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Executives

Mark Thierer - President and CEO

Jeff Park - SVP and CFO

Analysts

Brooks O'Neil - Dougherty & Company

Tom Liston - Versant Partners

David MacDonald - SunTrust

Charles Rhyee - Oppenheimer

Glenn Garmont with ThinkEquity

Blair Abernethy - Thomas Weisel Partners

Michael Baker - Raymond James

Paul Steep - Scotia Capital

Tony Perkins - First Analysis

John Kreger - William Blair

Michael Minchak - JPMorgan

Husein Kirefu -M Partners

Gabriel Leung - Paradigm Capital

SXC Health Solutions Corp. (SXCI) Q2 2009 Earnings Call August 6, 2009 8:30 AM ET

Operator

Welcome to the SXC Health Solutions Corp. 2009 Second Quarter Result Conference Call. At this time, all participants are in a listen-only mode. Following the presentation, we will conduct a question-and-answer session. Instructions will be provided at that time for you to queue up for questions. (Operator Instructions)

Listeners are reminded that portions of today's discussion may contain forward-looking statements that reflect current views with respect to future events. Any such statements are subject to risks and uncertainties that could cause actual results to differ materially from those projected in the forward-looking statements. For more information on the company's risk and uncertainties related to these forward-looking statements, please refer to SXC's annual information form. I would like to remind everyone that this call is being recorded on Thursday, August 06, 2009, at 8.30 AM Eastern Time.

I would now like to turn the conference over to Mr. Mark Thierer, President and Chief Executive Officer. Please go ahead, sir.

Mark Thierer

Good morning, everyone and thank you for joining us on today's call. This morning we issued our second quarter financial results by press release. If you did not receive a copy, the results can be found on our website, sxc.com.

With me on the call this morning is Jeff Park, our CFO. I'll summarize the key events for the quarter and Jeff will then provide an overview of the financial results along with an update on our 2009 guidance. I'll then close with a few comments and we'll open it up to Q&A.

Well Q2 was a very strong quarter for our company. The momentum we built in 2008 has clearly continued into 2009. Our record second quarter financial results reflect solid execution across all aspects of our business.

We're focused on driving progress across the following four key areas of our business. First, new business wins across each of our target markets; second, strong client retention; third, cross-sell and pull-through opportunities across our business; and finally cost containment and sound expense management.

Strategically we positioned SXC as the technology-enabled PBM. The flexible and diversified business model that underpins this approach enabled us to service a broad number of vertical markets and a wide range of customers within each segment. This diversified platform has enhanced our competitiveness and helped us to grow our business and expand our sales pipeline, even during a tough recessionary period.

As a result of our strong start to the year, combined with our positive outlook and clear visibility for the second half, we are raising our financial guidance for the full year. Jeff will go into detail on those new targets during his section of the call.

New sales wins in the second quarter included a three-year Medicaid drug rebate services contract in the state of Virginia. This contract gives us a nice toehold in the state and reinforces the government and public sector market as a growing area for our company.

Also in our healthcare IT business, we won a multi-year, multi-million dollar extension with Prime Therapeutics for software maintenance and professional services as well as a software license expansion. Prime has been a valued client for us for more than 15 years and this contract is a testament to our ability to meet our client's evolving needs and to retain their business.

Just after quarter end, we announced two material informedRx deals that provided good momentum for the second half. The first was a multi-year agreement to provide PBM services to Presbyterian Health Plan and a Mexico based health plan with an annual drug spend of approximately $150 million. Presbyterian was already a healthcare IT client of ours and their conversion to our full service PBM model informedRx is a major endorsement of the flexibility of our business model and our ability to show customers what we call a pathway to control.

We were able to offer Presbyterian a custom solution to enhance their member service and cost effectiveness while still leaving their pharmacy staff with direct control over certain important components of their pharmacy benefits program. We believe our ability to do this is truly unique in our industry and was a key factor in us with this win. We will continue to explore opportunities to expand this relationship with Presbyterian going forward.

As you might expect, we are pursuing other similar pull-through activities in our healthcare IT unit and are currently exploring a number of full service informedRx deal structure such as this with several other clients.

Another recent contract announcement was a multi-year PBM services contract with the Ohio Bureau of Workers' Compensation, a pharmacy plan and processes of approximately 1.6 million worker's comp cases annually. The worker's comp market has unique service characteristics. They set up well for our technology based platform. This agreement gives us a firm toehold in the worker's comp space and the ability to go after other business in this fragmented market.

Looking ahead to the second half of the year, we continue to build our sales pipeline and have numerous opportunities in both the informedRx and HCIT sides of our business. Our pipeline is very active and we have got qualified business opportunities across all our target markets as we enter our prime selling season.

Looking briefly at some operational highlights; our PBM ops team has done a truly exceptional job, the integration of NMHC. With the closing of the final two sites in the month of July, we have successfully now brought the NMHC integration effort to a close. We delivered on our promises and in fact significantly exceeded our original synergy commitments finishing the integration two full quarters ahead of schedules.

The professionalism speed and effectiveness, which our team carried out the integration, were key factors in our ability to generate our recent strong financial performance and I want to publicly thank our operations and IT teams for a job very well done. I believe our successful integration experience here positions us well for future acquisitions.

As part of the integration success, we have capitalized on several mail order and specialty pull-through opportunities since the beginning of the year. Mail order and specialty provide excellent margin expansion opportunities for the company and our pull-through pipeline continues to build nicely.

As we discussed on our last call, due to our growing scale of operations, we are driving much stronger purchasing efficiencies through both our network and rebate management functions. This is driving significant savings for our clients and importantly, when we save our clients' money our performance improves as well.

Our focus here on driving generic utilization is yielding solid results. And in this tough economic environment our unique clinical programs and plan designs are helping clients maximize their drug spend and save money.

Finally, I'm very optimistic with the quality of the customer experience and the client service that we are delivering throughout the business. SXC's differentiated model delivers the tools, technology, and services to help a wide a range of clients in multiple markets to save money on pharmaceuticals and take better care of patients. Our customer value proposition is certainly resonating out there and our financial results really speak for themselves.

At this point I'll turn it over to Jeff to take a closer look at out financial results for the quarter.

Jeff Park

Thanks Mark and welcome everyone. As Mark said, Q2 was another very strong quarter for SXC. Revenue for the quarter was $320.8 million, up 10% from Q1 and represents an almost $93 million increase over Q2 of '08. Q2 revenues benefited from agreements such as PharMerica, UFCW in Northern California along with strong performance from several existing clients in both the healthcare IT and informedRx lines of business.

Adjusted prescription claims volumes for our informedRx unit was $8.9 million in Q2, up from $8.4 million in Q1 2009. Our mail penetration remains steady at approximately 8% for the quarter and increasing this level remains a key focus for the company going forward. Our generic dispense rates are industry leading at 71%.

Turning to the financial performance on the healthcare IT business, revenue increased year-over-year and sequentially due to new business with Prime Therapeutics, strong transaction processing activity in our long-term care and public sector segments. Recurring revenues on the healthcare IT business were relatively steady at 75% in Q2 compared to 79% in Q1 and 70% in Q2 '08.

Transaction processing volume for the HCIT segment was $98.8 million in Q2 compared to $96.8 million in Q1'09. Consolidated gross profit for Q2 was $47.2 million, up from $39.2 million in Q1, a 20% increase in the quarter.

Gross profit for adjusted claim for the PBM business was $3.88 in Q2 compared to $3.43 in Q1. Strong gross profit performance in the quarter was due primarily to purchasing leverage gained though our pharmacy network and manufacture rebate initiatives, the addition of new clients and a one-time benefit of approximately $4.5 million.

This 4.5 million numbers is made up of a large license sale in the quarter as well as a approximately $1.5 million of unexpected reprocessing for some of our Part D clients and approximately $1 million of non-recurring margin improvements for our PBM segment based on our purchasing activities.

Q2 adjusted EBITDA was $23.7 million compared to $16.3 million in Q1 and $9.6 million in Q2 '08. On a year-over-year basis this equates to growth of a 147%. Adjusted EBITDA totals for Q2 increased due to strong gross profit expansion and realized efficiencies related to the NMHC acquisition.

Our adjusted EBITDA performance in the quarter and the year-to-date period is obviously well ahead of our expectations from earlier in the year, and reflects our success in driving improved performance post acquisition.

A number of factors have contributed to the success. These include first, synergies; the integration process has proven NMHC to be an excellent fit in to the SXC platform and has resulted in our ability to exceed the cost and revenue synergy targets that were established at the time of the acquisition.

Second, new business wins and high client retention; third, growth in higher margin specialty operations; fourth, one-time items during the first half of the year than included Part D reprocessing activity, seasonality factors in license sales; and finally fifth, as you know, we have aggressively pursued cost of goods savings for the PBM segment.

These activities have helped our clients to save money and have helped to make our offering more completive and have helped drive additional earnings accretion for our shareholders. As a result of these factors we are in a position to substantially increase our guidance, which I will address in details shortly.

Back to some key income statement items, Q2 GAAP net income was $0.47 per diluted share, compared to $0.31 per diluted share in Q1 and $0.14 per diluted share in Q2 '08. GAAP EPS growth year-over-year was achieved despite the inclusion of significant non-cash acquisition related costs in a difficult economic environment.

Non-GAAP adjusted EPS was $0.53 per diluted share in Q2 compared to $0.38 in Q1 and $0.21 in Q2 '08. This metric excludes the amortization of intangibles directly related to the NMHC acquisition. A reconciliation of Q2 '09 adjusted EPS can be found in today's press release. We still expect 2009 to have $7.6 million in deals related amortizations and $6 million for 2010 related specifically to the NMHC acquisition.

Post-acquisition, our ability to generate strong cash from operations remains a key feature of our business model. In Q2, we generated net cash from operations of $19.8 million compared to $9 million last year, a 120% increase.

Looking quickly at the balance sheet; due to the acquisition, we had $48 million in term loan. At the end of Q2, we had $96.6 million in cash on the balance sheet compared to $80 million at the end of Q1, plus an additional $14.1 million in restricted cash. CapEx for 2009 is expected to be $10 million to $11 million.

Before I provide an overview of 2009 guidance, I want to highlight that the company will be filing an S-3 Shelf Registration next week. We believe the Shelf filing will benefit the company and our shareholders by providing us with greater flexibility in the future to take advantage of favorable market conditions for capital. We believe its part of our prudent capital market strategy as we look to execute on our growth plan.

Finally let's focus on 2009 guidance. As mentioned, we are very pleased with some key developments in the quarter and year-to-date periods, which have put us in a position to make a dramatic improvement in our guidance for 2009.

As such, we have increased our revenue forecast from $1.25 to $1.35 billion to now $1.35 to $1.4 billion. With Q4 seasonality and as a high period for utilization, we expect revenue growth to trend upward through the second half of the year.

With consolidated gross profit we have increased our guidance from $145 million to $155 million to now a $166 million to $171 million. In considering this range relative to the year-to-date level of gross profit, you should take into account Q2's one-time benefit of $4.5 million.

We've increased the adjusted EBITDA guidance range by $21 million to $78 million to $81 million. GAAP EPS guidance on a diluted basis is now expected to be $1.42 to $1.50 versus our previous estimate of $0.93 to $1.01. The [mid point] here implies strong year-over-year EPS growth of more than 100%.

We expect our annual tax rate to be 32% versus 30% for the year-to-date period due to the higher guidance provided.

With respect to non-GAAP adjusted EPS guidance on diluted basis, its expected to be $1.62 to $1.70 versus our previous estimate of $1.13 to $1.21. As mentioned before by excluding the deal-related amortization of intangibles for the NMHC acquisition, this measure really provides the best comparison to the pre-transaction GAAP EPS. It also highlights the ability of the cash generating potential of the combined business.

In closing, Q2 saw the continuation of our strong start in 2009 and our outlook for the remainder of year remains very positive. Having completed the integration of NMHC, we have enhanced our visibility into our revenue generating, and cost saving potential of the combined organization and we are pleased with the results. We believe that the increase to our guidance targets reflects our optimism in the business and we have remained conservative.

With that I will turn it back to Mark for closing comments. Thank you again for your time and your continued support.

Mark Thierer

Thank you, Jeff. Overall, we are very pleased with our strong performance so far this year and with the growth opportunities in front of us. We are working to advance our mission of redefining pharmacy benefit management as the industry's technology-enabled PBM and carve out a leadership position in the markets in which we compete.

Although the broader economic outlook remains unclear our core business continues to perform very well and we are once again in a enviable position of increasing our guidance for the full year.

Our game plan for 2009 remains very straight forward. First, deliver superior service to our clients to maintain high client retention. Second, drive pull-through sales opportunities throughout our business. Third, capitalize on operating efficiencies across the company. And fourth, realize our growth potential with ongoing sales initiatives that drive customer wins throughout 2009 and into 2010.

While our focus remains on sales and client retention, we are also keeping our eyes wide open on future acquisition opportunities. In general, the types of companies that fit our criteria would be PBMs with region or specific customer focus; companies in niche areas such as specialty pharmacy in particular oncology or outcomes in analytics; and an ideal target company would be generating strong EBITDA with high recurring revenues streams.

In closing, thank you for your participation on today's call and for your ongoing support for SXC. Over the next several months we will maintain an active schedule with investors to continue to get the word out regarding the SXC story. Jeff will be presenting at the Canaccord conference in Boston on August 11, and we will continue to meet with current and perspective investors during planned Non-Deal Road shows.

This concludes our prepared remarks for today and at this point I would like to open the call to any questions. Operator?

Question-and-Answer Session

Operator

Thank you. Ladies and gentlemen, we will now conduct the question-and-answer session. (Operator Instructions). Your first question comes from Brooks O'Neil with Dougherty & Company.

Brooks O'Neil - Dougherty & Company

Congratulations on a terrific quarter. I have a couple of questions. I guess first, Jeff. I am curious, if it would be appropriate to say look at that $4.5 million of what you described as non-recurring gains or items in the quarter as coming out of the pretax income line, are there cost associated with those that $4.5 million?

Jeff Park

Thanks Brooks. Good question. No, there is not really much cost, they are associated with recognition of license revenues or some of the reprocessing activities in the pick up and the purchasing as I mentioned.

Brooks O'Neil - Dougherty & Company

As you and hopefully everyone else knows and on that account, but I didn't see you earmark any of those one-time items in the income statement. Did I miss something?

Jeff Park

No.

Brooks O'Neil - Dougherty & Company

So, you just calling those items out because you would say they are non-recurring items, at least as relates to those specific activities in the second quarter?

Jeff Park

Yeah. The color on it really Brooks is to help you think about the guidance correctly.

Brooks O'Neil - Dougherty & Company

So, you don't think we should use $0.53 annualized as the appropriate run rate going forward. Is that what you are saying?

Jeff Park

That's right.

Brooks O'Neil - Dougherty & Company

That's good. That's helpful. Secondly, you've mentioned the Shelf Registration, can you give us any color on sort of the magnitude of what you are think about. I'm guessing you are thinking about a mixed shelf that would give you some flexibility to issue debt or equity or some combination therein, but roughly how much money are you thinking about?

Jeff Park

Sure. Well as you outlined Brooks, the Shelf Registration that we're going to be putting together is called a universal shelf which is basically just allows maximum amount of flexibility for the type of instruments etcetera. As we grow in size, we need to be as active as possible to ensure the company retains with maximum amount of flexibility for the future. Shelf registration as you outlined are really commonplace and they generally have a life of three years, so we believe this is just a prudent step in the company.

Brooks O'Neil - Dougherty & Company

Generally given the very strong balance sheet you have today, this would likely be used in the event that you could identify an attractive acquisition candidate?

Jeff Park

Well the shelf business isn't a capital raise. The shelf is just that, it's just the shelf.

Brooks O'Neil - Dougherty & Company

Right. But I'm thinking about the capital that's implied by the shelf offering. I am trying to think about how you might use the capital. Obviously there is lots of things you could do, but you have a $100 million of cash on the balance sheet right now?

Jeff Park

Right.

Brooks O'Neil - Dougherty & Company

So the acquisitions is the most likely use for that or it could be other things as well?

Jeff Park

Our use of capital has historically been really for two purposes, general working capital purposes and acquisitions. Like I said, we're not doing a capital raise, we're putting a shelf in place.

Brooks O'Neil - Dougherty & Company

I understand that. Okay just one or two other quick questions. Obviously, the tax rate continues to be modestly below what a statutory tax rate would be. Is 30% still a good estimate?

Jeff Park

For 2009, the guidance would imply 32%.

Brooks O'Neil - Dougherty & Company

32%. And then just to have a broad general sense, what you would think about for 2010?

Jeff Park

Unfortunately, I can't you 2010 guidance at this time, Brooks.

Operator

Your next question comes from Tom Liston with Versant Partners.

Tom Liston - Versant Partners

Good morning and congratulations as well. Just on the gross margin, I hate to repeat this up, but I want to get a sense on what you call the one-time purchasing gain, is that something that especially is not recurring but you maybe able to secure further rebates, similar type of rebates in the future, is this harder to predict from quarter-to-quarter?

Jeff Park

Yeah, it's a good question. Maybe if I could answer a few things in the gross margin. The expansion in the quarter is really due to some of things we have talked about. There's really three legs to our cost improvement strategy. First of all, its network deficiencies of purchasing generic. The second is pharmaceutical manufacturer rebates and the third is really through how we purchase drugs from wholesalers for our mail and specialty operations.

Our margins also get helped by activities such as helping to promote our specialty pharmacy. As Mark was saying in the prepared remarks there is a number of clients who see the benefits of really finding more active management of their specialty pharmaceuticals and the clients really have also been more supportive of really clinical initiatives like formulary changes, depth therapies, inherence in compliance programs that has really helped us grow our margins.

So we have continued to see improvement on all those areas. In the quarter, what I'm calling out is some specific sort of non-recurring amount of those savings and synergies.

Tom Liston - Versant Partners

Okay. That's good. And, to be clear, even if you whacked that out it looks like you still had a record 13 percentage margins and I think the back half is more in that 11% type of range. Is that just trying to be conservative, is there anything specifically you see that may account for those margin expectations or is it again just being trying to be conservative in the back half?

Jeff Park

Well, part of it is the mix of business that we have. As we sign more pass-through business, it does add gross margin expansion but not to the same extent as perhaps some of the traditionally priced business. The drive for increased generics actually has the pressure of pushing your revenues down, but it can add incremental margin as well. So, it's really a combination of those facts as well as trying to maintain some conservative view, Tom.

Tom Liston - Versant Partners

Okay. And, just finally I think last quarter you talked about NMHC and maybe I think it was closing two more sites down around maybe a month ago or so. Could you just update on us a timeline of your synergies related to the acquisition and are we mostly through there or is there still a fair bit to go?

Jeff Park

No. We are complete with the integration. So, we obviously are going to continue to work on refining the internal operations processes and systems. But the facility closures are completed as well as the converging the accounts.

Operator

Your next question comes from David MacDonald with SunTrust. Please go ahead.

David MacDonald - SunTrust

Good morning guys. A couple of questions, Mark, can you just give us a little but more detail on the pipeline. I know historically sometimes you have given us multiples of [the sales] activity relative to last year or any specific sectors that are stronger or weaker than others?

Then also on the new business that you guys are adding, are the bulk of these coming with mail and specialty included or not, just a little color on that and then I have one or two follow-ups?

Mark Thierer

Good morning, Dave. The sales pipeline right now is healthy and in fact I just reviewed our metrics. July was our busiest month relative to the bids in the history of the company. So; it's pretty heavy in our business proposals department.

In terms of where we are seeing most activity, it's across the Board, smaller employers. We've got a number of small to intermediate size health plans we're active on. We actually have a couple of very large state opportunities that are in the pipeline and that we've been very, very active on. As well as a couple of nice sized HCIT deals which are newer to the pipeline, so we're encouraged with the sales pipeline and obviously our big focus is on conversion from pipeline to the win column.

On your second question, you are asking relative to mail and specialty, the workers comp deal in Ohio did not include mail and specialty, it was actually more of a technology and transaction processing play, but for the bulk of the small employer and small health plan business, they all are including mail and specialty as a general rule. So, the trend there is positive for us.

David MacDonald - SunTrust

Okay and Mark when we think about the workers comp market, is that similar to long-term care or it's just a lot of transactions, a little bit messy and kind of perfect for your HCIT fit?

Mark Thierer

That's a great way to categorize it. Workers comp is very fragmented. You really don't see the big three in the workers comp market in a big way. One of the major players has a bit of a footprint but you will find small regional players.

Worker's comp is very state specific and in many respect it does look like long-term care where we are taking our technology tool set, applying it to the unique requirements in a worker's comp market and then helping that plan sponsor, in this case the state of Ohio, manage drug spend by more active financial and clinical management of a case rather than a claim. So we'd like to state, it does set up as a messy market and we're setting out to help organize that market.

David MacDonald - SunTrust

Jeff, could you just run through the three pieces of the 4.5, I didn't get it down and when we think about our '010 estimate over '09, is the year-to-date non-recurring stuff in the neighborhood about $5 million wasn't there about $500,000 grand in the first quarter?

Jeff Park

Yes, it's actually a couple of million dollars in the first quarter, Dave. The 4.5 is made up of really the large license sale in the quarter and as well as approximately $1.5 million in reprocessing some of our Part D clients and approximately $1 million in the PBM gross margin expansion for the purchasing activities.

Operator

Your next question comes from Charles Rhyee with Oppenheimer.

Charles Rhyee – Oppenheimer

Thanks for taking the question guys. Maybe, Jeff, just to continue on that line on the guidance. If I hear you correctly you are saying about $1 million then of the 4.5 gain is coming from the PBM significant from sort of non-recurring purchasing benefits? Is that right?

Jeff Park

Yeah, that's right.

Charles Rhyee – Oppenheimer

Okay. If that's the case then why wouldn't that purchasing benefit persist in that sense, if you are getting better terms either through rebate or better of purchasing for your mail and specialty business? Why wouldn't we want to consider that as ongoing?

Jeff Park

There are ongoing benefits from our manufactures as well as our purchasing activities. What I'm trying to highlight for you is some non-recurring components that are there. So the question is really how can you have non-recurring pieces that occur.

If you think about it when we go out and do negotiations with manufactures, and when we go out and negotiate for better purchasing discounts in our mail and specialty groups, at times we are not sure what are negotiating power will be able to meet and for what periods of time we are going to be covered and we actually won't see some of that until the claims have been filed, the work has been submitted, and results the come in. So, sometimes they can relate to previous quarter or other quarter activities.

Charles Rhyee – Oppenheimer

Okay. That's fine. And, then if I back out like a $1 million from the gross margin, it looks like you still had a nice sequential increase in the gross margins for the PBM business. That suggests that the guidance is and this is pertaining to an earlier question, that the gross margins are, you are assuming the margins to come down as a back half of the year.

Can you help us understand why we would like to see that again? I know you are trying to touch on a couple of things but it strikes me that we are really expecting sort of the back half to be a bit lower than even backing out the one-time benefits?

Jeff Park

Yeah. So, the guidance is actually if you back out some of the one-times and carry forward you will see that the guidance is really calling for something very close to the same as the first half of the year. If your question is really regarding the percentages, I did try to address that with Tom's question to say that as we add different businesses. Whether its pass-through or otherwise the percentage of gross margin to revenues can change. But the gross margin contributions will still be positive.

Charles Rhyee – Oppenheimer

Okay. So, in other words maybe we need to -- I need to look at my revenue mix?

Jeff Park

Correct.

Charles Rhyee – Oppenheimer

Okay. That's fair. You know maybe a question for Mark. Can you talk about what are opportunities on the Medicaid side is and obviously you signed with Commonwealth of Virginia recently; can you talk about what the pipeline on that side of that business is?

I know there is probably number as Dave said, you need to come up ROP in the near term, can you just address this -- obviously the economy has perhaps hit a bottom here, did that change the equation for some of these states and when they think about their fee-for-service plans?

Mark Thierer

It's a good question, and I'll tell you the Medicaid fee-for-service market has become a very important and strategic market for us. We've never been busier to be honest with you and we also have a very capable team in our Atlanta public sector office who is leading the charge here.

Candidly we've got a large number of opportunities, some of which include full state [contracts] on fee-for-service Medicaid. The states are under so much pressure and the biggest change we've seen is, states becoming more aggressive on managed pharmacy techniques to really get after the drug spend.

Historically fee-for-service Medicaid has been lower no co- pays and just fill it when the doctor writes it. What's happening now, is a very aggressive generic step therapy, clinical protocol introduction, which sets up so well for SXC because that's sort of our department, something we're good at and so each of the state has different requirements and sometimes you feel this often do components of the Medicaid fee-for-service model, which was the case in Virginia through the rebate management process.

So, what we do is sort of build a stair-step approach within the state, get our foot in there, ultimately leading toward a full PBM [contract]. So hopefully that's a little bit more color but we really like that market. There is limited competition. It's truly transparent. Its transaction processing driven and you have to have good technology to compete in that space.

Operator

Your next question comes from Glenn Garmont with ThinkEquity. Please go ahead.

Glenn Garmont - ThinkEquity

Just two quick questions if I could. I think, Mark, in your prepared comments you had indicated that your synergy capture on the NMHC deal exceeded your expectations. I think you were targeting $12 million to $14 million on annualized basis. I'm wondering if you could put a number on the actual synergies that you realize and maybe where the upside came from relative to your expectations?

The second question is, I think, Jeff, you had indicated that maybe a greater retail pricing is contributing to your success here and that's a theme that has emerged during some of our competitors calls as well and I'm wondering if you'd just comment on what changed, that's allowing the benefit manager to maybe appear to be exerting a bit more leverage over retailers at this point?

Mark Thierer

Sure. I'll answer the question on synergies. With respect to, where we are at, we're pleased obviously with the cost improvements and the expense reduction. If you recall, there is really four key metrics to the acquisition. First, there was client retention and we exceeded our expectations with this regard.

Second, with respect to the acquisition we modeled little or only sales growth and as you know we have sold quite a bit. Really, the third was the cost of goods area, where we had modest improvements and we've significantly improved the cost of good on a combined basis for these companies and that's really the component of Mark's remarks.

Then finally, with respect to the expense integration we finished the integration early ahead of schedule which has enabled us to drive these numbers faster and closer to get there.

Mark Thierer

Glenn I will -- this is Mark. I'll address your question relative to retail pricing I don't have a comment on what the other guys are doing. I'll tell this in our business this is not so much about what you call leveraging the network. This has more to do with two things scale and skills. And in our case, part of thesis on the acquisition is that with better scale you can contract better with the retail network and that in fact has been the case. We have improved our contracting posture with not just the chain drug stores but the food mass merchandisers as well as independents. So scale has helped us.

Secondly skills. We have a gentleman named Russell Annunziata, who worked with me at Caremark and helped build their network and candidly I'd put our network team up against anybody in the business and so the skills require to make this things happen are an important component.

I'll also tell you that the industry is benefiting from the generic conversions that have happened and so in terms of the wireline sort of moving up in terms of generic effective rates, generic dispensing rates, a lot of that's happening in the network and the industry is benefiting from that including SXC.

Operator

Your next question comes from Blair Abernethy with Thomas Weisel Partners.

Blair Abernethy - Thomas Weisel Partners

Thanks very much. Nice quarter guys. Just wanted to touch on two things really, in terms of the progress you have been making in the cross selling of mail orders and specialty, I wondered if you can sort of fill out what progress you had in the first six months of this year and give us a sense of how far down the road you think you are, how much more opportunity there is for you there?

Secondly I'd like to just sort of walk through the workers compensation market in a little more detail if you could and give us some sense of the timing, whether you think that there are some more opportunities you could secure there in this year or is it sort of more over the next couple of years that this market is going pay for you guys?

Mark Thierer

Okay. Blair. Good morning. This is Mark. So let me first address your question regarding pull-through in mail and specialty and kind of where we're at. Jeff in his remarks talked about our penetration rates and you haven't seen a big pick up in penetration rates, which I think is an indication to you that it takes time to drive pickups in plant design and pull-through.

I will tell you we have seen success and have new customers as well as the installed base putting in mail order and specialty aggressively and so while our penetration rates don't reflect it yet, I think we've set the foundation for some good growth.

In terms of where it can go, candidly some of the big players in this market talk about penetration rates in mail in excess of 30% approaching 40%. I don't see us necessarily getting to that level, but if we could get to the high teen low 20's over a reasonable period of time, that would be something that we would aspire to.

So we really like both the revenue and margin opportunity that both mail and specialty provide us and candidly it's a focus item for us on our management side. We are account by account evaluating and putting clinical and financial recommendations in front of our clients to make these moves.

Blair Abernethy - Thomas Weisel Partners

Mark just before you go on, in terms of our gross margins if you got to that high or low 20s kind of range, can you give a sense of what you think the incremental would be on the gross margin?

Mark Thierer

It depends on the types of clients and the pricing that we have. How is that for an answer for you, Blair. When you look at the spectrum of what our clients are looking at and how they can save money, really the tools that we can bring to the clinical is one thing, being able to drive more mail utilization helps client save money. It's a cheaper way to dispense, it's a cheaper to fill and that's really some of the recommendations that we talk to our clients about.

Then finally with respect to specialty; specialty is very convoluted. Many of the specialty claims are buried inside some of the medical reimbursement and its tough for people to get their arms around, what is one the fastest growing spends categories. So we've been very aggressively working with our clients to help find more cost effective ways to spend either through mail and more cost effective ways to manage their specialty spend.

Blair Abernethy - Thomas Weisel Partners

Okay.

Mark Thierer

And, Blair, you had asked about the worker's comp market. Let me just spend a minute on it and give you a feel for the size and the opportunity and how we fit. The worker's comp market I will categorize as a niche in the managed pharmacy space and if you stop and step back on SXC's model you can start to think of us as the special purpose PBM. Because of our technology heritage we are installed in cash plans, were installed in Part D plans, MAPD plans, managed Medicaid plans.

All forms of commercial insurance plans were installed in hospice and in fact we are installed in worker's comp plans with PBMs who needed a technology solution to deliver worker's comp space. So we've had experience in worker's comp. The Ohio business is our first foray into managing it ourselves.

So in terms of the market it is a fragmented market it's not been rolled up. It starts to look like the hospice market in the sense that its lower revenue but high gross margin, lower claim count but you get paid more to do the work on a case basis versus a prescription basis, they use the word cases to manage these workers comp claims. So there are a number of carriers that are providing workers compensation insurance and obviously there are a handful of regional PBMs providing workers comp PBM services.

Now, what makes this business interesting and unique is that they have a complex set of eligibility and then individual formulary management requirements. If you are on workers comp claim you are probably getting filled for some kind of pain medication, you have immediate needs and the notion of dynamic eligibility is something that you have to provide in the space and it's a complex system requirement that our platform is technology enabled to provide. So, all in we like the spaces, its really our first kind of big step into the space and you know we like the opportunity but its never going to be the size of you know say the health plan or employer market space.

Blair Abernethy - Thomas Weisel Partners

Okay. How would you stuck it up against the state medicate market?

Mark Thierer

On its relative size I would say its probably comparable really. Obviously if the state medicate market caped at 50 states and many of the states do it differently. In terms of drug spans the Medicaid market is much, much larger. But keep in mind we only run transaction processing fees through for the Medicaid business. I don't have the data in front of me so I don't want to be specific, but I kind of think of them as relatively the same size.

Operator

Your next question comes from Michael Baker with Raymond James.

Michael Baker - Raymond James

Thanks a lot. I was wondering in and I didn't catch the very early comments that you made Mark, but I was wondering if you could give us a sense of where the net new business is right now for 2010? I know some of your peers have given that number, I was just wondering if you are prepared to do that?

Mark Thierer

We don't really quote a net new business per se. I will tell you Presbyterian is a example was 450,000 lives. We talked about a 150,000 lives in the first quarter, so you can begin to kind of put that together but, our net new lives number is not something that we've made a practice of quoting.

Michael Baker - Raymond James

Okay. Then I was wondering, obviously you gave us and update on mail penetration, I was wondering where you think you could push that over the next two three years?

Mark Thierer

Michael I think if we got to the mid-teens in the next couple of years, we'd feel good about it and if you get a couple of large clients to go mandatory mail, you could improve on that. We are seeing some very large clients active on this topic of mandatory mail, which really drives utilization, so I don't know that sort of my horse sense on mail penetration.

Michael Baker - Raymond James

Okay. Can you give us a similar sense on specialty penetration, where you think you can drive that?

Mark Thierer

Much higher. The specialty penetration is kind of a more natural snap-on to a managed pharmacy benefit. There is no reason that we can't reach 70% plus kind of penetration with specialty.

Michael Baker - Raymond James

Then the last time you were on the call, you indicated that you saw some opportunities in kind of the state Medicaid for acquisition. Obviously we saw an acquisition hit the tape and I was wondering if that was a business you looked and why maybe you passed? Was it a function of you had by other businesses along with it, in other words the first half?

Mark Thierer

I am not to going to comment on what we've looked and what we have not. You can assume we are looking at properties that would make sense strategically with our footprint. What I meant specifically about the managed Medicaid space is, there are some tool providers and some service providers around data analytics, reimbursement services, audit services, eligibility services, things on the frames that people get paid for with nice recurring revenue streams and decent gross margins that are typically meant to affect smaller players. Those are the kind of things that I was talking about. For us, we have won six states in two and a half or three years, it's cheaper for us to just win them.

Michael Baker - Raymond James

Okay, that's a fair comment. I was wondering, obviously, there's been a lot more talk about some of the managed care on PBM properties out there, obviously the ones that most talked about [Admin Signal]. I was wondering if size would be any constraint around that? More importantly hearing that there are some managed-care companies considering sales of some of their internal PBMs, I was wondering if you saw similar opportunities there as well?

Mark Thierer

If you think about our perspective in the industry we are really uniquely positioned. We get a pretty good look at everything because we are really literally in all four corners of the PBM market space. So, in terms of what looks interesting to us, I think peer play PBMs that are on our platform are obviously the most interesting from a synergy standpoint.

I think the larger health plan PBMs we would be less constrained financially but the notion of taking on huge customer clients concentration risk with one huge monster client I think adds complexities to the business model that we wouldn't necessarily need and so I would categorized those as less attractive to our business and as I said in my prepared remarks we are looking at all kind of properties, specialty, oncology, outcomes and analytics and at the end of the day we have got an operating model that's working pretty well, we're in no big hurry.

Michael Baker - Raymond James

Okay. And, then we recently saw the House put in their health reform proposals, some potential for additional PBM disclosures and obviously its wild card is to how it all plays. But if we were to see those finalized in some legislation would that result in any potential change in how you approach the PBM market from a sales perspective? In other words would you kind of bend a little bit more towards your transparency approach rather than traditional?

Mark Thierer

Yeah. I'm up on some of the proposed legislation and in this area transparency I don't think it makes us very nervous at all. That's kind of what we have been espousing for the last several year, as we have brought informedRX to the market

So, would it change anything that we are doing? It would not. You can't name a more transparent market than the fee-for-service Medicaid market and we have figured that space out. So, more broadly on the whole Washington sort of the trends and directions we are seeing, we generally view it as a net positive to the company and separate apart from your transparency question we think there are bunch of things that are being talked about that set up well for the company including file stimulus.

There is a lot of talk on the $20 billion piece of the stimulus relative to e-prescribing and you can look for us to be much more active in that space. They are obviously expanding coverage through Medicaid, which sets up well for us and all-in-all we are feeling pretty good about what we are hearing coming out of Washington.

Michael Baker - Raymond James

Okay and then just final point for Jeff, could you give us pre and post? Pre and post in terms of the volumes, the claims for HCIT or either that or adjudication.

Jeff Park

So, 98.8 million in the quarter. The pre and post works around $34 million and the commercial is $34.8.

Michael Baker - Raymond James

Thank you.

Jeff Park

I'm sorry if I could correct that, I said 34 and 64.8 to get to 98.8.

Operator

Your next question comes from Paul Steep with Scotia Capital.

Paul Steep - Scotia Capital

Actually you hit them all. Thank guys.

Operator

Your next question comes from Tony Perkins with First Analysis.

Tony Perkins - First Analysis

Good morning. Most of my questions have been answered but Mark I was wondering if you could talk about the 2010 selling season maybe at a high level, I'm just curious if you are seeing pricing pressure or increased pressure from the big three PBMs in the middle market, maybe greater willingness for clients to change PBM providers etcetera?

Mark Thierer

Tony. Thank you. We're actually very active in best of finals right now. I'm headed to one next week and we are very active today in 1-1-2010 opportunities. Most of the big stuff has been decided I would say. We've got a couple of larger opportunities that we're chasing.

Relative to the pricing environment, remember our five target markets, we are not trying to target the backyard of the big three PBMs. We're very disciplined about the five segments that we are competing in and I think the pricing in those segments, I have seen no measurable change and we are obviously bidding business at contribution margins that we will grow the company. So it's competitive, there is no doubt but we don't really see the big three that active in the segment that we are running after.

Tony Perkins - First Analysis

All right, just one more question now you obviously gone after workers comp space and there is more opportunity there and Medicaid fee-for-service and long-term care. Are there other niches we should think about or other niches may be you or someone on your radar that you think are potentially interesting in the future.

Mark Thierer

Yes, there are, we think that the hospice market is an underserved market and the total alternative site market is what I categorize as a messy and fragmented market. And so anywhere that pharmacy gets delivered, where complex online transaction processing and clinical management has not arrived, those are segments we are looking at and so those are a couple examples of market segments that we continue to explore.

Operator

Your next question comes from John Kreger with William Blair.

John Kreger - William Blair

I think you guys mentioned that one of your targets relating to NMHC renewals and you are doing better there. Can you just explain on that a bit more? Are you done with renewals for 2009 and I believe there are a couple of key customer renewals in 2010, any early visibility on retaining that business.

Mark Thierer

Yes, John, this is Mark, the whole account retention strategy that we set out when we model the NMHC acquisition, we have been very pleased with the results and in fact we have exceeded what we set out. I mean we modeled a bunch of attrition that ended up not happening. We retained the vast majority, we do have a handful of losses but we retained the vast majority of the NMHC clients and so between now and year end we have no big renewals that we are exposed to.

We do have a couple large renewals in 2010 mid-year and our standard practice is to early renew clients, not clients but certainly our largest clients and we are working on them as we speak.

John Kreger - William Blair

Great. That's helpful. Thanks. Just a follow-up question on Medicaid, I know that certainly one of the possibilities with healthcare reform, Can you refresh your memory as Medicaid grows let's just say if it grows faster than the rest of your business. Does that helper hurt the profitability of your company?

Jeff Park

Sure. I can help you understand that. We have a number of different types of business. Some are priced traditionally, some are pass-through, our state Medicaid is pass-through. We have absolutely seen growth in the state Medicaid business not only with the wins but with the economy being the way it has and unemployment doing what it has. Its driven up the enrolments state Medicaids. I think the margin profile probably speaks for itself.

We are set up as a very low cost, cost effective way and transparent way to deliver these services and as Mark was saying in that remarks around, whatever universal healthcare looks like in the push force transparency, it's bit going to be a negative to our business model.

John Kreger - William Blair

Great. Thanks very much, Jeff. A question about the economy as you sit down with your customers now, what impact are you seeing the economy have on the way they think about health plan designs and sticking with the incumbents versus going to a new vendor and do you have any insight on the underlying consumption trends of your members, given the economy are they stabilized getting better, getting worse?

Mark Thierer

John, this is Mark. I think its been and I spent a lot of time with clients and prospects. I think what I am hearing has been very interesting, first of all, 15 years in this business, its always been hard to clients to move. So, there is nothing new relative to that, but the notion that they want to stay because the economy is tough, is counterintuitive. What I am seeing is the opposite is true.

The dialogue is much more aggressive around our willingness to do things like aggressive prior ops, step therapies, contingent therapies, mandatory mail is being talked about, which is an aggressive clinical move. We are talking about large three tier co-pay differentials. We've got a handful of large clients putting in what we call reference-based pricing and value based designs, which are very aggressive cost containment strategies. So, what we are seeing is employers really getting focused on saving money in pharmacy and its setting up well for us.

In terms of utilization and you asked the question, are we seeing sort of down ticks there, actually we had modeled sort of zero growth there and we're not seeing the kind of utilization tail-offs that the industry I think was expecting.

John Kreger - William Blair

Excellent thanks, one final question. You done a great job integration NMHC over the last year. Where do you go from here. If you think about the next one or two years, what are your top couple of priorities to continue to get growth benefits out of that business?

Mark Thierer

Well, it's a great question. We talk about it a lot around here. We are focused on growing this business organically and our single most important priority of our top five priorities is building and delivering world-class sales and marketing machine.

We are all about selling new business in each of the five segments that we are competing in. It's the thing the senior management team focuses on. We now have a fully, filled out sales operation with capable people, under capable leadership and so we are all about executive on the sales pipeline and that's what is going to happen over the next year or two.

Having said that we are throwing off a lot of cash and we will deploy the cash in ways that make sense for the shareholders. So grow the business organically and be opportunistic if something attractive comes our way.

Operator

Your next question comes from Michael Minchak from JPMorgan.

Michael Minchak - JPMorgan

Good morning. Just a couple of questions, and first in terms of new business opportunities, is there still anything on the pipeline that could impact 2009?

Mark Thierer

Michael, we have got couple state bids if they started could have modest impact in 4Q but basically no, I don't see much impacting the balance of the year.

Michael Minchak - JPMorgan

You talked about transparent versus traditional business and the impact on the PBM margins. Can you provide some colors as to what percent of your informedRx business is currently on transparent basis?

Mark Thierer

No, we don't have that breakdown here Michael unfortunately.

Michael Minchak - JPMorgan

Okay and then just may be further on the [Portal] side of your business are seeing more interest in that model, in the transparent model versus the traditional based on the [fee per service too].

Mark Thierer

Yes, we have seen that trend really for the last three years, what was occasionally being asked for transparent pricing, now almost every bid we see is asking for traditional and transparent pricing. It's not an interesting concept, it's something that all the brokers and consultants are working through and employers are starting to get a lot more intelligent around ways to effectively manage their costs. So, the drumbeats continue.

Michael Minchak - JPMorgan

Great. And, then finally, you discussed your generic dispensing rates for the quarter and it's 71% is higher than your piers. Can you talk about how much that is up year-over-year? And then as a follow-up to that under your transparent model is the generic split more profitable for you relative to the branded or are you able to get that profitability else where?

Mark Thierer

Yes. It's up year-over-year. If, you look at sort of industry wide I would say the generic dispense rates have probably increased by 7% or 8%. Our business would be no exception in that as the last few years have been high amount of new generics coming online. From a margin profile perspective generics provide the best cost savings for clients and when we save those clients' money, that also is the most economical to us.

Michael Minchak - JPMorgan

That's same is true under the transparent models are?

Mark Thierer

Transparent model is basically a fee-for-service Medicaid type, where we charge admin fees to support the claims whether they are generic or pass through, or [generic], or branded drugs.

Michael Minchak - JPMorgan

Do you have the opportunity to get performance fees if you -- if the drug starts to comes in, in a certain level there?

Mark Thierer

Yes.

Michael Minchak - JPMorgan

Okay. Perfect that's all my questions. Thanks and congrats on the quarter.

Operator

Your next question comes from Dushan Batrovic from Canaccord Adams. Please go ahead.

Dushan Batrovic - Canaccord Adams

Just kind of a general question to begin with, as far the real over-achievement in Q2 results and in the raise for the full-year guidance. Perhaps, you could weigh some of the factors that led to that relative to last quarter, when you set that guidance. What areas surprised you the most? Was it new wins or was it something else?

Mark Thierer

No. We really have been able to see a number of things that have happened in the quarter. First and foremost you would agree that the trans the acquisition was really transformational. So we have been able to as I was discussing on the synergy side we have been able to see more than expected in both the retention, the sale, the cost of goods and the expense consolidation.

We have announced a few deals recently Presbyterian, State of Ohio. In the last quarter that certainly is another reason for the move on the guidance and we've been fortunate to experience some of these unexpected improvements and we continue to approach our guidance with a conservative and consistent approach.

Dushan Batrovic - Canaccord Adams

Okay. Next question for me is on the revenue per transaction on the healthcare IT side. I don't think there were one-time items that impacted that number, but it looks like it was up quiet nicely on a sequential basis. Maybe just comment on that a little bit?

Mark Thierer

I did actually mention Dushan in the remarks, there is roughly 1.5 million of reprocessing activities in the quarter for Part D.

Dushan Batrovic - Canaccord Adams

That would have been in that recurring number then.

Mark Thierer

Yes, that's one of the reasons.

Dushan Batrovic - Canaccord Adams

Got it, okay. And outside of that revenue would have been roughly stable.

Mark Thierer

You can see an increase, I mean if you just look back at the trend over the last few quarters, two years, the rate per transactions continue to increase and that's really related to the additional services we bring and provide to our clients.

Dushan Batrovic - Canaccord Adams

Okay. Last question for me is just on the reform side. In the US, maybe a little bit of commentary on how your clients are looking at the reform. I know you believe net-net it should be a positive, but is this an area that they are paying close attention to or are they really going through their usual course of business?

Mark Thierer

Yes, it's a good question. It is a topic that comes up almost universally with our clients. They are interested in what the impact is going to be on pharmacy spend. One of the topics that gets talked about a lot is this proposed legislation around generic biologics and biosimilars.

We are talking a lot with our clients about the money they get to spend in specialty and obviously our company is supportive of this proposed legislation to abbreviate the patent expiration window for generic Medicaid -- generic biologics and so I actually think this is one element of the platform that will happen and it's important because specialty is a big driver now in the overall drug spend, and bio generic drug save client's money. For us when that happens it will drive better margin. So that's one topic that's getting talked about lot.

The second is the whole sort of wiring of healthcare in the notion of electronic health records and in particular e-prescribing, SXC has quietly been a driver in this market. We've got a number of tool that our HCIT clients are using, basically to enable their own e-prescribing and you will see us much more active in this space.

When we talk about where we are taking this business with our client base? When we are selling our PBM services, we talk about SXC as the technology-enabled PBM and where we see the convergence of e-prescribing and the electronic health record businesses overtime. So in terms of future focus, that is somewhere that we spend a lot of time with our client base.

Operator

Your next question comes from Husein Kirefu with M Partners.

Husein Kirefu -M Partners

Good morning. All my questions had been taken care of. Thank you.

Operator

Next question comes from Gabriel Leung with Paradigm Capital.

Gabriel Leung - Paradigm Capital

Thanks, I think you hit almost everything but may be just a follow-up on an earlier question, Mark, last quarter you talked about signing mid-size deals representing 150,000 lives. Do you have an updated number for Q2 aside from the deals, which have been officially been announced?

Mark Thierer

No. Gabriel, I don't have an updated number. I mean, post quarter close, we did sign 450,000 lives with Presbyterian. The 150 lives included some 2009 starts as well 1/1/2010. So I don't have an updated number for you.

Gabriel Leung - Paradigm Capital

Okay. And, Sorry Jeff. I miss your mail penetration number. Can you repeat that please?

Jeff Park

Yes. Approximately 8%, Gab.

Operator

Mr. Thierer, there are no further questions at this time. Please continue.

Mark Thierer

Well. Great. Thank you, operator. And, thank you for everyone on the call. We look forward to talking to you at our next quarterly conference call. Have a good day.

Operator

Ladies and gentlemen, this concludes the conference call for today. Thank you for participating. Please disconnect your lines.

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Source: SXC Health Solutions Corp. Q2 2009 Earnings Call Transcript
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