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Executives

David Blair – CEO

Hai Tran – Treasurer & CFO

Analysts

Brooks O’Neil – Dougherty & Co.

Glen Santangelo – Credit Suisse

Glenn Garmont – ThinkEquity

Amanda Murphy – William Blair

Newton Juhng – BB&T Capital Markets

Robert Willoughby – Banc of America

David Toung – Argus Research

Michael Baker – Raymond James

Michael Minchak – JP Morgan

Mike Petusky – Noble Research

Larry Marsh – Barclays Capital

Catalyst Health Solutions, Inc. (CHSI) Q4 2008 Earnings Call Transcript February 25, 2009 10:00 AM ET

Operator

Good day everyone. Welcome to the Catalyst Health Solutions Incorporated fourth quarter and year-end earnings conference call. Today’s call is being recorded.

This conference call contains forward-looking statements and information. Forward-looking statements are made pursuant to the Safe Harbor provisions of the Private Securities Litigation Act of 1995. Forward-looking statements may be significantly impacted by certain risks and uncertainties described in the company’s filings with the Securities and Exchange Commission.

With that said I would now like to introduce the Chief Executive Officer of Catalyst Health Solutions Incorporated, Mr. David Blair. Please go ahead, sir.

David Blair

Great. Good morning and thank you for joining our investor call. Also with me is Hai Tran, our new Chief Financial Officer.

Clearly the company had another strong year as revenues grew by 37% and net income jumped 28%. Looking back now to the past five years, the company has grown earnings by an annual compound growth rate of 37%. In addition to the sound financial results, the company executed on a number of strategic initiatives in 2008 which positioned us for continued growth in 2009 and beyond.

In 2008, we added $300 million of new business, retained 97% of our existing clients, differentiated our services by launching our generic advantage programs, and we completed two strategic acquisitions.

Before turning the call over to Hai, I will discuss two topics which frequently come up with investors, the impact of the overall economy on our business and our sales pipeline.

First, let me address the impact of the economy on our business and our conservative underlying assumptions in our 2009 financial guidance. Clearly as unemployment rises and individuals lose pharmacy coverage, our business is adversely affected. We have considered and incorporated rising unemployment in our financial guidance. Again, we have considered and incorporated rising unemployment in our financial guidance.

It is important to note that we have a diverse and broad client base, while we have a significant number of well-known casino clients in Las Vegas. These clients only represent 3.8% of our total book of business.

Excluding client terminations and additions, we saw a modest decrease last year in the number of lives serviced in Vegas, and we project this trend to continue. Again, the casino client base represents a very small component of our overall book of business.

State and local governments comprised approximately 30% of our business and tend to be better insulated from the economy. Year-over-year enrolment accounts for our government business remained essentially flat. We projected a slight decrease in employment for these groups in 2009. Clearly the stimulus package, which was passed earlier this month should benefit our government clients and provide States the necessary resources to avoid substantial layoffs.

I would also mention that our managed care business, which represents approximately a third of our business, has remained stable over the last year with no decrease in enrolment counts.

The balance of our business is essentially comprised of employer groups and unions. These groups again, excluding new client additions, realized a modest decrease in lives last year, which were slightly better than the national unemployment figures would suggest. As those of you who know the locations of our regional offices, our clients tend to run across to the southern part of the country. In these regions, along with our significant presence in Iowa, tend to do better than the national unemployment figures. In fact, 70% of our business is in parts of the country that have lower unemployment rates than national averages.

As I mentioned before, our 2009 financial guidance reflects a continued increase in unemployment. Clearly this is not an exact science, and we try to be conservative with our assumptions. In addition, we provided a broad range of financial guidance to reflect the uncertain economic conditions.

Through almost 2 months of the year, business trends are consistent with our financial projections. The integration of our acquisitions has proceeded smoothly. New clients are successfully utilizing our new mail facility, and business mix and volumes are reaching our expectations. We remain confident that the company will reach or exceed our stated guidance of $3 billion in revenues and earnings per share of $1.35 to $1.45.

I would like to switch gears and discuss from a sales perspective, what we're seeing. Clearly the volume of business that we are pursuing with mid-year effective dates now is the strongest we have seen. Clearly with the deteriorating economy, health plans are seeking innovative ways to reduce their pharmacy costs. Our approach driven by aggressive formularies and benefit plans, effective [ph] member education, and over-the-counter coverage, as well as our low-cost retail networks are ideally suited for this challenging environment.

As a result, we are seeing unprecedented levels of sales activity for Catalyst. In addition, our sales opportunities are expanding as we pursue larger health plans and different types of business, different types of businesses as well as open offices in new parts of the country.

We continue to establish new relationships with benefit consultants, which provide us with an increasing number of RFPs to consider. The hundreds of millions of dollars in new business we secured last year surely demonstrate the continued appeal of our differentiated service model.

Overall, our sales message continues to be centered around local market solutions, financial transparency as well as the innovative approaches I described to controlling pharmacy costs.

Our financial guidance does not incorporate any contribution from midyear client additions, that as I mentioned earlier the sales pipeline is sound and we believe that we bring on new business throughout the year, just as we have in years past.

Based on the proposals we have submitted as well as the business we are pursuing, I fully expect that our sales totals this year will exceed $500 million.

So, at this point I will turn the call over to Hai for a review of our financials.

Hai Tran

Thank you David. We continue to deliver growth in Q4, as revenue grew by 29% on a year-over-year basis from $531.9 million to $687.4 million, and for the full year revenue grew by 37% from $1.9 billion to $2.5 billion.

Our adjusted script count for Q4 was 13.6 million, compared to 11.5 million in the fourth quarter of last year. Total unadjusted scripts for the year was 52 million compared to 41 million in 2007. If we look at the per script metrics in Q4, revenue per script, adjusted for the days supply at mail, was $46.72 compared to $43.30 last year and $46.42 last quarter. The principal contributor to the revenue per script growth is inflation on brand drugs.

Gross profit for the fourth quarter increased by $11.1 million to $40.3 million from $29.2 million in the prior year. Our gross profit margin percentage was 5.9% in Q4, a 40 basis point improvement over the fourth quarter of 2007 and a 9 basis point sequential improvement over the third quarter of 2008. The sequential improvement in gross margins was primarily due to our ability to continue to leverage direct operating expenses.

Gross profit per adjusted script for Q4 was $2.74 compared to $2.38 last year and a sequential improvement over the $2.68 in the third quarter of 2008. Generic utilizations for the fourth quarter increased from 62% in 2007 to 66% in 2008. Unadjusted mail order claims was approximately 540,000 for the fourth quarter, a 34% increase over the 403,000 unadjusted mail order claims in the fourth quarter of last year.

SG&A in the fourth quarter increased by $5.6 million to approximately $19.4 million, from $13.7 million in the fourth quarter of last year. $3.5 million of this change is attributable to consolidating the acquisitions and the balance is from investments associated with initiatives to support the company’s continued growth. Included in the increase is approximately $1.1 million of non-recurring charges for corporate development activities, such as transition services expenditures for IPS as part of the integration that were completed in Q4, and expenditures relating to tax analysis.

Operating income grew to $20.9 million or 3.0% of revenue from $15.4 million or 2.9% of revenue last year. On a per adjusted script basis, operating income per script increased by $0.16 over the prior year and $0.04 on a sequential basis. Operating income margins improved by six basis points sequentially.

Net interest income in Q4 was 531,000 down from 700,000 in Q3, primarily due to a lower interest rate environment.

From a cash flow perspective, capital expenditures for the quarter were $1.6 million and 8.7 million for the year. We expect capital expenditures in 2009 to be at similar levels as we continue to invest in our mail operations.

We ended the quarter with $55 million of cash on the balance sheet and no debt. Cash flow from operations was $7.1 million for the fourth quarter and $78.6 million for 2008.

David with that I will turn the call back to you.

David Blair

And operator we can open up the call for investor questions.

Question-and-Answer Session

Operator

Thank you. (Operator instructions) And we will take our first question from Brooks O’Neil with Dougherty & Co. Please go ahead. Your line is open.

Brooks O’Neil – Dougherty & Co.

Yes, good morning. I have a couple of questions guys. First, Hai, you mentioned the $1.1 million of non-recurring expenses, I think in the past you and others had commented that you had planned for some incremental spending to complete the integration of the recent acquisitions. Can you just tell us what changed or what factors drove that non-recurring item in the quarter?

Hai Tran

Yes, the expenditures we had planned for expenditures to increased capacity (inaudible) more transition services as they relate to the transition of some of the administrative functions and other functions we needed to sell [ph] for a period of time.

Brooks O’Neil – Dougherty & Co.

Okay, great. And then secondly obviously the tax rate was quite a bit lower than it had been running, can you comment about what factors drove that?

Hai Tran

Certainly, what we did was – we had always – this year going through this year we anticipated an effective tax rate for the year (inaudible) in the low 37% range, and – but we were conservative through the first two quarters relative to our tax provision. And so, what you saw in the fourth quarter was essentially a truing up once we finalized the effective tax rate for the year. So the effective tax rate for the year, excluding kind of any impact from one-time refund was 37.2% in 2008. Now looking forward into 2009, I think that we should expect an effective tax rate in the neighborhood of around 37.6%.

Brooks O’Neil – Dougherty & Co.

Okay, great. Thank you very much. Do you expect any significant renewals yet in 2009?

David Blair

Brook, this is David. The only significant renewal in 2009 is State of Ohio, which is currently out to bid and for July 1 renewal.

Brooks O’Neil – Dougherty & Co.

Okay, and then secondly can you tell us what percent of the business either in absolute dollars or as a percent of total is up for renewal in 2010, and maybe how that compares to prior years or whatever?

Hai Tran

Sure. I guess broadly speaking, we have with over 500 clients across the country. You can be pretty much rest assured that a third of those clients of so is coming up for renewal every year, and as you are well aware, we have demonstrated client retention rates in the high 90%, 97% this past year. Other years have been either 98% or 99%. As it relates to January 1, 2010, there are no significant renewals that I'm aware of. Once we get beyond 12 months, it is quite not beneficial to speculate which clients will go out to bid and which ones won't. But certainly, we will give you more color on that as the year progresses.

Brooks O’Neil – Dougherty & Co.

Okay, great. And then just lastly, maybe you can comment in light of the changing economy, whether you have seen any significant changes in the competitive dynamics in the industry?

David Blair

We have seen very much discipline pricing, not only in the latter part of 2008, but as well as in 2009. You know, this is a very competitive business but we haven't seen any anomalies.

Brooks O’Neil – Dougherty & Co.

Okay, great. Thank you very much.

David Blair

Sure.

Operator

Our next question comes from Glen Santangelo with Credit Suisse. Please go ahead. Your line is open.

Glen Santangelo – Credit Suisse

Yes, David, I just want to follow up on that previous pricing question, there's been obviously a lot of concern amongst the investment community kind of watch and see the essence of some of the announcements that they have made, and the fact that you are seeing more PBMs pull contracts forward may be giving steeper discounts. You know, you are suggesting that you are not really seeing any change in the pricing environment, is that a fair way to characterize it?

Hai Tran

Well, we – as it relates to, perhaps specifically Caremark CVS in the comments made by their CEO earlier this year. We did see a couple of one of the pricings – we were aware of some one-off pricings for some very large managed care clients. But the sector that we are in, the group's of a few thousand lives or 0.5 million business that we are bidding now and bid on in 2008 successfully. That pricing was consistent in prior years and certainly met our expectations.

Glen Santangelo – Credit Suisse

So, is it fair to say you are not really seeing, you know, Medco and Caremark really drifting down closer towards your customer base?

David Blair

Well, I think it is a little bit of a misnomer that we don't, that they don't compete with us for our client base. They very much do. So, whether it is the same clients of the employers, we do compete with them. With that being said, the pricing has been disciplined this year and we haven't seen anything out of the ordinary.

Glen Santangelo – Credit Suisse

Okay, and just to kind of follow up on the comments you made on mail-order, you kind of suggested you are starting some traction with your mail-order business with some new clients, and maybe if you can just give us a little bit of an elaboration there, and then maybe you can just update us in terms of transferring the mail-order scripts that currently you had running through Walgreens, kind of how is that progressing in the transfer.

David Blair

Sure. As you know, we have hired the facility last August, and over the past eight or nine months we recruited personnel there, we have trained both our client service and sales teams on the mail facility. We have made modest investments to improve the capacity of the facility there, as well as develop marketing materials and pricing proposals and that type of thing. We expect the capacity of that facility to increase from roughly 1 million or so scripts when we acquired it to approaching 3 million scripts by the end of this year. As it relates to the new business, the business that we brought on January 1, they are utilizing that facility. Certainly, clients that are interested in acquisition-based pricing, transparency of mail are very much interested in utilizing that facility. And I think what you will see going throughout the year as a consistent improvement in our gross margins as we are able to capture more margins at mail.

Glen Santangelo – Credit Suisse

So that 2 million, a lot of it is coming from and new clients, not necessarily scripts that were with Walgreens?

David Blair

I'm not sure of what 2 million.

Glen Santangelo – Credit Suisse

You said you were at 1 million, and now by the end of the year you'll be approaching 3 million. So, the net 2 million dollar difference, is a lot of that kind of new scripts or is that kind of some of the Walgreens scripts that are being transferred to your facility.

David Blair

Let me clarify, we expect the capacity of that facility to increase.

Glen Santangelo – Credit Suisse

Capacity, so it is not necessarily 2 million incremental claims.

David Blair

Right. From our financial guidance perspective, we essentially increased, we have projected no increase in mail volume though obviously we have got a number of initiatives in place to increase mail utilization as we do this – secured new clients. But that is not baked into our guidance.

Glen Santangelo – Credit Suisse

And then just my last question, then I will hop off. I mean, when you gave your guidance three months ago, obviously unemployment, you know the unemployment picture has changed quite a bit in the last three months, you know, as you look out to the remainder of 2009, could you get maybe give us a little bit of sense for what may be embedded assumptions you're using in terms of unemployment as we think about your volumes?

David Blair

Sure. I mean we – two things. One, we gave a broad range of net income guidance, two, captured exactly this. It will give us some cushion if perhaps our conservative guidance wasn't conservative enough. And so, we certainly project unemployment to rise by a few percentage points. We – from where it is now this year, which is relatively consistent with what the economists are saying out there and that would be in the 9%, 10% range. But as you look at our businesses, our forecast, it has been at a client level. I try to give some broad categories earlier about same local governments is certainly a big part of our business as is managed care business. And that has a different dynamic than perhaps your employer groups in Midwest might.

Hai Tran

And Glen, I think that, you know referring back to David’s prepared remarks, one think to note is that, I think it is tempting oftentimes to apply national unemployment rate to our book of business, but fact of the matter is that our footprint does have regional concentrations and as David alluded 70% of our book of business are in regions as defined by the Department of Labor, whereby the unemployment rate for those regions will be below the national average.

Glen Santangelo – Credit Suisse

Okay, thanks for all the comments guys.

David Blair

Sure.

Operator

(Operator instructions) Our next question comes from Glenn Garmont with ThinkEquity. Please go ahead. Your line is open.

Glenn Garmont – ThinkEquity

Thanks, good morning. Just a couple of follow-ups. David, with regards to the midyear pipeline, you know, it sounds like there is a lot of activity. Where is that business – where is that business from, I mean is that a lot of business that have previously been carved in or these, you know, contracts that reside with larger competitors, and then my second question is regarding, you know, your mail strategy, is mail something that you are going to be selling into sort of your legacy mid-market customer base or could we expect that maybe you'll be successful in selling mail into, you know, one of the larger accounts that you serve and to that end, I mean have you had any preliminary discussions with either these large state accounts or larger managed care accounts about potentially taking on mail on their behalf.

Hai Tran

The business that we’re pursuing for midyear start dates as I look at our new business leads, it really falls right in our sweet spot; and the business – the type of business that we secured in the past and so it might range from employer groups of a few thousand lives. We have some large state and local governments in the hundreds of thousands of lives as well as manage care clients that are approaching half a million lives. And those businesses currently reside with competing PBMs, the same type of PBM that we competed with for the last five or six years. As it relates to the mail strategy, we certainly think we can be successful selling our, you know, approach to mail to both small and large clients, and so while we – you know our largest account today is the million life [ph] group. Now we are targeting groups that might be upwards of 2 million lives. And so the only thing that we’re going to be restrained from as it relates to our mail strategies, existing capacity that we have within that facility.

Glenn Garmont – ThinkEquity

Okay, thank you. And if I could just follow up on the first question again I mean, you know, if pricing is relatively stable and everybody is kind of in the ballpark on pricing, what is the reason that these contracts are out to bid, I mean are clients looking for more transparency, are they dissatisfied with the service that they are getting, I mean is there a specific reason why, you know, midyear is shaping up to be, you know, very active.

David Blair

Well, this year is unique in that. With the economy moving in the direction that it had for the past 12 to 18 months that individual groups are becoming much more aggressive on the types of approaches they want to take managing pharmacy cost, and so – and that really works to our advantage because as you know some of the things that we've done around, you know, controlling pharmacy cost in a local environment, working and driving over-the-counter products, limited retail networks, those types of programs where employers may have been reluctant to implement previously in a good economy. Now they are very much interested in them because they need to save every nickel that they can. So, the fact that the economy is going down in many respects is helping us win new business because clients are being more aggressive to save money.

Glenn Garmont – ThinkEquity

Okay, thanks David.

Operator

We will take our next question from Amanda Murphy with William Blair. Please go ahead. Your line is open.

Amanda Murphy – William Blair

Hi good morning. Just a follow up to the economic impact, and you talked a lot about how unemployment has impacted your business. What about per capita utilization of the client. Did they have an effect and if so how have you incorporated that into guidance for this year?

Hai Tran

We – it did have an impact on our business last year because of lower prescription utilization and that is probably as a result of individuals forgoing the medication because of the $35 co-payment or something along those lines. As we look into 2009, we projected relatively flat pharmacy utilization, somewhat consistent with IMS projections.

Amanda Murphy – William Blair

So would you say that impact is coming more from the enrollment the clients stand at this point.

Hai Tran

That is correct.

Amanda Murphy – William Blair

Okay, and then also in terms of Vegas, I think you mentioned the casino impact. What is the, you know, overall Vegas exposure?

David Blair

Our total book of business as a present in Vegas is approximately 4.5% and as I mentioned earlier the casino is about 3.8% of that.

Amanda Murphy – William Blair

Okay, and then switching topics for a second, in terms of performance standard [ph], I think you have mentioned that about half of your transparent contracts have some form of incentive for generic utilization. I'm just curious how, you know, has that, have you seen more clients willing to consider that model and also have you seen clients willing to incorporate a more mail-based incentives as they move to mail.

David Blair

We don't have any mail incentives to push folks to get to certain target levels of mail, which you might see our competitors have. But our clients have been very much willing to incorporate management incentive fees for reaching certain performance criteria. Most likely that is going to be centered around generic utilization, but often times it might be centered around all in effective rates, network rates that we can achieve. And to that is something that has been a big push for the last several years. You mentioned half of our transparency business has those fees. My guess is it is north of that at this point.

Amanda Murphy – William Blair

Okay.

David Blair

And so that is something you will see going forward in all of our proposals.

Amanda Murphy – William Blair

I mean where do you think that number go to, you know, is it three quarters of the book or, you know, is there some sort of maximum rate that you think could move to kind of an incentive-based model?

David Blair

Well, I mean we very much have an open dialogue with our clients about where our fees come from, and we consistently try to align incentives with our clients, so that the members are getting the lowest cost drugs and the right drugs at the lowest price. And so to that extent, putting in these types of management benefit fees is in their best interest, it is in our best interest, and it has worked very well.

Amanda Murphy – William Blair

Okay, just last question, I just want to clarify that the $500 million in new business you mentioned, is that including midyear starts or does that also include some business for 2010.

David Blair

That would include midyear starts as well as January 1 –

Amanda Murphy – William Blair

2010.

David Blair

2010.

Amanda Murphy – William Blair

Okay, thanks very much.

David Blair

Sure then.

Operator

Our next question comes from Newton Juhng with BB&T Capital Markets. Please go ahead, your line is open.

Newton Juhng – BB&T Capital Markets

Thanks very much. You know, clearly with IPS kind of rolling along and HospiScripts [ph] integration seemingly complete, are there any other potential acquisition targets amongst regional PBMs or can you give us an idea as to how you might be prioritizing use of your free cash flow?

David Blair

The acquisition strategy that we are pursuing is consistent with what we have done before. So we're looking at either small regional PBMs that we could fold into Catalyst and enjoy economies of scale. PBMs that get us into a new geography are always sought after. Additionally, acquisitions that get us a new product or service in the mail acquisition last year, which is a great example of that. And so going forward there are different services that we could getting into absolutely, and certainly things are not helping well in these programs. Specialty is something that we are increasingly taking a look at. So, you know, while we certainly don’t need to get any acquisitions done this year to meet our targets, we’re always going to be opportunistic and in fact with valuations coming down, you know, I won't be surprised if we got something done this year.

Newton Juhng – BB&T Capital Markets

Thanks David, and then just with regard to generic utilization, I was wondering if you had or have provided a number that is baked into the 2009 expectations.

Hai Tran

I think that for the 2009 expectations, you know, we're talking about, you know, kind of a high 60s number Newton, and remember you know from a generic utilization perspective for our business and our approach to pricing impacts us in a couple of ways, clearly for the 20% or so of our book of business that is still traditional in nature. The similar impact it would any of your competitors, but for the balance the impact is primarily on performance incentives.

Newton Juhng – BB&T Capital Markets

Got you, okay thank you very much Hai.

Operator

Our next question comes from Robert Willoughby of Banc of America. Please go ahead, your line is open.

Robert Willoughby – Banc of America

David, you commented unprecedented sales activity for Catalyst. I guess, you are only targeting I guess $500 million or so in wins, but it doesn’t strike me as too heroic a goal here. Is this just chronic conservatism at work or, you know, what is out there that prevents you from doing better in an unprecedented kind of environment?

David Blair

Thanks Bob for the question. The $500 million, I think what I precisely say was that we fully expect to exceed $500 million, and the reason that I use $500 million is because that is what I mentioned at the JP Morgan healthcare conference as a target for us. So, you know, I think it is extremely conservative and if you look at, you know, some of the previous years, you know, we have added $700 million, $600 million, $800 million. So, there is a level conservatism baked into that number.

Robert Willoughby – Banc of America

Okay, but there have been questions on price, I mean, you don't see anything structurally out there that prevents you from winning or from a competitive standpoint that just merits an incremental level of conservatism.

David Blair

No, absolutely not. And in fact, we are probably more optimistic now than ever because of some of the programs that we have developed over the past year to specifically help our existing clients, clearly can benefit potential clients. So just the opposite, we think that what is going on in the industry will help us win business.

Robert Willoughby – Banc of America

Okay, and Hai do you have working capital balances, did you provide receivables, payables and inventories.

Hai Tran

Yes, hold on one second and I will provide that to you. While I'm pulling at the other, the one thing – there were other questions relative to some of our non-cash charges. The breakout for the quarter was that depreciation was $1.2 million, amortization was $1.7 million, and equity-based compensation charges were $1.2 million. Now on the balance sheet, total current assets are $362 million and total current liability was $313 million.

Robert Willoughby – Banc of America

You don't have receivables, payables, or inventories broken out as yet?

Hai Tran

Sure. Receivables were $293 million of that balance and inventory was $4.9 million.

Robert Willoughby – Banc of America

4.9, and that is down from the third quarter. What would that be if –

Hai Tran

That is down from the third quarter because one of the things that, you know, we did, which was a benefit to us was, we are sourcing our (inaudible) cost at IPS from a wholesaler, which now enable – I think which is part of the transition, which now enables us to take daily delivery, as opposed to the weekly or biweekly deliveries we had previously. So that was a nice improvement for us.

Robert Willoughby – Banc of America

Great. And you had the payables?

Hai Tran

Yes, on the payables side, the payable balance was $301 million.

Robert Willoughby – Banc of America

Okay, thank you.

Hai Tran

Thanks.

Operator

Our next question comes from Mr. David Toung of Argus Research. Please go ahead.

David Toung – Argus Research

Yes, thank you for taking the call. Hai and David, I just want to get into a little more on your guidance range for EPS. I know you mentioned unemployment as a factor but what other factors would either drive the EPS to either the upper or the lower end of guidance.

David Blair

Sure, we've tried to do you know as I mentioned conservative. So what is baked into our guidance is the business that we have under contract today. We've assumed flat mail penetration, so that that would increase – we would, you know, enjoy additional margins. You know, midyear sales, so obviously it is something we can bring on additional sales throughout the year that would improve that. We have projected – unemployment to continue to rise as well as, you know, pharmacy utilization to remain relatively flat to the extent that either one of those assumptions are off your guidance to be favorably impacted.

David Toung – Argus Research

What about on the operating expense side? Is there anything there that can drive it to the upper or lower end?

David Blair

My guess is the operating expenses will have a big swing in 2009. I think we had those pretty well understood. Probably generic utilization is one of the things that may have a bigger impact to the extent that we can continue to drive our patients to generic that improves our margins and obviously it is a win-win for our clients as well. And so that is something that we are focused on and we think we can do better than we projected that would only add incremental margin.

David Toung – Argus Research

So, are you saying that your midyear start-ups are not in the 135 to 145 guidance at all?

David Blair

That is correct, David. It is only our business that we have under contract today.

David Toung – Argus Research

Okay. I just have one other question. I think when you have new business come up there is typically, I think other PBMs have talked about it, where there is some pricing concession at the start of a contract. Is there anything you can say about how the margin looks like going through either quarters or, you know, the second and third year of those contracts, even on a sort of a qualitative basis?

David Blair

Sure. I don't know about how the other PBMs operate, but for us typically there is going to be upfront implementation cost associated with bringing a new client on board. Generally speaking, we've been able to absorb those implementation costs within our kind of run rate SG&A, and having looked up to anyone's attention. And I would expect that to be through the business that we will win this year. The Blue Cross Blue Shield account we won a couple of years ago was an exception to that. Obviously, there was much larger investment that was required to get that up and running. Then typically we see margins improve each calendar year or each year that we have a new client, just as we achieved the performance-based management incentives, which was I think Amanda had asked me about earlier this morning. So, you will see a typical improvement in margins on our business year-over-year.

David Toung – Argus Research

Great, thank you very much.

David Blair

Sure.

Operator

Our next question comes from Michael Baker of Raymond James. Please go ahead.

Michael Baker – Raymond James

Thanks a lot. David, I was wondering if I could remind us when the state of Louisiana renews, is that 2010 or 2011?

David Blair

I don't have that in front of me Michael, but it is certainly after January 1, 2010. So, it is going to be midyear ’10 or ’11.

Michael Baker – Raymond James

Okay, I appreciate some color on that, and then can you give us a sense whether or not you anticipate any early renewals in 2009.

David Blair

Michael that's a good question. Absolutely, I mean one of the things that we've done as an organization and to achieve those high retention rates is renew our clients early, and so a big push this year just like in the years past is to secure multi-year contracts, when your products or contract expiring. So, we would expect to do that this year.

Michael Baker – Raymond James

Are there any meaningful ones that you have done effective the first quarter of ’09?

David Blair

We think all of our clients are meaningful.

Michael Baker – Raymond James

I mean in terms of size, a single client.

David Blair

No, I mean there is certainly nothing that would raise to the attention of a press release, if you would, but yes we've already signed up renewed clients this year, and as we get near halfway through the year, I think that is when we start kind of saying hi, we’ve retained X% of our business, you know Y%. So, most likely by the second quarter conference call, and certainly by the third quarter conference call, you know, we'll give you those percentages.

Michael Baker – Raymond James

Thank you.

David Blair

Sure.

Operator

Our next question comes from Michael Minchak with JP Morgan. Please go ahead.

Michael Minchak – JP Morgan

Thanks. Good morning. Just a follow up on the earlier questions on competition. The small and mid-sized employer market is traditionally been your sweet spot, and the larger PBMs are talking more about targeting that market specifically. Are you beginning to see them more as part of your RFP process for those types of accounts, and then related to that there has also been talk about smaller clients increasingly using consultants as part of the RFP process. Can you talk about what you're doing to increase your exposure to the Benefits Consultants community?

David Blair

Sure. The smaller group clients, we compete with the big three on a routine basis. Nothing has changed in the last several years from our perspective as it relates to who we compete with for that business. And to the extent that it would – we certainly tell you but it is – consistently it is kind of (inaudible) for the big three, and perhaps either a regional player or you know, a managed care organization might be in the mix as well. So that composition hasn’t changed. And Mike, what was your second question?

Michael Minchak – JP Morgan

It was about the consultant communities. You know, there has also been talk about the smaller clients increasingly using consultants as part of the RFP process. You know, what are you doing to sort of increase your exposure to the consultant community.

David Blair

Well, we've been successful engaging regional benefit consulting firms and that's how we secure a lot of our business. So, we continue to do that. We have kind of Catalyst 101 [ph] road shows, where we go out and meet with local consultants, tell them about our services, or we bring them to our corporate offices, and put them through a full day of, you know, how we are different than the big three. So that plays well. The PBM tracing games that are played are very complicated to the extent that the consultants are involved that only helps us because many times a smaller employer client might not have the resources to understand all the different components of a pharmacy benefit management proposal.

Michael Minchak – JP Morgan

And how about with this sort of a national consultants like the Mercers of the world. Are you trying to make cash in there as well or –

David Blair

We do – we have relationships with the National consulting firms and we secured business when they represented their clients in the past absolutely, I mean the large state client that we have a number of them, were represented by one of the big consulting firms as well as some of the managed care business that we bought.

Michael Minchak – JP Morgan

Great, and then they don't provide quarterly guidance, but I'm just wondering if you could give us some color as to how we should think about the first quarter earnings directionally relative to the fourth quarter, and should we be thinking about EPS being flat to down sequentially as we've seen in previous years?

Hai Tran

Yes, I mean I don't think from a seasonality perspective, nothing has changed from a year, you know, year-to-year basis. So, you know, other than that we really don't talk about the quarter.

Michael Minchak – JP Morgan

Okay, great. Thanks for the comments.

Hai Tran

Thanks.

Operator

Our next question comes from Mike Petusky from Noble Research. Please go ahead. Your line is open.

Mike Petusky – Noble Research

Hi good morning fellows. Hi, I didn't catch it if you mentioned it. Did you say what your cash was at the end of the quarter?

Hai Tran

Yes, cash flow from operations for Q4 was $7.1 million and for the year in 2008 was $78.6 million.

Mike Petusky – Noble Research

And what did you end the quarter with in terms of cash.

Hai Tran

In terms of cash, I’m sorry, it is $55 million of cash on the balance sheet and no debt.

Mike Petusky – Noble Research

And again I may have missed this, but did you guys say that HospiScripts, the integration was done or virtually done. How would you characterize that?

Hai Tran

Yes, I think the integration of HospiScripts is on track, you know, I think last time we talked about in April timeframe, we are on track for that.

Mike Petusky – Noble Research

Okay, and then finally David you said that when you acquired IPS, script capacity was about 1 million, it will be 3 million at the end of the year. What will the script capacity right now?

Hai Tran

You know, it is about, it is lower than a million.

David Blair

I mean, you get an immediate pickup when you add an additional shift, and so we've got that in place now. So, what do you say, Hai, over a million and a half, maybe.

Hai Tran

You get the real pickup between kind of a 1 million to 1.5 million to 3 million, around some dispensing automation that we are looking to put in this year.

Mike Petusky – Noble Research

And then just the last question. Could you remind me what percentage of revenues the State of Ohio contract represents?

David Blair

That is something we haven't disclosed before. It is not one of our top 10 clients. I mean that is a significant client for us, but it wouldn’t rise to that level and to the extent that you know, there won't be any meaningful change in our book of business that would require us to change guidance. We certainly would bring that to your attention immediately.

Mike Petusky – Noble Research

Okay, great work.

David Blair

Thank you.

Operator

(Operator instructions) We will take our next question from Larry Marsh with Barclays Capital. Please go ahead, your line is open.

Larry Marsh – Barclays Capital

Hi good morning David, and Hai. Just a couple of quick things. You know, as you rolled out this acquisition-based pricing at mail this year, can you characterize the kinds of clients that you're seeing that are interested in this model, and are there any surprises that you're seeing in the types of clients who have or haven't really expressed an interest this year so far or is it too early to tell?

David Blair

Larry, the more sophisticated clients have expressed an interest because they get it. And they understand what kind of margins can be generated on generic mail. The clients, specifically types of clients that are interested in it are certainly clients that have net high mail utilization. So those are the one that can favor me, you know, the most immediately.

Larry Marsh – Barclays Capital

All right, okay. I know that a part of your past initiative around being transparent to create a lot of interest in the State account area, where you had some success, would you characterize that as the same type of more sophisticated client or again is it, you know, a different type of maybe more of a corporate employer.

David Blair

You know, our state clients tend not to have the high – real high mail utilization, but they are certainly sophisticated and understand transparency and are seeking that. But generally it is the more an employer group client that implemented a mandatory mail program, perhaps five or six years ago that has mail penetration in the high 20s to low 30% that can save the most amount of money.

Larry Marsh – Barclays Capital

Okay. Are there voices of complaint that you have heard in this year so far, maybe apart from generic transparency that has surprised you from clients, is there a hot button that you hear or is it really, you know, is that hot button centered around generic transparency?

David Blair

Well, I would say a larger topic, Larry with our client is what can you do to immediately save me money on my pharmacy cost, and you know that's going to be largely driven by effective use of generics, you know regardless of whether they are $4 generics or $20 generics. It is getting more close on generic drugs, over-the-counter programs, perhaps eliminating certain therapeutic categories where the employer feels like those are no longer necessary to cover. So, limited networks, so those are the conversations that we are having with employers today. Really, immediate pharmacy savings opportunities, things that they can put in place and you know, get savings, you know from the third quarter or second quarter this year.

Larry Marsh – Barclays Capital

Okay, and then to that, I know you have highlighted the saving opportunity at retail pushing more to some of the mass merchants, the Targets and (inaudible) of the world that have really come out with these generic programs. Are you seeing any traction in that in the market relative to national average or is that just, you know, more a discussion at this point.

David Blair

Well, it is a terrific savings opportunity for clients. I mean you might be familiar with the Caterpillar case study with Wal-Mart and they were able to, you know, demonstrate the savings that they were able to achieve by putting in a financial incentive for their members to go to Wal-Mart. Now, we are not suggesting any kind of a limited network of that scope, but certainly programs to get folks to lower costs networks. It is an immediate savings opportunity and it is a thing that we are discussing with our clients currently.

Larry Marsh – Barclays Capital

Okay. Two of the things – and to that point, one would be around generic transparency, you know, the topic of discussion of revisiting AMP sometime in the next year or so maybe, may be not. From what you said do you – would you view yourself as somewhat agnostic around implementation of AMP. Do you think it is going to be disruptive there for clients or would it be good for you?

David Blair

I think it will be an immense positive Larry because for us, right we don't – we're not – we don't care how the drug is described in the pricing, whether it is AMP, ASP, AWP,WAC, you name it, right. For us, we are just going to pass through the lowest cost that we can get, and I think it is going to put our competitors in an awkward situation to describe, “ Oh, it is AWP discount actually equivalent to this AMP discount,” and that will only will create opportunity for us perhaps to move into secure business.

Larry Marsh – Barclays Capital

All right, okay. And just back to point on mail. Why wouldn't your customers be (inaudible) to use your mail pharmacy operations to save money, you know, especially since you are presenting a transparent bid, you know, versus using your prior mail vendor, you know, and what would keep those customers from you know from switching, because I know some of them haven’t – many of them haven’t.

David Blair

Larry, I think, maybe I misspoke earlier about incentives to use different mail providers versus incentives for the members to utilize mail. So, clearly there are benefits to utilizing our mail facility, but the incentives for the specific member, you know, whether it is using your mandatory mail program or awaiting co-payments. You know, that is something that we have not been a big proponent of. We always try to get patient to the lowest cost provider and we think mail is an important convenience for members, and we want to have mail as part of that, but we don't necessarily want to drive members to mail at potentially the expense of the plan sponsor.

Larry Marsh – Barclays Capital

Right, okay. Makes sense, and then finally you alluded it to earlier, in areas of perhaps a high margin from a manufacturing standpoint specialties still sits at somewhat of an unregulated space with the potential for innovation. How are you addressing specialty now, and why wouldn't that be, you know, an opportunity for you to continue to drive value for your customers.

David Blair

It did Larry, and so today at Catalyst, we have a group of clinicians that focus on developing clinical criteria for specialty drugs. We implement compliance programs, member education programs around specialty medications. It is clearly one of the most important drivers for our clients today. The difference between our organization and our competitors is we don't actually distribute those drugs at this point, but we have all of the clinical criteria of the management around those programs. So, absolutely a natural extension target to our business would be to migrate into that business and so you know, along those lines it is no secret that we have been looking at different various specialty providers to acquire.

Larry Marsh – Barclays Capital

Okay, very good. Thanks.

David Blair

Sure.

Operator

(Operator instructions) Mr. Blair there are no other questions in queue at this time.

David Blair

Great, well I just want to thank everyone for their time. I apologize for the inconvenience earlier, and we look forward to speaking with you on the next quarterly call.

Operator

That concludes today's Catalyst Health Solutions Incorporated conference call. Thank you for joining us and have a wonderful day.

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Source: Catalyst Health Solutions, Inc. Q4 2008 Earnings Call Transcript
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