of operations.
During 2011 and 2010 there were no movements of fair value measurements between levels 1, 2 and 3.