The Company’s Specialty Service operation, which supports the delivery of certain medications to individuals with chronic or genetic diseases and disorders, has its main locations in Maine and Alabama, with seven additional facilities mostly located in the southeastern states of the U.S. The Company's Mail Service operation is located in Florida.
The Company believes these properties are adequate for its current operations.
The following selected consolidated financial data as of December 31, 2010 and 2009 and for each of the years in the three-year period ended December 31, 2010 has been derived from the audited consolidated financial statements of the Company contained elsewhere in this Annual Report on Form 10-K. The selected consolidated financial data as of December 31, 2008 and for the year ended December 31, 2007 has been derived from the audited financial statements of the Company contained in the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2009. The selected consolidated financial data as of December 31, 2007 and for the year ended December 31, 2006 has been derived from the audited financial statements of the Company contained in the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2008. The selected consolidated financial data as of December 31, 2006 has been derived from the audited financial statements of the Company contained in the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2007. Selected consolidated financial data for fiscal 2010, 2009, 2008, 2007, and 2006 are all in accordance with U.S. GAAP. 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 audited consolidated financial statements, including the notes thereto.
On September 23, 2009, the Company completed a public offering in Canada and the U.S of 10,350,000 of its common shares at a price
See Exhibit 12.1 to this Annual Report for the computation of the ratios of earnings to fixed charges.
Under the Company’s customer contracts, the retail pharmacy is solely obligated to collect the co-payments from the participants. As such, the Company does not include participant co-payments to retail pharmacies in revenue or cost of revenue. If these amounts were included in revenue and cost of revenue, operating income and net income would not have been affected.
The PBM industry is 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 to improve operating margins, and target the acquisition of other businesses to achieve its strategy of expanding its product offerings and customer base. The Company also looks to retain and expand its customer base by improving the quality of service provided by enhancing its solutions and lowering the total drug spend for customers.
Various aspects of the Company’s business are governed by federal and state laws and regulations. Because sanctions may be imposed for violations of these laws, compliance is a significant operational requirement. The Company believes it is in substantial compliance with all existing legal requirements material to the operation of its business. There are, however, significant uncertainties involving the application of many of these legal requirements to its business. In addition, there are numerous proposed health care laws and regulations at the federal and state levels, many of which could adversely affect the Company’s business, results of operations and financial condition. The Company is unable to predict what additional federal or state legislation or regulatory initiatives may be enacted in the future relating to its business or the health care industry in general, or what effect any such legislation or regulations might have on it. The Company also cannot provide any assurance that federal or state governments will not impose additional restrictions or adopt interpretations of existing laws or regulations that could have a material adverse effect on its business or financial performance.
Leading technology and platform: The Company’s technology is robust, scalable, and web-enabled. The Company’s payor offerings efficiently supported over 460 million transactions in 2010. 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.
The Company’s technology platform allows it to provide more comprehensive PBM services through informedRx by offering customers a selection of services to choose from to meet their unique needs versus requiring them to accept a one-size-fits-all solution. The Company believes this à la carte offering is a key differentiator from its competitors.
Selected financial highlights for the years ended December 31, 2010 and 2009 are noted below:
The Company reported net income of $64.7 million, or $1.03 per share (fully-diluted), for the year ended December 31, 2010 compared to $46.1 million, or $0.86 per share (fully-diluted), for the same period in 2009. Net income is higher for the year ended December 31, 2010 as compared to the same period in 2009, due to higher gross profit attributable to an increase in HCIT and PBM revenues, plus lower interest expense due to the extinguishment of the Company's long-term debt in December 2009. These increases are partially offset by an increase in income taxes.
Operating income increased $25.2 million, or 34.4%, in 2010 to $98.5 million as compared to $73.3 million in 2009. This
increase was driven by increased gross profits in both the PBM and HCIT segments.
Strong operational results drove an increase in operating cash flow of $9.9 million, or 11.4%, in 2010 to $96.3 million as compared to $86.4 million in 2009.
On March 4, 2010, the Company announced a new agreement with HealthSpring Inc. (“HealthSpring”), pursuant to which the Company's informedRx subsidiary will provide HealthSpring with its full suite of PBM services, and therefore manage significant drug spend. The initial term of the agreement is three years with provisions for two additional one-year extensions. HealthSpring began to deploy specialty pharmacy services in mid-2010, with implementation of the full PBM services starting on January 1, 2011. The Company expects that gross profit percentage related to this agreement will be significantly lower than historical gross profit percentages due to the related transaction volume.
Cost of revenue increased $482.3 million, or 38.5%, to $1.73 billion during 2010, primarily due to the increased revenues from the PBM segment driven by the factors noted above. Cost of revenue in the PBM segment relates to the actual cost of the prescription drugs sold. Cost of revenue for the HCIT segment relates primarily to the cost of labor to deliver the services provided.
Gross profit increased $27.5 million, or 14.7%, to $214.1 million during 2010, mostly due to increased margins of $21.5 million, or 15.5%, earned from incremental PBM revenues as compared to the same period in 2009. Gross profit percentage has decreased from 13.0% for the year ended December 31, 2009, to 11.0% of revenue for the year ended December 31, 2010, as a result of the PBM business producing a greater percentage of the Company's total gross profit. PBM revenues carry a lower gross profit percentage as compared to HCIT revenues due to the highly competitive nature of the PBM industry. 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.
SG&A costs for the year ended December 31, 2010 were $89.3 million compared to $85.8 million for the year ended December 31, 2009. 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 also include stock-based compensation cost of $4.9 million and $2.8 million for the years ended December 31, 2010 and 2009, respectively. The increase in SG&A costs is largely attributable to $2.4 million in expenses incurred in connection with the acquisition of MedfusionRx, and increased stock-based compensation cost. Stock-based compensation costs increased in 2010 driven by grants in 2010 and an increased value of the grants made in 2010 versus prior years. Although the Company has experienced an increase in the overall customer base during 2010, it has been able to hold its SG&A expenses steady, exclusive of the increases due to acquisition expenses and stock-based compensation charges, due to a focus on controlling its operating costs throughout 2010.
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 $0.2 million to $6.0 million for the year ended December 31, 2010 from $5.8 million for the same period in 2009, primarily due to purchases related to the Company’s expansion of its data centers and information technology equipment to expand network capacity.
Interest income remained flat for the year ended December 31, 2010 as compared to 2009, due primarily to interest rates remaining at similar levels in 2010 as compared to 2009. Interest expense and other expense, net, decreased $4.3 million to $1.7 million for the year ended December 31, 2010 compared to the same period in 2009, due to the extinguishment of the Company’s long-term debt in the fourth quarter of 2009.
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 business segments for the years ended December 31, 2010 and 2009 is as follows (dollars in thousands):
Revenue was $1.84 billion for the year ended December 31, 2010 as compared to $1.34 billion for the same period in 2009. The $505.6 million, or 37.8%, increase in revenue is primarily due to new customer starts as of January 1, 2010, as well as other customers added later in 2009. Revenues have also increased as compared to the same period in 2009 due to an increase in PBM services sold to several HCIT customers during 2010 and the end of 2009. As contracts with these existing customers are renewed or renegotiated to provide for additional PBM services, revenue derived from these customers' contracts is moved from the HCIT segment to the PBM segment.
For transactions at retail pharmacies, driven by the terms of the customer contracts, the pharmacy is solely obligated to collect the co-payments from the participants. The Company does not assume liability for participant co-payments in retail pharmacy transactions, and therefore does not include participant co-payments in revenue or cost of revenue.
Cost of revenue was $1.68 billion for the year ended December 31, 2010, compared to $1.20 billion for the same period in 2009. Cost of revenue increased $484.2 million, or 40.4%, in line with the increase in PBM revenues, and is predominantly comprised of the cost of prescription drugs. 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 additions in 2010. Generally, new customer additions start at lower margins due to costs incurred to bring in the new business. This was partially offset by the increased use of lower cost generic drugs. Generic drug usage continues to be a focus of the industry, and the Company, to help drive down health care costs to our customers. The Company will continue to seek opportunities for increased generic prescription drug usage to help reduce overall prescription drug costs to its customers and the Company.
Total HCIT revenue increased $4.1 million, or 4.0%, for the year ended December 31, 2010 as compared to the same period in 2009. Revenues increased mainly due to the rise in transaction processing revenues, driven by increased transaction volumes, and additional revenues earned for meeting certain contractual performance conditions during the year. This increase was partially offset by decreases in professional services and system sales revenues.
Transaction processing revenue consists of claims processing and generally increases as a result of the launch of new contracts as well as increased volumes of services provided to existing customers. Professional services revenue is derived from providing support projects for both system sales and transaction processing clients, on an as-needed basis. This revenue is dependent on customers initiating new projects and system enhancements which require the Company to assist them on either a fixed bid or time and materials basis. System sales are derived from license upgrades and additional applications for existing and new clients, as well as software and hardware sales to pharmacies that purchase the Company's pharmacy system. Maintenance revenue is generated from maintenance services provided on related system or license sales.
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. 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 the increase in transaction processing revenues that are able to leverage a fixed cost base, as well as due to additional revenues earned for meeting certain contractual performance conditions discussed earlier. These increases were offset by decreases in revenue earned from professional services and system sales.
Year ended December 31, 2009 as compared to year ended December 31, 2008
Revenue increased $575.7 million to $1.44 billion during 2009, primarily due to three main factors: 1) the inclusion of a full year of operating results of NMHC in 2009 as compared to eight months in the prior year, 2) the conversion of existing HCIT customers to PBM customers through new contracts and contract amendments as a result of the Company taking advantage of cross-selling opportunities between the Company's two segments and 3) new customer additions during 2009.
Gross profit increased $71.1 million to $186.6 million during 2009, primarily due to having a full year of PBM segment gross profits versus eight months in the prior year, as well as the launch of new contracts during the year.
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 $1.0 million to $5.8 million for the year ended December 31, 2009 from $4.8 million for the same period in 2008, due primarily to the expense related to assets associated with the acquisition of NMHC, as well as purchases related to the Company's expansion of its data centers and information technology equipment to expand network capacity.
Interest income decreased $1.9 million for the year ended December 31, 2009 as compared to the same period in 2008, due primarily to lower interest rates in 2009. Interest expense and other expense, net, increased $1.1 million to $6.0 million for the year ended December 31, 2009 compared to the same period in 2008, due to a $1.1 million charge recorded to fully amortize deferred financing costs. The amortization of the deferred financing costs was accelerated due to the extinguishment of the Company's long-term debt in the fourth quarter of 2009. These increases were offset by lower interest rates, and a lower outstanding principal balance of the debt in 2009 versus 2008.
HCIT revenue increased $11.6 million, or 12.7%, for the year ended December 31, 2009 as compared to the same period in 2008. Revenues increased mainly due to the rise in transaction processing revenues that are dependent on transaction volumes, driven by the launch of new customer contracts during 2009, as well as increased volumes from existing customers.
Transaction processing revenue consists of claims processing and generally increases as a result of the launch of new contracts as well as increased volumes of services provided to existing customers. Professional services revenue is derived from providing support projects for both system sales and transaction processing clients, on an as-needed basis. This revenue is dependent on customers initiating new projects and system enhancements which require the Company to assist them on both a fixed bid and time and materials basis. System sales are derived from license upgrades and additional applications for existing and new clients, as well as software and hardware sales to pharmacies that purchase the Company's pharmacy system. Maintenance revenue is generated from maintenance services provided on related system or license sales.
Cost of revenue increased 20.3% to $54.3 million for the year ended December 31, 2009 from $45.1 million for the year ended December 31, 2008. Cost of revenue includes the direct support costs for the HCIT business as well as depreciation expense of $2.2 million and $1.8 million for the years ended December 31, 2009 and 2008, respectively. In addition, cost of revenue includes stock-based compensation expense of $0.7 million and $0.6 million for the years ended December 31, 2009 and 2008, respectively. The increase in HCIT cost of revenue is due primarily to personnel and support costs related to the growing transaction processing business and the implementation costs of new customer contracts.
Gross profit increased $2.4 million to $48.4 million for the year ended December 31, 2009 as compared to $46.0 million for the same period in 2008. The increase is primarily due to increases in higher margin recurring revenue services. The increased gross profit was partially offset by additional HCIT personnel needed to support the growing HCIT business.
The Company’s sources of liquidity have primarily been cash provided by operating activities, proceeds from its public offerings, and proceeds from credit facilities. The Company’s principal uses of cash have been to fund working capital, finance strategic acquisitions and capital expenditures, satisfy contractual obligations, and to meet acquisition and investment needs. The Company anticipates that these uses will continue to be the principal demands on cash in the future.
At December 31, 2010 and 2009, the Company had cash and cash equivalents totaling $321.3 million and $304.4 million, respectively. The Company believes that its cash on hand, together with cash generated from operating activities, will be sufficient to support planned operations for the foreseeable future. At December 31, 2010, cash and cash equivalents consisted of cash on hand, deposits in banks and bank term deposits with original maturities of 90 days or less. As of December 31, 2010, all of the Company’s cash and cash equivalents were exposed to market risks, primarily changes in U.S. and Canadian interest rates. Declines in interest rates over time will reduce interest income from these investments. 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 currently 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 the U.S. money market fund accounts.
Accounts receivable are made up of trade accounts receivable from both the PBM and HCIT segment customers. Accounts receivable increased $24.8 million to $122.2 million at December 31, 2010 from $97.3 million at December 31, 2009, driven by increases in revenue of $505.6 million during the year ended December 31, 2010, as well as additional trade accounts receivable related to the MedfusionRx acquisition. The accounts receivable balance is impacted by changes in revenues, as well as 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 Company’s inventory balance of $8.7 million consists predominantly of prescription drugs and medical supplies at its Mail Service and Specialty Service pharmacies. As of December 31, 2010, the inventory balance has increased $1.6 million from the balance at December 31, 2009, mainly due to inventory related to the MedfusionRx acquisition. Changes in the
The accounts payable balance of $30.9 million represents amounts owed to the Company's suppliers for prescription drugs at the Mail Service and Specialty Service locations, as well as amounts due to vendors for general operating expenses. As of December 31, 2010, the accounts payable balance has increased $21.0 million from the balance at December 31, 2009, mainly due to payables assumed related to the acquisition of MedfusionRx.
Pharmacy benefit management rebates payable represents amounts owed to customers for rebates from pharmaceutical manufacturers and third party administrators where the Company administers the rebate program on the customer’s behalf, and the Company is the principal contracting party. The payables are based on estimates, which are subject to final settlement. Pharmacy benefit management rebates payable increased $14.8 million to $61.4 million at December 31, 2010. The increase is due to increased rebate volumes driven by increased prescription drug sales transactions.
Other liabilities increased $4.0 million to $10.5 million at December 31, 2010 from $6.5 million at December 31, 2009, mainly due to the contingent purchase price liability recorded related to the MedfusionRx acquisition. The MedfusionRx purchase agreement includes a potential earn-out payment of $5.5 million to the former owners if certain performance criteria are met by MedfusionRx in 2012. The liability recorded is the estimated fair value of the liability as of December 31, 2010. See Note 4 to the consolidated financial statements for further information regarding the contingent purchase price related to the acquisition.
Changes in the Company’s cash from operations results primarily from profitability of the Company, as well as the timing of collections on its receivables and payment or processing of its various payables and accrued liabilities. The Company continually monitors its balance of trade and rebate accounts receivable and devotes ample resources to collection efforts on those balances. Rebates receivable and the related payables are primarily estimates based on claims submitted. Rebates are typically paid to customers on a quarterly basis upon receipt of the billed funds from the pharmaceutical manufacturers and third party administrators. The timing of the payments to customers and collections from pharmaceutical manufacturers and third party administrators on rebates causes fluctuations in the balances of these accounts on the balance sheet, as well as in the Company’s cash from operating activities.
For the year ended December 31, 2008, the Company generated $41.6 million of cash through its operations. Cash from operating activities consisted of net income of $15.1 million adjusted for $16.0 million in depreciation and amortization expense, $4.1 million in stock-
based compensation expense, and a $6.4 million increase in all other operating activities, primarily changes in working capital items. Included in the change in other operating activities (net of the effects of the acquisitions of NMHC and the assets of Zynchros, Inc.) is an $8.4 million decrease in claims payable, an $8.0 million decrease in accounts receivable, a $4.8 million increase in accrued liabilities and a $2.4 million increase in rebates receivable.
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, 2009, the Company used $15.8 million of cash for investing activities, which consisted primarily of $9.0 million for purchases of property and equipment to support increased transaction volume, and $5.1 million to purchase short-term investments.
For the year ended December 31, 2009, the Company generated $166.2 million of cash from financing activities, which mainly consisted of $203.1 million in net proceeds from the public offering of 10,350,000 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.
For the year ended December 31, 2008, the Company generated $48.2 million of cash from financing activities, which consisted of the net proceeds from the issuance of long-term debt of $45.8 million, the exercise of stock options of $1.5 million and a $0.8 million tax benefit on the exercise of stock options.
If adequate funds are not available, the Company may have to substantially reduce or eliminate expenditures for marketing, research and development, and testing of proposed products, or obtain funds through arrangements with partners that require the Company to relinquish rights to certain of its technologies or products. There can be no assurance that the Company will be able to raise additional capital if its capital resources are exhausted. A lack of liquidity and an inability to raise capital when needed may have a material adverse impact on the Company’s ability to continue its operations or expand its business.
The following table summarizes the Company’s significant contractual obligations as of December 31, 2010 and the effect such obligations are expected to have on the Company’s liquidity and cash in future periods assuming all obligations reach maturity:
As of December 31, 2010, certain contracts with the Company’s utilities providers require minimum annual purchases.
The Company acquired MedfusionRx on December 28, 2010 in exchange for $101.7 million in cash (subject to a customary working capital adjustment) and a contingent earn-out payment of up to $5.5 million based upon the achievement of certain performance targets in the 2012 fiscal year.
On September 23, 2009, the Company completed a public offering of 10,350,000 of its common shares. The shares were offered to the public at a price of $20.75 per share. The gross proceeds from the offering totaled $214.8 million, excluding $11.7 million for underwriting discounts and commissions, and other offering costs.
Principal versus agent considerations: The Company evaluates customer contracts using the indicators of the principal versus agent revenue accounting guidance to determine whether the Company acts as a principal or as an agent in the fulfillment of prescriptions through the retail pharmacy network. Assessing each contract requires judgment, and the conclusions reached on each contract will greatly impact the amount of revenue recorded. While gross profit is not impacted by the conclusion reached, revenues and cost of revenues will vary significantly. The Company assesses each contract to determine if the Company is acting as a principal or an agent. Key factors that the Company considers when determining whether it acts as a principal or an agent includes: (i) whether the Company has separate contractual relationships with customers and with pharmacies, (ii) is the Company responsible to validate and manage a claim through its claims adjudication process, (iii) does the Company commit to set prescription prices for the pharmacy, including instructing the pharmacy as to how that price is to be settled (co-payment requirements), (iv) does the Company manage the overall prescription drug plan relationship with the patients, who are participants of customers’ plans, (v) who has credit risk for the amount due from the customer, and (vi) does the Company have direct obligations to the retail pharmacies to pay for the prescription drug spend. The Company weighs the criteria that are present in order to conclude whether the contract should be recorded gross as a principal, or net as an agent.
Professional service revenues under long-term contracts: As part of the Company’s professional services offerings, the Company enters into contracts to provide professional services over a specified time frame, or for a specific contract deliverable. In cases where the contracts require professional services to be delivered for an extended time frame, the Company records revenue based on a percentage of completion model. The percentage of completion model is impacted by management’s estimate of hours required to complete a deliverable and the mix of staffing required for the project. When projects have a fixed fee, the Company must estimate the total cost to complete the deliverable in order to assess a projected margin from the project. Revenues are then recorded based on the hours completed for the project and the calculated margin to be earned from the project. Revenues are impacted based on management’s estimate of margin to be earned on the project, and may fluctuate throughout the project as estimates are revised. Whenever management expects a loss on a project, the Company records the expected loss immediately in its consolidated statement of operations.
The Company’s goodwill and long-lived assets (including property and equipment, and purchased intangibles subject to amortization) are subject to periodic impairment testing. Goodwill is tested for impairment annually as of October 31 of each year, while 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.
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. The conclusions and estimates made are further impacted by changes in economic and market conditions as well as changes to the customers’ financial condition.
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, 2010, 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 25, 2011 expressed an unqualified opinion on the effectiveness of the Company’s internal control over financial reporting.
We have audited SXC Health Solutions Corp.’s (the Company’s) internal control over financial reporting as of December 31, 2010, based on criteria established in Internal Control - Integrated Framework 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. Our responsibility is to express an opinion on the Company’s internal control over financial reporting based on our audit.
The Company acquired MedfusionRx, L.L.C. and certain affiliated entities and certain assets of Medtown South, L.L.C. (collectively, MedfusionRx) on December 28, 2010, and management excluded from its assessment of the effectiveness of the Company's internal control over financial reporting as of December 31, 2010, MedfusionRx's internal control over financial reporting associated with total assets of $125.9 million included in the consolidated financial statements of the Company as of December 31, 2010. Our audit of internal control over financial reporting of the Company also excluded an evaluation of the internal control over financial reporting of MedfusionRx.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheet of the Company as of December 31, 2010, and the related consolidated statements of operations, comprehensive income, cash flow and shareholders’ equity for the year then ended, and our report dated February 25, 2011 expressed an unqualified opinion on those consolidated financial statements.
The consolidated financial statements of the Company have been prepared in accordance with accounting principles generally accepted in the United States (“U.S. GAAP”) and include its wholly-owned subsidiaries. All significant inter-company transactions and balances have been eliminated in consolidation. Amounts in the consolidated financial statements are expressed in U.S. dollars, except where otherwise indicated. Certain reclassifications have been made to conform the prior years’ consolidated financial statements to the current year’s presentation.
As of the issuance date of the Company’s consolidated financial statements, no subsequent events have occurred that would require adjustment to, or disclosure in, the consolidated financial statements in accordance with the Financial Accounting Standards Board’s (“FASB”) guidance.
When an arrangement includes software and non-software deliverables, the Company allocates the arrangement consideration to the non-software deliverables, and to the software deliverables as a group, based on the relative selling prices of all deliverables in the arrangement. When a tangible product contains software that is not essential to the product’s functionality, that nonessential software and any other deliverables within the arrangement that relate to that nonessential software, are accounted for under accounting guidance for software. The non-software deliverables sold by the Company typically do not include software deliverables that are considered essential to the functionality of a tangible product.
For transactions at retail pharmacies, under the terms of the customer contracts, the pharmacy is solely obligated to collect the co-payments from the participants. The Company does not assume liability for participant co-payments in retail pharmacy transactions, and therefore does not include participant co-payments in revenue or cost of revenue. If these amounts were included in the Company’s operating results, its operating income and net income would not have been affected.
Inventory consists primarily of prescription drugs and medical supplies, computer hardware and sub-licensed software held for resale and is carried at the lower of cost or net realizable value. Inventory costs are calculated using the first-in, first-out method and the weighted-
Goodwill is not amortized, but rather, is tested for impairment annually, or more frequently if events or changes in circumstances indicate that the asset might be impaired. Prior to 2008, the Company completed its goodwill impairment test at December 31. In 2008, the Company changed the date of its annual impairment test to October 31 driven by the increase in reporting segments due to the NMHC acquisition completed in 2008. Changing the date to October 31 is preferable to allow the Company more time to accurately complete its impairment testing process.
Intangible assets acquired individually or as part of a group of other assets are initially recognized and measured at cost. 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 allocated to the individual assets acquired based on their fair values.
As of December 31, 2010 and 2009, total unbilled pharmaceutical manufacturer rebates receivable amounted to $9.3 million and $7.0 million, respectively.
Research costs are expensed as incurred. Costs related to development of software are expensed as incurred unless such costs meet the criteria for capitalization and amortization. The Company has not capitalized any software development costs incurred during 2010, 2009, or 2008.
The Company’s functional currency and reporting currency is the U.S. dollar. Monetary items denominated in foreign currency are translated to U.S. dollars at exchange rates in effect at the balance sheet date and non-monetary items are translated at rates in effect when the assets were acquired or obligations incurred. Revenue and expenses are translated at rates in effect at the time of the transactions. Foreign exchange gains and losses are included in the consolidated statements of operations as "Other (income) expense."
Deferred lease inducements represent cash inducements and tenant improvement allowances received from the Company’s landlords that are amortized against rent expense on a straight-line basis over the term of the respective lease.
When the terms of an operating lease provide for periods of free rent, rent concessions and/or rent escalations, the Company records rent expense on a straight-line basis over the term of the respective lease. The difference between the rent expense recognized and the actual payments made in accordance with the lease agreement is recognized as deferred rent liability.
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 $101.7 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.
Effective April 30, 2008, the Company completed the acquisition of NMHC, a PBM company, in an exchange offer of (i) 0.434 of a Company common share and (ii) $7.70 in cash for each outstanding NMHC common share. Total deal consideration approximated $143.8 million, which included the issuance of 5,571,920 Company common shares. The value of the common shares issued was based on the average market price of the Company’s common shares from a few days before to a few days after the agreement was finalized and announced. To fund the transaction, the Company entered into a six-year $48.0 million term loan agreement. The Company also signed a $10.0 million senior secured revolving credit agreement. NMHC results of operations are included in the consolidated financial statements from the date of acquisition.
Prior to the NMHC acquisition, the Company and one of NMHC’s subsidiaries, NMHCRX, Inc., were parties to a consulting agreement and software license and maintenance agreements pursuant to which the Company licensed, and provided consulting and support services in connection with, certain computer software for one of NMHCRX, Inc.’s claims adjudication systems.
The purchase price of the acquired NMHC operations was comprised of the following (in thousands):
During the year ended December 31, 2010, the Company recognized $6.0 million of amortization expense from intangible assets acquired. Amortization for 2011 is expected to be $5.3 million.
On December 22, 2008, the Company announced that it had acquired the assets of Zynchros, a privately-owned leader in formulary management solutions, in a cash transaction effective December 19, 2008. Founded in 2000, Zynchros provides a suite of on-demand formulary
Definite-lived intangible assets are amortized over the useful lives of the related assets. The components of intangible assets were as follows (in thousands):
On April 25, 2008, the Company’s U.S. subsidiary, SXC Inc., entered into a credit agreement (the “Credit Agreement”) providing for up to $58 million of borrowings, consisting of (i) a $10 million senior secured revolving credit facility (including borrowing capacity available for letters of credit and for borrowings on same-day notice) referred to as a swing loan (the “Revolving Credit Facility”) and (ii) a $48 million senior secured term loan (the “Term Loan Facility” and, together with the Revolving Credit Facility, the “Credit Facilities”). On April 29, 2008, US Corp. borrowed $48 million under the Term Loan Facility to pay a portion of the consideration in connection with the acquisition of NMHC and certain transaction fees and expenses related to the acquisition.
For the years ended December 31, 2010, 2009 and 2008, proceeds from the exercise of stock options totaled $11.0 million, $6.3 million, and $1.5 million, respectively. The additional amounts recorded for option exercises relate to the reclassification of the fair value of those options from additional paid-in capital to common shares.
Effective April 30, 2008, the Company completed the acquisition of NMHC in an exchange offer of (i) 0.434 of a common share of the Company’s common stock and (ii) $7.70 in cash for each outstanding NMHC common share. The Company issued 5,571,920 shares of its common stock in connection with the acquisition during 2008, and an additional 494 shares were issued during 2009.
Prior to May 2007, all stock options awarded by the Company were denominated in Canadian dollars as required by the Plan in effect at the grant date. Amendments to the Plan in May 2007 permitted the Company to denominate stock option awards in either Canadian or U.S. dollars. All grants made subsequent to May 2007 are denominated in U.S. dollars.
The following table summarizes activity related to stock options denominated in Canadian dollars for each of the years in the three-year period ended December 31, 2010:
The Company ceased granting Canadian dollar stock options in 2007. All Canadian dollar options outstanding expire five years from the date of vesting.
The aggregate intrinsic value and remaining contractual term of exercisable stock options at December 31, 2010 was approximately $9.4 million (Cdn.$9.4 million) and 1.66 years, respectively.
The total intrinsic value of Canadian stock options exercised during the years ended December 31, 2010, 2009, and 2008 was as follows (in thousands):
The following table summarizes activity related to stock options denominated in U.S. dollars for the years ended December 31,
The following table summarizes the information about the U.S. dollar stock options outstanding at December 31, 2010:
The Company assumed 341,000 restricted stock units (“RSUs”) of NMHC after the acquisition, which converted into 253,498 RSUs
of the Company. The RSUs vested 33% each in November 2008, November 2009 and November 2010.
For the years ended December 31, 2010, 2009, and 2008, the Company recorded stock-based compensation expense of $5.9 million, $3.7 million, and $4.1 million, respectively.
At December 31, 2010, the Company had gross deferred tax assets (“DTAs”) totaling $15.6 million compared to $20.3 million at December 31, 2009. Of the $15.6 million, $4.4 million of DTAs related to its Canadian operations compared to $5.7 million at December 31, 2009. The Company also had deferred tax liabilities which increased to $19.7 million at December 31, 2010 from $18.7 million at December 31, 2009.
The balance of the valuation allowance was $3.7 million at December 31, 2010 compared to $3.6 million at December 31, 2009. The
valuation allowance arising from the Canadian operations was $3.5 million at December 31, 2010 and $3.4 million at December 31, 2009. The Canadian valuation allowance increased 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, 2010, the Company had a DTA of $0.4 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 $0.7 million, which can be offset against Canadian federal income taxes payable in future taxation years. These investment tax credits expire in varying amounts from 2020 up to 2029. Successful closure of various taxation authorities’ examinations of these investment tax credits, along with an expectation of future profitability, resulted in a reversal of valuation allowance related to these investment tax credits, which impacted the Company’s effective tax rate in 2009.
The components of the provision for income taxes are as follows (in thousands):
The changes in this accrued liability from January 1, 2010 to December 31, 2010, and from January 1, 2009 to December 31, 2009, were a result of recognizing accrued interest and penalties related to the liability for tax uncertainties, as well as the effect of various additions
The Company recognizes interest and penalties related to uncertain tax positions in income tax expense. Accrued interest at December 31, 2010 and 2009 was $0.2 million and $0.1 million, respectively. It is reasonably possible that the total amount of unrecognized tax benefits will increase or decrease within twelve months of December 31, 2010. The Company currently estimates that such increases or decreases will not be material.
The Company and its subsidiaries file income tax returns in Canadian and U.S. federal jurisdictions, and various provincial, state and local jurisdictions. With few exceptions, the Company is no longer subject to tax examinations by tax authorities for years prior to 2006.
There were no options excluded from computation of the diluted EPS during 2010. Stock options totaling 22,000 and 1,456,332 were not included in the computation of diluted EPS for 2009 and 2008, respectively, as the exercise prices were greater than the average market price of the common shares for the periods.
(c) Cash paid (received) for income taxes and interest was as follows for the years ended December 31, 2010, 2009, and 2008 (in thousands):
The Company maintains operating lease agreements for office space in its main operating locations. The Company also leases certain office equipment. Aggregate future minimum payments in respect of non-cancellable operating lease agreements as of December 31, 2010, which extend until 2018, are as follows (in thousands):
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, mail service pharmacy claims management, specialty pharmacy claims management, 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 owns a Mail Service pharmacy and a Specialty Service pharmacy. In addition, the Company is a national provider of drug benefits to its customers under the federal government’s Medicare Part D program.
The Company evaluates segment performance based upon revenue and gross profit. Results for periods reported prior to the three months ended June 30, 2008 (the period in which the Company acquired NMHC) were reported in one operating segment, HCIT. Selling, general and administrative expenses, product development, depreciation and amortization are reported as corporate expenses. In addition, interest and other income and interest expense are reported within the corporate category. Prior period results have not been restated because to do so would be impracticable.
After the Company repaid all of its long-term debt in the fourth quarter of 2009, the cash flow hedge treatment was discontinued as the future transactions that the interest contracts were hedging were no longer probable of occurring.
Interest expense for the year ended December 31, 2008 includes $0.4 million of net losses related to the aforementioned derivative instruments. This amount represents the change in the fair value of the interest rate swap from the date the transaction was entered into through the date that the Company implemented cash flow hedge accounting and the change in the fair value of the interest rate cap from the date the transaction was entered into through the end of the year.
The estimated fair value of the Company’s financial instruments has been determined based on the Company’s assessment of available market information and appropriate valuation methodologies. However, these estimates may not necessarily be indicative of the amounts that the Company could realize in a current market exchange. See Note 16 for the Company’s disclosure on the fair value of derivative instruments. The Company has determined that it is not meaningful to calculate the fair value of the non-current accrued liabilities as a portion of this amount is an accrual for tax uncertainties.
The Company acquired MedfusionRx, a specialty pharmacy provider on December 28, 2010. The selling members of Medfusion have
The corporate debt securities are recorded in short-term investments in the 2009 consolidated balance sheet. The fair values of these securities are based on quoted market prices for the specific securities held based on a matrix of valuations received from several pricing sources. Other short-term investments represent certificates of deposits and treasury bills that mature in over 90 days. These are recorded in short-term investments in the 2009 balance sheet. The fair values of these securities are based on quoted market prices for the specific securities held based on a matrix of valuations received from several pricing sources. The changes in fair value of the debt securities and other short-term investments have been insignificant since their initial purchase in the fourth quarter of 2009. The amortized cost for the debt securities and other short-term investments was $4.6 million as of December 31, 2009.