The Company’s principal executive offices, along with PBM and HCIT operations, are located in a 116,712 square foot leased office facility located at 2441 Warrenville Road, Suite 610 in Lisle, Illinois (suburban Chicago). This lease expires in January 2018. Additionally, the Company maintains PBM and HCIT operations in several other leased locations in the U.S. and Canada, including Arizona, Arkansas, Colorado,Georgia, Ontario (Canada), Massachusetts, Maryland, Pennsylvania and Texas. We operate mail order pharmacy facilities in Colorado, Florida, Ohio and Texas and specialty pharmacies in Alabama, Georgia, Kansas, Louisiana, Maine, Massachusetts, Mississippi, Nevada, Tennessee, Texas, and West Virginia. The Company believes these properties are adequate for its current operations. All of the Company's facilities are leased.
The following selected consolidated financial data have been derived from the consolidated financial statements of the Company contained elsewhere in this Annual Report on Form 10-K and the Company’s Annual Report on Form 10-K for the fiscal years ended December 31, 2012, 2011 and 2010. 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.
On September 17, 2010, the Company executed a two-for-one stock split effected by a stock dividend on the issued and outstanding common shares of the Company. All share and per share data presented in this Annual Report have been adjusted to reflect this stock split.
In January 2012, the Company completed the acquisition of all of the outstanding equity interests of HealthTran, a full-service PBM, in exchange for $250 million in cash, subject to certain customary post-closing adjustments.
On September 20, 2012, the Company executed a two-for-one stock split effected by a stock dividend on the issued and outstanding common shares of the Company. All share and per share data presented in this Annual Report have been adjusted to reflect this stock split.
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, Medicare Part D services, patient 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 mail pharmacies provide members flexibility, privacy, and easy access to their maintenance medications while offering significant plan savings to the customer. These pharmacies provide high quality service, member support and convenient, easy-to-use mail service delivery throughout the U.S. Plan savings for mail service are dependent on plan design features, including co-payments and incentives, and utilization patterns.
Company’s transaction processing business in the form of claims processing for its payor customers. Through the Company’s transaction processing business, where the Company is generally paid based on the volume of transactions processed, the Company continues to benefit from the growth in pharmaceutical drug use in the United States. The Company believes that aging demographics and increased use of prescription drugs will continue to benefit the transaction processing business. In addition to benefiting from this industry growth, the Company continues to focus on increasing recurring revenue in the transaction processing area by adding new transaction processing customers to its existing customer base. The recognition of revenue depends on various factors including the type of service provided, contract parameters, and any undelivered elements.
Our results for the year ended December 31, 2012 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. A key focus during the year was the integration of our recent acquisitions of HealthTran, LLC ("HealthTran") in January and Catalyst in July. The addition of these companies with their additional scale and product offerings helped the Company continue to see the positive trends we experienced in 2011 related to improved pricing from increased scale and increased generic usage, and enabled the Company 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, the regulatory environment continued to evolve during the year and we have continued to make significant investments in our product offerings designed to keep us ahead of the competition.
Total revenue in 2012 was $9.9 billion as compared to $5.0 billion in 2011. The increase is largely attributable to an increase in PBM revenue of $4.9 billion due primarily to the recent Merger with Catalyst, which was completed on July 2, 2012 and contributed $3.2 billion in revenue since the closing of the Merger, as well as organic growth driven by volume from the Company's PBM customers. As a result, the Company's adjusted prescription claim volume increased 116.9% in 2012 to 198.9 million from 91.7 million during 2011. Adjusted prescription claim volume equals the Company's retail and specialty pharmacy prescriptions, plus mail pharmacy prescriptions multiplied by three. The mail
pharmacy prescriptions are multiplied by three to adjust for the fact that they typically include approximately three times the amount of product days supplied compared with retail and specialty prescriptions.
The Company reported net income attributable to the Company of $116.7 million, or $0.70 per share (fully-diluted), for the year ended December 31, 2012 compared to $91.8 million, or $0.73 per share (fully-diluted), in 2011. Net income attributable to the Company is higher for the year ended December 31, 2012 as compared to 2011 as a result of the addition of the Catalyst book of business and other new customer implementations during the year. These increases were offset by an increase in interest expense of $23.9 million as a result of the Company's borrowings utilized to partially finance the Merger with Catalyst, plus the additional expenses discussed above. Amortization expense was $130.1 million in 2012 as compared to $16.4 million in 2011.
Earnings per share attributable to the Company decreased for the year ended December 31, 2012 as compared to 2011, primarily attributable to an increase in common shares outstanding as a result of the Company's issuance of approximately 12.0 million common shares in a May 2012 public offering and the issuance of 66.8 million shares to complete the Merger with Catalyst, as well as an increase in amortization expense as discussed above.
In July 2012, following the completion of the Merger with Catalyst, the Company changed its name from SXC Health Solutions Corp. to Catamaran Corporation. Along with the name change, the Company's shares began being traded under the ticker symbols "CTRX" on the NASDAQ Stock Market (" NASDAQ") and as "CCT" on the Toronto Stock Exchange ("TSX"), replacing the ticker symbols "SXCI" and "SXC" on the NASDAQ and TSX, respectively.
On May 16, 2012, the Company announced that it successfully completed a public offering of 12.0 million of its common shares at a price to the public of $45.30 per share. The net proceeds to the Company from the offering were approximately $519.1 million, after deducting
Revenue increased $3.0 billion, or 155.4%, to $5.0 billion during 2011 as compared to 2010, primarily due to the implementation of HealthSpring as well as new customer starts during 2011. Revenues also increased in 2011 as compared to 2010 due to an increase in new PBM services sold to several existing HCIT customers as a result of synergies between the HCIT and PBM segments, which allowed the Company to focus on offering a broader array of products and services to the Company's customers.
December 31, 2011. 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.
SG&A costs for the year ended December 31, 2012 were $369.5 million compared to $145.8 million and $101.7 million for the years ended December 31, 2011 and 2010, respectively. SG&A costs consist primarily of employee costs in addition to professional services costs, facilities and costs not related to cost of revenue. SG&A costs have increased $223.7 million, or 153.4%, from 2011 to 2012 due to the addition of operating costs related to the Company's recent Merger with Catalyst and acquisition of HealthTran during 2012 that were not present during 2011. In addition to the increased costs as a result of adding operations from Catalyst and HealthTran, the Company had organic increases in SG&A in order to support the growth of the PBM segment, plus increases due to transaction and integration expenses related to the Merger totaling $27.2 million and another $17.0 million of expenses related to the Merger comprised of $6.6 million for transactions entered into by Catalyst prior to the Merger that were deemed to have future benefit to the Company and $10.4 million in severance charges incurred subsequent to the close of the Merger. SG&A costs also include stock-based compensation expense of $17.0 million, $8.8 million and $5.2 million for the years ended December 31, 2012, 2011 and 2010, respectively. The increase in stock-based compensation was due to additional awards granted and increasing fair values per award.
Amortization expense for the year ended December 31, 2011 was $16.4 million compared to $7.9 million for the year ended December 31, 2010. The increase was driven mainly by the amortization of intangible assets acquired in the 2011 and 2010 acquisitions. Refer to Note 4- Business Combinations in the notes to the consolidated financial statements for further details of the Company's recent acquisitions.
The Company's intangible assets are amortized in line with their estimated future economic benefits, which for certain assets is greater at the beginning of their life versus the end. Refer to Note 7 - Goodwill and Other Intangible Assets in the notes to the consolidated financial statements for more information on amortization expected in future years.
Interest and other expense, net increased $24.4 million to $26.7 million for the year ended December 31, 2012 from $2.3 million in 2011. The increase is driven by an increase in the interest expense of $23.9 million to $25.8 million for the year ended December 31, 2012 from $1.9 million in 2011, related to the $1.4 billion utilized on the Company's credit facility to partially finance the Merger with Catalyst. Refer to Note 9 - Long - Term Liabilities in the notes to the consolidated financial statements for more information related to the Company's credit facility. Interest expense, increased $0.5 million to $1.9 million for the year ended December 31, 2011 compared to 2010, primarily due to increased banking fees driven by a higher number of transactions as a result of business added from recent acquisitions and growth in the PBM segment.
The Company manages its business in two segments: PBM and HCIT, and evaluates segment performance based on revenue and gross profit. Information about the Company’s reportable segments for the years ended December 31, 2012, 2011 and 2010 is presented below:
Revenue increased by $4.9 billion, or 101.4% to $9.8 billion for the year ended December 31, 2012 as compared to $4.9 billion in 2011. The increase in revenue is primarily due to the recent Merger with Catalyst, which was completed on July 2, 2012, and the acquisition of HealthTran in January 2012, as well as organic growth as a result of the implementation of new customer contracts in 2012. As a result of these customer additions, adjusted prescription claim volume for the PBM segment increased 116.9% to 198.9 million from 91.7 million during 2011.
Cost of revenue was $9.1 billion for the year ended December 31, 2012, compared to $4.6 billion for the same period in 2011, an increase of $4.5 billion, or 98.6%, in line with the increase in PBM revenue and increased adjusted prescription claim volume. Cost of revenue is predominantly comprised of the cost of prescription drugs. As a percentage of revenue, cost of revenue was 93.4% and 94.7% for the years ended December 31, 2012 and 2011, respectively. The decrease in the cost of revenue as a percentage of revenue was primarily due to the synergies realized as a result of the Merger as well as the increased use of lower cost generic drugs and higher utilization of the Company's owned mail and specialty pharmacies. 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 average GDR for PBM clients reached 82% in 2012, a 4% increase from 2011. This increase was achieved through a broad range of plan design solutions, helped considerably by a continuing wave of major generic releases. 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.
Gross profit increased $387.5 million, or 151.0% to $644.1 million for the year ended December 31, 2012, compared to $256.6 million in 2011 due to the the integration of Catalyst customers acquired as of July 2, 2012 as well as incremental revenue as a result of the HealthTran acquisition and new customer contract implementations. Gross profit percentage was 6.6% and 5.3% for the years ended December 31, 2012 and 2011, respectively. Gross profit percentage increased primarily as a result of synergies realized from the integration of Catalyst and HealthTran customers during 2012, along with improved usage of generics and higher utilization at the Company's mail and specialty pharmacies.
EBITDA increased $51.6 million for the year ended December 31, 2011, compared to 2010. The growth in EBITDA was primarily due to an increase in sales within the PBM segment, driven by the 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, 2012 was $1.19 as compared to $0.82 in 2011. Increased gross profit earned from the expansion of the Company's PBM business, as well as recent acquisitions helped improve the Company's adjusted EPS during 2012. This was partially offset by increased costs incurred to support the Company's business growth and recent acquisitions along with an increase in the number of diluted shares during 2012 as compared to 2011. Diluted shares increased in 2012 primarily due to the Company's issuance of 12.0 million common shares in a May 2012 public offering and the issuance of 66.8 million shares to complete the Merger with Catalyst.
The May 2012 public offering of 12 million common shares raised approximately $519.1 million in net proceeds. Refer to Note 10 - Shareholders' Equity in the notes to the unaudited consolidated financial statements for more information regarding the May 2012 public offering.
As of December 31, 2012, all of the Company’s cash and cash equivalents were exposed to market risks, primarily changes in U.S. interest rates. Declines in interest rates over time would reduce interest income related to these balances. Additionally, although the Company's primary operations are in the U.S., the Company is incorporated as a Canadian company. Cash that the Company holds in the U.S. would be subject to taxation if it is repatriated to Canada; however, the Company has determined that its U.S. earnings are permanently reinvested in the U.S. and accordingly deferred income taxes have not been recorded on the Company's U.S. earnings. Due to the Merger, the Company was required to pay a tax on its non-repatriated U.S. earnings through the end of 2012. As a result, the Company does not have any non-repatriated earnings as of December 31, 2012.
Pharmacy benefit management rebates payable represents amounts owed to PBM 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 $242.8 million to $302.1 million at December 31, 2012, from $59.2 million at December 31, 2011, due to the increased rebate volume as a result of the addition of Catalyst and HealthTran customers. Similar to the change in rebates receivable, the Company does not process rebates for all customers, and accordingly the rebates payable balance does not always fluctuate proportionately with changes in revenues and prescription claim volumes.
Changes in the Company’s cash from operations result primarily from increased gross profits and the timing of payments on accounts receivable, rebates receivable, and the payment or processing of its various accounts payable and accrued liabilities. The Company continually monitors its balance of trade accounts receivable and devotes ample resources to collection efforts on those balances. Rebates receivable and the related payable 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 third-party rebate administrators and pharmaceutical manufacturers. The timing of the rebate payments to customers and collections of rebates from third-party rebate administrators and pharmaceutical manufacturers causes fluctuations on the balance sheet, as well as in the Company’s cash from operating activities.
For the year ended December 31, 2011, the Company used $89.5 million of cash for investing activities, which consisted primarily of cash used to acquire PTRX and Save DirectRx. Additionally, the Company used $9.7 million for purchases of property and equipment to support increased transaction volume.
Cash flows from financing activities generally fluctuate based on the timing of option exercises by the Company’s employees, which are affected by market prices, vesting dates and expiration dates. The associated tax benefit on the exercise of stock options will also fluctuate based on the timing of option exercises, the market price of the Company's shares at the time of exercise, and the exercise price of the option. The Company will continue to incur significant cash outflows related to its amounts due under the 2012 Credit Agreement. Refer to Contractual Obligations later in this MD&A for further analysis of future payments due under the Company's 2012 Credit Agreement.
The Company’s future capital requirements depend on many factors, including its integration of recent acquisitions and any future transactions. 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 funds available under the 2012 Credit Agreement. See Note 9 - Long-Term Liabilities in the notes to the consolidated financial statements for more information on the Company's 2012 Credit Agreement. The Company expects that purchases of property and equipment will increase in 2013 due to the increase in the size of the business as a result of the Merger with Catalyst in 2012, and the move of the Company's headquarters planned for 2013. 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 following table summarizes the Company’s significant contractual obligations as of December 31, 2012 and the effect such obligations are expected to have on the Company’s liquidity and cash in future periods assuming all obligations reach maturity (in millions):
The 2012 Credit Agreement is due on the 2012 Credit Agreement's maturity date, July 2, 2017. The amount noted includes the amount borrowed by the Company under the Revolving Credit Facility as of December 31, 2012, which will fluctuate based on the principal outstanding under the Revolving Credit Facility.
The earn-out payments relate to our MedfusionRx, SaveDirectRx and Walgreens Health Initiatives (acquired by Catalyst in 2011)acquisitions and are subject to the achievement of certain performance targets during the measurement periods that range from 2012 to 2014. In February 2013, the Company settled the Medfusion earn-out paying the former owners $5.5 million.
The above table excludes $18.8 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.
On July 2, 2012, the Company completed the Merger with Catalyst, a full-service PBM. Each share of Catalyst common stock outstanding immediately prior to the effective time of the Merger (other than shares owned by the Company or Catalyst or any of their respective wholly-owned subsidiaries or shares with respect to which appraisal rights have been properly exercised) was converted in the Merger into the right to receive 1.3212 of a Company common share (0.6606 of a Company common share prior to the October 2012 two-for-one stock split) and $28.00 in cash. This resulted in the Company issuing approximately 66.8 million shares of common stock, assuming 0.5 million Catalyst warrants, and paying $1.4 billion in cash to Catalyst shareholders to complete the Merger.
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 financial performance targets through 2012.
The Company recognizes revenue when all of the following conditions are satisfied: (i) there is persuasive evidence of an arrangement; (ii) the service or product has been provided to the customer and no uncertainties exist surrounding product acceptance; (iii) the amount of fees to be paid by the customer is fixed or determinable; and (iv) the collection of fees is reasonably assured. Areas of judgment and subjectivity in
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. See Note 2 - Significant Accounting Policies in the notes to the consolidated financial statements for additional information on the Company's 2012 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.
From time to time in connection with its operations, the Company is named as a defendant in actions for damages and costs allegedly sustained by the plaintiffs. Management also considers other areas of the Company’s business that may be subject to litigation and liability for damages arising from errors in processing the pricing of prescription drug claims, failure to meet performance measures within certain contracts relating to its services performed or its ability to obtain certain levels of discounts or rebates on prescription purchases from participating pharmacies, drug manufacturers and third party administrators or other actions or omissions. Reserves for contingencies are based upon the Company’s consideration of these proceedings and disputes. Management assesses the probability that these contingencies will be realized, and whether the outcome is reasonably estimable. The Company’s estimates for reserves recorded may be impacted by the history of similar claims, the limitations of any insurance coverage, advice from outside counsel, and management’s strategy with regard to the settlement or defense against such claims and obligations.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Catamaran Corporation and subsidiaries as of December 31, 2012 and 2011, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 2012, in conformity with U.S. generally accepted accounting principles.
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, 2012 and 2011, and the related consolidated statements of operations, comprehensive income, cash flows and shareholders’ equity for each of the years in the three-year period ended December 31, 2012, and our report dated March 1, 2013 expressed an unqualified opinion on those consolidated financial statements.
Catamaran Corporation (“Catamaran” or the “Company”) is a leading provider of pharmacy benefits management (“PBM”) services and healthcare information technology (“HCIT”) solutions to the healthcare benefits management industry. The Company’s product offerings and solutions combine a wide range of PBM services, software applications, application service provider (“ASP”) processing services and professional services designed for many of the largest organizations in the pharmaceutical supply chain, such as federal, provincial, state and local governments, unions, corporations, pharmacy benefit managers, managed care organizations, retail pharmacy chains and other healthcare intermediaries. The Company is headquartered in Lisle, Illinois with several locations in the U.S. and Canada.
The Company recognizes revenue when all of the following conditions are satisfied: (i) there is persuasive evidence of an arrangement; (ii) the service or product has been provided to the customer and no uncertainties exist surrounding product acceptance; (iii) the amount of fees to be paid by the customer is fixed or determinable; and (iv) the collection of fees is reasonably assured.
PBM revenue: The Company’s PBM revenue is primarily derived from sales of prescription drugs, together with any associated administrative fees, to customers and participants through the Company’s nationwide network of pharmacies. Revenue related to the sales of prescription drugs by the Company’s nationwide network of pharmacies is recognized when the claims are adjudicated. Claims are adjudicated at the point-of-sale using the Company’s on-line processing system. The Company records an offsetting reduction to revenue for any rebates earned from pharmaceutical manufacturers and third party administrators which are payable to the Company’s customers.
Revenue for the sale of prescription drugs dispensed at the Company's mail and specialty pharmacies, including amounts due from third-party payors and member co-payments, is recorded when the prescription drugs are shipped.
HCIT revenue: HCIT revenues are generated from transaction processing, system sales, maintenance, and professional services. Revenue is recognized for the specific types of HCIT transactions as follows:
The Company considers cash on hand, deposits in banks, money market funds, and bank term deposits with original maturities of ninety days or less as cash and cash equivalents. The amounts presented in the consolidated balance sheets approximate fair value of cash and cash equivalents. These assets are deemed Level 1 securities in the fair value hierarchy.
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-average method.
Property and equipment (“P&E”) are stated at cost less accumulated depreciation. Depreciation is generally calculated over the expected estimated useful lives of the assets. Assets are depreciated in the following manner: 1) Furniture and equipment is depreciated using the straight- line method based on a useful life of five years, 2) Computer equipment and software assets are depreciated using a straight-line method and a useful life of three to five years, and 3) Leasehold improvements are depreciated on a straight-line basis over the shorter of the asset’s life or the lease term.
Trade accounts receivable are recorded at the invoiced amount and do not bear interest. Amounts collected on trade accounts receivable are included in net cash provided by operating activities in the consolidated statements of cash flows. 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. Individual
customer events such as subsequent collections, discussions with management of the debtor companies, or other activities are used by management as factors in concluding whether to increase or decrease the calculated allowance. Any increase or decrease to the allowance is recognized in the statements of operations as bad debt expense within selling, general and administrative expense.
The Company adopted in the prior year 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 and there was no indication of an impairment to the Company's goodwill balances. In addition, an impairment in the near future is not considered reasonably likely. The Company previously completed impairment tests in 2011 and 2010 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 four to nine years. The Company's remaining intangible assets are amortized on a straight-line basis over one to ten years.
As of December 31, 2012 and 2011, total unbilled pharmaceutical manufacturer rebates receivable amounted to $14.6 million and $8.9 million, respectively.
The cumulative compensation cost is treated as a temporary difference for stock-based awards that are deductible for tax purposes. If a deduction reported on a tax return exceeds the cumulative compensation cost for those awards, any resulting realized tax benefit that exceeds the previously recognized deferred tax asset for those awards (the excess tax benefit) is recognized as additional paid-in capital. If the amount deductible is less than the cumulative compensation cost recognized for financial reporting purposes, the write-off of a deferred tax asset related to that deficiency, net of the related valuation allowance, if any, is first offset to the extent of any remaining additional paid-in capital from excess tax benefits from previous awards with the remainder recognized in the statement of operations.
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 statement 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.
In July 2012, FASB issued an update to the indefinite-lived intangible assets impairment testing standard. The revised standard is intended to reduce the cost and complexity of the annual impairment test by providing entities an option to perform a "qualitative" assessment to determine whether further impairment testing is necessary. The revised standard is effective for annual and interim impairment tests performed for fiscal years beginning after September 15, 2012; however, an entity can choose to early adopt provided that the entity has not yet performed its 2012 annual impairment test or issued its financial statements. The Company does not expect the implementation of the revised standard to have a significant impact on its financial results or in the presentation and disclosure of its financial statements.
(b) These measurement period adjustments were recorded to reflect changes in the estimated fair values of the associated assets acquired and liabilities assumed based on factors existing as of the acquisition date.
Due to the previous contractual relationship between the Company and Catalyst, there were pre-existing transactions between the entities which resulted in approximately $4.1 million in accounts receivable due to the Company from Catalyst at the time of the Merger, mainly for HCIT transaction processing services provided. No gain or loss was generated from the subsequent settlement of these pre-existing balances.
The HealthTran acquisition was accounted for under the acquisition method of accounting with the Company treated as the acquiring entity. Accordingly, the consideration paid by the Company to complete the acquisition has been allocated to the assets acquired and liabilities assumed based upon their estimated fair values as of the date of acquisition. The carrying values for current assets and liabilities were deemed to approximate their fair values due to the short-term nature of their maturities. Fair values for acquired amortized intangible assets were
determined as follows: customer relationships were valued using an excess earnings model based on expected future revenues derived from the customers acquired, non-compete agreements were valued using discounted cash flow models based on expected future results of HealthTran, trademarks/tradenames were valued using a royalty savings model based on future projected revenues of HealthTran and applicable market royalty rates and licenses utilized a replacement cost approach. The excess of the purchase price over the estimated fair values of the net assets acquired was recorded as goodwill. All of the assets and liabilities recorded for the HealthTran acquisition are included within the Company's PBM segment. Goodwill is non-amortizing for financial statement purposes and the entire goodwill balance generated from the HealthTran acquisition is tax deductible. The goodwill recognized by the Company represents many of the synergies and business growth opportunities that may be realized from this acquisition. The synergies include the expansion of the Company's product offerings and improved pricing from the Company's suppliers due to the increased volume of prescription drug purchases.
On October 3, 2011, the Company completed the acquisitions of PTRX, Inc. (“PTRX”), a full-service PBM, and its exclusive mail-order pharmacy provider, SaveDirectRx, Inc. (“SaveDirectRx”), both based in San Antonio, Texas. The combined purchase price was $77.2 million in cash, subject to certain customary post-closing adjustments, with an opportunity for the former owners of SaveDirectRx to earn an additional $4.5 million, subject to the achievement of certain performance targets through 2012.
The SaveDirectRx 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 Company utilized a probability weighted discounted cash flow method with expected future performance of SaveDirectRx, 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. As the fair value measurement for the contingent consideration is based on inputs not observed in the market, the measurement is classified as a Level 3 measurement as defined by the fair value hierarchy.
During the year ended December 31, 2012, the Company recognized $4.8 million of amortization expense from intangible assets acquired. Amortization for 2013 is expected to be $4.3 million.
The acquisition of MedfusionRx has helped transform the Company's specialty pharmacy business by expanding its presence and enhancing its capabilities in this rapidly growing sector of the PBM industry. The acquisition also provides an opportunity to create new revenues and generate cost savings through purchasing synergies.
Costs related to the MedfusionRx acquisition of $2.4 million are included in selling, general and administrative expenses for the year ended December 31, 2010. The costs incurred are comprised of legal, accounting, valuation, and professional services fees associated with the MedfusionRx acquisition.
the goodwill created.The acquisition of MedfusionRx adds to our ability to service customers more efficiently and effectively due to the
Beginning in December 2012, and through April 2016, the Company has the right to purchase all of the outstanding interests owned by the other equity member of Script Relief. The purchase of the outstanding interests is at our sole discretion and is subject to a contractually-defined purchase price. If the Company elects to exercise this call option, it contains a minimum purchase price of $50.0 million, which could be increased based on operating performance. Conversely, beginning in April 2016, the Company has the right to require Script Relief to redeem the Company's ownership interest in Script Relief at original cost plus a defined preferred return. There are no terms that would require the Company to provide additional financial support to the variable interest entity.
Net property and equipment was made up of the following at December 31, 2012 and 2011:
Depreciation expense, including property and equipment acquired under capital leases, totaled $20.2 million, $9.5 million, and $8.4 million for the years ended December 31, 2012, 2011, and 2010, respectively. Of the total depreciation expense, $3.5 million, $2.7 million, and $2.4 million was related to the data center operations and allocated to cost of revenue for the years ended December 31, 2012, 2011 and 2010, respectively.
The changes in the carrying amounts of goodwill by reportable segment for the years ended December 31, 2012 and 2011 are as follows (in thousands):
Represents adjustments to purchase price, including settlement of working capital adjustment.
Initial goodwill recorded for the the acquisition of HealthTran in January 2012.
Adjustments to purchase price, including settlement of working capital adjustment for recent acquisitions during the measurement period. The measurement period adjustments were not recast in the 2011 consolidated financial statements as they were not deemed material.
Future amortization associated with intangible assets recorded as of December 31, 2012 is estimated to be $194.2 million in 2013, $178.9 million in 2014, $163.8 million in 2015, $142.5 million in 2016, $131.2 million in 2017, and $388.4 million for years after 2017.
Concurrent with the consummation of the Merger on July 2, 2012, the Company executed a $1.8 billion credit agreement consisting of (i) a five-year senior secured term loan facility in the amount of $1.1 billion (the “Term A Facility”) and (ii) a five-year senior secured revolving credit facility in the amount of $700.0 million (the “Revolving Facility,” and, together with the Term A Facility, the “ 2012 Credit Agreement”). In July 2012, the Company borrowed $1.4 billion under the 2012 Credit Agreement consisting of $1.1 billion under the Term A Facility and $300.0 million under the Revolving Facility to fund in part the aggregate cash consideration payable to Catalyst stockholders in the Merger, repay and discharge existing indebtedness of the Company and Catalyst and pay related transaction fees and expenses. Net proceeds received under the Term A Facility were $1.1 billion less $29.6 million in debt discount. The debt discount related to the Term A Facility is presented on the consolidated balance sheet as a reduction to long-term debt and is being amortized to interest expense over the life of the Term A Facility using the straight-line method as this method does not result in a materially different interest expense than the effective - interest method. Additionally, the Company paid $18.8 million in debt issuance costs related to the Revolving Facility. The financing costs related to the Revolving Facility are presented on the consolidated balance sheet as other assets and are being amortized to interest expense over the life of the Revolving Facility using the straight-line method. The amortization related to financing costs and debt discounts totaled $5.0 million for the year ended December 31, 2012.
On December 16, 2011, the Company entered into a Credit Agreement (the “2011 Credit Agreement”) with JPMCB, as a lender and as administrative agent, and other financial institutions within the syndication, with respect to a five-year senior unsecured revolving credit facility. The 2011 Credit Agreement provided 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. On January 3, 2012, the Company borrowed $100 million under the 2011 Credit Agreement to pay a portion of the consideration in connection with the acquisition of HealthTran and certain transaction fees and expenses related to the acquisition. In connection with the 2011 Credit Agreement, the Company incurred approximately $1.6 million in financing costs. The financing costs were presented on the consolidated balance sheet as other assets and were amortized to interest expense over the life of the 2011 Credit Agreement using the straight-line method. In connection with the Merger, the Company terminated its 2011 Credit Agreement after repaying the outstanding balance in July 2012 and executed a new credit agreement as discussed above.
of the Merger consideration and other related fees and expenses in connection with the Merger and the balance was used for general corporate purposes.
On July 2, 2012, the Company issued 66.8 million common shares and 0.5 million warrants in connection with the Catalyst Merger. See Note 4 - Business Combinations for further information related to the Merger.
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.
In connection with the closing of the Merger with Catalyst on July 2, 2012, the Company assumed the 2003 HealthExtras, Inc. Equity Incentive Plan (the “2003 Plan”) and the Catalyst Health Solutions, Inc. 2006 Stock Incentive Plan (the “2006 Plan” and, together with the 2003 Plan, the "Catalyst Plans”), each as amended and adjusted for the purpose of granting awards to certain employees of Catalyst who continue their employment with the Company subsequent to the close of the Merger or to newly hired employees of the Company who were not employed with the Company as of the close of the Merger. The Catalyst Plans provide for the grant of stock option awards, restricted stock unit ("RSU") awards, performance awards and other stock-based awards to eligible persons. The maximum common shares of the Company allowed to be issued under the assumed Catalyst Plans is 1,492,014. Any full-value awards (i.e., any awards other than stock options or SARs) granted under the Catalyst 2006 Plan are counted against this share limit as 1.45 shares for every one share granted. There were 1,127,090 stock-based awards available for grant under the Catalyst Plans as of December 31, 2012.
The following table summarizes activity related to stock options denominated in Canadian dollars for the year ended December 31, 2012:
The total intrinsic value of Canadian stock options exercised during the years ended December 31, 2012, 2011, and 2010 was as follows (in thousands):
U.S. dollar options granted during 2012, were primarily subject to a graded vesting schedule of four years. U.S. dollar options granted expire seven years from the grant date.
On May 16, 2007, shareholders of the Company approved the creation of the Employee Stock Purchase Plan (“ESPP”) which allows eligible employees to withhold annually up to a maximum of 15% of their base salary, or $25,000, subject to U.S. Internal Revenue Service limitations, for the purchase of the Company’s common shares. Common shares will be purchased on the last day of each offering period at a
discount of 5% of the fair market value of the common shares on such date. The aggregate number of common shares that may be awarded under the ESPP may not exceed 400,000 common shares.
During 2012, the Company granted time-based RSUs and performance based RSUs to its employees and non-employee directors under both the LTIP and the Catalyst Plans. Time-based RSUs vest on a straight-line basis over a range of three to four years. During 2012, the Company also granted time-based RSUs that cliff vest after a three to four year period. Performance-based RSUs cliff vest based upon reaching agreed upon three-year performance conditions. The number of outstanding performance-based RSUs as of December 31, 2012 stated below assumes the associated performance targets will be met at the maximum level. The table below summarizes the number of time-based and performance-based RSUs that were granted and outstanding under both plans for the year ended December 31, 2012:
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, 2012, 2011, and 2010 was $6.5 million, $3.5 million, and $1.4 million, respectively.
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 2022 through 2029.
A reconciliation of the beginning and ending amount of unrecognized tax benefits, excluding interest and penalties, for 2012 is as follows (in millions):
The Company recognizes interest and penalties related to uncertain tax positions in income tax expense. Accrued interest at December 31, 2012 and 2011 was $0.5 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, 2012. The Company currently estimates that such increases or decreases will not be material.
(b) Cash paid / received for income taxes and interest was as follows for the years ended December 31, 2012, 2011, and 2010 (in thousands):
The total rental expense under operating leases for the years ended December 31, 2012, 2011, and 2010 was $17.1 million, $6.4 million, and $5.7 million, respectively. The lease renewal terms have not been factored into the commitments noted above as not renewing these leases would not have a detrimental impact on the Company.
Delaware Court of Chancery following notice to the Catalyst stockholders. At a hearing held on February 5, 2013, the Delaware Court of Chancery, approved the terms of the settlements, dismissed with prejudice all claims against the Company, Catalyst and other defendants and awarded plaintiffs attorney fees in the amount of $450,000, which were subsequently paid in full by the Company. The settlement terms provide that the Delaware cases will be dismissed with prejudice against all defendants. The settlement did not affect the amount of the merger consideration paid to the stockholders of Catalyst in the Merger. As of December 31, 2012, the Company had recorded an immaterial liability in the consolidated financial statements relating to the settlement of this matter.
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 third party plaintiffs. The Company has considered these proceedings and disputes in determining the necessity of any accruals 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 accruals 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 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 and 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 is also a leading provider of HCIT solutions and services to providers, payors and other participants in the pharmaceutical supply chain in North America. The Company’s product offerings include a wide range of software products for managing prescription drug programs and for drug prescribing and dispensing. The Company’s solutions are available on a license basis with on-going maintenance and support or on a transaction fee basis using an ASP model. The Company’s payor customers include managed care organizations, Blue Cross Blue Shield organizations, government agencies, employers and intermediaries such as pharmacy benefit managers. The Company’s provider customers include independent, regional chain, institutional, and mail-order pharmacies. The solutions offered by the Company’s services assist both payors and providers in managing the complexity and reducing the cost of their prescription drug programs and dispensing activities. The Company’s profitability from HCIT depends primarily on revenue derived from transaction processing services, software license sales, hardware sales, maintenance, and professional services.
At December 31, 2012, one customer accounted for 13% of the total accounts receivable balance and another customer accounted for 12% of the total accounts receivable balance. At December 31, 2011, one customer accounted for 16% of the total accounts receivable balance.
The fair value of the interest rate swap liability as of December 31, 2012 was $2.6 million. Interest expense for the year ended December 31, 2012 includes $0.4 million of interest expense reclassified from other comprehensive income into current earnings. As of December 31, 2012, approximately $1.4 million of deferred expenses related to the derivative instruments accumulated in other comprehensive income is expected to be reclassified as interest expense during the next twelve months. This expectation is based on the expected timing of the occurrence of the hedged forecasted transactions.
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, 2012 (in thousands):
The change in the present value of the amount expected to be paid in the future for the contingent purchase price consideration was $0.3 million and $1.7 million for the years ended December 31, 2012 and 2011, respectively and was recorded as interest expense in the consolidated income statement. 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 or the achievement of client retention milestones.
Derivative liabilities relate to the interest rate swap (refer to Note 17 - Financial Instruments for further information), which had a fair value of $2.6 million as of December 31, 2012. The fair value adjustment for the year ended December 31, 2012 is $0.4 million and was recognized as interest expense in the consolidated statements of operations. As the fair value measurement for the derivative instruments are based on quoted prices from a financial institution, these measurements are classified as Level 2 measurements as defined by fair value measurements guidance.
During 2012 and 2011, there were no movements of fair value measurements between levels 1, 2 and 3.