Twenty-one of our twenty-four satellite offices, with a total of 161,000 square feet, are under leases that expire over terms through 2018 and the other offices are under a month-to-month lease. We believe that suitable space on commercially reasonable terms will be available as required.
We provide our clients access to a contracted, non-exclusive national network of approximately 61,000 pharmacies. We provide our clients’ members with timely and accurate benefit adjudication, while controlling pharmacy spending trends through customized plan designs, clinical programs, physician orientation programs, and member education. We use an electronic point-of-sale system of eligibility verification and plan design information, and offer access to rebate arrangements for certain branded pharmaceuticals. When a member of one of our clients presents a prescription or health plan identification card to a retail pharmacist in our network, the system provides the pharmacist with access to online information regarding eligibility, patient history, health plan formulary listings, and contractual reimbursement rates. The member generally pays a co-payment to the retail pharmacy and the pharmacist fills the prescription. We electronically aggregate pharmacy benefit claims, which include prescription costs plus our claims processing fees for consolidated billing and payment. We receive payments from clients, make payments of amounts owed to the retail pharmacies pursuant to our negotiated rates, and retain the difference (except where we have entered into pass-through pricing arrangements with clients) including claims processing fees. Total claims processed increased to 52.0 million in 2008 from 41.5 million in 2007. Our revenue increased by 37% to approximately $2.5 billion in 2008 from $1.9 billion in 2007.
If we had included co-payments in our reported revenue and direct expenses, it would have resulted in an increase in our reported revenue and direct expenses of $753.5 million, $635.6 million, and $477.0 million, for the years ended December 31, 2008, 2007 and 2006, respectively. Our operating and net income, consolidated balance sheets and statements of cash flows would not have been affected.
The following table illustrates the effects on the reported revenue and direct expenses if we had included the actual member co-payments as indicated by our claims processing system (in millions):
In December 2008, we formed an entity called First Rx Specialty and Mail Services, LLC and extended existing contracts with Walgreen Co. to provide certain mail and specialty pharmacy services. This initiative is designed to provide enhanced capabilities in the distribution of specialty drugs, invest in various member-focused programs to deliver care-effective and cost-effective drugs to our customers, and access the Walgreens’ network of mail service pharmacies for over-flow mail volume, back-up, and redundancy.
On August 5, 2008, we acquired Immediate Pharmaceutical Services, Inc. (“IPS”) from Discount Drug Mart, Inc. IPS operates a fully-integrated prescription mail service fulfillment center located outside of Cleveland, Ohio. The IPS acquisition provides us with a foundation for building our mail service capability and to enable us to provide our clients with an in-house mail service option. Total consideration for the acquisition of IPS consisted of cash payments of $40.0 million and approximately $1.2 million in transaction costs. The purchase price of IPS was largely determined on the basis of management’s expectations of future earnings and cash flows, resulting in the recognition of goodwill. Based on management’s best estimate, the acquisition of IPS resulted in goodwill of $24.2 million and customer relationship intangibles of $6.0 million. Goodwill related to this acquisition is non-deductible for tax purposes.
The purchase price of HospiScript was determined on the basis of management’s expectations of future earnings and cash flows, resulting in the recognition of goodwill. Based on management’s best estimate, including our valuation report of the allocation of the purchase price to the net assets acquired, the acquisition of HospiScript resulted in goodwill of $79.4 million and intangibles assets, consisting of customer relationships of $18.6 million with an estimated 18 year life, trade names of $1.4 million with an estimated 3.5 year life, and developed technology of $0.6 million with an estimated 5 year life. Goodwill related to this acquisition is deductible for tax purposes.
In November 2006, the Company purchased all of the outstanding common stock of R/xx Pharmacy Solutions, Inc. (“R/xx”), an Arizona corporation, for $16.0 million in cash and $0.7 million in related transaction costs. Pursuant to the acquisition agreement, additional cash consideration of $2.1 million was earned and paid in 2007 based on successful achievement of certain client retention criteria and recorded as additional goodwill. R/xx is a provider of pharmacy benefit management services with a strategic focus on clients in the Arizona, Nevada and Hawaii markets.
In December 2005, the Company acquired the common stock of EBRx. Consideration consisted of a cash payment of $27.9 million and $0.9 million in related transaction costs. Pursuant to the acquisition agreement, additional cash consideration of $2.9 million was earned and paid through 2007 based on successful achievement of certain performance based standards and recorded as additional goodwill.
In January 2006, as contemplated by the original transaction, a separate entity owned by former owners of EBRx and its management team purchased a 20% ownership interest in the parent of EBRx through a $1.0 million equity investment. In February 2007, under the terms of the transaction, we acquired this remaining 20% minority ownership interest. This transaction resulted in a cash payment of $30.3 million, of which $29.0 million was recorded as additional goodwill, prior to the repayment of certain related transaction debt and accrued interest. In May 2007, the related transaction debt of $1.0 million plus accrued interest of $0.1 million was repaid.
Gross margin as a percentage of revenue was 5.6% and 5.9% for the years ended December 31, 2008 and 2007, respectively. In 2008, composite gross margin percentages were slightly reduced by the full year impact of the addition of several recent large contracts, including the state of Maryland and Ohio and the Puerto Rico based health plans, which are more competitively priced due to their size. These decreases were somewhat offset by gross margin improvements resulting from an increased level of generic substitution and higher network discount rates.
Minority Interest. The minority interest in 2007 represents 20% of the earnings of EBRx during the period in which there was a minority interest outstanding.
Net Income. Net income for year ended December 31, 2008 increased by approximately $11.1 million over the same period in 2007 to $50.4 million. The increase in net income was primarily a function of increased gross margin dollars, reduced by an increase in selling, general and administrative expenses.
Gross margin, calculated as revenue less direct expense, is generally predictable based on client contract terms and vendor/supplier contracts. Other factors that can result in changes in gross margins include generic substitution rates, changes in the utilization of preferred drugs with higher discounts and changes in the volume of prescription dispensing at lower cost network pharmacies. None of the foregoing factors have materially changed in 2007 in a manner that would meaningfully affect current results. Gross margin increased to $110.4 million for the year ended December 31, 2007 from $94.1 million for the comparable period in 2006.
Selling, general and administrative expenses of $46.4 million for the year ended December 31, 2006, consisted of $25.1 million in compensation and benefits, which includes $3.6 million in non-cash compensation, $4.1 million in professional fees and technology services, $4.2 million in facility costs, $2.2 million in travel expenses, $2.0 in insurance and other corporate expenses, $0.3 million in product endorsement and marketing, $3.7 million in other, which includes $2.2 million in recruitment and temporary help, and $4.8 million in depreciation and amortization.
Interest Expense. Interest expense decreased to $0.2 million for the year ended December 31, 2007 from $0.8 million for the year ended December 31, 2006. This decrease reflects the decrease in the average outstanding amount of indebtedness during the periods. In September 2006, we fully repaid the balance outstanding on our term loan facility.
Minority Interest. Prior to February 6, 2007, EBRx was majority owned by us and 20% owned by investors affiliated with EBRx’s former parent. On February 6, 2007, we acquired the minority ownership interest. The minority interest represents 20% of the earnings of EBRx during the period in which there was an outstanding minority interest.
Income Tax Expense. The effective income tax rates of 37.6% in 2007 and 39.1% in 2006 represent the combined federal and state income tax rates adjusted as necessary based on the particular jurisdictions where we operate. The effective tax rate in 2007 was lower than in 2006 primarily due to a decrease in our state income tax rates as well as additional interest income earned on federally tax exempt investments.
Net Income. Net income for year ended December 31, 2007 increased by approximately $7.7 million over the same period in 2006 to $39.3 million. The increase in net income was primarily a function of increased gross margin dollars and an increase in interest income, reduced by an increase in selling, general and administrative expenses.
investing our funds in ARS. As a part of these efforts, on February 23, 2009, we brought an arbitration claim before the Financial Industry Regulatory Authority (“FINRA”) against Credit Suisse Securities (USA), LLC (“Credit Suisse”) seeking rescission, restitution and damages for Credit Suisse’s conduct in connection with our investment account with Credit Suisse.
Net cash provided by financing activities for the year ended December 31, 2007 was $15.3 million compared to $5.7 million in 2006. In 2007, we purchased $1.4 million of treasury stock, received proceeds of $7.1 million from the exercise of options and $0.5 million in proceeds from issuance of common stock pursuant to the Employee Stock Purchase Plan. In addition, we received an income tax payable benefit of $9.1 million from the exercise of stock options and restricted stock vesting. In 2006, we repaid $12.5 million in notes payable and received proceeds of $8.8 million from the exercise of options and Employee Stock Purchase Plan purchases. In addition, we received an income tax payable benefit of $10.5 million from the exercise of stock options and restricted stock awards and incurred $1.1 million from all other financing activities.
We anticipate continuing to generate positive operating cash flow which, combined with available cash resources, should be sufficient to meet our planned working capital, capital expenditures and operating expenses for
the next year. However, there can be no assurance that we will not require additional capital. Even if such funds are not required, we may seek additional equity or debt financing. We cannot be assured that such financing will be available on acceptable terms, if at all, or that such financing will not be dilutive to our stockholders.
At December 31, 2008, we had available a $50.0 million revolving credit facility with no outstanding borrowings.
Rebates earned under arrangements with manufacturers are recorded as a reduction of direct expenses. The portion of such rebates due to clients is recorded as a reduction of revenue. Manufacturer rebates are based on estimates, which are subject to final settlement with the contracted party on an annual basis. A contractual allowance for manufacturer rebates is established and adjusted quarterly, if applicable, based on contractual terms with each manufacturer. The contractual allowance is included in our allowance for accounts receivable.
We account for income taxes in accordance with Statement of Financial Accounting Standard No. 109, Accounting for Income Taxes, (“SFAS No. 109”), as clarified by FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes (“FIN 48”). Under this method, deferred income taxes are determined based on the estimated future tax effects of differences between the financial statement and tax bases of assets and liabilities given the provisions of enacted tax laws. Deferred income tax provisions and benefits are based on changes to the assets or liabilities from year to year. In providing for deferred taxes, we consider tax regulations of the jurisdictions in which we operate, estimates of future taxable income, and available tax planning strategies. If tax regulations, operating results or the ability to implement tax-planning strategies vary, adjustments to the carrying value of deferred tax assets and liabilities may be required. Valuation allowances, if any, are recorded related to deferred tax assets based on the “more likely than not” criteria of SFAS No. 109.
In December 2007, the FASB issued SFAS No. 141 (revised 2007), Business Combinations (“SFAS No. 141 (R)”). SFAS No. 141(R) establishes principles and requirements for how an acquirer in a business combination recognizes and measures in its financial statements the identifiable assets acquired, the liabilities assumed and any controlling interest in the acquiree at the acquisition date fair value. SFAS No. 141(R) will significantly change the accounting for business combinations in a number of areas including the treatment of contingent consideration, pre-acquisition contingencies and transaction costs. In addition, any changes in an acquired entity’s deferred tax assets and uncertain tax positions after the measurement period will impact income tax expense. SFAS No. 141(R) also