This Form 10-K may contain forward-looking statements within the meaning of Section 21E of the Securities Exchange Act of 1934, as amended. These forward-looking statements involve a number of risks and uncertainties including, without limitation, those identified under Item 1A. “Risk Factors” and elsewhere in this Form 10-K. We undertake no obligation to revise any forward-looking statements in order to reflect events or circumstances that may arise after the date of this report. Readers are urged to carefully review and consider the various disclosures made in this report and in our other filings with the SEC that attempt to advise interested parties of the risks and factors that may affect our business.
We provide our clients access to a contracted, non-exclusive national network of approximately 63,000 pharmacies. We provide our clients’ members with timely and accurate benefit adjudication, while controlling pharmacy spending trends through customized plan designs, clinical programs, physician orientation programs, and member education. We use an electronic point-of-sale system of eligibility verification and plan design information and offer access to rebate arrangements for certain branded pharmaceuticals. When a member of one of our clients presents a prescription or health plan identification card to a retail pharmacist in our network, the system provides the pharmacist with access to online information regarding eligibility, patient history, health plan formulary listings, and contractual reimbursement rates. The member generally pays a co-payment to the retail pharmacy and the pharmacist fills the prescription. We electronically aggregate pharmacy benefit claims, which include prescription costs plus our claims processing fees for consolidated billing and payment. We receive payments from clients, make payments of amounts owed to the retail pharmacies pursuant to our negotiated rates and retain the difference (except where we have entered into pass-through pricing arrangements with clients) including applicable claims processing fees. Total claims processed increased to 56.2 million in 2009 from 52.0 million in 2008. Our revenue increased by approximately 14% to $2.9 billion in 2009 from $2.5 billion in 2008.
Pharmacy benefit claims payments from our clients are recorded as revenue, and prescription costs to be paid to pharmacies are recorded as direct expenses. Under our network contracts, we generally have an independent obligation to pay pharmacies for the drugs dispensed and, accordingly, have assumed that risk independent of our clients. When we administer pharmacy reimbursement contracts and do not assume a credit risk, we record only our administrative or processing fees as revenue. Rebates earned under arrangements with manufacturers or third party intermediaries are recorded as a reduction of direct expenses. The portion of manufacturer or third party intermediary rebates due to clients is recorded as a reduction of revenue.
Retail member co-payments to pharmacies are not recorded as revenue or direct expenses. We incur no obligations for co-payments to pharmacies and have never made such payments. Under our pharmacy agreements, the pharmacy is solely obligated to collect the co-payments from the members. If we had included co-payments in our reported revenue and direct expenses, it would have resulted in an increase in our reported revenue and direct expenses of $810.6 million, $753.5 million, and $635.6 million for the years ended December 31, 2009, 2008 and 2007, respectively. Our operating and net income, consolidated balance sheets and statements of cash flows would not have been affected.
We have supported the growth of our business through acquisitions. We strive to timely integrate our acquisitions into our financial, organizational, management and technology structure. When successfully integrated, we expect to achieve cost savings from the consolidation of certain corporate activities and the elimination of certain duplicate components of our corporate operations.
On August 5, 2008, we acquired IPS from Discount Drug Mart, Inc. IPS operates a fully-integrated prescription mail service fulfillment center located outside of Cleveland, Ohio. The IPS acquisition provides us with a foundation for building our mail service capability and enables us to provide our clients with an in-house mail service option. Total consideration for the acquisition of IPS consisted of net cash payments of $39.5 million and approximately $1.2 million in transaction costs.
Selling, general and administrative expenses of $67.8 million for the year ended December 31, 2008, consisted of $34.1 million in compensation and benefits, which includes $5.2 million in non-cash compensation, $6.3 million in professional fees and technology services, $8.4 million in facility costs, $3.3 million in travel expenses, $3.0 in insurance and other corporate expenses, $4.1 million in other, which includes $1.2 million in recruitment and temporary help, and $8.6 million in depreciation and amortization.
Interest Expense. Interest expense increased to $0.6 million for the year ended December 31, 2009 from $0.3 million in the comparable period in 2008. The increase in interest expense was primarily attributable to the expense associated with the accretion of the liability related to our First Rx Specialty and Mail Services, LLC arrangement. At December 31, 2009, we had available a $100.0 million revolving credit facility with no outstanding borrowings.
Net Income Attributable to the Company. Net income attributable to the Company for year ended December 31, 2009 increased by approximately $14.8 million over the same period in 2008 to $65.2 million. The increase in net income attributable to the Company was primarily a function of increased gross margin, reduced by an increase in selling, general and administrative expenses.
Gross margin is calculated as revenue less direct expenses. Factors that can result in changes in gross margins include generic substitution rates, changes in the utilization of preferred drugs with higher discounts and changes in the volume of prescription dispensing at lower-cost network pharmacies. Our gross margin increased to $143.3 million for the year ended December 31, 2008 from $110.4 million for the comparable period in 2007.
Gross margin as a percentage of revenue was 5.6% and 5.9% for the years ended December 31, 2008 and 2007, respectively. In 2008, composite gross margin percentages were slightly reduced by the full year impact of the addition of several recent large contracts, including the States of Maryland and Ohio and the Puerto Rico-based health plans, which are more competitively priced due to their size. These decreases were somewhat offset by gross margin improvements resulting from an increased level of generic substitution and higher network discount rates.
Selling, general and administrative expenses of $67.8 million for the year ended December 31, 2008, consisted of $34.1 million in compensation and benefits, which includes $5.2 million in non-cash compensation, $6.3 million in professional fees and technology services, $8.4 million in facility costs, $3.3 million in travel expenses, $3.0 million in insurance and other corporate expenses, $4.1 million in other, which includes $1.2 million in recruitment and temporary help, and $8.6 million in depreciation and amortization.
Net Income Attributable to the Company. Net income attributable to the Company for year ended December 31, 2008 increased by approximately $11.1 million over the same period in 2007 to $50.4 million. The increase in net income attributable to the Company was primarily a function of increased gross margin dollars, reduced by an increase in selling, general and administrative expenses.
We have $12.5 million at par value in investments related to auction rate securities, or ARS, all of which are classified as non-current on our balance sheet at December 31, 2009 and 2008. Our ARS are floating rate securities with longer-term maturities with auction reset dates from 7 to 35 day intervals. Beginning in February 2008, auctions for these securities began to fail. Currently, we are unlikely to be able to access the principal amounts of these securities until future auctions for these ARS are successful, or until we sell the securities in a fully active secondary market, of which there are currently none. However, there has been instances of redemptions at par to date by issuers of ARS, including issuers of securities we currently own. Although we continue to receive timely interest payments, our ARS investments currently lack short-term liquidity and are therefore classified as non-current on our balance sheet.
Based on our cash and cash equivalents balance of $152.1 million, our new available $100.0 million revolving credit facility and our positive operating cash flows, we do not anticipate a lack of liquidity associated with our ARS to have a material impact on our liquidity, financial condition, results of operations or cash flows. Although liquidity is not currently required, where appropriate, we are exploring and pursuing alternatives for obtaining relief from the unanticipated temporary illiquidity of the ARS holdings, including seeking relief from entities involved in investing our funds in ARS. As a part of these efforts, on February 23, 2009, we brought an arbitration claim, still pending, before the Financial Industry Regulatory Authority (“FINRA”) against Credit Suisse Securities (USA), LLC
Net Cash Provided by Operating Activities. Our operating activities generated $112.1 million of cash from operations in 2009, a $33.5 million increase from the $78.6 million generated in 2008. This $112.1 million in cash provided by operating activities in 2009 reflects $65.2 million in net income attributable to the Company, plus $19.9 million in non-cash charges and $27.0 million net increase in working capital and other assets and liabilities. This $27.0 million net increase in working capital, net of effects of acquisitions, was primarily due to changes in accounts payable and accrued liabilities of $35.3 million, income tax receivable of $1.3 million and inventory of $1.3 million, offset by changes in accounts receivable of $7.6 million and other assets of $3.3 million.
Net cash used in investing activities for the year ended December 31, 2007 was $37.2 million. During 2007, we had $3.7 million in capital expenditures and net purchases of $1.4 million in marketable securities. The acquisition of our remaining 20% non-controlling ownership interest resulted in a cash payment of $30.3 million, of which approximately $29.0 million was recorded as additional purchase price. Also, additional contingent consideration and other payments of approximately $5.1 million relating to prior business acquisitions were paid during 2007. The period also reflects $1.0 million of cash provided upon the repayment of a note receivable as well as $1.0 million resulting from the lifting of restrictions on certain cash deposits.
million in proceeds from issuance of common stock pursuant to the Employee Stock Purchase Plan. In addition, we received an income tax payable benefit of $9.1 million from the exercise of stock options and restricted stock vesting. The acquisition of our remaining 20% non-controlling ownership interest resulted in a cash payment of $30.3 million, of which $1.3 million was attributable to the non-controlling interest.
At December 31, 2009, we had available a $100.0 million revolving credit facility with no outstanding borrowings. For additional information regarding our credit facility, deferred income taxes and operating leases, see Notes 8, 9 and 12, respectively, of our consolidated financial statements.
Retail member co-payments are not recorded as revenue. Under our pharmacy contracts, the pharmacy is solely obligated to collect the co-payments from the members. Under client contracts, we do not assume liability for member co-payments in pharmacy transactions. As such, we do not include member co-payments to pharmacies in revenue or direct expenses.
Trade accounts receivable are recorded at the invoiced amount and do not bear interest. The allowance for accounts receivable is our best estimate of the amount of probable credit losses in our existing accounts receivable. We determine the allowance based on historical write-off experience by industry and regional economic data. We review our allowance for accounts receivable quarterly. All past due balances over 120 days are fully reserved. All other balances are reviewed on a pooled basis by type of receivable. Account balances are charged off against the allowance when we feel it is more-likely-than-not the receivable will not be recovered. We do not have any off-balance-sheet credit exposure related to our customers.
Our goodwill is not amortized, but is tested for impairment at least annually. Each year, we test for impairment of goodwill according to a two-step approach. In the first step, we test for impairment of goodwill by estimating the fair values of our reporting units using a present value of future cash flows approach. Although we operate in one reportable segment, for the purposes of performing this impairment test under the accounting standards, we have identified three reporting units. If the carrying amount of the reporting unit exceeds the fair value, the second step of the goodwill impairment test is performed to measure the amount of the impairment loss, if any. In the second step, the implied fair value of the goodwill is estimated as the fair value of the reporting unit used in the first step less the fair values of all other net tangible and intangible assets of the reporting unit. If the carrying amount of the goodwill exceeds its implied fair market value, an impairment loss is recognized in an amount equal to that excess, not to exceed the carrying amount of the goodwill. In addition, the goodwill of a reporting unit is
Due to the failed auction status and current lack of liquidity in the market for such securities, prices from observable current market transactions or other observable market data are limited. Therefore, for each of our ARS, we evaluate the risks related to the structure, collateral and liquidity and estimate the fair value of the securities using a discounted cash flow model based on (a) the underlying structure of each security; (b) the present value of future principal and interest payments discounted at rates considered to reflect current market conditions; and (c) considerations of the probabilities of redemption or auction success for each period.
period ending on March 31, 2010, except for the Level 3 roll forward requirements which is effective for interim and annual periods beginning after December 15, 2010, which for us means our first quarterly period ending on March 31, 2011. The adoption of this ASU will not have an impact on our business, results of operations, financial position or cash flows.
In June 2009, the FASB approved the FASB Accounting Standards Codification, or the Codification, as the single source of authoritative Generally Accepted Accounting Principles in the United States. The Codification is applied by all non-governmental U.S. entities in preparation of financial statements in conformity with Generally Accepted Accounting Principles in the United States. All other accounting literature not included in the Codification is non-authoritative. Use of the Codification is effective for interim and annual periods ending after September 15, 2009, which for us annually means our year ending on December 31, 2009. The application of this Codification did not have an impact on the presentation of our business, results of operations, financial position or cash flows.