Effective April 30, 2008, the Company, through a wholly-owned subsidiary, acquired all of the outstanding shares of NMHC, based in Port Washington, New York, which provides PBM services. The results of operations of the acquired business are included from the date of acquisition. The Company issued 5,571,920 shares of its common stock in connection with the acquisition.
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 of $20.75 per share. The net proceeds to the Company from the offering were $203.1 million.
The Company completed its acquisition of MedfusionRx on December 28, 2010. The purchase price for MedfusionRx was $101.5 million in cash with an additional $5.5 million potential earn-out payment subject to the achievement of certain performance targets in the 2012 fiscal year.
was $77.2 million in cash, subject to customary working capital adjustments, with an additional $4.5 million potential earn-out payment subject to the achievement of certain performance targets in the 2012 fiscal year.
Revenue primarily consists of sales of prescription drugs, together with any associated administrative fees, to customers and participants, through the Company’s nationwide network of participating pharmacies or the Company's own mail and specialty pharmacies. Revenue related to the sales of prescription drugs is recognized when the claims are adjudicated and the prescription drugs are shipped. Claims are adjudicated at the point-of-sale using an on-line processing system.
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.
The complicated environment in which the Company operates presents it with opportunities, challenges, and risks. The Company’s clients are paramount to its success; the retention of existing and winning of new clients and members poses the greatest opportunity, and the loss thereof represents an ongoing risk. The preservation of the Company’s relationships with pharmaceutical manufacturers and the Company's network of participating pharmacies is very important to the execution of its business strategies. The Company’s future success will hinge on its ability to drive volume at its mail and specialty pharmacies and increase generic dispensing rates in light of the significant brand-name drug patent expirations expected to occur over the next several years. The Company’s ability to continue to provide innovative and competitive clinical and other services to clients and patients, including the Company’s active participation in the Medicare Part D benefit and the rapidly growing specialty pharmacy industry, also plays an important part in the Company’s future success.
The Company operates in a competitive environment where clients and other payors seek to control the growth in the cost of providing prescription drug benefits. The Company’s business model is designed to reduce the level of drug cost. The Company helps manage drug cost primarily by its programs designed to maximize the substitution of expensive brand drugs with equivalent but much lower cost generic drugs, obtaining competitive discounts from suppliers, securing rebates from pharmaceutical manufacturers and third party rebate administrators, securing discounts from retail pharmacies, applying the Company’s sophisticated clinical programs, and efficiently administering prescriptions dispensed through the Company’s mail and specialty pharmacies.
Flexible, customized and independent services: The Company believes a key differentiator between itself and its competitors is not only the Company’s ability to provide innovative PBM services, but also to deliver these services on an à la carte basis. The informedRx suite offers the flexibility of broad product choice along the entire PBM continuum, enabling enhanced customer control, solutions tailored to the Company’s customers’ specific requirements, and flexible pricing. The market for the Company’s products is divided between large customers that have the sophisticated technology infrastructure and staff required to operate a 24-hour data center and other customers that are not able or willing to operate these sophisticated systems.
Measurable cost savings for customers: The Company provides its customers with increased control over prescription drug costs and drug benefit programs. The Company’s pricing model and flexible product offerings are designed to deliver measurable cost savings to the Company’s customers. The Company believes its pricing model is a key differentiator from its competitors for the Company’s customers who want to gain control of their prescription drug costs. For example, the Company’s pharmacy network contracts and manufacturer rebate agreements are made available by the Company to each customer. For customers who select the Company’s pharmacy network and manufacturer rebate services on a fixed fee per transaction basis, there is clarity to the rebates and other fees payable to the client. The Company believes that its pricing model together with the flexibility to select from a broad range of customizable services helps the customers realize measurable results and cost savings.
Selected trends and highlights for the year ended December 31, 2011 compared to the same period in 2010
Total revenue in 2011 was $5.0 billion as compared to $1.9 billion in 2010. The increase is largely attributable to an increase in PBM revenue of $3.0 billion due primarily to the implementation of the HealthSpring contract on January 1, 2011, recent acquisitions, 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 91.0% in 2011 to 91.7 million from 48.0 million during 2010. 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 of $91.8 million, or $1.46 per share (fully-diluted), for the year ended December 31, 2011 compared to $64.7 million, or $1.03 per share (fully-diluted), for the same period in 2010. Net income is higher for the year ended December 31, 2011 as compared to the same period in 2010 due to higher gross profit attributable to an increase in PBM revenues from new customer starts, increased volume in the PBM segment due to organic growth of existing customers and from recent acquisitions. These increases were offset by an increase in SG&A expense to support the new business growth, as well as increased amortization of intangibles recognized in connection with our recent acquisitions. Amortization expense included in net income was $16.4 million in 2011 as compared to $7.9 million in 2010.
Operating income increased $42.0 million, or 42.7%, in 2011 to $140.6 million as compared to $98.5 million in 2010. This increase was driven by increased gross profit in the PBM segment due to new customer starts as compared to 2010, offset by an increase in SG&A expense and amortization expense due to the acquisitions of MedfusionRx, MedMetrics, PTRX and SaveDirectRx.
Strong operational results, driven by an increasing customer base, focus on cost control and strong attention to cash management yielded operating cash flow of $94.7 million in 2011.
Subsequent to the end of the Company's current reporting period, in January 2012, the Company completed the acquisition of all of the outstanding equity interests of HealthTran LLC (“HealthTran”), in exchange for $250 million in cash, subject to certain customary post-closing adjustments, in each case upon the terms and subject to the conditions contained in the HealthTran Purchase Agreement. HealthTran was an existing HCIT customer and utilizes one of the Company's platforms for its claims adjudication services.
On January 31, 2012, Cigna Corporation (“Cigna”) announced it has completed its acquisition of HealthSpring in an all-cash transaction. HealthSpring accounted for 40.0% of the Company's total revenues for the year ended December 31, 2011. The Company's contract with HealthSpring (the “HealthSpring contract”) was effective on January 1, 2011 and has an initial three-year term (with two additional one-year extensions). Neither party to the HealthSpring contract has the right to terminate the agreement prior to the end of the initial term, except in the event of a material breach. While the Company does not currently anticipate any adverse impact to its financial results through the initial term of the HealthSpring contract, we can give no assurances that we will be able to continue to generate a substantial portion of our revenues from HealthSpring for the foreseeable future, or that we will be able to extend or renew the HealthSpring contract past the initial period.
On May 11, 2011, at the Annual and Special Meeting of Shareholders, the Company’s shareholders approved an amendment to the SXC Health Solutions Corp. Long Term Incentive Plan ("LTIP") to increase the number of common shares available for issuance under the LTIP by 1,800,000.
Revenue increased $509.8 million, or 35.4%, to $1.9 billion during 2010 as compared to 2009 primarily due to new customer starts during 2010. Revenues also increased in 2010 compared to 2009 due to an increase in new PBM services sold to several existing HCIT customers
Cost of revenue increased $2.9 billion, or 169.0%, to $4.7 billion during 2011 from $1.7 billion in 2010, primarily due to the increased revenues from the PBM segment. As a percentage of revenue, cost of revenue was 93.8% and 89.0% for the years ended December 31, 2011 and 2010, respectively. The increase in cost of revenue as a percentage of revenue was mainly due to lower margins earned on new customer additions, principally related to the large increase in transactions under the Healthspring contract. Cost of revenue related to prescriptions dispensed through our network of participating pharmacies is comprised of the contractual cost of drugs dispensed by, and professional fees paid to, those participating pharmacies. Cost of revenue for our mail and specialty pharmacies consists primarily of the cost of prescriptions dispensed as well as costs incurred to process and dispense those prescriptions. All costs incurred for prescriptions dispensed at participating pharmacies as well as our mail and specialty pharmacies are net of any rebate amounts earned from pharmaceutical manufacturers or third-party rebate administrators. Cost of revenue for the HCIT segment relates primarily to the cost of labor to deliver the services provided.
During 2010, cost of revenue increased $482.3 million, or 38.5%, to $1.7 billion as compared to $1.3 billion in 2009. The increase in cost was consistent with the increased revenues during 2010, which was driven by the increased revenues from the PBM segment as a result of new customer starts in 2010 and additional services sold to existing customers.
Gross profit increased $27.5 million, or 14.7%, to $214.1 million during 2010 from 2009, mostly due to incremental PBM revenues. Gross profit percentage decreased from 13.0% of revenue 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.
Product development costs for the year ended December 31, 2011 were $14.3 million compared to $12.4 million for the year ended December 31, 2010, and $12.0 million for the year ended December 31, 2009. Product development costs represent the cost of labor related to development activities and includes stock-based compensation cost of $0.1 million for the year end December 31, 2011 and $0.2 million for each of the years ended December 31, 2010 and 2009. Driving the change in product development expense between the years ended December 31, 2011 and 2010 was an increase in resources due to additional development initiatives. Product development continues to be a key focus of the Company as it continues to pursue enhancements of existing products, as well as the development of new offerings, to support market expansion and to take advantage of cross-selling opportunities within its existing customer base.
SG&A costs for the year ended December 31, 2011 were $131.5 million compared to $89.3 million and $85.8 million for the years ended December 31, 2010 and 2009, 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 $42.2 million, or 47.3%, from 2010 to 2011 due to the addition of operating costs related to the Company's recent acquisitions that were not present during 2010, as well as additional resources added to support the growth of the PBM segment. SG&A costs also include stock-based compensation cost of $8.7 million, $4.9 million and $2.8 million for the years ended December 31, 2011, 2010 and 2009, 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 increased $8.5 million, or 108.6%, to $16.4 million compared to $7.9 million for the year ended December 31, 2010, mainly due to amortization of intangible assets acquired in the MedfusionRx, PTRX and SaveDirectRx acquisitions. These 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. Amortization expense for the year ended December 31, 2010 was $7.9 million compared
Refer to Note 6-Goodwill and Other Intangible Assets in the notes to the consolidated financial statements for more information on amortization expected in future years.
Interest income remained fairly flat for the years ended December 31, 2011, 2010 and 2009, due primarily to interest rates remaining at similar levels in each year. Interest expense and other expense, net, increased $1.1 million to $2.8 million for the year ended December 31, 2011 compared to the same period in 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. Interest expense and other expense, net, decreased $4.3 million to $1.7 million, respectively, 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 recognized income tax expense of $46.5 million for the year ended December 31, 2011, representing an effective tax rate of 33.6%, compared to $32.8 million, representing an effective tax rate of 33.6%, for the same period in 2010.
Revenue was $4.9 billion for the year ended December 31, 2011 as compared to $1.8 billion for the same period in 2010. The $3.0 billion, or 163.9%, increase in revenue is primarily due to the PBM segment's prescription claim volume increasing 91.0% to 91.7 million from 48.0 million during 2010. The prescription claim volume increase was due to new customer contracts which started during 2011, lead by the implementation of the HealthSpring contract on January 1, 2011.
Cost of revenue was $4.6 billion for the year ended December 31, 2011, compared to $1.7 billion for the same period in 2010, an increase of $2.9 billion, or 173.7%, in line with the increase in PBM revenue. Cost of revenue is predominantly comprised of the cost of prescription drugs. As a percentage of revenue, cost of revenue was 94.7% and 91.3% for the years ended December 31, 2011 and 2010, respectively. The increase in the cost of revenue as a percentage of revenue was primarily due to lower margins earned on new customer additions in 2011. 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 average GDR for PBM clients reached 78% in 2011, a 2% increase from 2010. This increase was achieved through a broad range of plan design solutions, helped considerably by a continuing wave of major generic releases. 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 $9.5 million, or 8.9%, for the year ended December 31, 2011 as compared to the same period in 2010, and 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 during both periods mainly due to an increase in transaction processing 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.
Cost of revenue increased 20.9% to $63.3 million for the year ended December 31, 2011 from $52.4 million for the year ended December 31, 2010. Cost of revenue includes the direct support costs for the HCIT business as well as depreciation expense of $2.7 million and $2.4 million for the years ended December 31, 2011 and 2010, respectively. In addition, cost of revenue includes stock-based compensation expense of $0.6 million and $0.7 million for the years ended December 31, 2011 and 2010, respectively. Cost of revenue increased during 2011 as compared to 2010 mainly due to the increased revenues.
EBITDA and Adjusted EBITDA are non-GAAP measures that management believes are useful supplemental measure of operating performance. EBITDA consists of earnings prior to interest income, interest expense and other expense, net, income taxes, depreciation, amortization, and the Company adds back stock-based compensation expenses to reach Adjusted EBITDA. Management believes it is useful to exclude depreciation, amortization, interest income and interest expense and other expense, net, as these are essentially fixed amounts that cannot be influenced by management in the short term. In addition, management believes it is useful to exclude stock-based compensation as this is a non-cash expense.
Adjusted EPS adds back the impact of all amortization of intangible assets, net of tax. Amortization of intangible assets arises from the acquisition of intangible assets in connection with the Company's business acquisitions. The Company excludes amortization of intangible assets from non-GAAP adjusted EPS because it believes (i) the amount of such expenses in any specific period may not directly correlate to the underlying performance of the Company's business operations and (ii) such expenses can vary significantly between periods as a result of new acquisitions and full amortization of previously acquired intangible assets. Investors should note that the use of these intangible assets contributes to revenue in the period presented as well as future periods and should also note that such expenses will recur in future periods. Below is a reconciliation of the Company's reported net income to Non-GAAP net income and the related adjusted EPS for the years ended December 31, 2011 , 2010 and 2009.
Adjusted EPS for the year ended December 31, 2010 was $1.11 as compared to $0.98 for the same period in 2009. Increased gross profit from an increased customer base within the PBM segment was the main driver of the adjusted EPS increase in 2010 over 2009.
The Company’s sources of liquidity have primarily been cash provided by operating activities, proceeds from its public offerings, stock option exercises, and proceeds from credit facilities. On December 16, 2011, the Company entered into a Credit Agreement and Revolving Credit Facility with an initial aggregate revolving commitment of $350 million, subject to increase from time to time up to a maximum aggregate revolving commitment of $450 million. The Company will use the proceeds from borrowings under the Revolving Credit Facility for general corporate purposes. As of December 31, 2011, no amount was outstanding under the Revolving Credit Facility. See Note 8 - Long-Term Liabilities to the consolidated financial statements for additional information regarding the Revolving Credit Facility. The Company’s principal uses of cash have been to fund working capital, finance 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, 2011 and 2010, the Company had cash and cash equivalents totaling $341.4 million and $321.3 million, respectively. In October 2011, the Company completed its acquisitions of PTRX and SaveDirectRx. The Company disbursed approximately $77.2 million from cash on hand in order to complete these acquisitions. As disclosed previously, subsequent to the end of the current reporting period, the Company completed its acquisition of HealthTran. The Company disbursed approximately $250 million from cash on hand and available revolver borrowings in order to complete this acquisition. The Company drew $100 million from its Revolving Credit Facility in January 2012 to partially fund the HealthTran acquisition. The Company believes that its cash on hand, together with cash generated from operating activities, and the amount remaining on its Revolving Credit Facility, will be sufficient to support planned operations for the foreseeable future.
As of December 31, 2011, 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.
Selected balance sheet highlights at December 31, 2011 are as follows:
The Company’s inventory balance of $19.6 million consists predominantly of prescription drugs and medical supplies at its mail and specialty pharmacy locations. As of December 31, 2011, the inventory balance has increased $10.8 million from $8.7 million at December 31, 2010, mainly due to the increased business at the Company's mail and specialty pharmacy locations as a result of increased volume from PBM customers and growth from recent acquisitions. Changes in the inventory balance from period to period are caused by some seasonality in certain products, taking advantage of buying opportunities, and changing inventory levels due to customer demands.
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 decreased $2.1 million to $59.2 million at December 31, 2011, from $61.4 million at December 31, 2010, due to timing of when rebates were paid, offset by increases in rebate rates and volumes. 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.
payments on its accounts receivable balances. This decrease in cash from operations was offset by an increase in pharmacy benefit claims payable of $115.1 million as a result of the increased volume of pharmacy transactions during 2011 and the timing of when payments are made for these transactions.
Changes in operating assets and liabilities, as well as non-cash items related to income taxes, will fluctuate based on working capital requirements and the tax provision, which is determined by examining taxes actually paid or owed, as well as amounts expected to be paid or owed in the future.
For the year ended December 31, 2010, the Company generated $96.3 million of cash through its operations. Cash provided by operating activities increased $9.9 million compared to the same period in 2009, mainly due to the increased profitability of the Company. Net income increased $18.6 million from $46.1 million during 2009. This increase was mainly due to increased transaction volume from new customer starts. Additionally, cash from operations increased due to an increase in pharmacy benefit rebates and claims payable of $14.8 million and $22.9 million, respectively, as a result of the increased volume of pharmacy transactions during 2010 and the timing of when payments are made for these transactions. These increases in cash from operations were offset by an increase in accounts receivable of $9.5 million due to the increase in pharmacy transactions in the PBM segment resulting from new customer starts during 2010 and the timing of when the Company received payments on its accounts receivable balances.
For the year ended December 31, 2010, the Company used $103.7 million of cash for investing activities, which consisted primarily of cash used to acquire MedfusionRx. Additionally, the Company used $9.1 million for purchases of property and equipment to support increased transaction volume, and $2.2 million to purchase short-term investments.
For the year ended December 31, 2009, the Company used $15.8 million of cash for investing activities, which consisted primarily of 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, 2011, the Company generated $14.9 million of cash from financing activities, which mainly consisted of proceeds from the exercise of stock options of $5.7 million and a $10.8 million tax benefit on the exercise of stock options.
For the year ended December 31, 2010, the Company generated $24.1 million of cash from financing activities, which mainly consisted of proceeds from the exercise of stock options of $11.0 million and a $13.1 million tax benefit on the exercise of stock options.
If adequate funds are not available to finance the Company's business growth goals, 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, 2011 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 thousands):
The earn-out payments relate to our MedfusionRx and SaveDirectRx acquisitions and they are subject to the achievement of certain performance targets in the 2012 fiscal year.
The following table provides summary quarterly results (unaudited) for the eight quarters prior to and including the quarter ended December 31, 2011 (in thousands except share and per share data):
The Company acquired MedfusionRx on December 28, 2010 in exchange for $101.5 million in cash, with an additional $5.5 million
potential earn-out payment, subject to the achievement of certain performance targets in the 2012 fiscal year.
The Company’s revenue is derived from prescription drug sales along with transaction processing services, maintenance, professional services, and systems sales (including software license and hardware sales).
Arrangements with multiple elements: When the Company enters into arrangements with multiple deliverables it must consider: (i) whether the delivered item has value to the customer on a stand-alone basis, and (ii) if the contract includes a general right of return relative to the delivered item, whether delivery or performance of the undelivered item(s) is considered probable and substantially in the control of the Company. In most cases, the Company is able to conclude that the separate deliverables have stand alone value since most of the deliverables are sold as stand alone products or services. A key area of judgment is for the Company to determine the relative selling prices of the undelivered items. The relative selling prices of undelivered elements, such as professional services, or ASP services, are determined based on stated pricing within the contract with each customer, or pricing for the same product sold to other customers. Professional services relative selling prices are determined based on billing rates per hour based on the type of professional services provided, whereas ASP services are generally based on transaction fee rates, or standard monthly access and processing fees. When the Company is unable to determine the relative selling prices based on contractual terms with the customer or from pricing of the same product sold to other customers, the Company uses its best estimate of the selling price for that deliverable. Once the relative selling prices are determined, revenue is allocated to each unit of accounting or element based on relative fair values.
claims submitted, the rebate program terms with its customers, the Company’s rebate contracts, and any additional information that becomes available. The amount of rebates ultimately earned by the Company, or paid to its customers, is contingent upon several factors, including validation of claims data submitted by the Company, and may require adjustments in future periods to the amounts originally estimated. Historically, adjustments to the Company’s original rebate estimates have not been significant.
As noted above, 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. Assessing whether an impairment test is necessary requires management to monitor results of the business that utilize the long-lived assets, as well as outside market forces that may impact the future recoverability of the long-lived assets. No events or other circumstances occurred in 2011 that caused management to conclude any of its long-lived tangible or intangible assets may not be recoverable. The Company considered the recent turmoil in the credit markets in assessing whether these events may indicate that one of the Company's long-lived assets were impaired. The assets assessed are mostly computer equipment, acquired customer lists and goodwill. The Company's assessment of the turmoil in the credit markets did not indicate that value of these assets were significantly impacted by the recent turmoil in the credit markets.
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. Factors considered when reviewing accounts receivable in the aggregate include the overall age of receivables, macro-economic issues impacting classes of customers and recent collection trends. The conclusions and estimates made are further impacted by changes in economic and market conditions as well as changes to the customers’ financial condition. Changes in estimates for the allowance of doubtful accounts have not had a significant impact on the results of the Company during 2011, 2010, or 2009.
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
See Note 2 - Significant Accounting Policies to the consolidated financial statements for information on recent accounting pronouncements that the Company adopted. The Company is currently assessing the impact on its financial condition and future operating results for recently issued accounting guidance, and does not expect the recently issued guidance to have a significant impact on the Company’s financial condition or future results of operations.
We have audited the accompanying consolidated balance sheets of SXC Health Solutions Corp. (the Company) as of December 31, 2011 and 2010, 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, 2011. These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.
We have audited SXC Health Solutions Corp.’s (the Company) internal control over financial reporting as of December 31, 2011, based on criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). 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.
SXC Health Solutions Corp. (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, and state and local governments, 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 trades on the Toronto Stock Exchange under ticker symbol “SXC” and on the Nasdaq Stock Market under ticker symbol “SXCI.”
After determining which deliverables represent a separate unit of accounting, each unit is then accounted for under the applicable revenue recognition guidance. In cases where elements cannot be treated as separate units of accounting, the elements are combined into a single unit of accounting for revenue recognition purposes.
PBM revenue: The Company’s PBM revenue is primarily derived from sales of prescription drugs, together with any associated
Maintenance revenue: Maintenance revenues consist of revenue derived from contracts to provide post-contract customer support (“PCS”) to license holders. These revenues are recognized ratably over the term of the contract. Advance billings of PCS are not recorded to the extent that the term of the PCS has not commenced or payment has not been received.
Goodwill is the residual amount that results when the purchase price of an acquired business exceeds the sum of the amounts allocated to the identifiable assets acquired, less liabilities assumed, based on their fair values. Goodwill is allocated to the Company’s reporting unit that is expected to benefit from the business combination as of the date of the business combination. As of December 31, 2011, the amount of goodwill carried at the HCIT and PBM segments were $19.7 million and $271.4 million, respectively.
The qualitative assessment performed by the Company considered the current operating results of the Company's reporting units, future expectations of each reporting unit, industry and competitor performance and other recent events that may impact each reporting unit. The Company then assessed whether, in light of the evidence gathered if it was more likely than not that a reporting unit's fair value is less than its carrying amount. As noted above, the Company concluded that it was not more likely than not that a reporting unit's fair value was less than its carrying value. If in the future the Company's qualitative assessment indicates that a reporting unit's fair value may be below its carrying value, the Company would prepare a quantitative test to determine whether an impairment existed, and the amount of such impairment.
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 2011, 2010, or 2009.
For stock-based awards issued to employees and directors, compensation cost related to those awards is measured based on the fair value of the awards on the date of the grant. For stock options, the fair value is determined by using the Black-Scholes-Merton option-pricing model. The compensation cost of the awards expected to vest is recognized on a straight-line basis over the service period as compensation expense and additional paid-in capital. In addition, the Company estimates forfeitures as part of the initial measure of the grant date fair value of the award.
The Company uses the asset and liability method of accounting for income taxes. Deferred tax assets and liabilities are recognized for the deferred tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases and operating loss and tax credit carryforwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the periods in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the date of enactment.
On September 2, 2010, the Company announced that its board of directors had declared a two-for-one stock split effected by a stock dividend on the issued and outstanding common shares of the Company. On September 17, 2010, shareholders of record at the close of business on September 14, 2010 were issued one additional common share for each share owned as of that date. All share and per share data presented in this Annual Report have been adjusted to reflect this stock split.
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 purchase price of the acquired PTRX and SaveDirectRx operations was comprised of the following (in thousands):
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. The Company will continue to reassess the fair value of the contingent purchase price until the applicable earn-out period has lapsed. Any future changes to the fair value of the contingent purchase price will be recognized in earnings of the Company. 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.
Costs related to the PTRX and SaveDirectRx acquisitions of $0.4 million are included in selling, general and administrative expenses for the year ended December 31, 2011. The costs incurred are comprised of legal, accounting, valuation, and professional services fees associated with the PTRX and SaveDirectRx acquisition. Due to the previous contractual relationship between the Company and PTRX, there were pre-existing transactions between the two entities which resulted in approximately $2.4 million in accounts receivable due to the Company from PTRX and SaveDirectRx mainly for PBM services provided, and approximately $2.6 million due to PTRX and SaveDirectRx primarily for pharmacy benefit management rebates. No gain or loss was generated from the subsequent settlement of these pre-existing balances.
The PTRX and SaveDirectRx acquisitions were 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 acquisitions have 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 value due to the short-term nature of their maturities. Fair values for acquired amortized intangible assets were determined as follows: customer lists are 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 PTRX and SaveDirectRx, trademarks/tradenames were valued using a royalty savings model based on future projected revenues of PTRX and SaveDirectRx, 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. The assets and liabilities recorded for PTRX and SaveDirectRx were recorded in the PBM segment. Goodwill is non-amortizing for financial statement purposes and $25.0 million of the goodwill balance generated from the PTRX and SaveDirectRx acquisitions is tax deductible. The goodwill recorded for PTRX and SaveDirect was included in the PBM segment.
The Company will continue to reassess the fair value of the contingent purchase price until the applicable earn-out period has lapsed. Any future changes to the fair value of the contingent purchase price will be recognized in earnings of the Company. 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 fair value measurements guidance.
The MedfusionRx 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 value due to the short-term nature of their maturities. Fair values for acquired amortized intangible assets were determined as follows: customer lists are 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 MedfusionRx, trademarks/ tradenames and software were valued using a royalty savings model based on future projected revenues of MedfusionRx 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 MedfusionRx 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 MedfusionRx acquisition is tax deductible.
The goodwill recognized by the Company represents many of the synergies and business growth opportunities that may be realized
The MedMetrics 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. All of the assets and liabilities recorded for the MedMetrics acquisition are included within the Company's PBM segment.
The following unaudited pro forma financial information presents the combined historical results of operations of the Company and its recent acquisitions of MedfusionRx, PTRX and SaveDirectRx as if the acquisitions had each occurred as of the beginning of the comparable prior reporting period. The unaudited pro forma financial information includes certain adjustments related to the acquisitions, such as increased amortization from the fair value of intangible assets acquired recorded as part of the purchase accounting, the elimination of transactions between the Company and the acquired entities, and related income tax effects.
This unaudited pro forma financial information is not intended to represent or be indicative of what would have occurred if the transactions had taken place on the dates presented and is not indicative of what the Company’s actual results of operations would have been had the acquisitions been completed at the beginning of the periods indicated above. Further, the pro forma combined results do not reflect one-time costs to fully merge and operate the combined organization more efficiently, or anticipated synergies expected to result from the combination and should not be relied upon as being indicative of the future results that the Company will experience.
Subsequent to the end of the Company's current reporting period, in January 2012, the Company completed the acquisition of all of the outstanding equity interests of HealthTran LLC (“HealthTran”) in exchange for $250 million in cash, subject to certain customary post-closing adjustments, in each case upon the terms and subject to the conditions contained in the Purchase Agreement. HealthTran was an existing HCIT and utilizes a Company platform for its claims adjudication services. The initial accounting for this acquisition was incomplete at the time these financial statements were available for issuance as the Company had not completed its valuations for assets acquired and liabilities assumed. The Company expects to finalize its accounting for these acquisitions as soon as practicable, but no later than one year from the acquisition date.
Net property and equipment was made up of the following at December 31, 2011 and 2010:
(1) Represents the acquisition of MedfusionRx in 2010 and other acquisitions.
(2) Represents adjustments to purchase price, including settlement of working capital adjustment.
The Company's accrued expenses and other current liabilities are comprised of the following (in thousands):
On December 16, 2011, the Company entered into a Credit Agreement (the “Credit Agreement”) with JPMorgan Chase Bank, N.A. (“JPMCB”), as a lender and as administrative agent, Bank of America, N.A., SunTrust Bank, Fifth Third Bank, PNC Bank, N.A. and The Toronto-Dominion Bank, as lenders and co-syndication agents, Barclays Bank PLC, Morgan Stanley Bank, N.A., Credit Suisse AG, Cayman Islands Branch, The Northern Trust Company, PNC Bank Canada Branch, U.S. Bank National Association and U.S. Bank National Association, Canadian Branch, as lenders, the other lenders from time to time party thereto (collectively the "Lenders") and J.P. Morgan Securities LLC, as sole bookrunner and sole lead arranger, with respect to a new five-year senior unsecured revolving credit facility (the “Revolving Credit Facility”). The Credit Agreement provides that, upon the terms and subject to the conditions set forth therein, the Lenders will make loans to the Company from time to time, with an initial aggregate revolving commitment of $350 million, subject to increase from time to time up to a maximum aggregate revolving commitment of $450 million. The Company will use the proceeds from the Revolving Credit Facility for general corporate purposes. On January 3, 2012, the Company borrowed $100 million under the Revolving Credit Facility to pay a portion of the consideration
The Credit Agreement requires the Company to maintain a consolidated leverage ratio less than or equal to 3.00 to 1 at all times. The Company's consolidated leverage ratio is defined as the ratio of (1) consolidated total debt to (2) consolidated EBITDA (with add-backs permitted to consolidated EBITDA for fees and expenses related to the HealthTran acquisition and other permitted acquisitions). The Company is also required to maintain an interest coverage ratio greater than or equal to 3.00 to 1, where the interest coverage ratio is defined as the ratio of (1) consolidated EBIT (with add-backs permitted to consolidated EBIT for fees and expenses related to HealthTran acquisition and other permitted acquisitions) to (2) consolidated interest expense, tested at the end of each fiscal quarter for the rolling four fiscal quarter period then most recently ended.
As of December 31, 2011, no amount was outstanding under the Revolving Credit Facility. In connection with the Revolving Credit Facility the Company incurred approximately $1.6 million in financing costs. The financing costs are presented on the consolidated balance sheet as other assets and are being amortized over the life of the Revolving Credit Facility using the straight-line method.
On September 23, 2009, the Company completed a public offering of 10,350,000 shares of its common stock. The shares were offered to the public at a price of $20.75 per share. The net proceeds to the Company from the offering totaled $203.1 million.
The following table summarizes certain information about the Canadian dollar stock options outstanding at December 31, 2011 in Canadian dollars:
The aggregate intrinsic value and remaining contractual term of exercisable stock options at December 31, 2011 was approximately $4.1 million (Cdn.$4.1 million ) and 1.17 years, respectively.
The total intrinsic value of Canadian stock options exercised during the years ended December 31, 2011, 2010, and 2009 was as follows (in thousands):
As of December 31, 2010, there was no unrecognized compensation cost related to Canadian dollar stock options as all options were fully vested. The total fair value of Canadian stock options which vested during the years ended December 31, 2010 and 2009 was as follows (in thousands):
The aggregate intrinsic value and remaining contractual term of exercisable stock options at December 31, 2011 was $20.9 million
As of December 31, 2011, there was $6.0 million of unrecognized compensation cost related to U.S. dollar stock options which is expected to be recognized over a weighted-average period of 2.75 years.
The ESPP is not considered compensatory as the plan terms are no more favorable than to all other share holders, and the purchase discount does not exceed the per-share costs that would be incurred through a public offering. Since the plan is not considered compensatory, no portion of the costs related to ESPP purchases is included in the Company’s stock-based compensation expense.
At December 31, 2011, there were 279,687 time-based RSUs and 330,222 performance based RSUs outstanding. The total intrinsic value of RSUs that vested during the year was $4.8 million. At December 31, 2011, there was $11.8 million of unrecognized compensation cost related to RSUs which is expected to be recognized over a weighted-average period of 2.3 years. The following table summarizes the information about RSUs for the year ended December 31, 2011:
There were no changes in this accrued liability from January 1, 2011 to December 31, 2011, and from January 1, 2010 to December 31, 2010. The change from January 1, 2009 to December 31, 2009 was a result of recognizing accrued interest and penalties related to the liability for tax uncertainties, as well as the effect of various additions to the Company's liability for tax uncertainties.
The Company recognizes interest and penalties related to uncertain tax positions in income tax expense. Accrued interest at December 31, 2011 and 2010 was $0.1 million and $0.2 million, respectively. It is reasonably possible that the total amount of unrecognized tax benefits will increase or decrease within twelve months of December 31, 2011. The Company currently estimates that such increases or decreases will not be material.
The Company and its subsidiaries file income tax returns in the 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 2007.
The Company calculated the number of options and restricted stock units included in the diluted EPS calculation following the treasury stock method as outlined in earnings per-share accounting guidance. Stock options and RSUs totaling 45,319 and 11,953, respectively, were not included in the computation of diluted EPS for 2011 due to their anti-dilutive impact. There were no options calculated to be anti-dilutive and excluded from computation of the diluted EPS during 2010. Stock options totaling 22,000 were not included in the computation of diluted EPS for 2009 as the exercise prices were greater than the average market price of the common shares for the periods.
The Company has a 401(k) savings plan that allows eligible employees to defer a percentage of their salary, not to exceed $16,500 in 2011 , 2010 and 2009 . The Company matches an amount equal to 100% of the first 1% of eligible earnings and 50% of the next 5% of eligible earnings. All participant contributions are 100% vested. Employer contributions become 100% vested after completion of three years of service. For 2011, 2010 and 2009 the Company’s contributions to this plan were $2.3 million, $1.7 million, and $1.3 million, respectively.
The Company maintains operating lease agreements for office space in its main operating locations. The Company also leases certain office equipment.
On December 28, 2010, the Company completed its acquisition of MedfusionRx, a leading independent specialty pharmacy services provider. In January and February 2012, three former employees of MedfusionRx and several third parties plead guilty or were convicted of violations of the federal anti-kickback statute that occurred prior to the closing of the acquisition. While the Company believes that it is entitled to indemnification with respect to any costs or expenses arising from or relating to this matter pursuant to the terms of the MedfusionRx Purchase Agreement, we can give no assurances that such indemnification will be recoverable or will be sufficient to cover all potential civil or criminal penalties and claims arising therefrom or relating thereto. As of December 31, 2011, the Company had not recorded any contingent liability in the consolidated financial statements relating to this matter as the Company currently has assessed the likelihood of a judgment being rendered against the Company in this matter as remote.
The Company manages its business in two segments: PBM and HCIT. The Company and its chief operating decision maker evaluates segment performance and allocates resources based upon revenue and gross profit. Selling, general and administrative expenses, product development, depreciation and amortization, interest and other income and interest expense are reported as corporate expenses as these are managed on a consolidated basis by the Company.
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 over 1,900 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.
When available and appropriate, the Company uses quoted market prices in active markets to determine fair value, and classifies such items within Level 1. Level 1 values include instruments traded on a public exchange. Level 2 inputs are inputs other than quoted prices included within Level 1 that are observable for the asset or liability, either directly or indirectly, for substantially the full term of the financial instrument. Level 2 inputs include quoted prices for similar assets or liabilities in active markets, quoted prices for identical or similar assets or liabilities in markets that are not active, or inputs other than quoted prices that are observable for the asset or liability or can be derived principally from or corroborated by observable market data. If the Company were to use one or more significant unobservable inputs for a model-derived valuation,
The Company acquired MedfusionRx, a specialty pharmacy provider on December 28, 2010. The selling members of Medfusion have the opportunity to earn an additional $5.5 million in cash, subject to the satisfaction of certain performance targets in the 2012 fiscal year. The $4.9 million fair-value of the contingent purchase price was accrued at the date of acquisition as part of the total consideration transferred. The fair value of the contingent purchase price consideration was $5.1 million as of December 31, 2011. The change in the value of the contingent purchase price of $0.3 million from December 31, 2010 was recorded to interest expense representing the change in the present value of the amount expected to be paid in the future for the contingent purchase price consideration. The Company utilized a probability weighted discounted cash flow method to arrive at the fair value of the contingent consideration based on the expected results of Medfusion in 2012. As of December 31, 2011 and December 31, 2010, the contingent purchase price consideration is classified as other liabilities in the consolidated balance sheets.