SYSTEMS
XCELLENCE INC.
MANAGEMENT’S
DISCUSSION AND ANALYSIS
(U.S.
dollars unless otherwise specified)
You
should read the following in conjunction with the audited annual and unaudited
interim consolidated financial statements and the notes of Systems Xcellence,
Inc. (“the Company”). The consolidated financial statements have been prepared
in accordance with Canadian GAAP. A reconciliation of significant differences
between Canadian GAAP and US GAAP of the net income, balance sheet, and cash
flow items is presented in Note 9 of the interim financial statements. The
forward-looking statements in this discussion regarding industry, our
expectations regarding future performance, liquidity and capital resources
and
other non-historical statements in this discussion include numerous risks
and
uncertainties, as described in the “Risk Factors” section. The Company’s actual
results may differ materially from those contained in any forward-looking
statements. You should read this discussion completely and with the
understanding that actual future results may be materially different from
expected results. Management is under no obligation to update these
forward-looking statements after the date of these interim financial statements,
even though the Company’s situation will change in the future. All
forward-looking statements attributable to the Company are expressly qualified
by these cautionary statements.
RISK
FACTORS
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 may not be limited to, the ability of the Company to adequately
address: the risks associated with acquisitions; the Company’s dependence on key
customers and key personnel; competition from both existing and new sources;
expanding its service offerings; the impact of technological change on its
product and service offerings; potential fluctuations in financial results;
the
sufficiency of its liquidity and capital needs; the indebtedness of the Company;
the volatility of its share price; the Company’s limited history of
profitability; the continued viability of its proprietary technology; its
product liability and insurance needs; its reliance on key suppliers, if
any;
continued confidence in e-commerce as an on-line delivery mechanism for
information; and the impact of government regulation on the business. The
primary risks affecting the Company are substantially unchanged from those
discussed in the Company's MD&A for the year ended December 31, 2005 and in
the prospectus dated June 22, 2006.
OVERVIEW
Company
Summary
The
Company is a leading provider of healthcare information technology solutions
and
services to providers, payers and other participants in the pharmaceutical
supply chain in the United States and Canada. The Company’s product offerings
include a wide range of pharmacy benefit management services and software
products for managing prescription drug programs and for drug prescribing
and
dispensing. The software products 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 over 70
Managed Care Organizations, Blue Cross Blue Shield organizations, government
agencies, employers and intermediaries such as Pharmacy Benefit Managers
(“PBMs”). Our provider customers include over 1,200 independent, regional chain,
institutional, and mail-order pharmacies. The solutions and 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 revenue is primarily derived from transaction processing services,
software license sales, hardware sales, maintenance, and professional services.
Revenue from transaction processing includes ASP and switching services and
is
recognized as services are provided. Revenue from software licenses and hardware
sales is recognized when a license agreement is executed with the customer,
the
software or hardware product has been delivered, the amount of the fees to
be
paid by the customer is fixed and determinable, and collection of these fees
is
deemed probable. Fees are reviewed for arrangements with significant payment
due
beyond normal trading terms to evaluate whether they are fixed or determinable.
If the fee is not fixed or determinable, revenue is recognized as the payments
become due from the customer. If collectibility is not considered probable,
revenue is recognized when the fee is collected. In cases where collectibility
is not deemed probable, revenue is recognized upon receipt of cash, assuming
all
other criteria have been met. Maintenance and professional services revenues
are
recognized as the services are performed. Professional services revenue
attributed to fixed price arrangements is recognized using the percentage
of
total estimated direct labor costs to complete the project. For arrangements
that are not fixed price arrangements, both
the
license revenue and professional services revenue are recognized using the
percentage-of-completion method where reasonably dependable estimates of
progress toward completion of a contract can be made. For more information
on
our revenue recognition policies, see ‘‘Critical Accounting Policies and
Estimates.’’
The
Company’s expenses primarily consist of cost of goods sold, product development
costs and selling, general and administrative (“SG&A”) costs. Cost of goods
sold includes 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 and any hardware or equipment sold to customers.
Product development costs consist of staffing expenses in support of the
payer
and provider products. In general, such costs are not directly related to
specific customer products or deliverables, but rather to enhancements and
new
initiatives. SG&A costs relate to selling expenses, commissions, marketing,
network administration and administrative costs that include legal, accounting,
investor relations and corporate development costs.
Outlook
SXC
continued to experience strong organic growth in transaction revenue for
the
three months ended September 30, 2006. This reflected growth from increased
transactions processed from existing commercial customers as well as Part
D
enrollees.
The
Company continued to expand its market penetration, including support for
institutional pharmacies serving long-term care facilities, which provides
a new
market for our transaction processing services. We expect that the aging
population and the increased complexity of Part D solutions for this demographic
will create a new high growth market opportunity for our existing technology
solutions. The Company continues to invest resources in both product development
and infrastructure. These efforts will support the significant growth in
transactions and services the Company has experienced, including the $1.4
million in capital expenditures during the quarter.
With
its facility requirements expanding, the Company will incur additional capital
costs during the fourth quarter of 2006 related to moving the U.S. head office
in Chicago.
The
financing completed in late June 2006 will provide the Company with additional
resources to support its plans for an accretive acquisition. The Company
is
actively targeting companies which would allow it to more deeply penetrate
the
payer market with solutions which expand its clinical and PBM capabilities.
In
addition, the financing has enabled the Company to repay its existing credit
facility of $12.9 million, which incurred interest expense of approximately
$1.8
million during 2005. The Company believes the U.S. listing (NASDAQ: SXCI)
will
provide it with a foundation to help increase awareness and liquidity in
the
long-term, and will expand the Company’s access to growth capital via U.S.
capital market relationships.
The
Company continues to attract attention from customers looking for more
flexibility and transparent pricing. The Company’s InformedRx offering, which
includes PBM services, is ideally suited for mid-sized employer groups looking
to gain more control over their prescription drug costs, and is expected
to be a
core growth engine in 2006 and beyond.
OVERALL
PERFORMANCE
During
the three months ended September 30, 2006, the Company’s financial performance
was affected by a number of important factors.
Total
Revenue
Total
revenue increased 43% to $21.0 million for the third quarter of 2006 from
$14.7
million for the third quarter of 2005.
Growth
in Pharmacy Benefit Management Services
During
2006, the Company has continued to build the InformedRx pharmacy benefit
management service offering that expands on the adjudication of prescription
drug claims to include the design of healthcare benefit plans for members,
managing the reimbursement of retail pharmacies in a pharmacy network, analyzing
drug utilization, managing rebate
contracts
with pharmaceutical manufacturers and establishing web portals to extend
the
point-of-contact between benefit plans and members. In addition, certain
customers utilized the Company’s pharmacy network to process prescription drug
benefits generated by their Medicare-approved discount drug card
program.
Recurring
Revenue
Recurring
revenue increased 63% to $14.3 million for the third quarter of 2006 from
$8.8
million for the third quarter of 2005. This increase is due primarily to
growth
in the transaction processing business (including InformedRx), the claims
processing and pharmacy benefit management services for the Company’s payer
customers, and switching and maintenance services for provider customers.
Transaction
processing revenue for the third quarter of 2006 increased $5.0 million,
or 93%,
as compared to the same period last year due to the new Medicare Part D
benefits, a federal program that allows for prescription drug coverage for
seniors.
The
Company continues to believe 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 the transaction processing segment of recurring revenue
by
adding new transaction processing customers to the existing customer
base.
RESULTS
OF OPERATIONS
The
discussion and analysis that follows relates to the results of operations
of the
Company and should be read in conjunction with the consolidated financial
statements and notes for the three and nine month periods ended September
30,
2006 and 2005 and the Company’s annual financial statements for the year ended
December 31, 2005, which are all available on www.sedar.com. The
financial statements, unless otherwise stated, are expressed in US
dollars.
Third
Quarter Results
Revenue
Consolidated
revenue increased $6.3 million, or 43%, to $21.0 million for the third quarter
of 2006 from $14.7 million for the third quarter of 2005.
Transaction
processing revenue (consisting of claims adjudication, benefits processing,
and
switching revenue) increased $5.0 million, or 93%, primarily due to the
introduction of Medicare Part D prescription benefit coverage, new payer
customers choosing the Company’s outsourced transaction processing offering, as
well as the organic growth of existing payer customers.
Professional
services revenue increased $0.4 million, or 10%, primarily due to the consulting
and implementation services performed for existing customers.
Systems
sales revenue (consisting of hardware and software license revenue) increased
$0.5 million, or 20%, primarily
due to work performed for customers under the Medicare Part D
program.
Maintenance
revenue (consisting of hardware and software maintenance and certain pharmacy
services) increased $0.5 million, or 14%, primarily due to new system
sales.
On
a percentage basis, recurring revenue accounted for 68% and 60% of consolidated
revenue in the
third quarter of 2006 and 2005, respectively. Recurring revenue consists
of
transaction processing and maintenance revenue.
Gross
Profit
Gross
profit was 61% for the third quarter of 2006 compared to 65% for the third
quarter of 2005. This decrease was primarily a result of the increase in
the
sale of lower margin professional services, in addition to a lower percentage
of
high margin system sales.
Product
Development Costs
Product
development costs were $2.3 million for the third quarter of 2006 and 2005.
This
represented 11% and 16% of revenue for the third quarter of 2006 and 2005,
respectively. The decrease in product development costs as a percentage of
revenue is the result of increased utilization of the Company’s employees for
professional services projects.
Selling,
General and Administrative Costs
SG&A
costs for the third quarter of 2006 were $4.5 million, or 22% of revenue,
compared to $3.5 million, or 24% of revenue, for the third quarter of 2005.
SG&A costs increased primarily as a result of additional sales resources to
continue the growth of the Company and costs related to the Sarbanes Oxley
initiatives.
Amortization
Amortization
expense (consisting of depreciation and amortization expense) increased to
$1.2
million for the third quarter of 2006 compared to $0.9 million for the third
quarter of 2005 due primarily to the build-out of the Company’s Scottsdale
location, and data center capacity to support the higher transaction volumes.
Stock-based
Compensation
The
Company accounts for all stock-based payments to employees and non-employees
using the fair value based method. Under the fair value based method,
compensation cost is measured at fair value on the grant date and recognized
over the vesting period. Stock compensation expense increased from $0.2 million
for the third quarter of 2005 to $0.5 million for the third quarter of 2006.
This increase was due to the issuance of 729,000 options during 2006 in
connection with the Company’s stock option plan as well as the an increase in
the fair value of the options issued.
Interest
Income and Expense
Interest
income increased $0.8 million to $0.9 million for the third quarter of 2006
from
$0.1 million for the third quarter of 2005. This increase was due to additional
cash balances available for investment from the Company’s equity offering in
November 2005 and June 2006. Interest expense increased to $1.1 million for
the
third quarter of 2006 from $0.4 million for the third quarter of 2005 due
to the
payoff of long-term debt in July 2006.
Income
Taxes
Current
tax expense of $0.9 million and future tax expense of $0.7 million were
recognized in the third quarter of 2006. The current tax expense includes
income
taxes related to U.S. pre-tax net income calculated at a rate of 36%. The
Company’s effective tax rate for the third quarter of 2006 is 39.4% due to $0.2
million of withholding tax related to intercompany debt that is included
in
current tax expense.
Net
income
The
Company reported net income of $2.5 million for the third quarter of 2006
compared to $2.2 million for the third quarter of 2005. The increase of $0.3
million was primarily due to an increase in revenue of $6.3 million and a
decrease in net interest expense of $0.2 million, offset by an increase in
project costs of $3.0 million, an increase in SG&A of $1.0 million, an
increase in income tax expense of $1.7 million, an increase in stock-based
compensation of $0.2 million, and an increase in amortization expense of
$0.3
million.
Nine
Month Results
Revenue
Consolidated
revenue increased $21.4 million, or 57%, to $58.9 million for the nine months
ended September 30, 2006 from $37.5 million for the nine months ended September
30, 2005.
Transaction
processing revenue increased $12.7 million, or 82%, primarily due to the
introduction of Medicare Part D prescription benefit coverage, new payer
customers choosing the Company’s outsourced transaction processing offering, as
well as the organic growth of existing payer customers.
Systems
sales revenue increased by $3.0 million, or 66%, primarily due to upgrades
for
license clients with tiered license upgrade fees which are linked to the
transaction processing volumes and the result of work performed for customers
under the Medicare Part D program, as well as selling more processing tiers
to
existing license customers.
Professional
services revenue increased by $4.6 million, or 61%, primarily due to consulting
and implementation services performed in regards to the Medicare Part D program
for existing customers as well as some larger, long-term consulting projects
for
existing customers.
Maintenance
revenue increased by $1.1 million, or 11%, primarily due to new system sales
compared to the prior period.
On
a percentage basis, recurring revenue accounted for 67% and 68% of consolidated
revenue for the nine months ended September 30, 2006 and 2005, respectively.
Recurring revenue consists of transaction processing and maintenance revenue.
The decrease on a percentage basis was primarily a result of the significant
percentage increase in systems sales, which are included in non-recurring
revenues.
Gross
Profit
Gross
profit was 60% and 61% for the nine months ended September 30, 2006 and 2005,
respectively due primarily to the increase in the sale of higher margin
transaction processing services and an increase in the sale of high margin
software licenses and transaction processing revenue during the
period.
Product
Development Costs
Product
development costs were $6.4 million, or 11% of revenue, and $6.8 million,
or 18%
of revenue, for the nine months ended September 30, 2006 and 2005, respectively.
The decrease is the result of increased utilization of the Company’s employees
for professional services projects.
Selling,
General and Administrative Costs
SG&A
costs were $12.7 million, or 22% of revenue, and $8.7 million, or 23% of
revenue, for the nine months ended September 30, 2006 and 2005, respectively.
The decrease as a percentage of revenue is due primarily to the continued
focus
on cost control and improving operational efficiencies. The $4.0 million
increase in costs relates to increased consulting, infrastructural and
recruiting expenses to support the Company’s growth.
Amortization
Amortization
expense (consisting of depreciation and amortization expense) was $3.1 million
and $2.6 million for the nine months ended September 30, 2006 and 2005,
respectively. The increase is due primarily to the build-out of the Company’s
Scottsdale location and increase in data center processing capacity during
2006.
Lease
termination charge
On
March 24, 2006, the Company entered into a new operating lease agreement
for new
office space in Lisle, Illinois. The lease is effective February 1, 2007
and
carries a term of 11 years. As
part of the agreement, the Company received certain leasehold inducements
including a cash inducement of $0.8 million, which will be recognized over
the
term of the lease as a charge against rent expense.
The
minimum payments under the lease agreement are as follows:
|
2007
|
|
$
|
829,127
|
|
|
2008
|
|
|
934,653
|
|
|
2009
|
|
|
967,544
|
|
|
2010
|
|
|
1,000,435
|
|
|
2011
|
|
|
1,033,326
|
|
|
Thereafter
|
|
|
6,993,448
|
|
| |
|
$
|
11,758,533
|
|
Coterminous
with this new lease agreement, the Company gave notice to the lessor of the
U.S.
Headquarters located in Lombard, Illinois, to terminate the lease effective
June
30, 2007. The Company paid $757,815 for this lease termination option which
was
expensed in the period.
Stock-based
Compensation
The
Company accounts for all stock-based payments to employees and non-employees
using the fair value based method. Under the fair value based method,
compensation cost is measured at fair value on the grant date and recognized
over the vesting period. Stock compensation expense was $1.4 million and
$0.6
million for the nine months ended September 30, 2006 and 2005, respectively.
This increase was due to the issuance of 729,000 options issued during 2006
in
connection with the Company’s stock option plan, as well as an increase in the
fair value of the options issued.
Interest
Income and Expense
Interest
income was $1.9 million and $0.3 million for the nine months ended September
30,
2006 and 2005, respectively. This increase was due primarily to additional
cash
balances available for investment from the Company’s equity offerings in
November 2005 and June 2006. Interest expense increased to $1.8 million from
$1.3 million for the nine months ended September 30, 2006 and 2005,
respectively.
Income
Taxes
During
the first quarter of 2006, it was determined by management that the company
will
be able to utilize a taxable benefit from historical net operating losses
and
tax-related timing, in accordance with CICA Handbook Section 3465, Income
Taxes.
As a result, approximately $2.5 million of previously unrecognized future
tax
assets (“FTAs”) were recognized. At December 31, 2005, approximately $0.7
million of FTAs already existed on the Company’s balance sheet.
A
future tax benefit of $1.8 million and current tax expense of $2.7 million
were
recognized for the nine months ended September 30, 2006. The current tax
expense
includes income taxes related to U.S. pre-tax net income calculated at a
rate of
36% in addition to $0.2 million in withholding tax related to intercompany
debt.
Net
income
Net
income was $10.2 million and $3.8 million for the nine months ended September
30, 2006 and 2005, respectively. The $6.4 million increase was primarily
the
result of an increase in revenue of $21.4 million and an increase in net
interest income of $1.2 million, offset by an increase in professional services
of $4.6 million, an increase in project costs of $8.8 million, an increase
in
SG&A costs of $4.1 million, an increase in lease termination charges of $0.8
million, an increase in stock-based compensation of $0.8 million, and an
increase in amortization of $0.5 million.
The
increase in revenue was generated primarily from growth in the Company’s
transaction processing revenue, and consulting, implementation and system
sales
related to Medicare Part D. The increase in project costs was required to
support the revenue growth. The increase in SG&A costs related primarily to
consulting, infrastructural and recruiting fees.
Adjusted
EBITDA Reconciliation to Net Income
Adjusted
EBITDA is a non-GAAP measure that management believes is a useful supplemental
measure of operating performance prior to amortization, debt service and
income
tax. Investors are cautioned that Adjusted EBITDA should not be construed
as an
alternative to net income, determined in accordance with GAAP, as an indicator
of the Company’s performance or to cash flows from operations as a measure of
liquidity and cash flows. Adjusted EBITDA may differ from the methods used
by
other companies and, accordingly, it may not be comparable to similarly titled
measures used by other companies. Reconciliation of Adjusted EBITDA to net
income is shown below:
| |
|
Three
months ended
|
|
Nine
months ended
|
|
| |
|
September
30,
|
|
September
30,
|
|
| |
|
2006
|
|
2005
|
|
2006
|
|
2005
|
|
|
Adjusted
EBITDA
|
|
$
|
6,030,412
|
|
$
|
3,662,878
|
|
$
|
16,363,903
|
|
$
|
7,503,618
|
|
|
Amortization
|
|
|
(1,191,747
|
)
|
|
(856,846
|
)
|
|
(3,138,294
|
)
|
|
(2,607,009
|
)
|
|
Stock-based
compensation
|
|
|
(471,110
|
)
|
|
(226,791
|
)
|
|
(1,384,843
|
)
|
|
(594,995
|
)
|
|
Gain
on sale of asset
|
|
|
-
|
|
|
-
|
|
|
-
|
|
|
626,342
|
|
|
Lease
termination fee
|
|
|
-
|
|
|
-
|
|
|
(757,815
|
)
|
|
-
|
|
|
Other
income (expense)
|
|
|
(9,254
|
)
|
|
-
|
|
|
21,177
|
|
|
-
|
|
|
Net
interest income (expense)
|
|
|
(158,629
|
)
|
|
(338,753
|
)
|
|
105,812
|
|
|
(1,063,937
|
)
|
|
Income
tax benefit (expense)
|
|
|
(1,656,055
|
)
|
|
(30,507
|
)
|
|
(975,246
|
)
|
|
(92,017
|
)
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income
after taxes
|
|
$
|
2,543,617
|
|
$
|
2,209,981
|
|
$
|
10,234,694
|
|
$
|
3,772,002
|
|
OUTSTANDING
SHARES
At
October 20, 2006, the Company had outstanding 20,379,824 common shares and
2,122,791 share-purchase options outstanding at a weighted average exercise
price of CDN $8.20.
LIQUIDITY
AND CAPITAL RESOURCES
At
September 30, 2006, the Company had a working capital position of $70.2 million,
with cash and cash-equivalents of $61.4 million, compared to $37.3 million
of
working capital and $36.0 million of cash and cash-equivalents at December
31,
2005. The $25.4 million increase in the Company’s cash position was primarily
the result of $36.1 million of cash generated from the public offering in
June
2006, partially offset by cash used to pay off long-term
liabilities.
Cash
flows from operating activities
During
the nine months ended September 30, 2006, the Company generated cash from
operations of $8.4 million, which primarily consisted of $10.2 million of
net
income adjusted for $3.9 million in amortization of capital and intangible
assets, $1.4 million in stock-based compensation expense, a future tax asset
of
$1.8 million, a $6.2 million decrease in non-cash working capital and $0.8
million in deferred lease inducements. This compares to $9.2 million of cash
generated from operations in 2005, which primarily consisted of net income
of
$3.8 million adjusted for a $2.9 million increase in non-cash working capital,
a
$2.6 million in amortization of intangible and capital assets, $0.6 million
in
gains on the sale of the Milton building, and $0.6 million of stock-based
compensation expense.
Cash
flows from financing activities
During
the nine months ended September 30, 2006, the Company generated cash from
financing activities of $21.8 million, which consisted of $34.7 million in
net
proceeds from a NASDAQ public offering and $0.2 million in proceeds from
stock
option exercises, offset by the $13.1 million repayment of long-term
liabilities. This compares to $0.7 million used during the nine months ended
September 30, 2005, which consisted primarily of the $0.8 million repayment
of
long-term liabilities.
Cash
flows from investing activities
During
the nine months ended September 30, 2006, the Company used cash for investing
activities of $4.7 million consisting primarily of capital purchases to support
increased ASP activity related to Medicare Part D. This compares to $21.9
million used during the nine months ended September 30, 2005, which consisted
of
the $22.4 million related to the acquisition of Health Business Systems and
$1.6
million of capital purchases, offset by $2.3 million of proceeds from the
disposal of capital assets.
The
company believes that cash flow generated from operations will be sufficient
to
fund working capital requirements and anticipated capital expenditures in
2006.
SUMMARY
OF QUARTERLY RESULTS (UNAUDITED)
The
following table provides summary quarterly results (unaudited) for the eight
quarters prior to and including the quarter ended September 30, 2006 (US
dollars
in thousands except per share data):
| |
|
2006
|
|
2005
|
|
2004
|
|
| |
|
Third
|
|
Second
|
|
First
|
|
Fourth
|
|
Third
|
|
Second
|
|
First
|
|
Fourth
|
|
| |
|
Quarter
|
|
Quarter
|
|
Quarter
|
|
Quarter
|
|
Quarter
|
|
Quarter
|
|
Quarter
|
|
Quarter
|
|
|
Revenue
|
|
$
|
21,046
|
|
$
|
18,528
|
|
$
|
19,337
|
|
$
|
16,611
|
|
$
|
14,730
|
|
$
|
12,209
|
|
$
|
10,573
|
|
$
|
8,526
|
|
|
Recurring
revenue
|
|
$
|
14,252
|
|
$
|
12,734
|
|
$
|
12,411
|
|
$
|
9,393
|
|
$
|
8,770
|
|
$
|
8,434
|
|
$
|
8,193
|
|
$
|
5,782
|
|
|
Recurring
revenue
|
|
|
68
|
%
|
|
69
|
%
|
|
64
|
%
|
|
57
|
%
|
|
60
|
%
|
|
69
|
%
|
|
78
|
%
|
|
68
|
%
|
|
Operating
income
|
|
$
|
4,349
|
|
$
|
3,071
|
|
$
|
3,624
|
|
$
|
3,783
|
|
$
|
2,379
|
|
$
|
1,323
|
|
$
|
400
|
|
$
|
877
|
|
|
Net
Income
|
|
$
|
2,544
|
|
$
|
2,065
|
|
$
|
5,577
|
|
$
|
3,950
|
|
$
|
2,210
|
|
$
|
1,546
|
|
$
|
16
|
|
$
|
647
|
|
|
Basic
EPS
|
|
$
|
0.12
|
|
$
|
0.12
|
|
$
|
0.33
|
|
$
|
0.26
|
|
$
|
0.15
|
|
$
|
0.11
|
|
$
|
-
|
|
$
|
0.05
|
|
|
Dilute
EPS
|
|
$
|
0.12
|
|
$
|
0.12
|
|
$
|
0.31
|
|
$
|
0.24
|
|
$
|
0.14
|
|
$
|
0.10
|
|
$
|
-
|
|
$
|
0.05
|
|
For
the Eight Quarters Ended September 30, 2006
Revenue
has steadily increased from $8.5 million to $21.0 million between the fourth
quarter of 2004 and the third quarter of 2006. Total revenue increased from
$18.5 to $21.0 million between the second and third quarters of 2006 primarily
due to increased transaction processing.
Recurring
revenue has increased over the past eight quarters from $5.8 million to $14.3
million as a result of increased transaction processing revenue from the
introduction of Medicare Part D prescription benefit coverage, new payer
customers choosing the Company’s outsourced transaction processing offering, as
well as the organic growth of existing payer customers.
The
recurring revenue percentage has fluctuated both up and down over the past
eight
quarters. The recurring revenue percentage from the third and fourth quarters
of
2005 were down compared to prior quarters primarily because both quarters
had a
larger mix of systems sales related to revenue from Medicare Part D modules
being recognized during those two quarters. The recurring revenue percent
increased in the first two quarters of 2006 primarily due to a higher mix
of
transaction processing revenue compared with the remaining recognition of
the
Medicare Part D system sales.
Operating
income steadily increased from $0.9 million for the fourth quarter of 2004
to
$3.8 million for the fourth quarter of 2005. Operating income declined for
the
first and second quarters of 2006 primarily due to the recognition of a one-time
lease termination fee of $0.8 million.
Net
income has increased from $0.6 million for the fourth quarter of 2004 to
$5.6
million for the first quarter of 2006. Net income was positively impacted
by the
set-up of $2.5 million of future tax assets related to future taxable benefits
that were determined by management to “more likely than not” be realizable in
the future, offsetting taxable income.
Net
income decreased $3.5 million between the first and second quarters of 2006
primarily due to the set-up of the future tax asset of $2.5 million in the
first
quarter of 2006, as well as the Company being fully taxable in the second
and
third quarters of 2006.
Net
income increased $0.5 million between the second and third quarter of 2006
primarily due to an increase in revenue of $2.5 million, offset by increased
cost of sales, increased taxes and $1.0 million in loan fees related to the
payoff of long-term debt.
FINANCIAL
INSTRUMENTS AND OTHER INSTRUMENTS
The
Company entered into a credit facility agreement with MCG Capital Corporation
in
December 2002 as a result of a refinancing of existing debt. The credit facility
consisted of a $1.0 million revolving line of credit and a $7.6 million term
loan. In connection with the HBS acquisition, in December 2004 the Company
refinanced its credit facility by terminating the revolving credit facility,
expanding the term loan to $13.6 million and renegotiating its
covenants.
On
July 5, 2006, the Company repaid its outstanding line of credit and
term loan with MCG Capital Corporation. The Company paid cash consideration
of
$12,785,207, which consisted of $12,580,000 in principal and $205,207 in
a
prepayment fee and accrued interest. Accordingly, the Company wrote off related
unamortized deferred charges of $821,641.
The
Company has not entered into any hedging activities owing to its limited
foreign
exchange exposure and preference for more conservative investing
instruments.
COMMITMENTS
AND CONTRACTUAL OBLIGATIONS
At
September 30, 2006, the Company’s contractual obligations related to operating
leases are as follows:
| |
|
Less
than
|
|
One
to Three
|
|
Four
to Five
|
|
Over
Five
|
|
|
|
| |
|
1
year
|
|
Years
|
|
Years
|
|
Years
|
|
Total
|
|
|
Operating
Leases
|
|
$
|
1,681,802
|
|
$
|
2,713,448
|
|
$
|
2,379,422
|
|
$
|
7,252,466
|
|
$
|
14,027,138
|
|
OFF
BALANCE SHEET ARRANGEMENTS
The
Company has no off balance sheet arrangements or derivative financial
instruments that have or are reasonably likely to have a current or future
effect on the results of operations.
IMPLEMENTATION
OF ACCOUNTING POLICY
On
March 24, 2006, in accordance with a lease provision, the Company gave notice
to
the lessor of the U.S. Headquarters located in Lombard, Illinois, to terminate
the lease, effective June 30, 2007. The Company paid $0.8 million for this
lease
termination option and entered into a new lease agreement with a different
lessor in Lisle, Illinois for an eleven year term from February 1, 2007 through
January 31, 2018. As part of a lease inducement, the lessor of the Lisle
building paid the Company $0.8 million to cover the expenses incurred to
terminate the Lombard lease.
In
accordance with EIC-21, Accounting
for Lease Inducements by the Lessee
and EIC-135, Accounting
for Costs Associated with Exit and Disposal Activities,
the lease inducement amount was recorded as a “Deferred lease inducement”
liability on the balance sheet and will be amortized over the life of the
Lisle
lease term while the Lombard lease termination option payment was recognized
as
a one-time expense in the first quarter of 2006.
CRITICAL
ACCOUNTING POLICIES AND ESTIMATES
The
preparation of financial statements requires management to make estimates
and
assumptions that affect the reported amounts of assets and liabilities and
contingent assets and liabilities and disclosure of contingent assets and
liabilities at the dates 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, preliminary purchase
price allocation in connection with acquisitions, the carrying amount of
capital
assets, intangibles, goodwill, and valuation allowances for receivables and
future income taxes. Actual results could differ from those estimates. These
items are unchanged from those discussed in the Company's annual MD&A for
the year ended December 31, 2005.
Additional
information
Additional
information relating to the Company, including its Annual Information Form,
is
available on SEDAR at www.sedar.com.