UNITED STATES
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

o		TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

Commission file number: 000-52073

 

SXC HEALTH SOLUTIONS CORP.

Yukon Territory (State or other jurisdiction of incorporation or organization)		75-2578509 (I.R.S. Employer Identification Number)

(800) 282-3232
(Registrant’s 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):.

     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 Registrant’s common shares, no par value, outstanding.

 

 

TABLE OF CONTENTS

				Page
PART I — FINANCIAL INFORMATION				3
Item 1.		Financial Statements (unaudited)		3
		Consolidated Balance Sheets as of September 30, 2009 and December 31, 2008		3
		Consolidated Statements of Operations for the Three and Nine Months Ended September 30, 2009 and 2008		4
		Consolidated Statements of Comprehensive Income for the Three and Nine months ended September 30, 2009 and 2008		5
		Consolidated Statements of Cash Flows for the Nine months ended September 30, 2009 and 2008		6
		Consolidated Statements of Shareholders’ Equity for the Nine months ended September 30, 2009 and 2008		7
		Notes to Consolidated Financial Statements		8
Item 2.		Management’s Discussion and Analysis of Financial Condition and Results of Operations		18
Item 3.		Quantitative and Qualitative Disclosures About Market Risk		29
Item 4.		Controls and Procedures		29
PART II — OTHER INFORMATION				30
Item 1.		Legal Proceedings		30
Item 1A.		Risk Factors		30
Item 2.		Unregistered Sales of Equity Securities and Use of Proceeds		30
Item 3.		Defaults Upon Senior Securities		30
Item 4.		Submission of Matters to a Vote of Security Holders		30
Item 5.		Other Information		31
Item 6.		Exhibits		31
SIGNATURE				32
Exhibit 31.1
Exhibit 31.2
Exhibit 32.1
Exhibit 32.2

Part I. FINANCIAL INFORMATION

ITEM 1. Financial Statements

SXC HEALTH SOLUTIONS CORP.
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.

SXC HEALTH SOLUTIONS CORP.
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.

SXC HEALTH SOLUTIONS CORP.
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.

SXC HEALTH SOLUTIONS CORP.
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.

SXC HEALTH SOLUTIONS CORP.
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.

SXC HEALTH SOLUTIONS CORP.
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 Company’s 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 Company’s 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 Company’s 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 Company’s financial statements, no subsequent events have occurred that would require disclosure in accordance with Financial Accounting Standards Board’s (“FASB”) guidance.
	(d)		Accounting Standards Codification
			Effective with the quarter ended September 30, 2009, the Company adopted the FASB’s 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.

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 Company’s 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 Company’s 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 Company’s 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 Company’s 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 Company’s common shares from a few days before to a few days after the agreement was finalized and announced. To fund the transaction, the Company entered into a six-year $48.0 million term loan agreement. The Company also signed a $10.0 million senior secured revolving credit agreement. NMHC results of operations are included in the consolidated financial statements from the date of acquisition.
		Prior to the acquisition, the Company and one of NMHC’s subsidiaries, NMHCRX, Inc., were parties to a consulting agreement and software license and maintenance agreements pursuant to which the Company licensed, and provided consulting and support services in connection with, certain computer software for one of NMHCRX, Inc.’s claims adjudication systems.
		The 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.

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 Company’s estimates of fair values recognized in the application of purchase accounting, and interest expense on borrowings to finance the acquisition.

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 Company’s 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 Company’s 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 Company’s 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 Company’s 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 Company’s 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 Company’s HCIT segment.

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 Company’s 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 Company’s 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 Company’s 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.

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 Company’s debt at September 30, 2009 is $45.1 million, which approximates its carrying value. The carrying value of the Company’s debt approximates the fair value of the Company’s 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 Company’s shareholders and recipients of awards under the LTIP by increasing the proprietary interest of such recipients in the Company’s 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 Company’s common shares. Common shares will be purchased on the last day of each offering period at a discount of 5% of the fair market value of the common shares on such date. The aggregate number of common shares that may be 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 Company’s 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.

			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

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 Company’s 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 management’s 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 Company’s effective tax rate for the three months ended September 30, 2009 and 2008 was 37.8% and 26.5%, respectively. The Company’s 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 Company’s effective tax rate.

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 Company’s 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 Company’s 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 management’s strategy with regard to the settlement or defense of such claims and obligations. While the ultimate outcome of those claims, lawsuits or performance obligations cannot be predicted with certainty, the Company believes, based on its understanding of the facts of these claims and performance obligations, that adequate provisions have been recorded in the consolidated financial statements where required.
		The Company provides routine indemnification to its customers against liability if the Company’s products infringe on a third party’s 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 Company’s $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.

		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

)

ITEM 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

The following discussion should be read in conjunction with the Management’s Discussion and Analysis (“MD&A”) section of the Company’s 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 Company’s 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 Company’s 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 Company’s 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 Company’s 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 Company’s 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 government’s 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 Company’s 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 Company’s nationwide network of pharmacies are not recorded as revenue. Under the Company’s 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 customer’s 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 customer’s 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.

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 Company’s product offerings include a wide range of software products for managing prescription drug programs and for drug prescribing and dispensing. The Company’s solutions are available on a license basis with on-going maintenance and support or on a transaction fee basis using an Application Service Provider (“ASP”) model. The Company’s 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 Company’s services assist both payers and providers in managing the complexity and reducing the cost of their prescription drug programs and dispensing activities.

The Company’s profitability from HCIT depends primarily on revenue derived from transaction processing services, software license sales, hardware sales, maintenance, and professional services. Recurring revenue remains a cornerstone of the Company’s business model and consists of transaction processing services and maintenance. Growth in revenue from recurring sources has been driven primarily by growth in the Company’s transaction processing business in the form of claims processing for its payer customers and switching services for its provider customers. Through the Company’s transaction processing business, where the Company is generally paid based on the volume of transactions processed, the Company continues to benefit from the growth in pharmaceutical drug use in the United States. The Company believes that aging demographics and increased use of prescription drugs will continue to benefit the transaction processing business. In addition to benefiting from this industry growth, the Company continues to focus on increasing recurring revenue in the transaction processing area by adding new transaction processing customers to its existing customer base. The recognition of revenue depends on various factors including the type of service provided, contract parameters, and any undelivered elements.

Operating Expenses

The Company’s 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 Company’s clients are paramount to its success; the retention of existing and winning of new clients and members poses the greatest opportunity, and the loss thereof represents an ongoing risk. The preservation of the Company’s relationships with pharmaceutical manufacturers and retail pharmacies is very important to the execution of its business strategies. The Company’s 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 Company’s active participation in the Medicare Part D benefit and the rapidly growing specialty pharmacy industry.

The frequency with which the Company’s customer contracts come up for renewal and the potential for one of the Company’s larger customers to terminate, or elect not to renew, its existing contract with the Company create the risk that the Company’s results of operations may be volatile. The Company’s 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 Company’s larger customers generally seek bids from other PBM providers in advance of the expiration of their contracts. In addition, many of the Company’s 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 Company’s largest customers elects not to renew, the Company’s 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 Company’s business model is designed to reduce the level of drug cost. The Company helps manage drug cost primarily by its programs designed to maximize the substitution of expensive brand-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 Company’s sophisticated clinical programs and efficiently administering prescriptions dispensed through the Company’s Mail Service and Specialty Service pharmacies.

Various aspects of the Company’s business are governed by federal and state laws and regulations. Because sanctions may be imposed for violations of these laws, compliance is a significant operational requirement. The Company believes it is in substantial compliance with all existing legal requirements material to the operation of its business. There are, however, significant uncertainties involving the application of many of these legal requirements to its business. In addition, there are numerous proposed health care laws and regulations at the federal and state levels, many of which could adversely affect the Company’s business, results of operations and financial condition. The Company is unable to predict what additional federal or state legislation or regulatory initiatives may be enacted in the future relating to its business or the health care industry in general, or what effect any such legislation or regulations might have on it. The Company also cannot provide any assurance that federal or state governments will not impose additional restrictions or adopt interpretations of existing laws or regulations that could have a material adverse effect on its business or financial performance.

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 Company’s 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 Company’s customers’ specific requirements, and transparent pricing. The market for the Company’s products is divided between large customers that have the sophisticated technology infrastructure and staff required to operate a 24-hour data center and other customers that are not able or willing to operate these sophisticated systems.

Leading technology and platform: The Company’s technology is robust, scaleable and web-enabled. The Company’s 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 Company’s 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 Company’s transparent pricing model and flexible product offerings are designed to deliver measurable cost savings to the Company’s customers. The Company believes transparent pricing is a key differentiator from its competitors for the Company’s customers who want to gain control of their prescription drug costs. For example, the Company’s pharmacy network contracts and manufacturer rebate agreements are made available by the Company to each customer. For customers who select the Company’s pharmacy network and manufacturer rebate services on a fixed fee per transaction basis, there is clarity to the rebates and other fees payable by the manufacturer to the client. The Company believes that the Company’s transparent model together with the flexibility to select from the Company’s 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 Company’s 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 Company’s 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.

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 Company’s 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 Company’s 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