Attached files
file | filename |
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EX-32.1 - EXHIBIT 32.1 - Catamaran Corp | c92066exv32w1.htm |
EX-31.2 - EXHIBIT 31.2 - Catamaran Corp | c92066exv31w2.htm |
EX-32.2 - EXHIBIT 32.2 - Catamaran Corp | c92066exv32w2.htm |
EX-31.1 - EXHIBIT 31.1 - Catamaran Corp | c92066exv31w1.htm |
Table of Contents
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
þ | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the quarterly period ended September 30, 2009
OR
o | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For
the transition period from to .
Commission file number: 000-52073
SXC HEALTH SOLUTIONS CORP.
(Exact name of registrant as specified in its charter)
Yukon Territory (State or other jurisdiction of incorporation or organization) |
75-2578509 (I.R.S. Employer Identification Number) |
2441 Warrenville Road, Suite 610, Lisle, IL 60532-3642
(Address of principal executive offices, zip code)
(Address of principal executive offices, zip code)
(800) 282-3232
(Registrants phone number, including area code)
(Registrants phone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed
by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or
for such shorter period that the registrant was required to file such reports), and (2) has been
subject to such filing requirements for the past 90 days. Yes þ No o
Indicate by check mark whether the registrant has submitted electronically and posted on its
corporate Web site, if any, every Interactive Data File required to be submitted and posted
pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period
that the registrant was required to submit and post such files). Yes o No o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated
filer or a non-accelerated filer or a smaller reporting company. See the definitions of large
accelerated filer, accelerated filer and smaller reporting company in Rule 12b-2 of the
Exchange Act (Check one):.
Large accelerated filer o | Accelerated filer þ | Non-accelerated filer o (Do not check if a smaller reporting company) |
Smaller reporting company o |
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of
the Exchange Act). Yes o No þ
As of October 31, 2009, there were 29,986,219 of the Registrants common shares, no par value,
outstanding.
TABLE OF CONTENTS
Page | ||||||||
PART I FINANCIAL INFORMATION | 3 | |||||||
3 | ||||||||
3 | ||||||||
4 | ||||||||
5 | ||||||||
6 | ||||||||
7 | ||||||||
8 | ||||||||
18 | ||||||||
29 | ||||||||
29 | ||||||||
PART II OTHER INFORMATION | 30 | |||||||
30 | ||||||||
30 | ||||||||
30 | ||||||||
30 | ||||||||
30 | ||||||||
31 | ||||||||
31 | ||||||||
SIGNATURE | 32 | |||||||
Exhibit 31.1 | ||||||||
Exhibit 31.2 | ||||||||
Exhibit 32.1 | ||||||||
Exhibit 32.2 |
2
Table of Contents
Part I. FINANCIAL INFORMATION
ITEM 1. Financial Statements
SXC HEALTH SOLUTIONS CORP.
Consolidated Balance Sheets
(in thousands, except share data)
Consolidated Balance Sheets
(in thousands, except share data)
September 30, | December 31, | |||||||
2009 | 2008 | |||||||
(unaudited) | ||||||||
ASSETS |
||||||||
Current assets |
||||||||
Cash and cash equivalents |
$ | 319,522 | $ | 67,715 | ||||
Restricted cash |
12,433 | 12,498 | ||||||
Accounts receivable, net of allowance for doubtful accounts of
$3,319 (2008 $3,570) |
90,083 | 80,531 | ||||||
Rebates receivable |
20,577 | 29,586 | ||||||
Unbilled revenue |
| 73 | ||||||
Prepaid expenses and other assets |
4,718 | 4,382 | ||||||
Inventory |
7,023 | 6,689 | ||||||
Income tax recoverable |
| 1,459 | ||||||
Deferred income taxes |
9,919 | 10,219 | ||||||
Total current assets |
464,275 | 213,152 | ||||||
Property and equipment, net of accumulated depreciation of
$25,388 (2008 $19,449) |
19,543 | 20,756 | ||||||
Goodwill |
141,785 | 143,751 | ||||||
Other intangible assets, net of accumulated amortization of $21,585
(2008 $14,099) |
39,820 | 46,406 | ||||||
Deferred financing charges |
1,154 | 1,481 | ||||||
Deferred income taxes |
1,846 | 1,323 | ||||||
Other assets |
1,293 | 1,474 | ||||||
Total assets |
$ | 669,716 | $ | 428,343 | ||||
LIABILITIES AND SHAREHOLDERS EQUITY |
||||||||
Current liabilities |
||||||||
Accounts payable |
$ | 5,920 | $ | 8,302 | ||||
Customer deposits |
12,553 | 11,875 | ||||||
Salaries and wages payable |
13,184 | 15,681 | ||||||
Accrued liabilities |
27,709 | 32,039 | ||||||
Pharmacy benefit management rebates payable |
43,830 | 36,326 | ||||||
Pharmacy benefit claim payments payable |
51,808 | 51,406 | ||||||
Deferred revenue |
8,430 | 7,978 | ||||||
Current portion of long-term debt |
4,800 | 3,720 | ||||||
Total current liabilities |
168,234 | 167,327 | ||||||
Long-term debt, less current installments |
40,320 | 43,920 | ||||||
Deferred income taxes |
13,032 | 15,060 | ||||||
Deferred lease inducements |
2,867 | 3,217 | ||||||
Deferred rent |
1,327 | 1,461 | ||||||
Other liabilities |
2,929 | 3,195 | ||||||
Total liabilities |
228,709 | 234,180 | ||||||
Commitments and contingencies (Note 12) |
||||||||
Shareholders equity |
||||||||
Common shares: no par value, unlimited shares authorized;
29,979,169 shares issued and outstanding at September 30, 2009
(2008 24,103,032 shares) |
360,131 | 146,988 | ||||||
Additional paid-in capital |
14,661 | 11,854 | ||||||
Retained earnings |
66,619 | 35,751 | ||||||
Accumulated other comprehensive loss |
(404 | ) | (430 | ) | ||||
Total shareholders equity |
441,007 | 194,163 | ||||||
Total liabilities and shareholders equity |
$ | 669,716 | $ | 428,343 | ||||
See accompanying notes to the consolidated financial statements.
3
Table of Contents
SXC
HEALTH SOLUTIONS CORP.
Consolidated Statements of Operations
(in thousands, except per share data)
Consolidated Statements of Operations
(in thousands, except per share data)
Three months ended September 30, | Nine months ended September 30, | |||||||||||||||
2009 | 2008 | 2009 | 2008 | |||||||||||||
(unaudited) | (unaudited) | |||||||||||||||
Revenue: |
||||||||||||||||
PBM |
$ | 357,473 | $ | 297,178 | $ | 919,158 | $ | 502,038 | ||||||||
HCIT: |
||||||||||||||||
Transaction processing |
16,461 | 11,631 | 45,852 | 38,167 | ||||||||||||
Maintenance |
4,733 | 3,998 | 13,684 | 12,338 | ||||||||||||
Professional services |
3,187 | 3,836 | 10,630 | 10,693 | ||||||||||||
System sales |
1,675 | 1,458 | 5,994 | 6,937 | ||||||||||||
Total revenue |
383,529 | 318,101 | 995,318 | 570,173 | ||||||||||||
Cost of revenue: |
||||||||||||||||
PBM |
321,234 | 272,654 | 819,608 | 460,700 | ||||||||||||
HCIT |
14,615 | 10,561 | 41,634 | 31,267 | ||||||||||||
Total cost of revenue |
335,849 | 283,215 | 861,242 | 491,967 | ||||||||||||
Gross profit |
47,680 | 34,886 | 134,076 | 78,206 | ||||||||||||
Expenses: |
||||||||||||||||
Product development costs |
2,833 | 2,486 | 9,024 | 7,425 | ||||||||||||
Selling, general and administrative |
22,153 | 21,863 | 64,857 | 47,291 | ||||||||||||
Depreciation of property and
equipment |
1,467 | 1,222 | 4,354 | 3,416 | ||||||||||||
Amortization of intangible assets |
2,238 | 3,449 | 7,478 | 6,277 | ||||||||||||
28,691 | 29,020 | 85,713 | 64,409 | |||||||||||||
Operating income |
18,989 | 5,866 | 48,363 | 13,797 | ||||||||||||
Interest income |
(101 | ) | (508 | ) | (572 | ) | (2,209 | ) | ||||||||
Interest expense |
1,088 | 1,609 | 3,248 | 2,407 | ||||||||||||
Net interest expense |
987 | 1,101 | 2,676 | 198 | ||||||||||||
Other income, net |
(20 | ) | (50 | ) | (62 | ) | (15 | ) | ||||||||
Income before income taxes |
18,022 | 4,815 | 45,749 | 13,614 | ||||||||||||
Income tax expense (benefit): |
||||||||||||||||
Current |
9,215 | 3,356 | 15,818 | 5,335 | ||||||||||||
Deferred |
(2,402 | ) | (2,080 | ) | (937 | ) | (1,884 | ) | ||||||||
6,813 | 1,276 | 14,881 | 3,451 | |||||||||||||
Net income |
$ | 11,209 | $ | 3,539 | $ | 30,868 | $ | 10,163 | ||||||||
Earnings per share: |
||||||||||||||||
Basic |
$ | 0.45 | $ | 0.15 | $ | 1.25 | $ | 0.45 | ||||||||
Diluted |
$ | 0.43 | $ | 0.15 | $ | 1.22 | $ | 0.44 | ||||||||
Weighted average number of shares used
in computing earnings per share: |
||||||||||||||||
Basic |
25,111,763 | 23,891,438 | 24,651,293 | 22,616,694 | ||||||||||||
Diluted |
26,109,202 | 24,346,740 | 25,318,349 | 23,034,651 |
See accompanying notes to the consolidated financial statements.
4
Table of Contents
SXC HEALTH SOLUTIONS CORP.
Consolidated Statements of Comprehensive Income
(in thousands)
Consolidated Statements of Comprehensive Income
(in thousands)
Three months ended September 30, | Nine months ended September 30, | |||||||||||||||
2009 | 2008 | 2009 | 2008 | |||||||||||||
(unaudited) | (unaudited) | |||||||||||||||
Net income |
$ | 11,209 | $ | 3,539 | $ | 30,868 | $ | 10,163 | ||||||||
Other comprehensive (loss) income, net of tax |
||||||||||||||||
Unrealized (loss) gain
on cash flow hedges
(net of income tax
benefit of $31, and
income tax expense of
$7, for the three and
nine months ended
September 30, 2009,
respectively) |
(50 | ) | | 26 | | |||||||||||
Comprehensive income |
$ | 11,159 | $ | 3,539 | $ | 30,894 | $ | 10,163 | ||||||||
See accompanying notes to the consolidated financial statements.
5
Table of Contents
SXC HEALTH SOLUTIONS CORP.
Consolidated Statements of Cash Flows
(in thousands)
Consolidated Statements of Cash Flows
(in thousands)
Nine months ended | ||||||||
September 30, | ||||||||
2009 | 2008 | |||||||
(unaudited) | ||||||||
Cash flows from operating activities: |
||||||||
Net income |
$ | 30,868 | $ | 10,163 | ||||
Items not involving cash: |
||||||||
Stock-based compensation |
2,477 | 3,006 | ||||||
Depreciation of property and equipment |
5,981 | 4,715 | ||||||
Amortization of intangible assets |
7,478 | 6,277 | ||||||
Deferred lease inducements and rent |
(484 | ) | (206 | ) | ||||
Deferred income taxes |
(937 | ) | (1,884 | ) | ||||
Tax benefit on option exercises |
(3,447 | ) | (799 | ) | ||||
Gain on foreign exchange |
(50 | ) | (14 | ) | ||||
Changes in operating assets and liabilities, net of
effects from acquisition: |
||||||||
Accounts receivable |
(9,444 | ) | 7,858 | |||||
Rebates receivable |
9,009 | 3,017 | ||||||
Restricted cash |
65 | (4,660 | ) | |||||
Unbilled revenue |
73 | 103 | ||||||
Prepaid expenses |
(302 | ) | 915 | |||||
Inventory |
(318 | ) | (171 | ) | ||||
Income tax recoverable |
5,205 | 1,618 | ||||||
Accounts payable |
(2,382 | ) | 496 | |||||
Accrued liabilities |
(3,575 | ) | (4,452 | ) | ||||
Pharmacy benefit claim payments payable |
402 | 1,049 | ||||||
Pharmacy benefit management rebates payable |
7,504 | (5,080 | ) | |||||
Deferred revenue |
409 | (393 | ) | |||||
Customer deposits |
678 | (1,070 | ) | |||||
Other |
383 | 111 | ||||||
Net cash provided by operating activities |
49,593 | 20,599 | ||||||
Cash flows from investing activities: |
||||||||
Purchases of property and equipment |
(6,611 | ) | (5,970 | ) | ||||
Lease inducements received |
| 373 | ||||||
Acquisitions, net of cash acquired |
(2,176 | ) | (102,562 | ) | ||||
Net cash used in investing activities |
(8,787 | ) | (108,159 | ) | ||||
Cash flows from financing activities: |
||||||||
Issuance of long-term debt |
| 48,000 | ||||||
Proceeds from public offering, net of issuance costs |
204,107 | | ||||||
Payment of financing costs |
| (1,792 | ) | |||||
Repayment of long-term debt |
(2,520 | ) | (240 | ) | ||||
Proceeds from exercise of options |
5,917 | 1,440 | ||||||
Tax benefit on option exercises |
3,447 | 799 | ||||||
Net cash provided by financing activities |
210,951 | 48,207 | ||||||
Effect of foreign exchange on cash balances |
50 | 14 | ||||||
Increase (decrease) in cash and cash equivalents |
251,807 | (39,339 | ) | |||||
Cash and cash equivalents, beginning of period |
67,715 | 90,929 | ||||||
Cash and cash equivalents, end of period |
$ | 319,522 | $ | 51,590 | ||||
See accompanying notes to unaudited consolidated financial statements.
6
Table of Contents
SXC HEALTH SOLUTIONS CORP.
Consolidated Statements of Shareholders Equity
(in thousands, except share data)
Consolidated Statements of Shareholders Equity
(in thousands, except share data)
Common Shares | Additional | Retained | Accumulated Other | |||||||||||||||||||||
Shares | Amount | Paid-in Capital | Earnings | Comprehensive Loss | Total | |||||||||||||||||||
Balance at December 31, 2008 |
24,103,032 | $ | 146,988 | $ | 11,854 | $ | 35,751 | $ | (430 | ) | $ | 194,163 | ||||||||||||
Activity during the period (unaudited): |
||||||||||||||||||||||||
Net income |
| | | 30,868 | | 30,868 | ||||||||||||||||||
Exercise of stock options |
687,045 | 8,549 | (2,632 | ) | | | 5,917 | |||||||||||||||||
Issuance of common shares |
5,175,000 | 204,107 | | | | 204,107 | ||||||||||||||||||
Issuance of common shares for
acquisition |
140 | 2 | | | | 2 | ||||||||||||||||||
Vesting of restricted stock units |
13,952 | 485 | (485 | ) | | | | |||||||||||||||||
Tax benefit on options exercised |
| | 3,447 | | | 3,447 | ||||||||||||||||||
Stock-based compensation |
| | 2,477 | | | 2,477 | ||||||||||||||||||
Other comprehensive income, net of tax |
| | | | 26 | 26 | ||||||||||||||||||
Balance at September 30, 2009 (unaudited) |
29,979,169 | 360,131 | 14,661 | 66,619 | (404 | ) | 441,007 | |||||||||||||||||
Balance at December 31, 2007 |
20,985,934 | 103,520 | 8,299 | 20,638 | | 132,457 | ||||||||||||||||||
Activity during the period (unaudited): |
||||||||||||||||||||||||
Net income |
| | | 10,163 | | 10,163 | ||||||||||||||||||
Issuance of shares under ESPP |
2,386 | 33 | | | | 33 | ||||||||||||||||||
Issuance of shares for acquisition |
2,785,636 | 40,921 | | | | 40,921 | ||||||||||||||||||
Costs to issue shares for acquisition |
| (362 | ) | | | | (362 | ) | ||||||||||||||||
Exercise of stock options |
269,426 | 2,095 | (655 | ) | | | 1,440 | |||||||||||||||||
Tax benefit on options exercised |
| | 799 | | | 799 | ||||||||||||||||||
Stock-based compensation |
| | 3,006 | | | 3,006 | ||||||||||||||||||
Balance at September 30, 2008 (unaudited) |
24,043,382 | $ | 146,207 | $ | 11,449 | $ | 30,801 | $ | | $ | 188,457 | |||||||||||||
See accompanying notes to the consolidated financial statements.
7
Table of Contents
SXC HEALTH SOLUTIONS CORP.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
1. | Description of Business |
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 Companys product offerings and solutions combine
a wide range of software applications, application service provider 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. For more information please visit www.sxc.com. |
2. | Basis of Presentation |
(a) | Basis of presentation: |
||
The consolidated financial statements of the Company have been prepared in accordance with
accounting principles generally accepted in the United States (U.S. GAAP) and include its
majority-owned subsidiaries. All significant inter-company transactions and balances have
been eliminated in consolidation. Amounts in the consolidated financial statements and
notes are expressed in U.S. dollars, except where indicated, which is also the Companys
functional currency. |
|||
Certain information and note disclosures normally included in the annual financial
statements prepared in accordance with U.S. GAAP have been condensed or excluded. As a
result, these unaudited interim consolidated financial statements do not contain all the
disclosures required to be included in the annual consolidated financial statements and
should be read in conjunction with the most recent audited annual consolidated financial
statements and notes thereto for the year ended December 31, 2008. |
|||
These unaudited interim consolidated financial statements are prepared following accounting
policies consistent with the Companys audited annual consolidated financial statements for
the year ended December 31, 2008. |
|||
The financial information included herein reflects all adjustments (consisting only of
normal recurring adjustments), which, in the opinion of management, are necessary for a
fair presentation of the results for the interim periods presented. The results of
operations for the three- and nine-month periods ended September 30, 2009 are not
necessarily indicative of the results to be expected for the full year ending December 31,
2009. |
|||
Effective with the acquisition of National Medical Health Card Systems, Inc. (NMHC) on
April 30, 2008, the Company began operating in two reportable segments: PBM and HCIT.
Please see Note 10 for more information. |
|||
(b) | Use of estimates: |
||
The preparation of financial statements in conformity with U.S. GAAP requires management to
make estimates and assumptions that affect the reported amounts of assets and liabilities,
and disclosure of contingent assets and liabilities at the date of the financial statements
and the reported amounts of revenue and expenses during the period. Significant items
subject to such estimates and assumptions include revenue recognition, rebates, purchase
price allocation in connection with acquisitions, valuation of property and equipment,
valuation of intangible assets acquired and related amortization periods, impairment of
goodwill, income tax uncertainties, contingencies and valuation allowances for receivables
and income taxes. Actual results could differ from those estimates. |
|||
(c) | Subsequent Events: |
||
As of the issuance date of the Companys financial statements, no subsequent events have
occurred that would require disclosure in accordance with Financial Accounting Standards
Boards (FASB) guidance. |
|||
(d) | Accounting Standards Codification |
||
Effective with the quarter ended September 30, 2009, the Company adopted the FASBs
Accounting Standards Codification (the Codification), which is now the exclusive
authoritative reference for nongovernmental U.S. GAAP. Where applicable, titles and
references to accounting standards have been updated to reflect the Codification. |
8
Table of Contents
3. | Recent Accounting Pronouncements |
Derivative Instruments and Hedging Activities Disclosures |
|||
In March 2008, the FASB issued an amendment to derivative instruments and hedging
activities guidance. The amended accounting guidance requires qualitative disclosures
about objectives and strategies for using derivatives, quantitative disclosures about fair
value amounts and gains and losses on derivative instruments, and disclosures about
credit-risk-related contingent features in derivative agreements. The amended accounting
guidance was effective for the Companys fiscal year beginning January 1, 2009, and its
adoption did not have a material impact to the Company. |
|||
Business Combinations |
|||
New accounting guidance for business combinations was issued by the FASB in December 2007.
The new accounting guidance applies to all transactions or other events in which an entity
(the acquirer) obtains control of one or more businesses. The new guidance establishes
principles and requirements for how the acquirer recognizes and measures in its financial
statements the assets, liabilities, noncontrolling interest and goodwill related to a
business combination. It also establishes what information to disclose to enable users of
the financial statements to evaluate the nature and financial effects of the business
combination. This new accounting guidance applies prospectively to business combinations
for which the acquisition date is on or after January 1, 2009. |
|||
Noncontrolling Interests in Consolidated Financial Statements |
|||
In December 2007, the FASB issued updated accounting guidance for non-controlling interests
in consolidated financial statements. The updated accounting guidance establishes
accounting and reporting standards for entities that have an outstanding noncontrolling
interest in one or more subsidiaries or that deconsolidate a subsidiary. A noncontrolling
interest (previously referred to as a minority interest) is the portion of equity in a
subsidiary not attributable, directly or indirectly, to a parent. The updated accounting
guidance was effective for the Companys fiscal year beginning January 1, 2009, and has
been applied prospectively to all noncontrolling interests, including those that arose
before the effective date. Its adoption did not have a material impact to the Company. |
|||
Revenue Arrangements with Multiple Deliverables |
|||
In October 2009, the FASB issued an amendment to revenue recognition guidance for
transactions with multiple deliverables. The updated accounting guidance changes the
criteria necessary for a delivered item to be considered a separate element. The new
accounting guidance eliminates the requirement of using objective and reliable evidence of
fair value in determining the amount of revenue to recognize. In place of having objective
and reliable evidence of fair value for delivered and undelivered elements, a company may
use its best estimate of selling price to determine the amount of revenue to recognize.
The new guidance is effective for the Companys fiscal year beginning January 1, 2011, with
early adoption permitted. The Company is currently evaluating the impact the new
guidance will have on its financial results. |
|||
Revenue Arrangements that Include Software Elements |
|||
The FASB issued new revenue recognition guidance in October 2009 for transactions of
tangible products that have software components. The new accounting guidance removes the
non-software components and software elements of the tangible product from the scope of
software revenue recognition accounting guidance. The new accounting guidance is effective
for the Companys fiscal year beginning January 1, 2011, with early adoption permitted.
The Company is currently evaluating the impact the new guidance will have on its financial
results. |
4. | Business Combinations |
NMHC
Acquisition Effective April 30, 2008, the Company completed the acquisition of NMHC, a pharmacy benefit management company, in an exchange offer of (i) 0.217 of a Company common share and (ii) $7.70 in cash for each outstanding NMHC common share. Total deal consideration approximated $143.8 million, which included the issuance of 2,786,100 Company common shares. The value of the common shares issued was based on the average market price of the Companys common shares from a few days before to a few days after the agreement was finalized and announced. To fund the transaction, the Company entered into a six-year $48.0 million term loan agreement. The Company also signed a $10.0 million senior secured revolving credit agreement. NMHC results of operations are included in the consolidated financial statements from the date of acquisition. |
||
Prior to the acquisition, the Company and one of NMHCs subsidiaries, NMHCRX, Inc., were
parties to a consulting agreement and software license and maintenance agreements pursuant to
which the Company licensed, and provided consulting and support services in connection with,
certain computer software for one of NMHCRX, Inc.s claims adjudication systems. |
||
The Company and NMHC have similar missions and core values, and the Company believes the
synergies gained from this business combination will create long term value for customers,
vendors and shareholders, as well as opportunities for new and existing employees by making
the Company better positioned to compete in the changing PBM environment. |
9
Table of Contents
The purchase price of the acquired operations was comprised of the following (in thousands): |
Cash payment to NMHC shareholders |
$ | 98,711 | ||
Value assigned to shares issued |
40,928 | |||
Direct costs of the acquisition |
4,114 | |||
Total purchase price |
$ | 143,753 | ||
Direct Costs of the
Acquisition Direct costs of the acquisition include investment banking fees, legal and accounting fees and other external costs directly related to the acquisition. |
||
Purchase Price Allocation The acquisition was accounted for under the purchase 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 excess of the purchase price over the estimated fair values of the net assets acquired and liabilities assumed was recorded as goodwill. Goodwill is non-amortizing for financial statement purposes and is not tax deductible. The changes in goodwill from December 31, 2008 to September 30, 2009 are primarily due to deferred tax adjustments, changes in the estimated fair value of acquired fixed assets and revisions to the estimated fair values of assumed liabilities related to the NMHC acquisition. During the three months ended September 30, 2009, the Company recorded an adjustment to goodwill and deferred tax liabilities. The adjustment decreased goodwill and decreased deferred tax liabilities (non-current) by approximately $2.1 million. The purchase price allocation is considered final as of June 30, 2009. |
||
The following summarizes the estimates of the fair values of the assets acquired and
liabilities assumed at the acquisition date (in thousands): |
Current assets |
$ | 115,864 | ||
Property and equipment |
3,495 | |||
Goodwill |
122,120 | |||
Intangible assets |
44,420 | |||
Other assets |
1,258 | |||
Total assets acquired |
287,157 | |||
Current liabilities |
132,618 | |||
Deferred income taxes |
10,490 | |||
Other liabilities |
296 | |||
Total liabilities assumed |
143,404 | |||
Net assets acquired |
$ | 143,753 | ||
During the three and nine months ended September 30, 2009, the Company recognized $1.7 million
and $5.9 million of amortization expense from intangible assets acquired, respectively.
Amortization for the remainder of 2009 is expected to be $1.7 million. Amortization for 2010
and 2011 is expected to be $6.0 million and $5.3 million, respectively. The estimated fair
values and useful lives of intangible assets acquired are as follows (in thousands): |
Fair value | Useful Life | |||||||
Trademarks/Trade names |
$ | 1,120 | 6 months | |||||
Customer relationships |
39,700 | 8 years | ||||||
Non-compete agreements |
1,480 | 1 year | ||||||
Software |
1,120 | 1 year | ||||||
Licenses |
1,000 | 15 years | ||||||
Total |
$ | 44,420 | ||||||
Unaudited Pro Forma Financial Information The following unaudited pro forma financial information presents the combined historical results of the operations of the Company and NMHC as if the acquisition had occurred on the first day of the period presented. Certain adjustments have been made to reflect changes in depreciation, amortization and income taxes based on the Companys estimates of fair values recognized in the application of purchase accounting, and interest expense on borrowings to finance the acquisition. |
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Unaudited pro forma results of operations are as follows (in thousands, except per share
data): |
Nine months | ||||
ended | ||||
September 30, | ||||
2008 | ||||
Sales |
$ | 951,842 | ||
Gross profit |
$ | 103,493 | ||
Income |
$ | 6,157 | ||
Income per share: |
||||
Basic |
$ | 0.26 | ||
Diluted |
$ | 0.25 | ||
Weighted average shares outstanding |
||||
Basic |
23,828,989 | |||
Diluted |
24,246,946 |
This unaudited pro forma financial information is not intended to represent or be indicative
of what would have occurred if the transaction had taken place on the date presented and is
not indicative of what the Companys actual results of operations would have been had the
acquisition been completed at the beginning of the period 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. |
||
Other Acquisitions On December 22, 2008, the Company announced that it had acquired substantially all of the assets of Zynchros, a privately-owned leader in formulary management solutions, in a cash transaction effective December 19, 2008. Founded in 2000, Zynchros provides a suite of on-demand formulary management tools to approximately 45 health plan and PBM customers. The zynchros.com platform helps payers to effectively manage their formulary programs, and to maintain Medicare Part D compliance of their programs. The Company recorded identifiable intangible assets of $1.7 million with estimated useful lives of 4 to 5 years and goodwill of $2.7 million associated with the acquisition. The goodwill acquired was allocated to the Companys HCIT segment. Zynchros results of operations are included in the consolidated statement of operations as of the effective date of the acquisition and were not material to the Companys results of operations on a pro forma basis. |
||
In the second quarter of 2009, the Company completed the acquisition of substantially all of
the assets of a small pharmacy system vendor in a cash transaction, effective June 11, 2009.
The Company recorded identifiable intangible assets of $0.9 million with estimated useful
lives of 1 to 10 years and goodwill of $1.1 million associated with the acquisition. The
goodwill acquired was allocated to the Companys HCIT segment. The results of operations are
included in the consolidated statement of operations as of the effective date of the
acquisition and were not material to the Companys results of operations on a pro forma basis. |
5. | Cash and Cash Equivalents |
The components of cash and cash equivalents are as follows (in thousands): |
September 30, | December 31, | |||||||
2009 | 2008 | |||||||
(unaudited) | ||||||||
Cash on deposit |
$ | 146,254 | $ | 46,532 | ||||
Payments in transit |
(79,476 | ) | (55,559 | ) | ||||
U.S. money market funds |
252,711 | 76,713 | ||||||
Canadian dollar deposits (September 30, 2009 Cdn. $35 at 1.0691; |
33 | 29 | ||||||
December 31, 2008 Cdn. $35 at 1.2168) |
$ | 319,522 | $ | 67,715 | ||||
The Company determined the carrying amount reported in the consolidated balance sheets as cash
and cash equivalents approximates fair value because of the short maturities of these
instruments and are considered Level 1 investments in the fair value hierarchy. |
6. | Goodwill and Other Intangible Assets |
Goodwill and indefinite-lived intangible assets are reviewed for impairment annually or more
frequently if impairment indicators arise. The Company allocates goodwill to both the PBM and
HCIT segments. There were no impairments of goodwill or indefinite-lived intangible assets
during the nine months ended September 30, 2009 and 2008. |
||
During the second quarter of 2009, the Company recorded an additional $0.9 million in
identifiable intangible assets related to the acquisition of a small pharmacy system vendor as
described in Note 4. The identifiable intangible assets were allocated to the Companys HCIT
segment. |
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Definite-lived intangible assets are amortized over the useful lives of the related assets.
The components of intangible assets were as follows (in thousands): |
September 30, 2009 | December 31, 2008 | |||||||||||||||||||||||
Gross | Gross | |||||||||||||||||||||||
Carrying | Accumulated | Carrying | Accumulated | |||||||||||||||||||||
Amount | Amortization | Net | Amount | Amortization | Net | |||||||||||||||||||
Customer relationships |
$ | 53,760 | $ | 16,090 | $ | 37,670 | $ | 53,100 | $ | 10,043 | $ | 43,057 | ||||||||||||
Acquired software |
3,765 | 2,748 | 1,017 | 3,565 | 1,903 | 1,662 | ||||||||||||||||||
Trademarks/Trade names |
1,370 | 1,170 | 200 | 1,360 | 1,122 | 238 | ||||||||||||||||||
Non-compete agreements |
1,510 | 1,483 | 27 | 1,480 | 987 | 493 | ||||||||||||||||||
Licenses |
1,000 | 94 | 906 | 1,000 | 44 | 956 | ||||||||||||||||||
Total |
$ | 61,405 | $ | 21,585 | $ | 39,820 | $ | 60,505 | $ | 14,099 | $ | 46,406 | ||||||||||||
Amortization associated with intangible assets at September 30, 2009 is estimated to be $2.2
million for the remainder of 2009, $7.9 million in 2010, $7.1 million in 2011, $6.5 million in
2012, $5.7 million in 2013, $5.2 million in 2014 and $5.2 million for years after 2014. |
7. | Long Term Debt |
On April 25, 2008, the Companys U.S. subsidiary, SXC Health Solutions, Inc. (US Corp.),
entered into a credit agreement (the Credit Agreement) providing for up to $58 million of
borrowings, consisting of (i) a $10 million senior secured revolving credit facility
(including borrowing capacity available for letters of credit and for borrowings on same-day
notice) referred to as a swing loan (the Revolving Credit Facility) and (ii) a $48 million
senior secured term loan (the Term Loan Facility and, together with the Revolving Credit
Facility, the Credit Facilities). On April 29, 2008, US Corp. borrowed $48 million under
the Term Loan Facility to pay a portion of the consideration in connection with the
acquisition of NMHC and certain transaction fees and expenses related to the acquisition. |
||
The interest rates applicable to the loans under the Credit Facilities are based on a
fluctuating rate measured by reference to either, at US Corp.s option, (i) a base rate, plus
an applicable margin, subject to adjustment, or (ii) an adjusted London interbank offered rate
(adjusted for the maximum reserves)(LIBOR), plus an applicable margin. The initial rate for
all borrowings is prime plus 2.25% with respect to base rate borrowings or LIBOR plus 3.25%.
During an event of default, default interest is payable at a rate that is 2% higher than the
rate otherwise applicable. The interest rate on the loan at September 30, 2009 was 3.53%. In
addition to paying interest on outstanding principal under the Credit Facilities, US Corp. is
required to pay an unused commitment fee to the lenders in respect of any unutilized
commitments under the Revolving Credit Facility at a rate of 0.50% per annum. US Corp. is
also required to pay customary letter of credit fees. In addition, pursuant to the terms of
its credit agreement, the Company entered into interest rate contracts for 50% of the borrowed
amount, or $24 million, to provide protection against fluctuations in interest rates for a
three-year period from the date of issue. See Note 13 for more information. |
||
The Credit Facilities require US Corp. to prepay outstanding loans, subject to certain
exceptions, with: |
| 50% of the net proceeds arising from the issuance or sale by the Company of its own
common shares; |
||
| 100% of the net proceeds of an incurrence of debt, other than proceeds from the
debt permitted under the Credit Facilities; and |
||
| 100% of the net proceeds of certain asset sales and casualty events, subject to a
right to reinvest the proceeds. |
The foregoing mandatory prepayments will be applied first to the Term Loan Facility and second
to the Revolving Credit Facility. |
||
In September 2009, the Company raised net proceeds of $204.1 million from a public
offering of the Companys common shares as described in Note 8. US Corp. obtained a consent
from its creditors which waived the need to use part of the proceeds to prepay the outstanding
loans under the Credit Facilities. The consent applies only to this public offering of the
Companys common shares and does not amend the Credit Facilities for future issuances or other
events that would require a prepayment of outstanding loans under the Credit Facilities as
noted above. |
||
The Term Loan Facility will amortize in quarterly installments, which commenced on June 30,
2008, in aggregate annual amounts equal to 1% (year 1), 10% (years 2 and 3), 15% (years 4 and
5), and 49% (year 6) of the original funded principal amount of such facility. Principal
repayments will be $3.7 million in 2009, $4.8 million in 2010, $6.6 million in 2011, $7.2
million in 2012, $19.4 million in 2013 and $5.9 million in 2014. Principal amounts
outstanding under the Revolving Credit Facility are due and payable in full on April 30, 2013. |
||
The Company and all material U.S. subsidiaries of US Corp. guarantee the obligations under the
Credit Agreement. All future material U.S. subsidiaries of the Company, as well as certain
future Canadian subsidiaries, will guarantee the obligations under the Credit Agreement as
well. In addition, the Credit Facilities and the guarantees are secured by the capital stock
of US Corp. and certain other subsidiaries of the Company and substantially all other tangible
and intangible assets owned by the Company, US Corp. and each subsidiary that guarantees the
obligations of US Corp. under the Credit Facilities, subject to certain specified exceptions. |
||
The Credit Agreement also contains certain restrictive covenants including financial covenants
that require the Company to maintain (i) a maximum consolidated leverage ratio, (ii) a minimum
consolidated fixed charge coverage ratio and (iii) a maximum capital expenditure level. As of
September 30, 2009, the Company is in compliance with its covenants. |
12
Table of Contents
In connection with the Term Loan Facility, the Company incurred approximately $1.8 million in
financing costs. The financing costs are presented on the consolidated balance sheet as
deferred financing charges and are being amortized into interest expense over the life of the
loan using the effective-interest method.
The fair value of the Companys debt at September 30, 2009 is $45.1 million, which
approximates its carrying value. The carrying value of the Companys debt approximates the
fair value of the Companys debt because the interest rates applicable to the debt are
market-based, and the Company believes such debt could be refinanced on materially similar
terms.
Interest expense relates to the following (in thousands):
Three months ended September 30, | Nine months ended September 30, | |||||||||||||||
2009 | 2008 | 2009 | 2008 | |||||||||||||
Long-term debt |
$ | 468 | $ | 782 | $ | 1,463 | $ | 1,372 | ||||||||
Finacing charges |
106 | 118 | 328 | 197 | ||||||||||||
Other |
514 | 709 | 1,457 | 838 | ||||||||||||
Total |
$ | 1,088 | $ | 1,609 | $ | 3,248 | $ | 2,407 | ||||||||
8. | Shareholders equity |
(a) | Public offering: |
||
On September 23, 2009, the Company completed a public offering of 5,175,000 of its common
shares. The shares were offered to the public at a price of $41.50 per share. The net
proceeds to the Company from the offering totalled $204.1 million, net of $10.7 million for
underwriting discounts and commissions, and other offering costs. |
|||
(b) | Stock incentive plans: |
||
The Company maintains a stock option plan (the Option Plan), as amended, under which
there were outstanding 1,581,956 stock options as of September 30, 2009. Effective on March
11, 2009, the Board of Directors of the Company adopted the SXC Health Solutions Corp.
Long-Term Incentive Plan (the LTIP), which was approved by the shareholders of the
Company at the Annual and Special Meeting of Shareholders on May 13, 2009. The LTIP
provides for the grant of stock option awards, stock appreciation rights, restricted stock
awards, restricted stock unit awards, performance awards and other stock-based awards to
eligible persons, including executive officers and directors of the Company. The purpose of
the LTIP is to advance the interests of the Company by attracting and retaining high
caliber employees and other key individuals who perform services for the Company, a
subsidiary or an affiliate; align the interests of the Companys shareholders and
recipients of awards under the LTIP by increasing the proprietary interest of such
recipients in the Companys growth and success; and motivate award recipients to act in the
best long-term interest of the Company and its shareholders. The LTIP replaced the Option
Plan, and no further grants or awards will be issued under the Option Plan. The LTIP
provides for a maximum of 1,070,000 common shares of the Company to be issued in addition
to the common shares that remained available for issuance under the Option Plan. |
|||
(c) | Employee Stock Purchase Plan: |
||
The Company maintains an 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 IRS limitations, for the purchase of the Companys 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 issued under the ESPP may not exceed 100,000 common shares. |
|||
During the first quarter of 2009, the ESPP was amended so that the common shares available
for purchase under the ESPP are drawn from reacquired common shares purchased on behalf of
the Company in the open market. During the nine months ended September 30, 2009 and 2008,
there were 6,198 and 2,386 shares issued under the ESPP, respectively. |
|||
The ESPP is not considered compensatory as its purchase discount is not greater than 5%,
the plan is available to substantially all employees, and the plan does not incorporate
option features. Accordingly, no portion of the cost related to ESPP purchases is included
in the Companys stock-based compensation expense. |
|||
(d) | Outstanding shares and stock options: |
||
At September 30, 2009, the Company had outstanding common shares of 29,979,169 and stock
options outstanding of 1,581,956. At December 31, 2008, the Company had outstanding common
shares of 24,103,032 and stock options outstanding of 2,093,194. As of September 30, 2009,
stock options outstanding consisted of 524,587 options at a weighted-average exercise price
of Canadian $12.04 and 1,057,369 options at a weighted-average exercise price of U.S.
$18.87. |
|||
(e) | Restricted stock units: |
||
The Company assumed 170,500 restricted stock units (RSUs) of NMHC after the NMHC
acquisition, which converted into 126,749 RSUs of the Company. In September 2008, the
Company issued an additional 51,000 RSUs with a grant date fair value of $15.90 per share
to certain new employees who were previous employees of NMHC. |
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Table of Contents
During the nine months ended September 30, 2009, the Company granted a total of 168,205
RSUs to its employees and non-employee directors with a grant date fair value of $25.54 per
share. |
|||
Substantially all RSUs vest on a straight-line basis over a range of three to four years.
Certain additional RSUs granted to senior management cliff vest based upon reaching agreed
upon three-year performance conditions. |
|||
At September 30, 2009, there were 256,133 RSUs outstanding. |
9. | Stock-based compensation |
During the three and nine month periods ended September 30, 2009, the Company recorded
stock-based compensation expense of $1.1 million and $2.5 million, respectively. During the
three and nine month periods ended September 30, 2008, the Company recorded stock-based
compensation expense of $0.9 million and $3.0 million, respectively. The Black-Scholes
option-pricing model was used to estimate the fair value of the stock options at the grant
date based on the following assumptions: |
Nine months ended September 30, | ||||||||
2009 | 2008 | |||||||
Total stock options granted |
191,607 | 474,950 | ||||||
Volatility |
47.1 48.0 | % | 49.6 52.4 | % | ||||
Risk-free interest rate |
1.96 2.75 | % | 1.67 3.27 | % | ||||
Expected life |
4.5 years | 2.5 4.5 years | ||||||
Dividend yield |
| | ||||||
Weighted-average grant date fair value: |
$ | 10.89 | $ | 5.69 |
There were no Canadian dollar stock options granted during the nine months ended September 30,
2009 and 2008. |
10. | Segment information |
The Company operates in two geographic areas as follows (in thousands): |
Three months ended September 30, | Nine months ended September 30, | |||||||||||||||
Revenue | 2009 | 2008 | 2009 | 2008 | ||||||||||||
United States |
$ | 382,754 | $ | 317,122 | $ | 993,486 | $ | 566,772 | ||||||||
Canada |
775 | 979 | 1,832 | 3,401 | ||||||||||||
Total |
$ | 383,529 | $ | 318,101 | $ | 995,318 | $ | 570,173 | ||||||||
Net assets | September 30, 2009 | December 31, 2008 | ||||||
United States |
$ | 427,113 | $ | 182,105 | ||||
Canada |
13,894 | 12,058 | ||||||
Total |
$ | 441,007 | $ | 194,163 | ||||
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With the acquisition of NMHC during the second quarter of 2008, the Company changed its
internal organization structure and now reports two operating segments: PBM and HCIT. The
Company evaluates segment performance based upon revenue and gross profit. Results for periods
reported prior to the three months ended September 30, 2008 were reported in one operating
segment, HCIT. Prior period results have not been restated because to do so would be
impracticable. Financial information by segment is presented below (in thousands): |
Three months ended September 30, | Nine months ended September 30, | |||||||||||||||
2009 | 2008 | 2009 | 2008 | |||||||||||||
PBM: |
||||||||||||||||
Revenues |
$ | 357,473 | $ | 297,178 | $ | 919,158 | $ | 502,038 | ||||||||
Gross profit |
$ | 36,239 | $ | 24,524 | $ | 99,550 | $ | 41,338 | ||||||||
Total assets at September 30 |
$ | 420,677 | $ | 291,544 | ||||||||||||
HCIT: |
||||||||||||||||
Revenues |
$ | 26,056 | $ | 20,923 | $ | 76,161 | $ | 68,135 | ||||||||
Gross profit |
$ | 11,441 | $ | 10,362 | $ | 34,526 | $ | 36,868 | ||||||||
Total assets at September 30 |
$ | 249,039 | $ | 121,460 | ||||||||||||
Consolidated: |
||||||||||||||||
Revenues |
$ | 383,529 | $ | 318,101 | $ | 995,319 | $ | 570,173 | ||||||||
Gross profit |
$ | 47,680 | $ | 34,886 | $ | 134,076 | $ | 78,206 | ||||||||
Total assets at September 30 |
$ | 669,716 | $ | 413,004 |
For the three-month period ended September 30, 2009, one customer accounted for 11.8% and
another for 11.2% of total revenues. For the three-month period ended September 30, 2008, one
customer accounted for 12.1% and another for 11.4% of consolidated revenue, respectively. |
||
For the nine-month period ended September 30, 2009, one customer accounted for 13.6% and
another for 12.6% of total revenue, respectively. For the nine-month period ended September
30, 2008, one customer accounted for 10.5% and another for 11.2% of consolidated revenue,
respectively. |
||
At September 30, 2009 and December 31, 2008, no one customer accounted for 10% or more of the
outstanding accounts receivable balance. |
11. | Income Taxes |
The Company recognizes income taxes based on the amount of taxes payable for the current year
plus deferred tax liability and asset impacts driven by future tax consequences. The Companys
tax recognition includes both tax benefits utilized by the Company as a result of historical
net operating losses (NOLs) and tax-related timing differences. In assessing the
realizability of deferred tax assets (DTAs), management considers whether it is more likely
than not that some portion or all of the DTAs will be realized. The ultimate realization of
DTAs is dependent upon the generation of future taxable income during the period in which
those temporary differences become deductible, in addition to managements tax planning
strategies. In consideration of net losses incurred, the Company has provided a valuation
allowance to reduce the net carrying value of DTAs. The amount of this valuation allowance is
subject to adjustment by the Company in future periods based upon its assessment of evidence
supporting the degree of probability that DTAs will be realized. |
||
The Companys effective tax rate for the three months ended September 30, 2009 and 2008 was
37.8% and 26.5%, respectively. The Companys effective tax rate for the nine months ended
September 30, 2009 and 2008 was 32.5% and 25.3%, respectively. |
||
Uncertain Tax Positions |
||
U.S. GAAP accounting guidance for uncertain tax positions prescribes a recognition threshold
and measurement attribute criteria for the financial statement recognition and measurement of
a tax position taken or expected to be taken in a tax return. As of September 30, 2009 and at
December 31, 2008, the Company had a long-term accrued liability of $0.3 million related to
various federal and state income tax matters on the consolidated balance sheet, the
recognition of which would impact the Companys effective tax rate. |
15
Table of Contents
Changes in the balance of the liability for tax uncertainties are as follows (in thousands): |
Three months ended | Nine months ended | |||||||||||||||
September 30, | September 30, | |||||||||||||||
2009 | 2008 | 2009 | 2008 | |||||||||||||
Beginning balance |
$ | 321 | $ | 270 | $ | 297 | $ | 202 | ||||||||
Effect of change in accounting position for income tax uncertainties |
(66 | ) | 2 | (63 | ) | 44 | ||||||||||
Increase in interest related to tax positions taken in prior years |
10 | 14 | 31 | 40 | ||||||||||||
Balance at September 30 |
$ | 265 | $ | 286 | $ | 265 | $ | 286 | ||||||||
The Company recognizes interest and penalties related to uncertain tax positions in income tax
expense. The Company does not expect the liability to change significantly in the next twelve
months. |
||
The Company and its subsidiaries file income tax returns in Canadian and U.S. federal
jurisdictions, and various provincial, state and local jurisdictions. With a few exceptions,
the Company is no longer subject to tax examinations by tax authorities for years prior to
2005. |
12. | Contingencies |
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. The Company has
considered these proceedings and disputes in determining the necessity of any reserves for
losses that are probable and reasonably estimable. In addition, various aspects of the
Companys business may subject it to litigation and liability for damages arising from errors
in the processing of prescription drug claims, failure to meet performance measures within
certain contracts relating to its services or its ability to obtain certain levels of
discounts for rebates on prescription purchases from retail pharmacies and drug manufacturers
or other actions or omissions. The Companys recorded reserves 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 managements 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 consolidated financial
statements where required. |
||
The Company provides routine indemnification to its customers against liability if the
Companys products infringe on a third partys intellectual property rights. The maximum
amount of these indemnifications cannot be reasonably estimated due to their uncertain nature.
Historically, the Company has not made payments related to these indemnifications. |
||
During the routine course of securing new clients, the Company is sometimes required to
provide payment and performance bonds to cover client transaction fees and any funds and
pharmacy benefit claim payments provided by the client in the event that the Company does not
perform its duties under the contract. The terms of these payment and performance bonds are
typically one year in duration and may require renewals for the length of the contract period. |
13. | Derivative Instruments and Fair Value |
The Company uses variable-rate LIBOR debt to finance its operations. These debt obligations
expose the Company to variability in interest payments on its long term-debt due to changes in
interest rates. If interest rates increase, interest expense increases. Conversely, if
interest rates decrease, interest expense also decreases. |
||
Pursuant to the terms of the Companys $48 million credit agreement, the Company entered into
interest rate contracts with notional amounts equal to 50% of the borrowed amount, or $24
million, for a three-year period from the date of issue. The Company entered into a 3-year
interest rate swap agreement with a notional amount of $14 million to fix the LIBOR rate on
$14 million of the term loan at 4.31%, resulting in an effective rate of 7.56% after adding
the 3.25% margin per the credit agreement see Note 7 for more information. Under the
interest rate swap, the Company receives LIBOR-based variable interest rate payments and makes
fixed interest rate payments, thereby creating the equivalent to fixed-rate debt. The Company
also entered into a 3-year interest rate cap with a notional amount of $10 million to
effectively cap the LIBOR rate on $10 million of the
term loan at 4.50%, resulting in a maximum effective rate of 7.75% after adding the 3.25%
margin per the credit agreement, excluding the associated fees, to help manage exposure to
interest rate fluctuations. These instruments were designated as cash flow hedges during 2008. |
||
The two derivative instruments mentioned above were entered into to manage fluctuations in
cash flows resulting from interest rate risk attributable to changes in the benchmark interest
rate of LIBOR, and to comply with the terms of the credit agreement. |
||
As of September 30, 2009, the interest rate swap derivative instrument is out of the money
and the Company is not currently exposed to any credit risk for amounts classified on the
consolidated balance sheet should the counterparty in the agreement fail to meet its
obligations under the agreement. To manage credit risks, the Company selects counterparties
based on credit assessments, limits overall exposure to any single counterparty and monitors
the market position with each counterparty. At September 30, 2009, the Company concluded that
it was probable that the counterparty would be able to comply with the contractual terms of
the agreements and that the forecasted transactions are probable of occurring. |
||
The Company assesses interest rate cash flow risk by continually identifying and monitoring
changes in interest rate exposures that may adversely impact expected future cash flows and by
evaluating hedging opportunities. The Company does not enter into derivative instruments for
any purpose other than hedging identified exposures. That is, the Company does not speculate
using derivative instruments and has not designated any instruments as fair value hedges or
hedges of the foreign currency exposure of a net investment in foreign operations. |
16
Table of Contents
Cash flow hedge accounting may be elected only for highly effective hedges, based upon an
assessment, performed at least quarterly, of the historical and prospective future correlation
of changes in the fair value of the derivative instrument to changes in the expected future
cash flows of the hedged item. To the extent cash flow hedge accounting is applied, the
effective portion of any changes in the fair value of the derivative instruments is initially
reported as a component of accumulated other comprehensive income or loss (AOCI).
Ineffectiveness, if any, is immediately recognized in the statement of operations. The amount
in AOCI is reclassified to earnings when the forecasted transaction occurs, even if the
derivative instrument is sold, extinguished or terminated prior to the transaction occurring,
if it is still probable that the forecasted transaction will occur. If the forecasted
transaction is no longer probable of occurring, the amount in AOCI is immediately reclassified
to earnings. |
||
There was no hedge ineffectiveness subsequent to the implementation of cash flow hedge
accounting related to the interest rate swap. Derivatives and hedge accounting guidance
requires that all derivative instruments are recorded on the balance sheet at their respective
fair values. |
||
Changes in the fair value of the interest rate swaps designated as hedges of the variability
in cash flows associated with floating-rate, long-term debt obligations, subsequent to the
implementation of cash flow hedge accounting, are reported in AOCI. These amounts are
subsequently reclassified into interest expense in the same period in which the related
interest on the floating-rate debt obligations affects earnings. The amount recorded in AOCI
at September 30, 2009 was $0.4 million net of income taxes. |
||
As of September 30, 2009, approximately $0.6 million of losses in AOCI related to the interest
rate swap are expected to be reclassified into interest expense as a yield adjustment of the
hedged debt obligation within the next 12 months. |
||
Effective January 1, 2008, accounting guidance for fair value measurements was issued. The
accounting guidance defines a three-level hierarchy which prioritizes 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 September 30, 2009 (in thousands): |
Quoted Prices in | Significant | Significant | ||||||||||||||
Active Markets | Observable Inputs | Unobservable Inputs | ||||||||||||||
(Level 1) | (Level 2) | (Level 3) | Total | |||||||||||||
Assets: |
||||||||||||||||
Interest Rate Cap Derivative |
$ | | $ | 11 | $ | | $ | 11 | ||||||||
Liabilities: |
||||||||||||||||
Interest Rate Swap Derivative |
$ | | $ | 910 | $ | | $ | 910 |
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 only include
derivative 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 resulting
valuation would be classified in Level 3. |
||
The Company has classified derivative assets as other noncurrent assets and derivative
liabilities as other noncurrent liabilities on the consolidated balance sheet. The interest
rate contract derivatives fair values are derived from calculations using observable interest
rate inputs from a financial institution. The fair values of the derivatives are noted in the
tables above. The notional amounts of the interest rate contracts are noted previously in
this footnote. The interest rate cap derivative fair value is recorded in other assets long
term. The fair value of the interest rate swap agreement is recorded in other liabilities
long term. |
||
The following table below categorizes the fair value changes in the derivative agreements
during the three and nine months ended September 30, 2009 (in thousands): |
Amount of Gain (Loss) | Amount of Gain (Loss) | Location of Gain (Loss) | Amount of Gain (Loss) | |||||||||||||||||||||||||||||
Recognized in OCI | Location of Gain | Reclassified from AOCI | Recognized in Income | Recognized in Income on Derivative | ||||||||||||||||||||||||||||
on Derivative | (Loss) | into Income | on Derivative | (Ineffective portion excluded | ||||||||||||||||||||||||||||
(effective portion) | Reclassified from | (effective portion) | (Ineffective portion | from effectiveness testing) | ||||||||||||||||||||||||||||
For the Three | For the Nine | AOCI into Income | For the Three | For the Nine | excluded from | For the Three | For the Nine | |||||||||||||||||||||||||
Months Ended | Months Ended | (effective portion) | Months Ended | Months Ended | effectiveness testing) | Months Ended | Months Ended | |||||||||||||||||||||||||
Interest Rate
Contracts |
82 | (31 | ) | Interest Expense | (133 | ) | (342 | ) | Interest Expense | (3 | ) | (4 | ) |
17
Table of Contents
ITEM 2. Managements Discussion and Analysis of Financial Condition and Results of Operations
The following discussion should be read in conjunction with the Managements Discussion and
Analysis (MD&A) section of the Companys 2008 Annual Report on Form 10-K. Results of the interim
periods presented are not necessarily indicative of the results to be expected for the full year
ending December 31, 2009.
Caution Concerning Forward-Looking Statements
Certain information in this MD&A, in various filings with regulators, in reports to shareholders
and in other communications contains forward-looking statements within the meaning of certain
securities laws and is subject to important risks, uncertainties and assumptions. These
forward-looking statements include, among others, statements with respect to the Companys
industry, objectives, competitive strengths and strategies, future financial performance and market
opportunities. These statements are often, but not always, made through the use of words or
phrases such as expects, anticipates, believes, estimates, and other similar expressions or
future or conditional verbs such as will, should, would and could. There are a number of
important factors that could cause actual results to differ materially from those indicated by such
forward-looking statements. Such factors include, but are not limited to, the ability of the
Company to adequately address: the risks associated with further market acceptance of the Companys
products and services; its ability to manage its growth effectively; its reliance on, and ability
to retain, key customers and key personnel; industry conditions such as consolidation of customers,
competitors and acquisition targets; the Companys ability to acquire a company, manage integration
and potential dilution; the impact of technology changes on its products and service offerings,
including impacts on the intellectual property rights of others; the impact of regulation and
legislation changes in the healthcare industry; and the sufficiency and fluctuations of its
liquidity and capital needs.
When relying on forward-looking information to make decisions, investors and others should
carefully consider the foregoing factors and other uncertainties and potential events. In making
the forward-looking statements contained in this MD&A, the Company does not assume any significant
acquisitions, dispositions or one-time items. It does assume, however, the renewal of certain
customer contracts. Every year, the Company has major customer contracts that are subject to
renewal. In addition, the Company also assumes new customer contracts. In this regard, the
Company is pursuing large opportunities that present a very long and complex sales cycle which
substantially affect its forecasting abilities. The Company has made certain assumptions with
respect to the timing of the realization of these opportunities which it thinks are reasonable but
which may not be achieved. Furthermore, the pursuit of these larger opportunities does not ensure
a linear progression of revenue and earnings since they may involve significant up-front costs
followed by renewals and cancellations of existing contracts. The Company has also assumed that
the material factors referred to in the previous paragraph will not have an impact such that the
forward-looking information contained herein will differ materially from actual results or events.
The foregoing list of factors is not exhaustive and is subject to change and there can be no
assurance that such assumptions will reflect the actual outcome of such items or factors. For
additional information with respect to certain of these and other factors, refer to the Risk
Factors sections of the Companys filings with the Securities and Exchange Commission, including
its 2008 Annual Report on Form 10-K and subsequent Quarterly Reports on Form 10-Q. The
forward-looking statements contained in this MD&A represent the Companys current expectations and,
accordingly, are subject to change. However, the Company expressly disclaims any intention or
obligation to update or revise any forward-looking statements, whether as a result of new
information, future events or otherwise.
Overview
PBM Business
The Company provides comprehensive PBM services to customers, which include managed care
organizations, local governments, unions, corporations, HMOs, employers, workers compensation
plans, third party health care plan administrators, and federal and state government programs
through its network of licensed pharmacies throughout the United States. The PBM services include
electronic point-of-sale pharmacy claims management, retail pharmacy network management, mail
service pharmacy claims management, specialty pharmacy claims management, Medicare Part D services,
benefit design consultation, preferred drug management programs, drug review and analysis,
consulting services, data access and reporting and information analysis. The Company owns a mail
service pharmacy (Mail Service) and a specialty service pharmacy (Specialty Service). In
addition, the Company is a national provider of drug benefits to its customers under the federal
governments Medicare Part D program.
Revenue primarily consists of sales of prescription drugs, together with any associated
administrative fees, to customers and participants, either through the Companys nationwide network
of pharmacies, Mail Service pharmacy or Specialty Service pharmacy. 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.
Participant co-payments related to the Companys nationwide network of pharmacies are not recorded
as revenue. Under the Companys customer contracts, the pharmacy is solely obligated to collect the
co-payments from the participants. As such, the Company does not include participant co-payments
to retail pharmacies in revenue or cost of revenue. If these amounts were included in revenue and
cost of revenue, operating income and net income would not have been affected.
The Company evaluates customer contracts to determine whether it acts as a principal or as an agent
in the fulfillment of prescriptions through its retail pharmacy network. The Company acts as a
principal in most of its transactions with customers and revenue is recognized at the prescription
price (ingredient cost plus dispensing fee) negotiated with customers, as well as an administrative
fee (Gross Reporting). Gross Reporting is appropriate because the Company (i) has separate
contractual relationships with customers and with pharmacies, (ii) is responsible to validate and
manage a claim through the claims adjudication process, (iii) commits to set prescription prices
for the pharmacy, including instructing the pharmacy as to how that price is to be settled
(co-payment requirements), (iv) manages the overall prescription drug relationship with the
patients, who are participants of customers plans, and (v) has credit risk for the price due from
the customer. In instances where the Company merely administers a customers network pharmacy
contract to which the Company is not a party and under which the Company does not assume credit
risk, the Company only records an administrative fee as revenue. For these customers, the Company
earns an administrative fee for collecting payments from the customer and remitting the
corresponding amount to the pharmacies in the customers network. In these transactions, the
Company acts as a conduit for the customer. As the Company is not the principal in these
transactions, the drug ingredient cost is not included in revenue or in cost of revenue. As such,
there is no impact to gross profit based upon whether gross or net reporting is used.
18
Table of Contents
HCIT Business
The Company is also a leading provider of HCIT solutions and services to providers, payers and
other participants in the pharmaceutical supply chain in North America. The Companys product
offerings include a wide range of software products for managing prescription drug programs and for
drug prescribing and dispensing. The Companys solutions are available on a license basis with
on-going maintenance and support or on a transaction fee basis using an Application Service
Provider (ASP) model. The Companys payer customers include managed care organizations, Blue
Cross Blue Shield organizations, government agencies, employers and intermediaries such as Pharmacy
Benefit Managers. The solutions offered by the Companys services assist both payers and providers
in managing the complexity and reducing the cost of their prescription drug programs and dispensing
activities.
The Companys profitability from HCIT depends primarily on revenue derived from transaction
processing services, software license sales, hardware sales, maintenance, and professional
services. Recurring revenue remains a cornerstone of the Companys business model and consists of
transaction processing services and maintenance. Growth in revenue from recurring sources has been
driven primarily by growth in the Companys transaction processing business in the form of claims
processing for its payer customers and switching services for its provider customers. Through the
Companys 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.
Operating Expenses
The Companys operating expenses primarily consist of cost of revenue, product development costs,
selling, general and administrative (SG&A) costs, depreciation and amortization. Cost of revenue
includes the costs of drugs dispensed as well as costs related to the products and services
provided to customers and costs associated with the operation and maintenance of the transaction
processing centers. These costs include salaries and related expenses for professional services
personnel, transaction processing centers personnel, customer support personnel, any hardware or
equipment sold to customers and depreciation expense related to data center operations. Product
development costs consist of staffing expenses to produce enhancements and new initiatives. SG&A
costs relate to selling expenses, commissions, marketing, network administration and administrative
costs, including legal, accounting, investor relations and corporate development costs.
Depreciation expense relates to the depreciation of property and equipment used by the Company.
Amortization expense relates to definite-lived intangible assets acquired through business
acquisitions.
Industry
The PBM industry is intensely competitive, generally resulting in continuous pressure on gross
profit as a percentage of total revenue. In recent years, industry consolidation and dramatic
growth in managed healthcare have led to increasingly aggressive pricing of PBM services. Given
the pressure on all parties to reduce healthcare costs, the Company expects this competitive
environment to continue for the foreseeable future. The Company looks to continue to drive
purchasing efficiencies of pharmaceuticals to improve operating margins as well as targeting the
acquisition of other businesses as ways to achieve its strategy of expanding its product offerings
and customer base to remain competitive. 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 Companys 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 Companys relationships with pharmaceutical
manufacturers and retail pharmacies is very important to the execution of its business strategies.
The Companys future success will hinge on its ability to drive mail volume and increase generic
dispensing rates in light of the significant brand-name drug patent expirations expected to occur
over the next several years, and its ability to continue to provide innovative and competitive
clinical and other services to clients and patients, including the Companys active participation
in the Medicare Part D benefit and the rapidly growing specialty pharmacy industry.
The frequency with which the Companys customer contracts come up for renewal and the potential for
one of the Companys larger customers to terminate, or elect not to renew, its existing contract
with the Company create the risk that the Companys results of operations may be volatile. The
Companys customer contracts generally do not have terms longer than three years and, in some
cases, are terminable by the customer on relatively short notice. The Companys larger customers
generally seek bids from other PBM providers in advance of the expiration of their contracts. In
addition, many of the Companys clients put their contract out for competitive bidding prior to
expiration. If existing customers elect not to renew their contracts with the Company at the
expiry of the current terms of those contracts, and in particular if one of the Companys largest
customers elects not to renew, the Companys recurring revenue base will be reduced and results of
operations will be adversely affected.
The Company operates in a competitive environment as clients and other payers seek to control the
growth in the cost of providing prescription drug benefits. The Companys 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-name drugs by equivalent but much
lower cost generic drugs, obtaining competitive discounts
from brand-name and generic drug pharmaceutical manufacturers, obtaining rebates from brand-name
pharmaceutical manufacturers, securing discounts from retail pharmacies, applying the Companys
sophisticated clinical programs and efficiently administering prescriptions dispensed through the
Companys Mail Service and Specialty Service pharmacies.
Various aspects of the Companys business are governed by federal and state laws and regulations.
Because sanctions may be imposed for violations of these laws, compliance is a significant
operational requirement. The Company believes it is in substantial compliance with all existing
legal requirements material to the operation of its business. There are, however, significant
uncertainties involving the application of many of these legal requirements to its business. In
addition, there are numerous proposed health care laws and regulations at the federal and state
levels, many of which could adversely affect the Companys business, results of operations and
financial condition. The Company is unable to predict what additional federal or state legislation
or regulatory initiatives may be enacted in the future relating to its business or the health care
industry in general, or what effect any such legislation or regulations might have on it. The
Company also cannot provide any assurance that federal or state governments will not impose
additional restrictions or adopt interpretations of existing laws or regulations that could have a
material adverse effect on its business or financial performance.
19
Table of Contents
Competitive Strengths
The Company has demonstrated its ability to serve a broad range of clients from large managed care
organizations and state governments to employer groups with fewer than a thousand members. The
Company believes its principal competitive strengths are:
Flexible, Customized and Independent Services: The Company believes a key differentiator between
itself and its competitors is not only the Companys ability to provide innovative PBM services,
but also to deliver these services on an à la carte basis with transparent pricing. The informedRx
suite offers the flexibility of broad product choice along the entire PBM continuum, enabling
enhanced customer control, solutions tailored to the Companys customers specific requirements,
and transparent pricing. The market for the Companys 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.
Leading technology and platform: The Companys technology is robust, scaleable and
web-enabled. The Companys payer offerings efficiently supported over 440 million transactions in
2008. The platform is able to instantly cross-check multiple processes, such as reviewing claim
eligibility, adverse drug reaction and properly calculating member, pharmacy and payer payments.
The Companys technology is built on flexible, database-driven rule sets and broad functionality
applicable for most any book of business. The Company believes it has one of the most comprehensive
claims processing platforms in the market.
Measurable cost savings for our customers: The Company provides our customers with increased
control over prescription drug costs and drug benefit programs. The Companys transparent pricing
model and flexible product offerings are designed to deliver measurable cost savings to the
Companys customers. The Company believes transparent pricing is a key differentiator from its
competitors for the Companys customers who want to gain control of their prescription drug costs.
For example, the Companys pharmacy network contracts and manufacturer rebate agreements are made
available by the Company to each customer. For customers who select the Companys pharmacy network
and manufacturer rebate services on a fixed fee per transaction basis, there is clarity to the
rebates and other fees payable by the manufacturer to the client. The Company believes that the
Companys transparent model together with the flexibility to select from the Companys broad range
of à la carte services helps our customers realize measurable cost savings.
Selected financial highlights for the three and nine months ended September 30, 2009 compared to
the same periods in 2008
NMHC Acquisition
Effective April 30, 2008, the Company completed its acquisition of National Medical Health Card
Systems, Inc. (NMHC). The Company believes that NMHC is a complementary company, the acquisition
of which has yielded benefits for health plan sponsors through more effective cost-management
solutions and innovative programs. The Company believes that it has operated the combined
companies more efficiently than either company could have operated on its own. The acquisition has
enabled the combined companies to achieve significant synergies from purchasing scale and operating
efficiencies. Purchasing synergies are largely comprised of purchase discounts and/or rebates
obtained from generic and brand name manufacturers and cost efficiencies obtained from retail
pharmacy networks. Operating synergies include decreases in overhead expense, as well as increases
in productivity and efficiencies by eliminating excess capacity. The Company expects synergies to
continue to be realized during the remainder of the year. In the long term, the Company expects
that the acquisition will create significant incremental revenue opportunities. These
opportunities are expected to be derived from a variety of new programs and benefit designs that
leverage client relationships.
Effective with the acquisition, the Company is now comprised of two operating segments: PBM and
HCIT.
Selected financial highlights for the three months ended September 30, 2009 and 2008 are noted
below:
| Total revenue in 2009 was $383.5 million as compared to $318.1 million in 2008. The
increase is largely attributable to an increase in PBM revenue of $60.3 million compared to
2008. PBM revenues increased primarily due to additional services and changes in services
provided to several HCIT customers. These additional services vary by customer, but
include the use of the Companys national pharmacy network, pharmaceutical rebate
agreements, eligibility and clinical services. The addition of these services and the
additional risks and rewards of these contracts have caused the new or revised arrangements
to be accounted for under gross revenue reporting whereas previously, they were accounted
for on a net basis. |
||
| The Company reported net income of $11.2 million, or $0.43 per share (fully-diluted),
for the three months ended September 30, 2009, compared to $3.5 million, or $0.15 per share
(fully-diluted), for the same period in 2008. The increase is driven by higher gross
profit caused by an increase
in revenues, as well as control over SG&A costs. These increases are partially offset by
increases in cost of revenues, interest expense and income taxes. |
Selected financial highlights for the nine months ended September 30, 2009 and 2008 are noted
below:
| Total revenue in 2009 was $995.3 million as compared to $570.2 million in 2008. The
increase is largely attributable to the acquisition of NMHC and the inclusion of a full
nine months of revenue from the Companys new PBM segment for the nine months ended
September 30, 2009 as compared to only five months for the same period last year. |
||
| The Company reported net income of $30.9 million, or $1.22 per share (fully-diluted),
for the nine months ended September 30, 2009 compared to $10.2 million, or $0.44 per share
(fully-diluted), for the same period in 2008. Net income is higher for the nine months
ended September 30, 2009 as compared to the same period in 2008 due to higher gross profit
as a result of having a full nine months of the PBM segment activity in 2009 versus five
months in 2008, as well as additional gross margin generated from new customers added
during 2009. The higher gross profit is offset by higher operating expenses in 2009,
mostly due to a full nine months of the PBM segment costs compared to five months in 2008,
plus higher interest expense and income taxes in 2009. |
20
Table of Contents
Results of Operations
Three months ended September 30, 2009 as compared to the three months ended September 30, 2008
Three months ended September 30, | ||||||||
In thousands, except per share data | 2009 | 2008 | ||||||
Revenue |
$ | 383,529 | $ | 318,101 | ||||
Gross profit |
47,680 | 34,886 | ||||||
Product development costs |
2,833 | 2,486 | ||||||
SG&A |
22,153 | 21,863 | ||||||
Depreciation of property and equipment |
1,467 | 1,222 | ||||||
Amortization of intangible assets |
2,238 | 3,449 | ||||||
Interest expense, net |
987 | 1,101 | ||||||
Other income, net |
(20 | ) | (50 | ) | ||||
Income before income taxes |
18,022 | 4,815 | ||||||
Income tax expense |
6,813 | 1,276 | ||||||
Net income |
$ | 11,209 | $ | 3,539 | ||||
Diluted earnings per share |
$ | 0.43 | $ | 0.15 |
Revenue
Revenue increased $65.3 million to $383.5 million during 2009, primarily due to changes in services
provided to several HCIT customers, as well as from new customers added during the quarter. During
the three months ended September 30, 2009, the terms of services for several HCIT customers were
changed to include, or add more, PBM services. The change in service terms and new contracts moved
these customers from the HCIT segment to the PBM segment. Additionally, the change in services and
contract terms also caused the revenue recognition for these customers to move from net recognition
to gross recognition as the Company is now acting as a principal versus an agent. Overall, these
changes are a result of synergies realized from the NMHC acquisition which has allowed the Company
to offer a broader array of products and services to the Companys customers. The Company will
continue to leverage these synergies to provide incremental revenue opportunities.
Cost of Revenue
Cost of revenue increased $52.6 million to $335.8 million for the three months ended September 30,
2009, primarily due to increased transaction volumes in 2009. The increase consists primarily of
PBM cost of revenue of $48.6 million. Cost of revenue in the PBM segment relates to the actual
cost of the prescription drugs sold. Costs of revenue have increased in line with the increase in
PBM revenues which are driven by prescription drugs sold.
Gross Profit
Gross profit increased $12.8 million to $47.7 million during 2009, primarily due to increased PBM
revenues, coupled with purchasing efficiencies realized in the cost of prescription drugs due to
the increased size of the organization as a result of the NMHC acquisition.
Product Development Costs
Product development costs for the three months ended September 30, 2009 were $2.8 million compared
to $2.5 million for the three months ended September 30, 2008. 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 its market expansion.
SG&A Costs
SG&A costs for the three months ended September 30, 2009 were $22.2 million compared to $21.9
million for the three months ended September 30, 2008. SG&A costs consist primarily of employee
costs in addition to professional services costs, facilities and costs not related to cost of
revenue. These costs have stayed relatively flat versus the prior year due to the Companys focus
on controlling its cost structure.
SG&A costs include stock-based compensation cost of $0.8 million and $0.7 million for the three
months ended September 30, 2009 and 2008, respectively. The increase is primarily attributable to
new grants during the second quarter of 2009.
Depreciation
Depreciation expense relates to property and equipment for all areas of the Company except for
those depreciable assets directly related to the generation of revenue, which is included in the
cost of revenue in the consolidated statements of operations. Depreciation expense was $1.5
million and $1.2 million for the three months ended September 30, 2009 and 2008, respectively. The
expense increase is mostly driven by new asset purchases in 2009.
Amortization
Amortization expense for the three months ended September 30, 2009 and 2008 was $2.2 million and
$3.4 million, respectively. Amortization expense has decreased due to the amortization methodology
for the intangible assets attained from the NMHC acquisition. 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. Accordingly, over time periodic
amortization will decrease. Amortization expense on all the Companys intangible assets is
expected to be approximately $2.2 million for the remainder of 2009. Refer to Note 6 Goodwill and
Other Intangible Assets in the Notes to the Unaudited Consolidated Financial Statements for more
information on amortization expected in future years.
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Table of Contents
Interest Income and Expense
Interest income decreased $0.4 million for the three months ended September 30, 2009 as compared to
the same period in 2008, due primarily to lower interest rates. Interest expense decreased to $1.1
million for the three months ended September 30, 2009 from $1.6 million in the same period in 2008
primarily due to lower interest rates in 2009 compared to 2008, and a higher loss on the interest
rate swap derivative in the three months ended September 30, 2008 compared to the same period in
2009.
Income Taxes
The Company recognized income tax expense of $6.8 million for the three months ended September 30,
2009, representing an effective tax rate of 37.8%, compared to a $1.3 million income tax expense,
representing an effective tax rate of 26.5%, for the same period in 2008. The effective tax rate
increased during the three months ended September 30, 2009 compared to the same period in 2008,
primarily due to the diminishing impact of the income tax benefit produced from the financing
structure used to fund the NMHC acquisition, and the difference in the proportion of overall income
among jurisdictions.
Net Income
The Company reported net income of $11.2 million for the three months ended September 30, 2009, or
$0.43 per share (fully-diluted), compared to $3.5 million, or $0.15 per share (fully-diluted), for
the three months ended September 30, 2008.
Segment Analysis
Effective with the acquisition of NMHC, the Company evaluates segment performance based on revenue
and gross profit. Results for periods reported prior to the three months ended June 30, 2008 were
reported in one operating segment, HCIT. Prior period results have not been restated because to do
so would be impracticable. A reconciliation of the Companys business segments to the consolidated
financial statements for the three months ended September 30, 2009 and 2008 is as follows (in
thousands):
PBM | HCIT | Consolidated | ||||||||||||||||||||||
2009 | 2008 | 2009 | 2008 | 2009 | 2008 | |||||||||||||||||||
Revenue |
$ | 357,473 | $ | 297,178 | $ | 26,056 | $ | 20,923 | $ | 383,529 | $ | 318,101 | ||||||||||||
Gross profit |
$ | 36,239 | $ | 24,524 | $ | 11,441 | $ | 10,362 | $ | 47,680 | $ | 34,886 | ||||||||||||
Gross profit % |
10.1 | % | 8.3 | % | 43.9 | % | 49.5 | % | 12.4 | % | 11.0 | % |
PBM
Revenue was $357.5 million for the three months ended September 30, 2009, an increase of $60.3
million compared to the same period in 2008. The increase is driven by new revenues from several
customers that were previously HCIT customers. During the three months ended September 30, 2009,
the terms of services for several HCIT customers were changed to include, or add more, PBM
services. The change in service terms moved these customers from the HCIT segment to the PBM
segment. Additionally, the change in services and contract terms also caused the revenue
recognition for these customers to move from net recognition to gross recognition as the Company is
now acting as a principal versus an agent.
For the three months ended September 30, 2009 and 2008, there were $3.4 million and $3.9 million of
co-payments, respectively, included in revenue related to prescriptions filled at the Companys
Mail and Specialty Service pharmacies. Co-payments retained by retail pharmacies on prescriptions
filled for participants are not included in revenue for the respective periods. Under customer
contracts, the pharmacy is solely obligated to collect the co-payments from the participants and as
such, the Company does not assume liability for participant co-payments in retail pharmacy
transactions. Therefore, the Company does not include participant co-payments to retail pharmacies
in revenue or cost of revenue.
Cost of revenue was $321.2 million for the three months ended September 30, 2009 compared to $272.7
million for the same period in 2008. Cost of revenue has increased in line with the increase in
PBM revenues, and is predominantly comprised of the cost of prescription drugs. As a percentage of
revenue, cost of revenue was 89.9% and 91.7% for the three months ended September 30, 2009 and
2008, respectively. The decrease in the cost of revenue as a percentage of revenue is due to the
improved purchasing efficiencies for prescription drugs realized as a result of the increased size
of the organization as a result of the NMHC acquisition and 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. The Company will continue to seek opportunities for increased generic
prescription drug usage to help reduce overall prescription drug costs to the Company and its
customers.
Gross profit was $36.2 million for the three months ended September 30, 2009 compared to $24.5
million for the same period in 2008. Gross profit increased due to higher revenues, plus lower
costs of revenue as a percentage of revenues. Gross profit margin was 10.1% and 8.3% for the three
months ended September 30, 2009 and 2008, respectively.
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HCIT
HCIT revenue is comprised of the following components for the three months ended September 30, 2009
and 2008 (in thousands):
2009 | 2008 | |||||||
Recurring |
||||||||
Transaction processing |
$ | 16,461 | $ | 11,631 | ||||
Maintenance |
4,733 | 3,998 | ||||||
Total recurring |
21,194 | 15,629 | ||||||
Non-Recurring |
||||||||
Professional services |
3,187 | 3,836 | ||||||
System sales |
1,675 | 1,458 | ||||||
Total non-recurring |
4,862 | 5,294 | ||||||
Total revenue |
$ | 26,056 | $ | 20,923 | ||||
Total HCIT revenue increased $5.1 million for the three months ended September 30, 2009 as compared
to the same period in 2008. On a percentage basis, recurring revenue accounted for 81.3% and 74.7%
of total HCIT revenue for the three months ended September 30, 2009 and 2008, respectively.
Recurring revenue consists of transaction processing and maintenance revenue.
Recurring Revenue: Recurring revenue increased 35.6% to $21.2 million for the three months ended
September 30, 2009 from $15.6 million for the same period in 2008. Recurring revenue is subject to
fluctuations caused by the following: the number and timing of new customers, fluctuations in
transaction volumes, and the number of contract terminations and renewals.
Transaction processing revenue, which consists of claims processing, increased $4.8 million, or
41.6%, to $16.5 million for the three months ended September 30, 2009 compared to $11.6 million for
the same period in 2008, due primarily to the launch of new contracts during 2008 and 2009 as well
as increased volumes on existing customers. The increase in revenue was offset by a decrease in
transaction processing revenue generated from HCIT customers who moved to the PBM segment in the
third quarter of 2009. As discussed previously, these customers moved to the PBM segment due to
additional services and changes in the nature of the services provided. The changes in our
contractual relationships with these customers also caused revenues to be recognized gross rather
than net, as the Company now acts as a principal versus an agent in those transactions.
Maintenance revenue, which consists of maintenance contracts on system sales, increased $0.7
million to $4.7 million for the three months ended September 30, 2009 compared to $4.0 million for
the same period in 2008, due primarily to the launch of new customer contracts during 2008 and
2009.
Non-Recurring Revenue: Non-recurring revenue decreased to $4.9 million, or 18.7% of total HCIT
revenue, for the three months ended September 30, 2009 from $5.3 million, or 25.3% of total HCIT
revenue, for the same period in 2008. Non-recurring revenues fell as a percentage of HCIT
revenues mostly due to the increase in transaction processing revenues.
Professional services revenue decreased $0.7 million, or 17.0%, to $3.2 million for the three
months ended September 30, 2009 compared to $3.8 million for the same period in 2008. Professional
services revenue is derived from providing support projects for both system sales and transaction
processing clients, on an as-needed basis. This revenue is dependent on customers continuing to
require the Company to assist them on both a fixed bid and time and materials basis.
System sales are derived from license upgrades and additional applications for existing and new
clients, as well as software and hardware sales to pharmacies that purchase the Companys pharmacy
system. Systems sales revenue increased $0.2 million, or 14.9%, to $1.7 million for the three
months ended September 30, 2009 compared to $1.5 million for the three months ended September 30,
2008. This revenue is dependent on acquiring new
customers, or selling license upgrades or additional applications to existing customers, and will
fluctuate accordingly as new customers are added, or license upgrades and additional applications
are sold to existing customers.
Cost of Revenue: Cost of revenue increased 38.4% to $14.6 million for the three months ended
September 30, 2009 from $10.6 million for the three months ended September 30, 2008. The increase
is due primarily to personnel and support costs related to the growing transaction processing
business and related support services.
Cost of revenue includes depreciation expense of $0.6 million for the three months ended September
30, 2009 and $0.5 million for the same period in 2008.
Gross Profit: Gross profit margin was 43.9% for the three months ended September 30, 2009 compared
to 49.5% for the three months ended September 30, 2008. Gross profit margin decreased for the
three months ended September 30, 2009, compared to the same period in 2008, due to fixed costs in
the HCIT segment increasing faster than revenues. A large portion of HCIT costs of revenue are
fixed in nature and do not generally change in line with the increase in revenues. During the
three months ended September 30, 2009, fixed costs increased due to an increase in HCIT personnel
to help support the growing transaction processing and support services businesses. Gross profit
increased $1.1 million to $11.4 million for the three months ended September 30, 2009 as compared
to $10.4 million for the same period in 2008. The increase is due to the increase in transaction
sales in the third quarter of 2009 as compared to the same period last year, offset by increased
support costs for new customers added in 2009 and higher transaction volumes.
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Nine months ended September 30, 2009 as compared to the nine months ended September 30, 2008
Nine months ended September 30, | ||||||||
In thousands, except per share data | 2009 | 2008 | ||||||
Revenue |
$ | 995,318 | $ | 570,173 | ||||
Gross profit |
134,076 | 78,206 | ||||||
Product development costs |
9,024 | 7,425 | ||||||
SG&A |
64,857 | 47,291 | ||||||
Depreciation of property and equipment |
4,354 | 3,416 | ||||||
Amortization of intangible assets |
7,478 | 6,277 | ||||||
Interest expense, net |
2,676 | 198 | ||||||
Other income, net |
(62 | ) | (15 | ) | ||||
Income before income taxes |
45,749 | 13,614 | ||||||
Income tax expense |
14,881 | 3,451 | ||||||
Net income |
$ | 30,868 | $ | 10,163 | ||||
Diluted earnings per share |
$ | 1.22 | $ | 0.44 |
Revenue
Revenue increased $425.1 million to $995.3 million during 2009, primarily due the inclusion of a
full nine months of the activities of NMHC in 2009 as compared to only five months in the prior
year. Revenue under the contracts acquired in the NMHC acquisition are recorded gross as the
Company acts as a principal in the transaction, whereas revenues from the majority of historical
PBM contracts are recorded net as the Company functions as an agent. In addition, revenue
increased due to new contracts and contract amendments entered into with several HCIT customers
that brought them into the PBM segment. Refer to the three months ended September 30, 2009
discussion within this section for further information on these new contracts and contract
amendments.
Cost of Revenue
Cost of revenue increased $369.3 million to $861.2 million during 2009, primarily due to the
increase in revenue over the prior year, and consists primarily of PBM cost of revenue of $819.6
million. Cost of revenue in the PBM segment relates to the actual cost of the prescription drugs
sold. Cost of revenues has increased in line with the increase in PBM revenues, which are driven
by prescription drugs sold. Cost of revenue for the HCIT segment relates primarily to the cost of
labor to deliver the services provided.
Gross Profit
Gross profit increased $55.9 million during 2009, primarily due to the NMHC acquisition, as well as
the launch of new contracts during 2008 and 2009.
Product Development Costs
Product development costs for the nine months ended September 30, 2009 were $9.0 million compared
to $7.4 million for the nine months ended September 30, 2008. 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 its market expansion.
SG&A Costs
SG&A costs for the nine months ended September 30, 2009 were $64.9 million compared to $47.3
million for the nine months ended September 30, 2008. The increase is largely attributable to
increased operating expenses due to the acquisition of NMHC. 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 include stock-based compensation cost of $1.9 million and $2.4 million for the nine
months ended September 30, 2009 and 2008, respectively. The decrease is primarily attributable to
stock options that fully vested in 2008, partially offset by new grants late in 2008 as well as in
2009.
Depreciation
Depreciation expense relates to property and equipment for all areas of the Company except for
those depreciable assets directly related to the generation of revenue, which is included in the
cost of revenue in the consolidated statements of operations. Depreciation expense increased $0.9
million to $4.4 million for the nine months ended September 30, 2009 from $3.4 million for the same
period in 2008, due primarily to the expense related to assets associated with the acquisition of
NMHC, as well as purchases related to the Companys expansion of its Lisle, Illinois facility and
network capacity.
Amortization
Amortization expense for the nine months ended September 30, 2009 was $7.5 million compared to $6.3
million for the same period in 2008. The increase is due to nine months of amortization of
intangible assets associated with the acquisition of NMHC in 2009 compared to five months of
amortization in the same period for 2008. Amortization expense on all the Companys intangible
assets is expected to be approximately $9.7 million for the year ending December 31, 2009. Refer
to Note 6 Goodwill and Other Intangible Assets in the Notes to the Unaudited Consolidated Financial
Statements for more information on amortization expected in future years.
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Table of Contents
Interest Income and Expense
Interest income decreased by $1.6 million for the nine months ended September 30, 2009 as compared
to the same period in 2008 due to lower interest rates. Interest expense increased to $3.3 million
for the nine months ended September 30, 2009, primarily due to the long-term debt incurred to
finance a portion of the NMHC acquisition.
Income Taxes
The Company recognized income tax expense of $14.9 million for the nine months ended September 30,
2009, representing an effective tax rate of 32.5%, compared to a $3.5 million income tax expense,
representing an effective tax rate of 25.3%, for the same period in 2008. The effective tax rate
increased during the nine months ended September 30, 2009 compared to the same period in 2008,
primarily due to the diminishing impact of the income tax benefit produced from the financing
structure used to fund the NMHC acquisition, and the difference in the proportion of overall income
among jurisdictions.
Net Income
The Company reported net income of $30.9 million for the nine months ended September 30, 2009, or
$1.22 per share (fully-diluted), compared to $10.2 million, or $0.44 per share (fully-diluted), for
the nine months ended September 30, 2008.
Segment Analysis
Effective with the acquisition of NMHC, the Company evaluates segment performance based on revenue
and gross profit. Results for periods reported prior to the nine months ended September 30, 2008
were reported in one operating segment, HCIT. Prior period results have not been restated because
to do so would be impracticable. A reconciliation of the Companys business segments to the
consolidated financial statements for the nine months ended September 30, 2009 and 2008 is as
follows (in thousands):
PBM | HCIT | Consolidated | ||||||||||||||||||||||
2009 | 2008 | 2009 | 2008 | 2009 | 2008 | |||||||||||||||||||
Revenue |
$ | 919,158 | $ | 502,038 | $ | 76,160 | $ | 68,135 | $ | 995,318 | $ | 570,173 | ||||||||||||
Gross profit |
$ | 99,550 | $ | 41,338 | $ | 34,526 | $ | 36,668 | $ | 134,076 | $ | 78,206 | ||||||||||||
Gross profit % |
10.8 | % | 8.2 | % | 45.3 | % | 53.8 | % | 13.5 | % | 13.7 | % |
PBM
Revenue was $919.2 million for the nine months ended September 30, 2009 as compared to $502.0
million for the same period last year. The increase is due to the inclusion of a full nine months
of revenue related to the NMHC business as compared to only five months for the same period in
2008. In addition, revenue increased due to new contracts and contract amendments entered into with
several HCIT customers that brought them into the PBM segment. Refer to the three months ended
September 30, 2009 discussion within this section for further information on these new contracts
and contract amendments.
For the nine months ended September 30, 2009 and 2008, there were $9.1 million and $6.6 million of
co-payments, respectively, included in revenue related to prescriptions filled at the Companys
Mail and Specialty Service pharmacy. Co-payments retained by retail pharmacies on prescriptions
filled for participants are not included in revenue for the respective periods. Under customer
contracts, the pharmacy is solely obligated to collect the co-payments from the participants and as
such, the Company does not assume liability for participant co-payments in retail pharmacy
transactions. Therefore, the Company does not include participant co-payments to retail pharmacies
in revenue or cost of revenue.
Cost of revenue was $819.6 million and $460.7 million for the nine months ended September 30, 2009
and 2008, respectively, nearly all of which was due to the acquisition of NMHC. Cost of revenue is
predominantly comprised of the cost of prescription drugs. The increase is due to the inclusion of
a full nine months of revenue related to the NMHC business as compared to only five months for the
same period in 2008.
Gross profit was 10.8% for the nine months ended September 30, 2009 as compared to 8.2% for the
same period last year. The increase is due to increased purchasing efficiencies achieved over the
year due to the increased size of the organization as a result of the NMHC acquisition resulting in
lower cost of prescription drugs and 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. The Company will continue to seek opportunities for increased generic prescription drug
usage to help reduce overall prescription drug costs to the Company and its customers.
HCIT
HCIT revenue is comprised of the following components for the nine months ended September 30, 2009
and 2008 (in thousands):
2009 | 2008 | |||||||
Recurring |
||||||||
Transaction processing |
$ | 45,852 | $ | 38,167 | ||||
Maintenance |
13,684 | 12,338 | ||||||
Total recurring |
59,536 | 50,505 | ||||||
Non-Recurring |
||||||||
Professional services |
10,630 | 10,693 | ||||||
System sales |
5,994 | 6,937 | ||||||
Total non-recurring |
16,624 | 17,630 | ||||||
Total revenue |
$ | 76,160 | $ | 68,135 | ||||
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Total HCIT revenue increased $8.0 million for the nine months ended September 30, 2009 as compared
to the same period in 2008. On a percentage basis, recurring revenue accounted for 78.2% and 74.1%
of total HCIT revenue for the nine months ended September 30, 2009 and 2008, respectively.
Recurring revenue consists of transaction processing and maintenance revenue.
Recurring Revenue: Recurring revenue increased 17.9% to $59.5 million for the nine months ended
September 30, 2009 from $50.5 million for the same period in 2008. Recurring revenue is subject to
fluctuations caused by the following: the number and timing of new customers, fluctuations in
transaction volumes, and the number of contract terminations and renewals.
Transaction processing revenue, which consists of claims processing, increased $7.7 million, or
20.1%, to $45.9 million for the nine months ended September 30, 2009 compared to $38.2 million for
the same period in 2008, due primarily to the launch of new contracts during 2008, as well as
increased volumes on existing customers.
Maintenance revenue, which consists of maintenance contracts on system sales, increased $1.4
million to $13.7 million for the nine months ended September 30, 2009 compared to $12.3 million for
the same period in 2008, due primarily to the launch of new customer contracts during 2008 and
2009.
Non-Recurring Revenue: Non-recurring revenue decreased 5.7% to $16.6 million, or 21.8% of total
HCIT revenue, for the nine months ended September 30, 2009 from $17.6 million, or 25.9% of total
HCIT revenue, for the same period in 2008, due to a decline in system sales revenues of $0.9
million.
Professional services revenue declined slightly to $10.6 million for the nine months ended
September 30, 2009 compared to $10.7 million for the same period in 2008. Professional services
revenue is derived from providing support projects for both system sales and transaction processing
clients, on an as-needed basis. This revenue is dependent on customers continuing to require the
Company to assist them on both a fixed bid and time and materials basis.
System sales are derived from license upgrades and additional applications for existing and new
clients, as well as software and hardware sales to pharmacies that purchase the Companys pharmacy
system. Systems sales revenue decreased $0.9 million, or 13.6%, to $6.0 million for the nine
months ended September 30, 2009 compared to $6.9 million for the nine months ended September 30,
2008. This revenue is dependent on acquiring new customers, or selling license upgrades or
additional applications to existing customers, and will fluctuate accordingly as new customers are
added, or license upgrades and additional applications are sold to existing customers.
Cost of Revenue: Cost of revenue increased 33.1% to $41.6 million for the nine months ended
September 30, 2009 from $31.3 million for the nine months ended September 30, 2008. The increase
is due primarily to personnel and support costs related to the growing transaction processing
business.
Cost of revenue includes depreciation expense of $1.6 million for the nine months ended September
30, 2009 and $1.3 million for the same period in 2008. In addition, cost of revenue includes
stock-based compensation expense of $0.5 million for the nine months ended September 30, 2009 and
$0.4 million for the same period in 2008.
Gross Profit: Gross profit margin was 45.3% for the nine months ended September 30, 2009 compared
to 53.8% for the nine months ended September 30, 2008. Gross profit margin decreased for the nine
months ended September 30, 2009, compared to the same period in 2008, due to fixed costs in the
HCIT segment increasing faster than revenues. A large portion of HCIT costs of revenue are fixed
in nature and do not generally change in line with the increase in revenues. During the nine
months ended September 30, 2009 fixed costs increased due to an increase in HCIT personnel to help
support the growing transaction processing and support services businesses. Gross profit decreased
$2.2 million to $34.5 million for the nine months ended September 30, 2009
as compared to $36.7 million for the same period in 2008. The decrease is due primarily to the
increased costs related to the support of the new business added since September 30, 2008.
Liquidity and Capital Resources
Historically, the Companys sources of liquidity have primarily been cash provided by operating
activities and proceeds from its public offerings. The Companys 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 September 30, 2009 and December 31, 2008, the Company had cash and cash equivalents totalling
$319.5 million and $67.7 million, respectively. The Company believes that its cash on hand,
together with cash generated from operating activities and amounts available under its existing
credit facility, will be sufficient to support planned operations for the foreseeable future. At
September 30, 2009, cash and cash equivalents consist of cash on hand, deposits in banks, money
market funds and bank term deposits with original maturities of 90 days or less. As of September
30, 2009, all of the Companys 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.
Credit Agreement
On April 25, 2008, the Companys U.S. subsidiary, SXC Health Solutions, Inc. (US Corp.), entered
into a credit agreement (the Credit Agreement) providing for up to $58 million of borrowings,
consisting of (i) a $10 million senior secured revolving credit facility (including borrowing
capacity available for letters of credit and for borrowings on same-day notice, referred to as
swing loans (the Revolving Credit Facility) and (ii) a $48 million senior secured term loan (the
Term Loan Facility and, together with the Revolving Credit Facility, the Credit Facilities).
On April 29, 2008, US Corp borrowed $48 million under the Term Loan Facility to pay a portion of
the consideration in connection with the acquisition of NMHC and certain transaction fees and
expenses related to the acquisition.
The interest rates applicable to the loans under the Credit Facilities are based on a fluctuating
rate measured by reference to either, at US Corp.s option, (i) a base rate, plus an applicable
margin, subject to adjustment, or (ii) an adjusted London interbank offered rate (adjusted for
maximum reserves) (LIBOR), plus an applicable margin. The initial margin for all borrowings is
2.25% with respect to base rate borrowings and 3.25% with respect to LIBOR borrowings.
26
Table of Contents
The interest
rate at September 30, 2009 was 3.53%. During an event of default, default interest is payable at a
rate that is 2% higher than the rate otherwise applicable. In addition to paying interest on
outstanding principal under the Credit Facilities, US Corp. is required to pay an unused commitment
fee to the lenders in respect of any unutilized commitments under the Revolving Credit Facility at
a rate of 0.50% per annum. US Corp. is also required to pay customary letter of credit fees.
The Credit Facilities require US Corp. to prepay outstanding loans, subject to certain exceptions,
with:
| 50% of the net proceeds arising from the issuance or sale by the Company of its own common
shares; |
|
| 100% of the net proceeds of any incurrence of debt, other than proceeds from debt permitted
under the Credit Facilities; and |
|
| 100% of the net proceeds of certain asset sales and casualty events, subject to a right to
reinvest the proceeds. |
The foregoing mandatory prepayments will be applied first to the Term Loan Facility and second
to the Revolving Credit Facility.
In September 2009, the Company raised net proceeds of $204.1 million from a public offering of the
Companys common shares as described in Note 8 Shareholders Equity in the Notes to the Unaudited
Consolidated Financial Statements. US Corp. obtained a consent from its creditors which waived the
need to use part of the proceeds to prepay the outstanding loans under the Credit Facilities. The
consent applies only to this public offering of the Company common shares and does not amend the
Credit Facilities for future issuances or other events that would require a prepayment of
outstanding loans under the Credit Facilities as noted above.
The Term Loan Facility will amortize in quarterly installments, which began on June 30, 2008, in
aggregate annual amounts equal to 1% (year 1), 10% (years 2 and 3), 15% (years 4 and 5), and 49%
(year 6) of the original funded principal amount of such facility. Principal repayments will be
$3.7 million in 2009( $1.2 million remaining payments in 2009 as of September 30, 2009), $4.8
million in 2010, $6.6 million in 2011, $7.2 million in 2012, $19.4 million in 2013 and $5.9 million
in 2014. Principal amounts outstanding under the Revolving Credit Facility are due and payable in
full on April 30, 2013.
The Company and all material US subsidiaries of US Corp. guarantee the obligations under the Credit
Agreement. All future material U.S. subsidiaries of the Company, as well as certain future
Canadian subsidiaries, will guarantee the obligations under the Credit Agreement as well. In
addition, the Credit Facilities and the guarantees are secured by the capital stock of US Corp. and
certain other subsidiaries of the Company and substantially all other tangible and intangible
assets owned by the Company, US Corp. and each subsidiary that guarantees the obligations of US
Corp. under the Credit Facilities, subject to certain specified exceptions.
The Credit Agreement also contains certain restrictive covenants, including financial covenants
that require the Company to maintain (i) a maximum consolidated leverage ratio, (ii) a minimum
consolidated fixed charge coverage ratio and (iii) a maximum capital expenditure level. In
addition, the Company was required to enter into interest rate contracts to provide protection
against fluctuations in interest rates for 50% of the borrowed amount as required by the Credit
Agreement.
Consolidated Balance Sheets
At September 30, 2009, cash and cash-equivalents totaled $319.5 million, up $251.8 million from
$67.7 million at December 31, 2008. The increase is primarily related to the $204.1 million in net
proceeds from the public offering of 5,175,000 shares and favorable operating cash flows.
Selected balance sheet highlights at September 30, 2009 are as follows:
| Restricted cash totaling $12.4 million relates to cash balances required to be
maintained in accordance with various state statutes, contractual terms with customers
and other customer restrictions related to the PBM business. The Company continues to
monitor changes in balance requirements that may release restrictions and allow the
funds to be used for general corporate purposes. |
||
| Rebates receivable of $20.6 million relate to billed and unbilled PBM receivables
from pharmaceutical manufacturers in connection with the administration of the rebate
program where the Company is the principal contracting party. The receivable and
related payables are based on estimates, which are subject to final settlement.
Rebates receivable decreased $9.0 million from $29.6 million at December 31, 2008, due
primarily to improved collections of rebates. |
||
| Prepaid expenses and other assets increased $0.3 million to $4.7 million at
September 30, 2009 compared to $4.4 million at December 31, 2008, due primarily to the
renewal of the Companys annual corporate insurance policies in the second quarter of
2009 which expire in 2010, offset by the amortization of the prepayments during 2009. |
||
| The Companys inventory balance of $7.0 million consists predominately of
prescription drugs and medical supplies at its Mail Service and Specialty Service
pharmacies. 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 to properly support sales. |
||
| Other assets of $1.3 million consist primarily of security deposits related to the
Companys distribution facilities. |
||
| Customer deposits payable of $12.6 million relate to deposits required by the
Company from certain customers in order to satisfy liabilities incurred on the
customers behalf for the adjudication of pharmacy claims, and is related to the
restricted cash balances outlined above. |
||
| Pharmacy benefit management rebates payable of $43.8 million represents amounts owed
to customers for rebates from pharmaceutical manufacturers where the Company
administers the rebate program on the customers 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 $7.5 million
from $36.3 million at December 31, 2008 due to increased rebate volumes driven by
increased prescription drug sales transactions. |
||
| Pharmacy benefit claim payments payable of $51.8 million predominantly relates to
amounts owed to retail pharmacies for prescription drug costs and dispensing fees in
connection with prescriptions dispensed by the pharmacies to the Companys customers
when the Company is the principal contracting party with the pharmacy. |
||
| Total long-term debt decreased $2.5 million to $45.1 million at September 30, 2009
from $47.6 million at December 31, 2008 due to quarterly installment payments made in
2009. |
||
| Accrued liabilities decreased $4.3 million to $27.7 million at September 30, 2009
from $32.0 million at December 31, 2008 due primarily to final adjustments made to the
fair values of assumed liabilities related to the NMHC acquisition. In addition, the
decrease is due to payments on previously recorded liabilities related to the NMHC
acquisition. |
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Table of Contents
Cash flows from operating activities:
For the nine months ended September 30, 2009, the Company generated $49.6 million of cash through
its operations. Cash provided by operating activities has increased as compared to the same period
in 2008 mainly due to increased profitability of the Company. The Companys continued focus on
timely collection for its accounts receivables, and cost containment, has also pushed operating
cash flows higher. Cash from operations consisted of net income of $30.9 million adjusted for
$13.5 million in depreciation and amortization, $2.5 million in stock-based compensation expense, a
reduction of rebates receivable of $9.0 million, an increase in deferred revenue of $0.4 million,
an increase in rebates payable of $7.5 million and an increase in customer deposits of $0.7
million. These were partially offset by a reduction of accrued liabilities of $3.6 million, a
decrease in accounts payable of $2.4 million, an increase in accounts receivable of $9.4 million, a
$3.4 million tax benefit from option exercises, and an increase in prepaid expenses of $0.3
million.
Changes in the Companys cash from operations results primarily from increased gross profits and
the timing of collections on its accounts receivable and 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
pharmaceutical manufacturers. The timing of the payments to customers and collections from
pharmaceutical manufacturers on rebates causes fluctuations on the balance sheet, as well as in the
Companys cash from operating activities.
Changes in non-cash items such as depreciation and amortization are caused by the purchase and
acquisition of capital and intangible assets. In addition, as assets become fully depreciated or
amortized, the related expenses will decrease.
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 nine months ended September 30, 2008, the Company generated $20.6 million of cash through
its operations. Cash from operations consisted of net income of $10.2 million adjusted for $11.0
million in depreciation and amortization, $3.0 million in stock-based compensation expense, a
reduction of accounts receivable of $7.9 million, and a reduction in rebates receivable of $3.0
million. These were partially offset by a reduction of accrued liabilities of $4.5 million, an
increase in restricted cash of $4.7 million, and a reduction in pharmacy benefit claim payments
payable of $5.1 million.
Cash flows from investing activities
For the nine months ended September 30, 2009, the Company used $8.8 million of cash for investing
activities, which consisted primarily of $6.6 million for purchases of property and equipment to
support increased transaction volume. In addition, the Company used $2.0 million to purchase the
assets of a small pharmacy system in June 2009 (see Note 4 to the unaudited consolidated financial
statements for more information).
As the Company grows, it continues to purchase capital assets to support increases in network
capacity and personnel. The Company monitors and budgets these costs to ensure the expenditures
aid in its strategic growth plan.
For the nine months ended September 30, 2008, the Company used $108.2 million of cash for investing
activities, which consisted primarily of cash paid for the acquisition of NMHC of $102.6 million,
along with the purchases of property and equipment to support increased transaction volume.
Cash flows from financing activities
For the nine months ended September 30, 2009, the Company generated $211.0 million of cash from
financing activities, which mainly consisted of proceeds from the public offering of 5,175,000
shares, netting $204.1 million. The Company intends to use the net proceeds from the public
offering for general corporate purposes, which may include financing potential acquisitions and
strategic transactions, funding capital expenditures and providing working capital to enhance
capital and maintain financial flexibility. In addition to the cash generated from the public
offering, other items adding to cash inflows from financing activities included proceeds from the
exercise of stock options of $5.9 million and a $3.4 million tax benefit on the exercise of stock
options. These were partially offset by repayments of long-term debt of $2.5 million.
Cash flows from financing activities generally fluctuate based on the timing of option exercises by
the Companys employees, which are affected by market prices, vesting dates and expiration dates.
In addition, the Company is required to make quarterly principal and interest payments on its
long-term debt, which varies based on the loans repayment schedule and respective interest rates.
For the nine months ended September 30, 2008, the Company generated $48.2 million of cash from
financing activities, which consisted of the net proceeds from the issuance of long-term debt of
$46.0 million, the proceeds from the exercise of stock options of $1.4 million, and a $0.8 million
tax benefit on the exercise of stock options.
Future Capital Requirements
The Companys future capital requirements depend on many factors, including its product development
programs. The Company expects to fund the growth of its business through cash flows from
operations and its cash and cash equivalents. The Company expects that purchases of property and
equipment will remain consistent with the prior year. The Company cannot provide assurance that
its actual cash requirements will not be greater than expected as of the date of this report. 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.
If sources of liquidity are not available or if it cannot generate sufficient cash flow from
operations during the next twelve months, the Company might be required to obtain additional funds
through operating improvements, capital markets transactions, asset sales or financing from third
parties or a combination thereof. The Company cannot provide assurance that these additional
sources of funds will be available or, if available, will have reasonable terms.
If adequate funds are not available, the Company may have to substantially reduce or eliminate
expenditures for marketing, research and development and testing of proposed products, or obtain
funds through arrangements with partners that require the Company to relinquish rights to certain
of its technologies
or products. There can be no assurance that the Company will be able to raise
additional capital if its capital resources are exhausted. A lack of liquidity and an inability to
raise capital when needed may have a material adverse impact on the Companys ability to continue
its operations or expand its business.
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Contingencies
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. The Company has considered these
proceedings and disputes in determining the necessity of any reserves for losses that are probable
and reasonably estimable. In addition, various aspects of the Companys business may subject it to
litigation and liability for damages arising from errors in processing prescription drug claims,
failure to meet performance measures within certain contracts relating to its services or its
ability to obtain certain levels of discounts for rebates on prescription purchases from retail
pharmacies and drug manufacturers, or other actions or omissions. The Companys recorded reserves
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 managements
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 routine indemnification to its customers against liability if the Companys
products infringe on a third partys intellectual property rights. The maximum amount of these
indemnifications cannot be reasonably estimated due to their uncertain nature. Historically, the
Company has not made payments related to these indemnifications.
During the routine course of securing new clients, the Company is sometimes required to provide
payment and performance bonds to cover client transaction fees and any funds and pharmacy benefit
claim payments provided by the client in the event that the Company does not perform its duties
under the contract. The terms of these payment and performance bonds are typically one year in
duration and may require renewals for the length of the contract period.
Contractual Obligations
For the three months ended September 30, 2009, there have been no significant changes to the
Companys contractual obligations as disclosed in its 2008 Annual Report on Form 10-K.
Outstanding Securities
As of October 31, 2009, the Company had 29,986,219 common shares outstanding, 1,568,406 options
outstanding and 255,633 restricted stock units outstanding. The options are exercisable on a
one-for-one basis into common shares and, upon vesting, the restricted stock units convert into
common shares on a one-for-one basis.
Critical Accounting Estimates
See Item 7 Managements Discussion and Analysis of Financial Condition and Results of Operations
Critical Accounting Estimates in the 2008 Annual Report on Form 10-K for a discussion of the
Companys critical accounting estimates.
Recent Accounting Standards
See Note 3- Recent Accounting Pronouncements in the Notes to the Unaudited Consolidated Financial
Statements for information on recent accounting pronouncements. The Company is currently assessing
the impact on its financial condition and future operating results for recently issued accounting
guidance, or does not expect the recently issued guidance to have a significant impact on the
Companys financial condition or future results of operations.
ITEM 3. Quantitative and Qualitative Disclosures About Market Risk
The Company is exposed to market risk in the normal course of its business operations, including
the risk of loss arising from adverse changes in interest rates and foreign exchange rates with
Canada.
There has been no material change in the Companys exposure to market risk during the three months
ended September 30, 2009.
ITEM 4. Controls and Procedures
The Company carried out an evaluation under the supervision and with the participation of the
Companys management, including its Chief Executive Officer and Chief Financial Officer, of the
effectiveness of the design and operation of the Companys disclosure controls and procedures as of
the end of the period covered by this Quarterly Report on Form 10-Q (the Evaluation).
In designing and evaluating the disclosure controls and procedures, management recognizes that any
disclosure controls and procedures, no matter how well designed and operated, can provide only
reasonable assurance of achieving the desired control objectives, and management is required to
apply its judgment in evaluating the cost-benefit relationship of possible disclosure controls and
procedures. Based on the Evaluation, the Companys Chief Executive Officer and Chief Financial
Officer concluded that the Companys disclosure controls and procedures, as of the end of the
period covered by this Quarterly Report on Form 10-Q, were effective at the reasonable assurance
level to ensure that information required to be disclosed by the Company in reports that it files
or submits under the Securities Exchange Act of 1934 (the Exchange Act) is recorded, processed,
summarized and reported within the time periods specified in United States Securities and Exchange
Commission rules and forms, and were effective to ensure that the information required to be
disclosed in the
reports filed or submitted by the Company under the Exchange Act, was accumulated
and communicated to management, including to the Chief Executive Officer and the Chief Financial
Officer, to allow timely decisions regarding required disclosure.
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There has been no change in the Companys internal controls over financial reporting (as such term
is defined in Exchange Act Rules 13a-15(f)) during the Companys most recent fiscal quarter that
has materially affected, or is reasonably likely to materially affect, the Companys internal
controls over financial reporting.
PART II. OTHER INFORMATION
ITEM 1. Legal Proceedings
In the ordinary course of business, the Company may become subject to legal proceedings and claims.
The Company is not aware of any legal proceedings or claims, which, in the opinion of management,
will have a material effect on its financial condition, results of operations or cash flows.
However, the results of legal proceedings cannot be predicted with certainty. If the Company failed
to prevail in any of these legal matters or if several of these legal matters were resolved against
the Company in the same reporting period, the operating results of a particular reporting period
could be materially adversely affected. The Company can give no assurance that its operating
results and financial condition will not be materially adversely affected, or that the Company will
not be required to materially change its business practices, based on: (i) future enactment of new
healthcare or other laws or regulations; (ii) a change in the interpretation or application of
existing laws or regulations, as they may relate to the Companys business or the pharmacy benefit
management industry; (iii) future federal or state governmental investigations of the Companys
business or the pharmacy benefit management industry; (iv) institution of government enforcement
actions against the Company; or (v) adverse developments in other pending or future legal
proceedings against the Company or affecting the pharmacy benefit management industry.
ITEM 1A. Risk Factors
In the third quarter of 2009, there have been no material changes from the risk factors previously
disclosed in Item 1A of the Companys 2008 Annual Report on Form 10-K, except for the changes in
the risk noted below.
BUSINESS RISKS
Changes in the industry pricing benchmarks could adversely affect our financial performance.
Contracts in the prescription drug industry, including our contracts with our retail network
pharmacies and with our PBM customers, have traditionally used certain published benchmarks to
establish pricing for prescription drugs. These benchmarks include Average Wholesale Price (AWP),
Average Sales Price (ASP), Average Manufacturer Price, Wholesale Acquisition Cost, and Direct
Price. Most of our contracts with pharmacies and customers historically utilized the AWP standard.
In March 2009, class action litigation against the two primary entities that publish AWP, First
DataBank (FDB) and Medi-Span, was settled. Those cases, which had challenged the way in which the
AWP for certain prescription drugs had been established, were settled with agreements by FDB and
Medi-Span to reduce the reported AWP of certain prescription drugs by approximately four percent
effective September 26, 2009. FDB and Medi-Span also announced that they would discontinue
publishing AWP within two years of the settlement. In response to this action, the Company, as
authorized in most of the Companys standard customer contracts, adopted a revised pricing
benchmark to assure cost neutrality for the Company, its customers and pharmacies as to what they
paid or received, as applicable, for prescription drug products using the AWP pricing benchmark
before September 26, 2009 and what they would pay or receive on or after September 26, 2009. While
that transition has been accomplished to date with no material adverse effect on the Company, there
can be no assurances that customers and pharmacies in reviewing the results of the transition may
not challenge the way in which the transition occurred and/or whether it preserved cost neutrality
as intended, or that the results of such challenges will not have a material adverse effect on our
financial performance, results of operations and financial condition in future periods.
Further, changes in the reporting of any applicable pricing benchmarks, including the expected
introduction of a new pricing benchmark in place of AWP by FDB and Medi-Span, or in the basis for
calculating reimbursements proposed by the federal government and certain states, and other
legislative or regulatory adjustments that may be made regarding the reimbursement of payments for
drugs by Medicaid and Medicare, could impact our pricing to customers and other payors and could
impact our ability to negotiate discounts with manufacturers, wholesalers, or retail pharmacies. In
some circumstances, such changes could also impact the reimbursement that we receive in our mail
order and specialty pharmacies or that we receive from Medicare or Medicaid programs for drugs
covered by such programs and from managed care organizations that contract with government health
programs to provide prescription drug benefits. In addition, it is possible that payors and
pharmacy providers will disagree with the use or application of the changes we have put in place or
begin to evaluate other pricing benchmarks as the basis for contracting for prescription drugs and
PBM services in the future, and the effect of this development on our business cannot be predicted
at this time. Due to these and other uncertainties, we can give no assurance that the short or long
term impact of changes to industry pricing benchmarks will not have a material adverse effect on
our financial performance, results of operations and financial condition in future periods.
ITEM 2. Unregistered Sales of Equity Securities and Use of Proceeds
None.
ITEM 3. Defaults Upon Senior Securities
None.
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ITEM 4. Submission of Matters to a Vote of Security Holders
None.
ITEM 5. Other Information
None.
ITEM 6. Exhibits
Exhibit | ||||
Number | Description of Document | Reference | ||
10.1
|
Underwriting Agreement dated September 17, 2009, among SXC Health Solutions Corp. and J.P. Morgan Securities Inc., as representative of the several underwriters named therein, J.P. Morgan Securities Canada Inc., Paradigm Capital Inc. and Versant Partners Inc. | Incorporated by reference to Exhibit 1.1 to SXC Health Solutions Corps Current Report on Form 8-K filed on September 18, 2009. | ||
31.1
|
Rule 13a-14(a)/15d-14(a) Certification of CEO pursuant to Section 302 of the Sarbanes-Oxley Act | Filed herewith | ||
31.2
|
Rule 13a-14(a)/15d-14(a) Certification of CFO pursuant to Section 302 of the Sarbanes-Oxley Act | Filed herewith | ||
32.1
|
Section 1350 Certification of CEO as adopted by Section 906 of the Sarbanes-Oxley Act | Filed herewith | ||
32.2
|
Section 1350 Certification of CFO as adopted by Section 906 of the Sarbanes-Oxley Act | Filed herewith |
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SIGNATURE
Pursuant to the requirements of the Securities and Exchange Act of 1934, the registrant has duly
caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
SXC Health Solutions Corp. |
||||
November 5, 2009 | By: | /s/ Jeffrey Park | ||
Jeffrey Park | ||||
Chief Financial Officer (on behalf of the registrant and as Chief Accounting Officer) |
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EXHIBIT INDEX
Exhibit | ||||
Number | Description of Document | Reference | ||
10.1
|
Underwriting Agreement dated September 17, 2009, among SXC Health Solutions Corp. and J.P. Morgan Securities Inc., as representative of the several underwriters named therein, J.P. Morgan Securities Canada Inc., Paradigm Capital Inc. and Versant Partners Inc. | Incorporated by reference to Exhibit 1.1 to SXC Health Solutions Corps Current Report on Form 8-K filed on September 18, 2009. | ||
31.1
|
Rule 13a-14(a)/15d-14(a) Certification of CEO pursuant to Section 302 of the Sarbanes-Oxley Act | Filed herewith | ||
31.2
|
Rule 13a-14(a)/15d-14(a) Certification of CFO pursuant to Section 302 of the Sarbanes-Oxley Act | Filed herewith | ||
32.1
|
Section 1350 Certification of CEO as adopted by Section 906 of the Sarbanes-Oxley Act | Filed herewith | ||
32.2
|
Section 1350 Certification of CFO as adopted by Section 906 of the Sarbanes-Oxley Act | Filed herewith |
33