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Catamaran Corp. (CTRX)

June 10, 2013 5:00 pm ET

Executives

Mark A. Thierer - Chairman and Chief Executive Officer

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

Analysts

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

Tom Liston - Cantor Fitzgerald Canada Corporation, Research Division

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

Robert M. Willoughby - BofA Merrill Lynch, Research Division

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

Operator

Good afternoon, ladies and gentlemen. Thank you for standing by. Welcome to Catamaran Corporation's Corporate Update Conference Call. Listeners are reminded that portions of today's discussions contain forward-looking statements that reflects current views with respect to future events such as Catamaran's outlook for future performance and revenue, 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 from those projected in the forward-looking statements. Please refer to the cautionary language in Catamaran's filing 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 sort of items that do not conform to generally accepted accounting principles, including the adjusted EPS and EBITDA. Catamaran has reconciled these items of the most comparable GAAP measures in its SEC filings and its historical quarterly earnings releases. At the conclusion of the prepared remarks, management will host a brief question-and-answer session. [Operator Instructions] I would like to remind everyone that this call is being recorded on Monday, June 10, 2013, at 5 p.m. Eastern time. A replay of today's call will be available on Catamaran's website within approximately 1 hour after the conclusion of this call. At this time, I would like to turn the conference over to Mr. Mark Thierer, Chairman and CEO. Please go ahead, sir.

Mark A. Thierer

Thank you, Operator, and good afternoon to everyone on this call. We are very pleased to announce that Catamaran has been chosen by Cigna to be its exclusive pharmacy benefit partner in a strategic 10-year agreement to service the more than 8 million Cigna lives. Our 2 market-leading organizations will partner on sourcing, fulfillment and clinical services to drive superior cost and clinical outcomes for Cigna's clients and members. Securing this major contract win brings increased opportunity to create value for customers, clients and shareholders alike. Catamaran will augment Cigna's core service capabilities with our leading technology and service platform to provide a full suite of programs and services to meet the needs of Cigna's existing and future pharmacy customers. Catamaran will provide prescription drug procurement, cost of goods and inventory management, order fulfillment for home delivery, retail network contracting, claims processing and other PBM services over time. We will migrate Cigna's pharmacy business to Catamaran over the next 24 to 36 months. As partners, Cigna will remain involved in aspects of the PBM services being delivered, but the intent of this relationship is to give Cigna the ability to leverage the skill and scale and the breadth and depth of services that Catamaran can deliver. Most importantly, we will help Cigna execute on their stated goals of improving value and affordability for their clients, improving their market competitiveness and driving innovation inside their business.

Our relationship with the Cigna is significant for a number of reasons. First, the combined purchasing power of the 2 organizations, coupled with the superior clinical programs and interventions, will enable Cigna and Catamaran to deliver the most cost-effective and complete set of services to the health care marketplace. Second, it sends a clear message to the market that Catamaran is a flexible and strategic partner with the ability to adapt our business model to meet the strategic business goals of the [indiscernible] in this marketplace. Our relationship with Cigna squarely places Catamaran as the PBM of choice in the managed care market.

Again, the on-boarding of Cigna's business will be a staged and deliberate process beginning later this year and staged over a 24 to 36-month time frame. In addition, we'll bring our best-of-class service offering to Cigna through a dedicated Center of Excellence, or COE, to be located in Hartford, Connecticut area. By dedicating a team of working -- working out our new COE now, we are sure to be well positioned for our success and deliver world-class service to Cigna and all our clients.

I would like to now pass the call to Jeff Park, our CFO, to outline the financial impact we expect from this strategy partnering with Cigna.

Jeffrey Park

Thank you, Mark, and good afternoon, everyone. I want to start by reiterating Mark's point that Catamaran is honored to have chosen by Cigna as its strategic partner for its pharmacy benefit offering. This agreement brings together 2 leading organizations in a way that will drive value to clients, members and shareholders.

The 2 organizations are in the process of finalizing the client and service migration time lines. Therefore, some aspects of the financial impact to Catamaran are not available at this time. From a revenue perspective, we expect an -- to increase by $5 billion to $5.5 billion in annualized drug spend from the incremental Cigna agreement in 2014. Transition schedules will be solidified in the coming months with a focus on driving high levels of client service, minimal disruptions. As we combine our purchasing power, we expect to see revenues grow in advance of final service transition, but estimating any revenue impact for 2013 is not possible at this time. We will provide more information as it comes available on our Q2 and Q3 earnings calls.

We will be executing this integration work with the same skill and approach you have come to expect from us. We will continue to support HealthSpring's lives under contract through 2013, following which this new contract will cover the lives in 2014. Cigna's non-HealthSpring's Part D lives will be migrated for January 1, 2015. We expect the full transition of services to take 24 to 36 months to complete. As you know, health plans can generate 1% to 2% gross margins for us, and we expect margins at the low end of this range in the early years of the contract with modest margin expansion possible upon completion of the 24 to 36 month transition period.

We will ramp up our operations to service the additional lives coming online from Cigna. We will increase our operating expenses in preparation for and during the implementation period starting in the second half of 2013. The operating expense ramp should continue through the transition time frame. We will also open a Center of Excellence of the Hartford area with a dedicated team to service Cigna, it's clients and members.

As far as 2013 guidance is concerned, at this point, the timing and the amount of drug spend to transition on 2013 is unknown, so we are reiterating our 2013 revenue guidance. We will be giving more clarity on our Q2 earnings call as more details are available. We expect the implementation costs in 2013 related to the transition to reduce our 2013 adjusted EPS by approximately $0.02 to $0.06.

At this point, we'd like to open the call for a few questions. Operator?

Question-and-Answer Session

Operator

[Operator Instructions] We'll hear first from David McDonald from SunTrust.

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

Look, I guess first question is, Cigna obviously went through an extremely exhaustive process here. Can you just give us a couple of kind of the key points in terms of what they verbalized to you in terms of why they picked you, once they came back from the back side of the process?

Mark A. Thierer

Yes, Dave. Thank you. This is Mark. I would agree with you that this has been a long and very detailed process. And in my 30 years in this business, I would say that it was the most complete procurement process, from a strategy and operational standpoint, that I've ever participated in. And so it was obviously highly competitive and everybody was at the table. So I think in the end and what was communicated to me by the guys who run the business is that we just lined up very nicely across the board in terms of number one, we were a lower-risk alternative; number two, and more -- most importantly, our ability to make them more competitive, we were able to prove that, that was in fact the case. And so obviously, our COGS leverage that we bring to the market and the cost savings that will help, that will get passed through their clients, was a big driver in this decision. But more than that, I think our technology platform and the fact that we bundled this offering and put our flexible and customized offering into a complex environment. And Cigna is a multiline provider, they've got a lot of products and services they bring to the market. And we looked at each of them in a lot of detail. I would say that our -- the fact that we don't compete in the open market relative to Medicare Part D was an important driver. And finally, this is very important, we've proven that we know how to convert very large and very complex customers. And so I would say our track record on execution was the final point that I'd mention. We just -- we couldn't be happier with this. This is obviously a transformational deal for us.

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

And then Mark, you gave a little bit more detail on all of the services that you guys would be providing in addition to kind of what was in the release. Can you just run through those one more time? I just want to make sure that I've got kind of everything that you guys will be doing for them in terms of services.

Jeffrey Park

Dave, this is Jeff. So we're contracted for a full suite of services including cost of goods, the pharmacy technology, home delivery fulfillment, pharmacy rebate clinical services really what makes us a unique partner to the point Mark was making as we wrap our solutions around our client's needs like Cigna and really fit into how they go to market. Being able to leverage some of the investments that we make in our infrastructure as well as our member in clinical tools and really enable their brand in the market. There is no confusion to who own the members and who interacts with them. Cigna owns all the members, the contact including on fulfillment of mail and specialty.

Operator

We'll hear next from Tom Liston with Cantor Fitzgerald.

Tom Liston - Cantor Fitzgerald Canada Corporation, Research Division

Jeff, you went through it fairly well. But 2013, can you give us a sense of why some of the uncertainty? Is there some upside to the potentially the numbers? And then just reiterate the expectations currently for 2014 before you get fully transitioned over on the revenue line especially?

Jeffrey Park

Thanks, Tom. So the revenue impact, we expected, as you see in from Cigna, Cigna supports around 8 million lives with their PBM and Part D products. We already have around $3 billion of the business through the HealthSpring's unit. And so we estimate an incremental impact when we get the business up and live of between $5 billion and $5.5 billion once it's up and running. As we transition and consolidate purchasing and platforms, we will see revenues from drug spend come into our results, and these revenues will lead the integration work. As the transition unfolds over the next 24 to 36 months, we also expect our margins to improve over time. So it's unclear from the impact on 2013 as it relates to the transition plan and the timing of that business that will come in. But so that's why we're not providing any further updates on 2013 revenue impact at this point in time. But with respect to what we expect to see in 2014, hopefully that adds a little bit more clarity for you.

Tom Liston - Cantor Fitzgerald Canada Corporation, Research Division

That's certainly helpful. And just a follow-up, didn't address it specifically that, Dave, maybe another way of asking, do you expect any increase in your -- do you expect to increase your mail or specially capacity with this?

Mark A. Thierer

Sure, Tom. Well, we are making investments in our own delivery and our specialty fulfillment, both from an infrastructure perspective as well as from a technology perspective. We've previously discussed the growth that we've been experiencing in our specialty footprint and really driving new distribution capabilities. We're opening a specialty facility in Indiana that will be opened by the end of the year, and we continue to see this as a great area for us to continue to grow our business.

Operator

We'll hear now from Amanda Murphy with William Blair.

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

So just thinking about, I know it's a bit early, but if you think about the operating expenses that will be required when this is kind of up and running, is there a way to think about the relations of kind of your corporate average, if you will? And also, just a follow-up to Tom's in terms of CapEx assumptions for this year, any more detail you can provide there?

Jeffrey Park

Sure, Amanda. This is Jeff. With respect to CapEx, with -- we'd expect between $30 million and $40 million in CapEx over the transition period with Cigna. Those capital items with respect to the infrastructure, the technology investments that we're making, those would lead the transition periods. But that's really hopefully can frame that for you from a size and scope perspective. From an implementation cost that we outlined, this, the $0.02 to $0.06, with any deal of the size we will have some cost to ramp up the support including staffing. Although we won't be going into specifics to support this time to the point of your question, but implementation costs and transition costs that we're expecting to see in 2013. I will give more clarity on the 2013 impacts on the upcoming quarterly call, Amanda.

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

Got it. Okay. And then just a question to you on the M&A side. Obviously, that's something you talked a lot about. I'm just curious at this point, given you've got the Catalyst integration, I guess it's mostly complete but not this. I mean, are you still going to be active from an M&A perspective?

Jeffrey Park

Amanda, this is Jeff again. We are -- continue to be active in the marketplace. We are a unique position to be a consolidate or in the middle-market. With our footprint, our technology footprint that supports so many different PBMs in the marketplace, we expect to continue to focus on the driving the objectives that we outlined here with Cigna and then continue to look at our opportunities to consolidated in the middle-market.

Operator

And Robert Willoughby with Bank of America Merrill Lynch has our next question.

Robert M. Willoughby - BofA Merrill Lynch, Research Division

Just a quick one, Jeff. Any idea once everybody's onboard and happy and smiling what the pro forma cash flow number might look like for you?

Jeffrey Park

Bob, thanks for the question, but I don't have that with me yet, Bob.

Robert M. Willoughby - BofA Merrill Lynch, Research Division

Is there anything unique from a working capital standpoint around the relationship?

Mark A. Thierer

No, there's nothing unique with respect to the working capital around the relationship. We have a relatively steady set of economic flow with respect to the funding from the HealthSpring's book of business. We'd expect that to continue through this larger relationship, so you shouldn't expect to see much of a change.

Operator

We will move next to Glen Santangelo with Crédit Suisse. And hearing no response, we'll move to Brian Tanquilut with Jefferies.

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

Jeff, just a quick question to summarize the deal. I mean, I'm guessing it's safe to assume that this is accretive, right, within the first year, is that right? I mean, am I thinking about it the right way, given the expenses and the margin that we're assuming here?

Jeffrey Park

Yes, Brian. We're not giving 2014 guidance out. But yes, it's an accretive for us, absolutely.

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

Okay. And then Mark, on the last call, you talked about how the HealthSpring business was -- has little impact on your purchasing power. So how different is this agreement from the HealthSpring book in terms of you talked about how this enhances your buying power going forward?

Mark A. Thierer

Well, the balance of Cigna, Cigna's the #4 health plan out there. This is a big business and it's kind of approaching $10 billion all in on drug spend. And so the cost of goods leverage comes across multiple product lines, including any form of commercial businesses out there, Medicare Advantage. They have their own HealthSpring -- I'm sorry, Cigna Medicare business that we'll be picking up 1/1/15. And so obviously, a large mail order and specialty footprint. And so up from the cost of goods standpoint, that is a central hypothesis here. Bolting of these 2 businesses together, we will be deriving COGS leverage right now the line from wholesaler deals to biotech to mail order by and obviously, network contracting. And that is a very central part of the value creation here that we're doing with Cigna.

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

Got it. And then last question if you don't mind. Jeff, does this have a reset mechanism in the margin the way the HealthSpring business has it set up today?

Jeffrey Park

We've got -- we're not going to go into the specific contract details but it was a competitive process. It's a 10-year deal so it has performance requirements from us and pricing to ensure its competitive through the term. We feel very good about the terms of the contract for both Cigna and for Catamaran.

Operator

And at this time, I'd like to turn the call back over to management for closing remarks.

Mark A. Thierer

Okay, operator. Thank you. And obviously, we are very excited about working closely with the Cigna team to deliver the best-in-class pharmacy solution to Cigna's clients and members. Also we look forward to our Q2 earnings call when we'll be prepared to provide more details on this strategic partnering agreement. And with that, we appreciate your time this afternoon. Have a great evening.

Operator

Again, that will conclude today's conference. Thank you, all, for joining us.

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