Catamaran Management Discusses Q4 2012 Results - Earnings Call Transcript

Feb.28.13 | About: Catamaran Corp. (CTRX)

Catamaran (NASDAQ:CTRX)

Q4 2012 Earnings Call

February 28, 2013 8:30 am ET

Executives

Mark A. Thierer - Chairman and Chief Executive Officer

Jeffrey Park - Chief Financial Officer, Principal Accounting Officer and Executive Vice President of Finance

Analysts

Ricky Goldwasser - Morgan Stanley, Research Division

David S. MacDonald - SunTrust Robinson Humphrey, Inc., Research Division

Robert M. Willoughby - BofA Merrill Lynch, Research Division

Robert P. Jones - Goldman Sachs Group Inc., Research Division

Lisa C. Gill - JP Morgan Chase & Co, Research Division

George Hill - Citigroup Inc, Research Division

Glen J. Santangelo - Crédit Suisse AG, Research Division

Michael Cherny - ISI Group Inc., Research Division

Brooks G. O'Neil - Dougherty & Company LLC, Research Division

Tom Liston - Cantor Fitzgerald Canada Corporation, Research Division

Amanda Murphy - William Blair & Company L.L.C., Research Division

Brian Tanquilut - Jefferies & Company, Inc., Research Division

Operator

Good morning, ladies and gentlemen. Thank you for standing by. Welcome to Catamaran Corporation's 2012 Fourth Quarter and Year End Results Conference Call. Catamaran issued an earnings press release this morning, which has been filed with the SEC and is available on the Investor Information section of Catamaran's website at www.catamaranrx.com.

Listeners are reminded that portions of today's discussions contain forward-looking statements that reflect current reviews with respect to future events, such as Catamaran's outlook for future performance and revenue and earnings growth and various other aspects of its business. Any such statements are subject to risks, uncertainties and assumptions that could cause actual results to differ materially from those projected in the forward-looking statements. Please refer to the cautionary language in the earnings release and in Catamaran's filings with the SEC, as well as Catamaran's most recent annual report on Form 10-K.

During the call, there will also be a discussion of some items that do not conform to Generally Accepted Accounting Principles, including adjusted EPS and EBITDA. Catamaran has reconciled these items to the most comparable GAAP measures in today's earning release. [Operator Instructions] I would like to remind everyone that this call is being recorded on Thursday, February 28 at 8:30 a.m. Eastern Time. A replay of today's call will be available on Catamaran's website approximately 1 hour after the conclusion of this call. I would now like to turn the conference over to Mr. Mark Thierer, Chairman and CEO. Please go ahead, sir.

Mark A. Thierer

Thank you, and good morning, everyone. We appreciate you joining our call today.

2012 was truly a transformational year for Catamaran, as we took the company to new levels of financial and operational performance, and laid the groundwork for continued growth in the future. There are many reasons to feel great about this past year. We continued to execute on our acquisition strategy, first with the integration of HealthTrans and PTRX and subsequently with the SXC Catalyst transaction. We posted record new business during the year, and in fact, closing $700 million of that new business after our merger.

We strengthened our balance sheet by paying down $200 million in debt in the last 2 quarters of this past year. And once again, we were named one of America's fastest-growing companies by FORTUNE Magazine. The pace has been both brisk and productive.

By any measure, these are significant accomplishments, but they're especially impressive given the backdrop of economic, political and competitive change that has been marked in the last 12 months.

For the full year, we're pleased to report that Catamaran, again, posted record results, including a strong fourth quarter. Revenues for the full year were $9.9 billion, with $363 million in EBITDA.

Fourth quarter revenues were $3.3 billion, with EBITDA of $147 million. Jeff will provide you with more details on our financial shortly, but I'd like to take a few minutes to share some thoughts on the last year and what's ahead for us.

You heard me use the word transformational to describe the year. In 2012, through the combination of SXC and Catalyst, Catamaran evolved from a mid-market player into a major market challenger, one that is able to compete against the largest companies in our industry and win. And the timing is right. We've emerged at a whole new level as a truly scalable alternative, just at a time when the marketplace needs it most.

In 2012, we leveraged our proven technology platform to smoothly integrate a number of acquisitions in record time. Since the closing of our merger with Catalyst in July, we have been focused on the integration and have reached all of our milestones ahead of schedule. We've built a core competency around the integration of acquisitions, which has been a major advantage for us, as we quickly build scale.

We also strengthened our organization in 2012, adding new talent in making leadership appointments in key areas such as innovation, sales, government affairs, clinical services, human resources and member services.

Additionally, we added experience and diversity to our Board of Directors, most recently with the appointment of 2 new directors, Betsy Holden and Karen Katen. I believe that we've assembled the very best team in our industry, and we are well positioned to capitalize on the many opportunities in front of us.

We reinforced our capabilities in strategic areas as well. As we covered during our November Investor Day, specialty continues to be one of the very key growth drivers for our business. Last summer, we launched BriovaRx, which is now the fifth largest specialty pharmacy in the country and climbing. Among other highlights, we continue to gain access to the most notable limited distribution drugs in specialty. We've added to our direct field sales force and have capitalized on transition opportunities resulting from our Catalyst merger. Our unique customer-focused approach, combined with strong supply chain relationships, has established the foundation for significant growth in that area.

We just came off a very busy January with our biggest set of 1/1 implementations in our company's history. And so how did we do? The early results from our post-implementation surveys show that we are earning high marks. I personally checked in with many of our new clients. In fact, the CEO of one of our largest new health plans described his go-live as the "best PBM conversion he'd seen in his 30-year career." At a time when client service is so crucial, execution and implementation is a key factor, which is, in fact, the driving force behind our client retention rate of 98%.

I am incredibly proud of all of our 3,500 employees who truly raised their game in 2012 to make sure we kept our promises and delivered for our clients. Their performance has set us up for success in 2013 and beyond.

Shifting gears. On the new sales front, our business pipeline is robust. Our current pipeline is very different from what we've seen historically on multiple levels. The deals we are seeing now are bigger, there are more of them, and they are coming sooner at us than they have in the past.

Because the marketplace has narrowed and clients are looking for alternatives, we are actively engaged in opportunities we would not have seen in prior years. In addition, we've developed a reputation for quality execution among clients, consultants and the supply chain, proving we can deliver solutions that scale to the largest and most complex customers in our marketplace.

Our clients today include some of the largest health plans in America, as well as 2 of the Fortune 10 and the leading -- and other leading employers like Target, a relationship we announced this past fall. To our prospects and to the consultant community, we have become a strong and credible alternative to the traditional model.

This year, more than ever, we are seeing health plan actively evaluating their options in anticipation of the changes driven by health care reform. We are well positioned in this segment and have become a very strong competitor in the Medicare Part D marketplace.

Our technology position and our expertise in this arena have made us a market-leading partner for health plans with Medicare Part D offerings. And the 5-star rating that we received for our EGWIP is a clear indication of our excellence in clinical care, clinical outcomes, member service and satisfaction.

Looking at 2013 and beyond, we're very well positioned to succeed as a leading PBM in the new market environment, created by the Affordable Care Act. We are proactive in helping our clients navigate new purchasing, payment and delivery models. And in addition, we're pursuing emerging strategic opportunities, including accountable care organizations, Consumer Operated and Oriented health plans, also known as CO-OPs, Medicaid expansions, both private and public exchange opportunities throughout the country.

Our leadership in health policy, government, clinical and technology services, combined with sophisticated analytics, give us an advantaged position in the marketplace. We are ready for the upcoming consumer-centric model, including servicing the millions of Americans, newly insured citizens, who will be purchasing pharmacy benefits, some for the very first time.

With this portfolio and a consultative partnering approach, we are poised to gain market share in this demanding and very fluid environment, integrating pharmacy and medical data, and managing the increasing intersections between public and commercial sectors. We understand and are very active in health care reform arena and expect to be a major growth driver for us in 2014 and beyond.

So inside Catamaran, there is clearly a great deal of enthusiasm for the year ahead. Earlier this month, we held our National Business conference for our top 175 people in the company, and the goal was to align around our plan for the next 12 months. We had clients joined us for this session and share their views as well. There is a definite sense that Catamaran has arrived and have set the right pieces in place.

In summary, we become a major player with a reputation as a high-quality partner, and I believe we're just getting started on our journey.

So at this point, I'd like to turn the call over to our CFO, Jeff Park, who can provide you with a more detailed financial look at the year and the quarter.

Jeffrey Park

Thank you, Mark, and good morning, everyone. Q4 was another successful quarter in the company's history, and it was the second quarter in which we reported as a combined company. We generated record revenue growth, driven by new clients we implemented this year and the addition of Catalyst book of business.

Let me take you through the results for the fourth quarter, and then I'll spend a few minutes summarizing our initial 2013 guidance and underlying assumptions.

For Q4, revenues for Catamaran were $3.3 billion compared to $1.4 billion in Q4 last year, an increase of 142% on a year-over-year basis. $1.6 billion of revenue in the quarter was related to the acquisition of Catalyst. Adjusted prescription claim volume for the PBM was $68 million in Q4 compared to $24 million in Q4 2011.

The company's gross profit increased to $265.6 million in the quarter. Gross profit percentage for the PBM segment increased to 7.5% compared to 6.7% in Q3 2012. We are very pleased with our margin performance on a sequential and year-over-year basis. We started the year with 5.4% in Q1 and are proud of the work done to increase performance throughout the year due to specialty pull-through and purchase synergies related to our acquisitions.

This strong Q4 includes our achievement of service and performance targets for the year. As you know, these targets reset as we start the new year, and additionally, our gross profit will be impacted by the reset of high-deductible or consumer-directed plans, where members pay pharmacies directly as they start the year. So we expect a dip in gross profit and then continued expansion throughout 2013.

We continue to deliver strong EBITDA results, achieving $146.6 million in the quarter, our highest performance in the company's history. This represents 203% growth on a year-over-year basis.

Adjusted EPS was $0.39 in the quarter and represents a 56% increase over Q3. We also generated $250 million in cash from operations in 2012, which enabled us to pay down an additional $100 million in debt in the fourth quarter. We have repaid $200 million of debt in the second half, and as you can see, cash flow from operations continues to be an important value driver of our business model.

SG&A expenses in the quarter include some integration costs, in addition to headcount costs we incurred in the quarter, as we ramped for our January 1 go-lives. In the year, we've taken $44 million in charges or $0.17 in EPS related to deal and integration expenses.

In Q3, we announced $16 million of synergies achieved, which annualized to $64 million in synergies. We are pleased to have added an additional $20 million in Q4 or another $80 million annually, which brings our annualized synergies to $144 million. We are very pleased with the execution of our team, and we expect to add an additional $25 million to $30 million in synergies in 2013, therefore, achieving $175 million in synergies by the end of 2013.

At this point, we believe the supply chain synergies from the Catalyst transaction are largely complete. The additional $25 million to $30 million in synergies will be achieved by continued operational efficiencies and specialty pharmacy penetration, but will be offset by $20 million to $25 million of costs to achieve these synergies. We've been successful in pulling through specialty scripts from the Catalyst book of business that were exclusive to Catalyst, and the rest of the specialty scripts in Catalyst book will require more time to convert to our in-house distribution. We are pleased with our progress on synergies and continue to be ahead of schedule with the integration.

Our earnings release this morning included our initial 2013 guidance. Revenue is $14.2 billion to $14.6 billion. Our EBITDA guidance for the year is $660 million to $670 million. We expect 2013 GAAP EPS to be in the range of $1.18 to $1.25; and our adjusted EPS guidance, which excludes deal-related amortization, is in the range of $1.81 to $1.88.

A few further assumptions to highlight for you in thinking about our 2013 guidance. We expect interest expense to be approximately $45 million to $50 million. We expect a full year 2013 tax rate of 32% to 33%. We expect deal-related amortization for 2013 to be roughly $195 million. And we expect our fully diluted share count to be 208 million to 210 million.

As you can see, our guidance at the top end indicates very strong growth for Catamaran, with EPS and EBITDA growing 78% or more. If you look at 2013 guidance and compare it to annualized second half of 2012, which would be following the Catalyst acquisition, our guidance suggests $170 million in EBITDA growth and doubling of EPS.

We expect 2013 to be another strong year for Catamaran. We continue to be a strong player in the health plan and middle-market segments, and we like our prospects for moving into the large employers. Catamaran has posted strong new business sales for 2013 and, as Mark said, we are seeing a lot of opportunities for the 2014 selling season.

The PBM industry is changing rapidly and prepared itself for the expected changes in the health care environment, and Catamaran is poised to take advantage of the many opportunities that these changes present. Payers are looking for alternatives, and we expect to capitalize on this demand in the marketplace.

I want to thank you for your continued support. And operator, we'd like to now open the line for questions.

Question-and-Answer Session

Operator

[Operator Instructions] And we'll take our first question from Ricky Goldwasser with Morgan Stanley.

Ricky Goldwasser - Morgan Stanley, Research Division

Thank you for some of the comments on the selling season, but if you can just give us an early read on what percent of your book is up for renewal, and also there's some opinion out there that there's just going to be less movement into selling season this year ahead of reform. So do you agree with this view or not? And then my second question is around Cigna and, more specifically, when do you expect to hear an update from them, and does your 2013 guidance range include the possibility of an early renewal or repricing?

Mark A. Thierer

Okay, Ricky, it's Mark. On your first question in terms of the percentage of our book that's up for renewal, basically you can just consider, in particular, the employer segment at any given time a 30-year book is up for renewal. So we've been very focused on early renewals across the book of business. That was an initiative we kicked off immediately post-acquisition of the Catalyst deal. For the balance of our book, we don't see any material renewals in 2013 that we haven't already got our arms around. In terms of Cigna, let me just take a moment and address your question. The business relationship that we have with Cigna continues to be strong. We are, as we have been focused on helping them execute on their strategies and we have a great respect for this leadership team and what they're doing in the marketplace. We do think the fact we don't compete in the Medicare Part D business sets us up well for a go-forward relationship. I do think it's important to put the opportunity in perspective. And as we've said from the beginning, our health plan book of business has a 1% or 2% gross margin profile on the P&L. And as is public, the current contract we have ends 12/31 this year. So if we were to lose this business, which we don't expect, the earnings impact is actually minimal. And so none of our guidance incorporates any changes in that contract or relationship. I'd just like to add one other thing I think that's important. With the Catalyst acquisition, we would actually see no impact to our COGS line or our buying power in the unlikely event we lost that business. And our game plan is to only renew or expand that relationship if it makes sense for our shareholders. So that I hope that answers your question.

Ricky Goldwasser - Morgan Stanley, Research Division

No, no, it does. And just on the client views ahead of complex health care reform in terms of staying put or making changes. What are you seeing or hearing from clients about that?

Mark A. Thierer

Yes, I think we see it a different way, to be honest. I mean, right now, the pipeline that we're seeing across the board is bigger than it's ever been. And the words I use being bigger, more and sooner are really very relevant. Our bids group is running full stride. And at this point in the selling season, we've never seen the pipeline like this. Our highest levels of activity are first and foremost in the health plan space and in advanced reform, we are being asked by a number of very large health plans to evaluate working with them in a number of different areas, including Part D, driving COGS leverage. But at the heart of it is our flexibility in our model. We're also seeing employers come to market and evaluate their alternatives. And we've got very large bids in-house, larger employers and have already experienced some success here. I should tell you we've beefed up our consultant relations area, and this whole movement to move-up market is something we're very serious about. Also in the states and what we call strategic accounts, we've got RFP activity across the board. And so I would say that this is going to be a very active bid and selling season. And it remains to be seen how many people move, but we're feeling early indications are pretty good right now.

Operator

We'll take our next question from David MacDonald with SunTrust.

David S. MacDonald - SunTrust Robinson Humphrey, Inc., Research Division

Just a quick question on specialty. Jeff, I just wanted to see if I heard it right. Did you say that you guys have moved most of the exclusive specialty from the Catalyst deal? And then the remaining piece, I would assume you're talking about business that has either preferred or open networks, and is that more of kind of a slog as these things renew -- the contracts renewed, that's when you'll be able to kind of capture some of that incremental business?

Jeffrey Park

Yes, Dave, this is Jeff. We outlined that there's roughly about $1 billion of specialty opportunity inside the Catalyst book. To your point, you did hear me correctly. We've moved the amounts that are exclusively contracted to Catalyst to our distribution and fulfillment capabilities. And we are moving through the rest of the book of business that has open or nonpreferred relationships. We aren't waiting for the contracts from a renewal perspective or in these accounts and have been actively in the accounts since the close of the transaction. So that's something we've also a made some progress on. But to your point, it does take a little bit more time. And then finally, on the specialty sales, one of the areas that we continue to expand is our open market, where we sell into open networks, Part D, any willing provider, where people have flexibility. In those cases, we're talking to doctors about our capabilities, and we're making sure patients understand our high-touch model and how they can save money when they do their specialty fulfillment.

David S. MacDonald - SunTrust Robinson Humphrey, Inc., Research Division

Okay. And Mark, just one other question just on the pipeline, just a little more details. I was wondering if -- I mean, a number of RFPs probably become less relevant because they're getting so much bigger. But can you give us a sense of how much revenue you're sitting in front of in terms of the pipeline? And also are there any kind of early hot buttons that people are asking for with regards to 2014?

Mark A. Thierer

Yes, Dave, I would say that what's happened here on a kind of size-and-scale basis is we're -- our pipeline is an order of magnitude larger than it's ever been, and it's a function of being asked to the dance to most everything that moves in the marketplace. And that's a very new place for us to be. So without putting a number on it, I will tell you our pipeline is actually very large, and it's early. One thing that I would like to point to in terms of an emerging area is this whole post-Affordable Care Act market strategy. And we think that we're going to stake a claim early as the market leader here. There are 4 elements in terms of market opportunities that are evolving. The first are these CO-OPs, Consumer-oriented -- Operated and Oriented Plans. There are 24 of them in the United States. They're not for profit health insurance companies. They are funded by sizable federal loans, and we are all over this space. We've already posted wins. The second is private health exchanges. Here, we have employers forming private exchanges where employees are going to be active rather than passive participants in the purchase of their health care benefits, and we're active in that space. The third market opportunity is the dual eligibles and the demonstration projects. This is an area, where obviously public-private partnerships are designed to manage these very high costs and chronically ill patients, and this -- we're active in that space and have a number of demonstration projects in the works. And then finally, it's going to be Medicaid expansions, which is a space that we've talked about for years, Fee-For-Service Medicaid, states have the option to expand their own Medicaid books with a guarantee now of 100% federal funding. And so we have been all over this. We have plans in place to capitalize on these market opportunities, and our sales teams engaged in these markets. And as I mentioned earlier, we're posting wins. And so this is new. We like our positioning. Aside from our core market segments, this is emerging as a pretty hot space.

Operator

We'll take our next question from Robert Willoughby with Bank of America.

Robert M. Willoughby - BofA Merrill Lynch, Research Division

Your debt reduction target as gauged by the interest expense guidance seems a bit low. Can you remind us what is the cash flow expectation for '13? How much debt you would like to take down? And then just separately, how are we modeling that net income attributable to the noncontrolling interest going forward?

Mark A. Thierer

Okay. Bob, just with respect to the first part, the interest expense. Effectively, what we're assuming is the Q4 interest expense numbers are a good reflection of what we'd see annually next year. We have been paying down the revolver part of our debt, $100 million in Q3, $100 million in Q4. We'll look to have that revolver paid off most likely in the first half of 2013. We have very little amount of principal repayment due on the remaining amount of the term loan, so we'll be paying the principal amounts as what we've modeled. And that's really why we've got a $45 million to $50 million interest expense assumption for 2013. With respect to the impact of the noncontrolling interest, we'd expect that to be around $15 million to $20 million next year, which is, again, in line sort of with the Q4 run rate.

Robert M. Willoughby - BofA Merrill Lynch, Research Division

Okay. And any cash flow target, just an EBITDA number, plus some CapEx assumption?

Jeffrey Park

Yes, we'd have north of $400 million of cash flow based on, again, the assumptions we've got from where we are in Q4 and what our 2013 guidance would suggest.

Operator

And next, we'll go to Robert Jones with Goldman Sachs.

Robert P. Jones - Goldman Sachs Group Inc., Research Division

Actually just a follow-up on Bob's questions there. Based on your debt today and your EBITDA guidance, it looks like you'll be just below 2x by end of '13. Jeff, can you remind us what your comfort level is? And then maybe as it relates to that, how you're thinking about -- how you guys are thinking about potential prospects right now on the M&A front?

Jeffrey Park

Sure, thanks. As we opened the acquisition with Catalyst, we did look at making sure we had a reasonable amount of debt and a flexible capital structure, so we've borrowed up to around 3.2%. We've been focused on our debt repayments, and we've been down to closer around 2x is really what our goal had -- has been. As I look out to the acquisitions and the opportunities we have in front of us, we've certainly got the flexibility of our capital structure and our cash flows to really put us in a good position. We've got $400 million of cash on the balance sheet at the end of the year, and we've got a very -- a good amount of the revolver available to us, $600 million. We have a very active pipeline of opportunities. So to step back for a minute and just to think about the market dynamics as it relates to M&A, first, the merger of the Medco and Express and then followed by our merger with Catalyst and the changes that we're seeing with health care reform now that it's been clarified and upheld in addition to this liquid capital and debt markets are really driving acquisitions, as I know you know, across the industry. Because of our position in the market, the increased number of acquisition opportunities has been amazing. We've really become a preferred strategic exit for many of these providers in the market. Our focus continues to be the same, which is consolidate middle-market PBMs, evaluate these businesses based on fit, accretion, valuation and, as I mentioned, we like our cash position. So we continue to look, and we're very active and interested in looking at some scaled properties in the marketplace.

Robert P. Jones - Goldman Sachs Group Inc., Research Division

Got it. And then just switching gears over to 2013 revenue, I'm trying to reconcile a few things. If I take your gross wins from 2012 and adjust for some of the mid-year starts like Regence and factor in the April '13 start for target, it seems like you're calling for kind of flattish growth on adjusted basis to the 4Q 2012 run rate. Are you assuming any organic growth in the underlying base book, or is there something else around this that I might be missing?

Mark A. Thierer

Well, I think you got big pieces of it right. We went live January 1 with our biggest Jan 1 ever. Some of our wins like Target, to your point, go live in 4/1. Keep in mind, we had a large amount of wins went live in 2012 like Regence and a good amount on 7/1 and the guidance would suggest up to $1.4 billion over the Q4 run rate for new business wins. We have modeled in a modest increase from a trend utilization, et cetera, of 1% or 1.5%. So that's a modest factor, but not a significant factor.

Operator

And next, we'll go to Lisa Gill with JPMorgan.

Lisa C. Gill - JP Morgan Chase & Co, Research Division

Mark, I was wondering maybe if you could talk about your relationship with the managed care companies as we do move into ObamaCare. How many managed care states do you cover as we start thinking about exchanges and the opportunities that might come as we move into 2014?

Mark A. Thierer

Lisa, we are all over the country in terms of our footprint. We have 25 or so middle-market health plans we service, a number of very large health plans that you're aware of. We also become a very strong player in the Blues market, with a growing number of state-based Blues plans that are our clients. And so our strategy is, first, to not compete with our clients. It's to enable them in their own service areas. We -- that's a very differentiating factor as we go to market. And so we'll be working hand in glove with our health plan partners in their service areas. And separate from that, I outlined earlier a 4-point strategy in the post-ACA market in a couple of new models, including CO-OPs, private health exchanges, the duals and the Medicaid expansions. Keep in mind, we've got 9 fee-for-service states that we cover directly. And so we've got bets out across the board and spend a lot of time thinking about how can Catamaran capitalize on these 10 million, 20 million, 25 million new people. It's unclear to me how many exactly are going to come through. But we've got bets out really on every delivery vehicle.

Lisa C. Gill - JP Morgan Chase & Co, Research Division

Okay, great. And my second question will just be around conversion opportunities. Clearly, over the last several years, that's been a big opportunity to take health care IT clients and convert them. What do you see as far as opportunities in 2013? And do you see any of those coming through in 2013, or would they be more 2014 opportunities at this point?

Jeffrey Park

Lisa, this is Jeff. We have been active on our conversion opportunities to take these, to your point, technology clients of ours who have used our claims processing tools and move them into our cost of goods, clinical services, mail order specialty and rebates. We've been successful doing that, and we've continued to pursue customers on these. We've got a number of very active discussions with some long-term clients of ours, and we've got a pretty active pipeline of them of roughly 20-or-so clients are in our active conversion list, and we'd expect to get some of those queued up for 2013.

Operator

And next we'll go to George Hill with Citi.

George Hill - Citigroup Inc, Research Division

I've got 2, 1 for Jeff, 1 for Mark. Jeff, I'll start with you first. It looks like the implied guidance talks about 100 basis point improvement in operating margin or adjusted EBITDA margin. Given the mix of business that's been coming on it, it would seemingly be coming on it at lower margin. Can you talk about where the margin improvement's coming from, how much is synergy, how much is operating improvement, how much is business or product mix, and just how should we think about that?

Mark A. Thierer

Sure, George. There's couple of areas where we see expansion. To your point, as you bring on new accounts, they generally come in at a lower margin profile than the rest of the book of business. You've seen that. And basically, what we see is margin expansion throughout the year. It comes from a few pieces. First, as we drive more operating leverage through the contract, we see improvement through generic purchasing, synergy savings with our clients on clinical programs and upsell, as well as principally around specialty and our ability to drive more pull-through of our specialty book. If you think about it, specialty, in particular, I'll go back to what the Catalyst book of business is. The specialty drug spend is already reflected in our run rate. The specialty fulfillment is being done by other places. So our ability to drive pull-through on specialty will have margin impact, although it won't have any top line impact. And those are really some of the factors. The last -- I'm sorry, George, was to confirm your point around synergies as we pull through 2013.

George Hill - Citigroup Inc, Research Division

Okay. And, Mark, just kind of coming back to your comments on Cigna. You had said that the company isn't going to take a deal that's bad for its shareholders. I imagine by that you would be alluding to in negotiations, by my math, if you guys were to take an outsourcing agreement where the Bravo business originally came on -- I'm sorry, the HealthSpring business originally came on for pricing that would be -- that would actually be dilutive to you guys if the whole -- if the composite book of business got priced out to that 50 or 60 basis point level. I guess, should we think about that's the right way that you're thinking about negotiations? And I'd say the way that you go about business in general is that your -- the company is now at a point where it's not going to give business away just for the sake of growth and just for the sake of building scale.

Jeffrey Park

George, this is Jeff. As we think about our underwriting and what we look at from our client perspective, health plans, large employers, the margin profile for these businesses are 1% to 2%, and they can improve over time with additional services. We look at -- and we look and we've written business and we'll continue to look at business if it makes sense for us in that range. So that's really the way to think about any new opportunities, but not really commenting on any particular client input.

Operator

And we'll now go to Glen Santangelo with Credit Suisse.

Glen J. Santangelo - Crédit Suisse AG, Research Division

Mark, I just wanted to sort of ask you a question a little bit longer term in nature. It kind of -- if I hear your comments regarding this selling season kind of sounds like you're excited about all the opportunities you're seeing. And I think CVS, obviously, I think, has made similar commentary that they're excited about the selling season. So I'm just kind of curious, in your mind, as you look at the evolution of this competitive landscape you have, other players like CVS and United that may be operating with the different set of financial incentives, and then you take the customers that are certainly happy to flow to RFPs and let everybody fight for that business. And so I'm just kind of curious, in your mind, what are you seeing in the marketplace, and as you look longer term past the generic wave, are you nervous at all about the potential pricing and margin structure in this business given what seems to be an increasingly competitive landscape?

Mark A. Thierer

Yes, Glen, it's a good question. It's one we think about a lot as we model our 3-year plan around here. I think the first thing I'd say is we are a different model. We have a more diversified model than any other player in this market, certainly the publicly-traded players. If you look at our market segments in which we compete, we're in markets where, as a general rule, these guys don't even go Fee-For-Service Medicaid, Worker's Compensation, the cash card market, we're in this hospice market. We like these messy smaller markets, and they are margin drivers for us. So if the only place we lived was on the high end for Fortune 50 accounts and large, large health plans, I would say I'd be in agreement with your observations. But in fact, the way we build this business is by competing for large-scale deals. It helps us to drive buy-side leverage through the book, and then continue to grow in the middle market, as well as in these messier markets, we call them strategic markets. And so that's our business model, and we're really very bullish about it. I'd say we're bolting on the backend some early wins and staking out a claim in what we think will be a new model of PBM kind of post-ACA, and I've tried to describe what we see is the early evolution of it in some earlier remarks. So I'm actually very bullish about the profile for the industry. I'm not worried per se about the margin profile. We're not going to underwrite business at a loss. That's not the business we're in. And so hopefully, that addresses your question.

Glen J. Santangelo - Crédit Suisse AG, Research Division

No, no, it does. I appreciate that. Maybe if I could just ask you one follow-up. Several weeks ago you sort of quoting in the media about the potential pipeline of M&A opportunities, and you kind of, I think, sized it in that media report. And I'm just kind of curious could you give us an update in terms of your ability to do acquisitions near term? And I guess, although, it's obviously I'm guessing, not contemplated at all in the fiscal '13 guidance, would you be surprised or disappointed if we exited fiscal '13 and you didn't complete another acquisition?

Jeffrey Park

Glen, this is Jeff. We have a lot of opportunities to -- from an acquisition perspective. Since my tenure here, it's more opportunities than I've seen before. And a lot of it's due to what's emerging in the market as these new models have come out. And we really are a strategic exit for a choice for many of these providers. When you look at the activity and the amount of work to bring on some of these platforms, we have 33 of those clients that are PBMs in the marketplace that are already using our technology, and that really derisks the integration and the work and effort to put those transactions in. So that we are mindful of a backstep, but we also are looking at opportunities that are not on our platform, and that does introduce more work candidly than one that is on our platform, and it's a factor in how we think about these bids. As we think about what we would do in 2013 and where our focus is, our focus is continuing to look at areas where we've got good integration capabilities. It's not going to be diversion -- any diversion for the activities we have in front of us. And then good synergies and accretion. And we have the opportunity to deploy the capital. That's the easiest part to do. We're being very selective about what we would do, when we would do it.

Operator

We'll take our next question from Michael Cherny with ISI Group.

Michael Cherny - ISI Group Inc., Research Division

Just 1 point of clarification going back to a couple of the comments you've made in the press. I think around the JPMorgan conference, Mark, you had mentioned that you were in conversations for the RFPs with 2 Fortune 10 clients. You had noted in your prepared remarks that you have 2 Fortune 10 clients you're currently servicing now. I just want to correlate those 2 comments just to get a clarity in terms of, especially as you think about going to the employer market where you stand with some of the larger companies in this country?

Mark A. Thierer

Yes, Michael, it's a good question. The first thing is I'd like to just talk about our go-to-market strategy. We have beefed up this area inside the company with talent, very experienced people who know both the employers themselves, as well as the kind of bolt bracket consultants on the high end, the Aon Hewitts, Towers Watsons, Mercers of the world. You have to have relationships at the top of the food chain to be able to compete in this space, and we've got that done. We've been included, as I mentioned, on the bid list for many of these opportunities that are out there. And we're active in them right now. We have a very good feeling. And we're not -- obviously, not going to win everyone we engage on because we're just kind of moving into that section of the market. But we have a very good feeling about our ability to compete and win on clients that we think we're a good fit for. And this is one thing that I want to make sure. I mean, we're very discerning about where we bid and where we really focus our time and energy. And we're not taking a shotgun approach at all, but instead more of a rifle approach on picking our spots. And for clients, high-end employers who want flexibility, customization, where they're looking for more of a Center of Excellence model, where our kind of high-touch and technology-driven service offering makes sense, we're a good fit and are competing aggressively for those customers. So early indications are good. I mean, we posted wins last year and announced them, and I think you can expect more of the same from us in 2013.

Michael Cherny - ISI Group Inc., Research Division

Great. That's helpful. And just one quick question, Jeff, and kind of dovetailing a bit. But as you think about the growth in your business and the evolution to more adjacent markets in terms of the investments for the organization, is there any type of major investments you need to make, particularly on the capital side or thinking about going forward preparing yourself to service some of these larger clients as you continue to win them?

Jeffrey Park

Great, thanks, Michael. When we look at our CapEx, we have some investments that we're making now, some investments we're making in 2013 really that are infrastructure-related to put the businesses together with respect to the technology, to integrate these 2 -- the 2 companies, to increase the capacity of our data center operations and redundancy over member service and support systems, increase the telecommunications and scale of the operations as we've grown. As far as areas where we're focusing investment to take advantage of market growth, really those are around a few different key areas. Mark spent some time talking about health care exchanges and CO-OPs, an area that we see investment and growth in. And what that brings with it in those markets are new payment reimbursement models, new tools and technologies to allow for flexible and dynamic eligibility, and management of consumers and how they think about their health care, how we engage them and how we help them stay healthy and well. So those are really some of the areas that we've been making investments in that are market facing and clinically focused. And then as I started my comments with, the stuff that we've been investing in internally are improving operational efficiencies and driving more scale into the business.

Operator

We'll take our next question from Brooks O'Neil with Dougherty & Company.

Brooks G. O'Neil - Dougherty & Company LLC, Research Division

I have a couple of questions. First, I just wanted to be sure I understood, Jeff, I think you said the synergy assumption, you're increasing from $125 million to $175 million, but that you would have some incremental spending this year to realize those synergies? Can you just make sure -- try to help me understand what you're saying?

Jeffrey Park

Yes, absolutely, Brooks. Thanks for asking. Yes, we increased -- you've got it right, we increased the synergy assumption that we initially outlined on the announcement of the deal, which was $125 million to $175 million. The activity we put in place in 2012 would have our natural run rate of about $144 million. So we've expected to see continued improvement in 2013 as we hit this $175 million of synergy achievement. As far as the cost to achieve synergies, when we announced the deal, we outlined between $40 million and $45 million of cost to achieve. In addition to those costs to achieve, we had outlined roughly $25 million in deal-related expenses. So that's $45 million and $25 million, $70 million. And then -- and in the press release, we outlined that we had expensed $44 million of costs related to mergers and integrations. So we've got about $20 million to $25 million left of cost to achieve. Some of those will be incurred through 2013 in the second half we see as some of the operations start to integrate further.

Brooks G. O'Neil - Dougherty & Company LLC, Research Division

Great, that's very helpful. I appreciate that. Secondly, I guess, I'm curious there's been a lot of commentary about the government's proposals for Medicare Advantage health plans and the, I think, perception is that the current administration not terribly favorably disposed towards the for-profit publicly-traded participants in that marketplace. Do you see anything in either the government's proposals or the government's attitude that would be negative with regard to the pharmacy piece of the Medicare opportunity that you're pursuing down the road?

Jeffrey Park

Brooks, this is Jeff. One of the things that you see with the MA-PD plans is actually the government is focusing more on the stars program, which are aligned around quality and consumer engagement. And they're actually providing incentives for the programs that have 3 stars. The government's now moving those to 3.5 stars. So they're slowly raising the bar on what they're providing, but they are providing incentives to these programs. They're focusing really around cost, quality, consumer engagement. So I think your commentary around their views on for-profit and not-for-profit might be yours, but as far as what we see in the MA-PD plans, that's what our clients are focused on.

Brooks G. O'Neil - Dougherty & Company LLC, Research Division

And I guess, if I could just follow up, so you're saying that because you guys have particularly unique capabilities to help plans deliver cost, quality and consumer engagement, you see the environment in the Medicare is very favorable to your company going forward?

Mark A. Thierer

Yes, Brooks, this is Mark. So just to add to Jeff's comments, Medicare Advantage health plans are under pressure. There's obviously reimbursement cuts that are going to hit anybody who's using the government as a payer. And so if you're a provider or an MA plan, you are planning for already well into how you're going to deal with these reimbursement cuts. And so I think that work is well underway. And pharmacy is embedded in the M&A -- or in the MA cost structure obviously. And so here, we're being asked to look at restricted networks, cost savings, opportunities, heavy generic programs, all the things that we get paid to do. And so in that respect, we're really very aligned to reduce costs and help them remain competitive. If you look at the enrollment numbers, I mean, the MA plans have done well, and people are utilizing Medicare Advantage and will continue to do so. That's our expectations. So we love this market and, to Jeff's earlier comments, we think the new frontier is capitalizing on these incentives using our 5-star capability to help MA plan get paid to perform, getting paid for value rather than get paid for volume. And so that's how we see it.

Operator

We'll take our next question from Tom Liston with Canter Fitzgerald.

Tom Liston - Cantor Fitzgerald Canada Corporation, Research Division

[indiscernible] with the large employer and how you're being selective and at the same time, managing resources in the mid-market opportunities and not sort of forgetting what that market, and with that, how is the Catalyst and SXC former teams sort of parsed between those 2 selling groups?

Mark A. Thierer

Tom, we've got -- the first half of that was truncated. Can I ask you to ask the question once more?

Tom Liston - Cantor Fitzgerald Canada Corporation, Research Division

Yes, sure. Just you answered part of this question with the large employer groups and trying to be selective. So I just want to understand that opportunity and where you're targeting a little more with what type of teams. Is it former Catalyst, former -- or SXC teams, how you're parsing those between that? And just making sure the resources are balanced versus the mid-market and making sure you continue to succeed on those wins as well.

Mark A. Thierer

Yes, I understand your question. It's a good one. The place where we're making hay is in the middle market. It's where we've lived and breathed. It's where we've built our plan. It's where we do a lot of our acquisition work, and it's where we've become a very dominant player. The move-up market is a strategy for us. We put incremental resource in place, new talent in place in some cases, and a new service offering. It has a different margin profile as we enter that space. And so we are not, in any way, deemphasizing or moving resource out of our middle-market strategy. To the contrary, we've continued to invest, and it's very strategic for us. The move-up market is incremental to us, and we put new resource in place to go get it.

Tom Liston - Cantor Fitzgerald Canada Corporation, Research Division

Okay. And just a quick one for Jeff. Doesn't move the needle as much anymore, but any incremental new opportunities on the COB side of things?

Jeffrey Park

Yes, Tom, thanks. We have actually with the -- some of the not-for-profit and mid-market health plans are starting to take advantage of our enhanced coordination and benefits. It's certainly something we started to roll out with some of our fee-for-service clients. And we're pleased to be able to see this project -- the plan really move into new client base. To your point, it's not going to move the needle very much significantly in our HCIT marketplace. But what it does do is it helps us glue tighter to our client base. It also gives us a selling tool that we don't have effectively significant competition in. So it's generally something we can upsell to our clients, and we've been successful doing that. And it gives us a new weapon when we go to the market.

Operator

Next we'll go to Amanda Murphy with William Blair.

Amanda Murphy - William Blair & Company L.L.C., Research Division

I just had a follow-up on some of the reform discussions that you've had. So Mark, you mentioned 4 opportunities with the ACA. Is there a way to think about that without, obviously, having you give long-term profit guidance, but to think about those opportunities in terms of profitability sort of relative to your existing customer base? And maybe even if you don't want to go there, just help us think through what types of services you might offer to that -- to the exchanges and what have you relative to employers and health plans?

Jeffrey Park

Amanda, this is Jeff. I'll answer the piece about how we think about some of the profitability and then, I'll hand it to Mark to answer the rest of your question. One of the things that we see in these new models is really 3 different tiers of their offerings. They need to be able to have multiple service models that they can bring sort of the bronze, silver, gold offering, and it's going to fit into different people and different lifestyles. As you look at a lot of the uninsured that are coming to market, the predominance of their selections are going to be into the bronze component, which is really a stripped-down service model that looks a lot like our HCIT and our pass-through businesses that takes advantage of some of the costs and some of the services. And then as it scales up, you start to see more inclusive, more longer-term clinical programs attached to it, and the profitability kind of moves correspondingly with those models.

Mark A. Thierer

Yes, and in terms of sizing the market opportunity, Amanda, I actually think it's a little early to put a number on how large CO-OPs will be versus private exchanges. I think we're in the early innings here. And even when you think about duals and state Medicaid expansions, I mean, there's still a lot of governors straddling the fence here on are they in or are they out. Are they going to take the money, are they not. So I think it's the early innings. And our strategy has been to have bets out on each of these models. And I feel great about the fact we've already posted wins in the CO-OP space and have had great foot traffic in the Medicaid. We're active in the Medicaid states who are evaluating those expansions, and as well the private health exchanges. So do I think this is going to be huge in 2014? I don't think it's going to be huge. Do I think it could become huge? I do. That's why we're investing in this area.

Amanda Murphy - William Blair & Company L.L.C., Research Division

Got it. So really the profitability could be as low as the 1% to 2% health plan bucket all the way up to even the commercial -- the employer book? Is that fair just depending on the services offered?

Mark A. Thierer

Well, and I think, in fact, some of it could fall into our HCIT reporting segment and see pretty substantial gross margin opportunities that look and feel like HCIT. So I do think, depending on what gets deployed, it's a wide range.

Amanda Murphy - William Blair & Company L.L.C., Research Division

Got it. And then just one more on this. So have you just in -- I know it's a bit early, but in your discussions with employers, have they talked about how they're going to handle their employee base in terms of potentially shifting them to exchanges or sort of moving them more towards a part-time model? Have you had any of those discussions at this point?

Mark A. Thierer

Yes, we sure have, and it does vary. I would say that if I were to just collapse it all together and sort of put it out there for you, I do not see a wholesale move for employers dumping employees onto the exchange with a big student body move. There will be some movement and for sure, people are sizing what's the penalty, how much money am I spending on my fully funded benefit? We've done that math ourselves. But my instinct is you're not going to see 10 tons of dumping onto the exchange anytime soon.

Operator

And next we'll go to Brian Tanquilut with Jefferies.

Brian Tanquilut - Jefferies & Company, Inc., Research Division

Mark, just the first question for you on the employer opportunity. Just want to see if you can give us some color on what the discussions are in terms of what they're looking for as they send out their RFPs and how important is price in those discussions? And conversely, what's your pitch to match exactly what they're looking for versus what you guys offer?

Mark A. Thierer

Yes, Brian, it's a good question. And first of all, in this business, and it's always been this way, you have to be in the zip code. You have to be in the market on price. It's the first hurdle you have to clear or you don't get to talk about all the rest. And so as we've scaled, we are competitive on the COGS line and can compete on that front. But what some of these large customers are looking for is, in fact, the change. We're seeing much more around restricted networks. We're seeing many of these clients want to unbundle the offering and, in some cases, take an active role in managing certain parts of their pharmacy benefit. We're seeing a request for higher levels of services, sometimes on-site, which we're responding to with our Center of Excellence model, and a big focus on specialty. What can you do to get in front of this train? And so the old cost-saving initiatives are being sort of put on steroids, I would say, and they're looking for new and unique ways to contain pharmacy costs. And that's the dialogue. So we're showing up on price and then selling our full suite of services aggressively on the high end.

Brian Tanquilut - Jefferies & Company, Inc., Research Division

Okay, and then the second question is given the margin differential, do you think you can describe to us or characterize to us the mix in the RFPs between health plans versus employers?

Jeffrey Park

Sure, this is Jeff. If you think about it, Brian, the largest dollar value is always health plans. They represent -- even a mid-sized health plan at $250 million, $350 million is generally larger than most mid-market, mid-sized employers. So from a dollar value perspective, health plans represent the largest dollar value to pipeline. From a quantum perspective and the number of opportunities, employers are representing the vast majority of the number of RFPs that we pursue. And then, we've got very unique market segments that we participate in these messy markets that continue to see good growth and momentum in, but they represent a relatively small percentage of dollar, a small number but arguably, some of the best, better profitability areas for us.

Operator

And due to time constraints, that was our final question. I would now like to turn the call back over to Mr. Mark Thierer for any closing remarks.

Mark A. Thierer

Well, thank you, operator. We're looking forward to continuing the journey into 2013. We're excited about this year and building on our momentum. As always, we're going to maintain a focus on execution for our clients and growing this business. So thanks for your time today. Have a good day.

Operator

And that does conclude today's conference. We appreciate your participation. You may now disconnect.

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