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Executives

Mark A. Thierer - Chairman and Chief Executive Officer

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

Analysts

Glen J. Santangelo - Crédit Suisse AG, Research Division

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

Zachary William Sopcak - Morgan Stanley, Research Division

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

Robert M. Willoughby - BofA Merrill Lynch, Research Division

Michael J. Baker - Raymond James & Associates, Inc., Research Division

Brian Tanquilut - Jefferies LLC, Research Division

Charles Rhyee - Cowen and Company, LLC, Research Division

Michael Cherny - ISI Group Inc., Research Division

David Larsen - Leerink Swann LLC, Research Division

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

Catamaran (CTRX) Q3 2013 Earnings Call October 31, 2013 8:30 AM ET

Operator

Good morning, ladies and gentlemen. Thank you for standing by. Welcome to Catamaran Corporation's Third Quarter 2013 Results Conference Call. Catamaran has issued an earnings press release this morning, which has been filed with the SEC and is available on Catamaran's website at www.catamaranrx.com.

This is a reminder that portions of this today's discussion contains forward-looking statements that reflect current views with respect to future events such as Catamaran's outlook for future performance, revenue and earnings growth and various other aspects of its business. Any such statements are subject to risks and uncertainties and assumptions that could cause actual results to differ materially from those projected in the forward-looking statements. Please refer to cautionary language in the earnings release and in Catamaran's filings with the SEC, and 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 earnings release. [Operator Instructions] I would like to remind everyone that this call is being recorded on Thursday, October 31, 2013, 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 the call.

I would like to turn the conference over to Mr. Mark Thierer, Chairman and CEO. Please go ahead, sir.

Mark A. Thierer

Well, good morning, everyone, and thank you for joining us on our call today. This morning, we released our third quarter earnings, and I am very pleased with the consistent strong financial results the team continues to deliver. During the third quarter, Catamaran posted record revenues of $3.6 billion and EBITDA of $168 million. This performance represents a 13% increase in revenue and a 62% increase in EBITDA compared to the same period last year.

Now if you'll recall, last year at this time, we were in the process of integrating SXC and Catalyst to create Catamaran Corporation, bringing to the market a compelling new alternative to the traditional industry model. Now just 1 year later, we have proven that our expanded scale and resources, combined with our flexible technology platform, have put us at a table for the biggest and most complex client opportunities in our industry. Our track record of driving savings and delivering on our commitments have resonated across the market, as evidenced by our recently announced strategic partnership with Cigna.

The Cigna contract is the industry's largest PBM contract announced in recent history, and it's proof positive of Catamaran's ability to compete and win at the highest levels. Beyond Cigna, the pace of new business was brisk this year, as we are now wrapping up our 2014 selling season. We posted new wins across all categories in which we compete, including regional health plans, midsized employers and several Fortune 500 employers. In addition to our 10-year Cigna win, we signed over $1 billion in annualized net new business. The Catamaran team successfully executed on our strategy to build scale through new business wins, and we are very pleased with the new sales results that we posted.

Now there's been a great deal written about the Affordable Care Act, and in particular, the private and public exchanges. And I believe there's significant confusion and certain inaccuracies on the impact of the PBM industry and to Catamaran specifically. I want to provide some clarity around the risks and the opportunities as we see them. We believe Catamaran is incredibly well-positioned to succeed in this new world. We've created a company and a set of flexible product offerings perfectly suited to navigate the changing landscape. Our technology, our service model and the breadth of our offerings across the healthcare spectrum give Catamaran a level of flexibility we think is unequaled in healthcare services. As you all know, the expansion of coverage by Medicaid programs is already in motion and the public exchange has began enrolling individuals on October 1. Obviously, the recent implementation of this monumental piece of legislation has been bumpy, to put it mildly. Following what we expect to be a modest 2014 total exchange enrollment, we see a significant ramp in new lives in 2015 and beyond. So our intention today is to focus on Catamaran's opportunities beyond calendar year 2014.

Fundamentally, we see the Affordable Care Act as legislation that will transform the healthcare landscape for years to come. I want to spend some time going through numbers to make sure everyone understands and appreciates the opportunities in front of us. There are 315 million individuals in the United States in 2012 and 47 of the non-elderly were uninsured in that year. The Congressional Budget Office estimate that 20 million to 30 million of these uninsured lives will gain coverage either through Medicaid programs or through an exchange. If we assume the newly insured lives are split and that half of them gained coverage through Medicaid and half through the exchanges, then there will be 10 million to 15 million additional Medicaid beneficiaries and 10 million to 15 million additional health plan and co-op lives.

So let's start by focusing on Medicaid expansion, a market in which we've competed in for over 7 years. Most states have a blend of fee-for-service and managed Medicaid, although each state has a different mix. We currently have contracts with 8 state Fee-For-Service Medicaid programs, which utilize our tools, our technology and our services to manage their beneficiaries. We record Medicaid revenue in our HCIT segment. So if we assume our current market share in fee for service programs, then we estimate we will add drug coverage for approximately 1 million new currently uninsured individuals. Our HCIT segment runs at approximately 50% gross margins so this will be a very positive gross margin contributor to Catamaran.

Now let's turn to managed Medicaid. Catamaran's contracts with dozens of health plans to manage Medicaid beneficiaries on behalf of the state. If you assume our overall market share in the industry applies to the managed Medicaid segment, Catamaran would expect the addition of approximately 1 million Managed Medicaid beneficiaries. These are lives captured through our health plan clients and recorded in our PBM segment. So the associated scripts would be solid, revenue and gross profit contributors for Catamaran.

Now I'd like to transition the discussion to exchanges, both private and public, because obviously, exchanges have been a hot topic recently. First, public exchanges. We believe the Catamaran market opportunity for public exchanges is underappreciated by investors. When I talk about a public exchange, I'm talking about an exchange that enrolled mainly uninsured individuals. It can either be state managed, federally managed or a hybrid exchange, providing health insurance options for individuals. Blue Cross and Blue Shield plans are expected to be aggressive competitors in public exchanges, and Catamaran has a leading PBM market share position with the Blues. Beyond the Blues, we have secured a 45% market share position in the co-op market, the newest entrants to public changes. When you combine our Blues plan, our co-op and commercial health plan market share, it creates a very large catcher's mitt. So if you conservatively assume we secure our pro rata share of lives, we would expect 1 to 1.5 million additional lives secured through our health plan and coop relationships. Importantly, individuals that choose coverage through the exchanges were previously uninsured so they're paying for prescription medications out-of-pocket and represent brand-new lives for PBMs. When they enter exchange, it is our belief that many are likely to select the bronze plans. Bronze plans are the least expensive option because they have the lowest coverage levels and the most aggressive cost-containing features integrated into their benefit designs, such as limited and generic first formularies, as well as narrow retail networks.

These are 2 of the many PBM tools utilized to drive down the cost of drug coverage, which will control cost for individuals and simultaneously drive better earnings for Catamaran. We see the margin profile of the new exchange lives coming in slightly better than the typical health plan margins.

I will now turn to private exchanges or exchanges managed primarily by health consulting firms. While we do not see -- foresee a massive shift of employers into private exchanges in the short term, we are actually excited about the opportunities that exist for Catamaran with any employer shifts to private exchanges. As a reminder, Catamaran's book of business has always been heavily weighted to health plans, which is driven by our flexible service model and our ability to break apart the PBM offering. Including Cigna, our book of business is almost 70% weighted to health plans. Our exposure to the employer segment is growing, as we continue our strategy of targeting larger employers, but this overall exposure is approximately 15% to 20% of our entire book of business. We believe our health plan relationships will prove invaluable as the catcher's mitts for lives entering private exchanges. In most cases, lives captured by our health link clients in private exchanges will be lives not serviced by Catamaran in the past. Therefore, these lives will be additive to our revenue and gross profit.

The margin for Catamaran on a direct contract for a large employer and a contract with a regional health plan or a Blues plan are typically the same so we see no margin impact from the few instances where Catamaran loses a direct employer contract and recaptures the member through a health plan client. Again, we do not foresee a significant shift of employer lives into private exchanges in the short term, but we believe Catamaran will be a benefactor from any level of shifting to private exchanges based on our disproportionate share in terms of our health plan mix.

So in summary, we expect Catamaran to be a clear market share and margin winner post-ACA environment. We see great opportunities to participate in the expansion of health coverage in this country and ride the PBM tailwinds created by the ACA. Medicaid expansions should drive both our HCIT and PBM segments revenue and profitability. The advent exchanges, both public and private, should drive disproportionate amounts of lives, prescriptions, revenue and profits to Catamaran, as we are perfectly positioned to benefit from the exchanges based on our health plan relationships.

The examples I provided could represent 3 million to 3.5 million new members in the early years of the ACA, with more lives added as the program expands through 2017 and beyond. We are very optimistic about the future, and we're investing today to support our growth prospects. Our continued success in securing new business, plus our acquisition opportunities will continue to serve as foundational growth drivers for Catamaran. The future has never looked brighter for Catamaran as we enter this new era, and we'll leverage our strength as an organization to capitalize on these opportunities.

So before I turn the call over to Jeff, I wanted to highlight the recent acquisition of Restat, which closed on October 1. The team at Restat has built a tremendous business over multiple decades, and its client portfolio fits hand in glove with our flexible and innovative strategy. We're very excited about integrating this world-class team into Catamaran. And at this point, I'd like to turn the call over to our CFO, Jeff Park, who can provide you with a more detailed look into the quarter.

Jeffrey Park

Thank you, Mark, and good morning, everyone. The third quarter was another successful quarter, both financially and operationally. We generated strong growth in all key metrics. Let me take you to the quarter results and then I'll spend some time on our underlying assumptions for the updated 2013 guidance. Third quarter revenues for Catamaran were $3.6 billion compared to $3.4 billion in Q2, an increase of 6% sequentially. The revenue growth was due mainly to new client starts in the quarter, as well as continued growth in our specialty operations. We expect to grow revenue sequentially in Q4 due to typical utilization increases and additional go live, as well as the full quarter of Restat, which closed on October 1.

The company's gross profit increased to $288 million in the quarter. Gross margin percentage in the fourth quarter for the PBM was 7.5%. You've seen a steady expansion of our PBM margin through 2013, and we had experienced every year the same effect. We delivered strong EBITDA results in the quarter, achieving $168 million versus $103 million in Q3 of 2012. This represents a 62% growth on a year-over-year basis.

SG&A in the quarter increased to support the new business that went live in the second half. We expect additional operating expenses in Q4, as we continue to ramp operations in support of our new business and with anticipation of healthcare reform lives coming online throughout 2014. We view these investments in our long-term growth as critical to our success. These investments are targeted at member services in a post-reform environment, specialty pharmacy and leveraging our analytics and tools to help drive better outcomes for patients and payers.

We generated $100 million in cash from operations in Q3. You can see cash flow continues to be an important value driver of our business model. We remain focused on our strategy to consolidate the PBM space with our financial and operational flexibility, coupled with a robust acquisition pipeline. Our Q4 results will include the use of $350 million from our revolver to pay for the Restat acquisition. We expect interest cost to increase to Q2 levels to support the additional debt, and we will continue to be below 2x debt-to-EBITDA, as we exit 2013, and we expect to continue to be leveraged in 2014.

Taxes in the quarter were a positive impact to EPS. We expect to close the year with a 27% to 28% effective tax rate for 2013. As we look forward to 2014, we believe Q3 EBITDA is a good baseline to consider with the following additions: Restat will contribute approximately $650 million in annual drug spend and approximately $45 million in annual EBITDA. We expect to generate $20 million in annualized synergies once fully integrated, and this integration will take 18 months post-close. The incremental Cigna business is expected to ramp throughout 2014, as we get to a $5 billion run rate to the back half of the year, followed by the migration of all the Part D book of business in January 2015, which will get us to $5.5 billion. This 2 to 3-year migration schedule will see some services migrate throughout 2014 and 2015. However, our investments in people and infrastructure have already began. We expect cost to support the business will largely offset the contributions in 2014. As this 10-year agreement rolls out, we are taking a long-term view, and will continue to provide clarity on these investments and the contributions as they become known. As a result, we have maintained our 2013 revenue guidance of $14.2 billion to $14.6 billion, and EBITDA guidance of $650 million to $660 million and raised our EPS guidance now $1.24 to $1.27, and adjusted EPS of $1.96 to $1.99. Adjusted EPS only excludes the after-tax effect of deal-related amortization.

As you can see, our guidance reflects continued core growth for Catamaran to close out the year, which is somewhat offset by investments associated with new business and Restat. On a year-over-year basis, the high end of our guidance reflects revenue growth of 47% and EPS growth of 81%. The healthcare industry is transforming rapidly with many changes on the horizon. Catamaran is well-positioned to take advantage of these transformative changes, especially as it relates to Medicaid expansion in both the public and private exchanges. Beyond opportunities due to the ACA, we remain very encouraged by our continued success in the market with our customized solutions, as well as opportunities to expand our specialty services. Operator, I'd like to now open the line for questions.

Question-and-Answer Session

Operator

[Operator Instructions] We'll go next to Glen Santangelo of Crédit Suisse.

Glen J. Santangelo - Crédit Suisse AG, Research Division

Mark, I just want to follow up with some of the commentary you made with respect to the private exchanges. It sounds like you don't believe there's going to be a big migration into the private exchanges. And I'm just kind of curious, is that a function of some dialogue you've had with some of your employer relationships? Could you give us a sense for how those conversations are going and are -- in fact, are your employers even considering migrating to a private exchange or not, and does that make sense in your mind?

Mark A. Thierer

Thank you, Glen, and good morning. We've had exactly 1 client select a movement to private exchanges in our entire book of business. And as we talk about our customer base, we don't hear much about our employer base looking to dump employees into private exchanges. Part of that has to do with what is the construction of the exchange, and what are your motivations to do it. I do think that some of the lower-skilled, lower-wage type industries setup for private exchanges, and I think, over time, like we saw in the defined benefit world, migrating the defined contribution for 401(k)s, you will see some migration. But in the near term or even the intermediate term, we're really not expecting much of a migration, and for us, keep in mind, our primary book of business is middle-market employers. And it's truly been moving up market to larger employers, but the fact of matter is the bulk of our client base is not talking about moving employees into private exchanges.

Glen J. Santangelo - Crédit Suisse AG, Research Division

Maybe if I can just ask 1 follow-up on the pricing around that. Could you discuss how the pricing works within these private exchanges? Is it basically just consistent with how your managed care contracts are struck today, and it's just incremental volume that could potentially roll on if you were to pick up lives?

Jeffrey Park

Glen, this is Jeff. Yes, you're thinking about it right. As those lives come in and come on, we got pricing in place for these health plans that are participants in these exchanges. And I think you also need to keep in mind, as lives move into these exchanges and select the cost themselves, they generally are picking plans that have lower premium. Those lower premiums are coming with more disruption of services, and so the narrower networks, they're looking at generics first formularies, all those things that are actually helpful at driving savings and profits for us.

Operator

We'll go next to Robert Jones of Goldman Sachs.

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

Yes, I guess just to follow-up on Glen's questions. I guess it would be somewhat counterintuitive to investors to think that the margins through a private exchange would be -- it sounds like you're saying net neutral to a large employer. Could you maybe just walk through a little bit on how we can balance that against your book of business, especially as we think about what you've shared with us on the Cigna profitability, just given that is such a large piece of your book? And I know the profitability around that is below the rest of your health plan book. Just trying to square those comments if you could help.

Jeffrey Park

Yes, Bob. This is Jeff. First of all, we have different relationships with all of our client base with respect to the selection of services that they have and how the economics work. As you'd anticipate, larger health plans that have unique configurations of only portions of the services that we provide definitely get more aggressive pricing. But in balance, when you think about -- your question with respect to shifts to private exchanges, the first point to think about is that this is a move from self-insured -- generally self-insured components of an employer to a fully insured component, and that means -- and if you think about why people have moved towards self-insured versus fully-insured, generally, because they've been able to save more money. In most cases, it's kept them close -- it saved them up to 10%, which is pretty significant. So as these lives move in, like I said, the first thing to consider is that they're taking on more narrow networks, definitely higher utilization towards generics, which helps drive profitability, and then there is the health plan configuration. Health plans in our book of business can range in size from the large plans at 1 to 2, and can see 2% to 4% gross margin profile for these health plans, which matches largely the large employer book that we have today.

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

Got it. And then, I guess, just to follow-up on that. I mean, is it safe to assume that if, say, Cigna, for example, did win lives through a private exchange and those lives were put on a much more restrictive pharmacy benefit, is the profitability to you flexible relative to the contract that you had signed with Cigna originally?

Jeffrey Park

Bob, we're not going to get into the specifics of our contract with Cigna. But hopefully, the comments around how we see it on a global basis will be helpful for you.

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

Super. And then just the last one on the net new, the 1 billion, a pretty impressive number. Just wanted to get a sense of how much of that is Jan 1 starts, and then just anything around the mix of that 1 billion relative to your original expectations coming into the selling season?

Mark A. Thierer

Yes, the $1 billion, we felt good about as a net new selling number to put on the board, especially having posted the Cigna win. We include in that number several Fortune 500 employers that we won, and that will be 1/1 business. In fact, all of the $1 billion is 1/1 effective big business. They include some midsized health plans, regional health plans, as well as a good number of midsized employers, companies in the workers' comp space. We had nice representation across each of our operating segments. And today -- and if I were to comment on the margins, I'd say the margins look pretty solid and in line with our current operating margins. For 2015, actually, the selling season for health plans is in force, and we are looking at 1/1/15 opportunities as we speak, as well as a good number of midyear and third quarter opportunities. So we feel good about 1/1/14 starts and the selling season for the larger opportunities has already cranked up for 1/1/15.

Jeffrey Park

This is Jeff. One of the questions that we've received is there's been any -- shifts or changes in the type of agreements that we've had with respect to reform and how the -- how our customers are contracting with us. Clients are contracting consistently, so 3-year deals that are focused on specialty and tightening formularies, as I mentioned. The margins, as Mark had outlined, have been consistent. And as you know, the margins expand over the 3-year term of our agreements with our clients as we continue to drive efficiencies in our operation and extend savings for our clients, and these new wins will come in the 2% to 4% margins and expand and grow with our clients.

Operator

We'll take our next question from Ricky Goldwasser from Morgan Stanley.

Zachary William Sopcak - Morgan Stanley, Research Division

This is Zach, in for Ricky. Just wanted to follow-up with a question on the net new business. Does that include Medicaid expansion at all in the number?

Mark A. Thierer

No, Zach. When you look at what we're contemplating for these expanded lives under healthcare reform, we haven't included any of that in our estimates.

Zachary William Sopcak - Morgan Stanley, Research Division

Okay, great. And then just a question on the tax rate in the quarter and fourth quarter. Is the tax rate in this quarter a fair estimation for next year -- for the next quarter or should we assume that it normalizes back to prior quarter levels?

Mark A. Thierer

Well, taxes, to your point, are best looked at an annual basis. There can be some quarterly fluctuations, but we see the full year tax rate at 27% to 28%, and that would be a little below what our historical average is. As you look forward, I think you should probably use that as a barometer for looking forward.

Operator

We'll go next to Lisa Gill of JP Morgan.

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

Mark, on the several Fortune 500 wins, can you maybe just give us a little bit more color as to what they're looking for, one, are these ASO clients that have stayed ASO? Obviously, clearly, they've stayed ASO, but are they looking at anything different? Clearly, you have a different business model than perhaps some of the other players that you may have won this business from. So just trying to get an idea of what the win factor was or what you brought to the table would be my first question.

Mark A. Thierer

Yes, Lisa, I appreciate the question. We feel pretty good about our large employer approach here. And as you -- just as a reminder, we built out an entire selling organization dedicated to this segment, and have been after this for the last couple of years. And obviously, we're being asked to the table to be bid on many of these larger opportunities. I would say large employers are becoming much more aggressive on clinical programs that they're willing to implement. We had a pretty good percentage of preferred or restricted network opportunities that we went forward with. There's a tremendous amount of dialogue around step therapies relative to specialty and expansive therapies. Four and 5-tier plan designs are not at all uncommon. And so we're beginning to see large employers begin to get aggressive like health plans on managing the pharmacy benefit. The other thing I would say is we've seen requests for on-site assistance on a number of larger employer opportunities, which we -- which sets up with our model. We like that. So employers are looking for ways to save money big time.

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

And then secondly, can you just give us an update? I know, last year, you talked about the $1 billion opportunity in specialty. Can you talk about where you are on that conversion as well as in this new business that you've won through all of the contracts on the Fortune 500 side include specialty within the contracts?

Jeffrey Park

Lisa, this is Jeff. Your question with respect to the $1 billion in specialty was -- the comments that we outlined regarding Catalyst and their book of business. We've done a great job at really driving the integration of their book of business that was not open. So many of them had preferred networks or specialty that was being fulfilled by other providers. We really closed the gap and sold out on almost all of those. With respect to the rest of the book of theirs that was open market, that we can't contract directly. In that area, we've gone directly into the membership base. We're working with the physicians, the high prescribers in these open networks to help drive towards our Briova brand, and we've done good work there, and we're going to continue to expand the open market part of our book of businesses. This post-ACA world is continuing to drive open networks for specialty. With respect to the new business that we've signed, I can't think of every single one of them, but every one of the employer books of business that we have comes over with specialty. And it's been, certainly, a large part of the selling component is how can we drive costs down at specialty and appropriate use of the medication with the members.

Operator

We'll go next to Robert Willoughby of Bank of America Merrill Lynch.

Robert M. Willoughby - BofA Merrill Lynch, Research Division

Jeff, I had the preliminary Cigna contribution as $4.5 billion to $5 billion for fiscal '14 with another $500 million on Medicare coming on in fiscal '15. You said, I think, in you comments, it was a $5 billion expectation for '14. Is that a range you have kind of narrowed to the higher end there or am I interpreting you incorrectly?

Jeffrey Park

Thanks for the question, Bob. What I was saying was that we expect to get up to the $5 billion run rate by the second half of 2014. And then as the Part D book of business goes live on 1/1/15 we'll move through our $5.5 billion complete book.

Robert M. Willoughby - BofA Merrill Lynch, Research Division

Okay. But it is scaling up to 5.0, not scaling up to 4.5?

Jeffrey Park

Correct.

Robert M. Willoughby - BofA Merrill Lynch, Research Division

Okay. And just given the bigger size, Mark, can you reveal your strategy on mail, what the infrastructure currently looks like, what you need to invest, what it may look like a couple of years from now?

Jeffrey Park

Robert, this is Jeff. With respect to our mail and home delivery as well as our specialty infrastructure, this has been an area of our book that has continued to grow. I'd say, generally, as you already know, the trends that are happening in mail is you're not looking at mail on a global basis seeing high growth rates. It's relatively static, as Retail90 programs are moving those prescriptions back into the store. We have been making investments in our home delivery and our specialty footprint. In fact, we just opened a very large facility in Indiana that's really going to be a nice showcase for us. And we continue to see this as an area of growth, in particular, on specialty more than the mail assets that we have, but both of the books of business are growing significantly as we look forward into 2014 and beyond.

Robert M. Willoughby - BofA Merrill Lynch, Research Division

Okay. And just the last one on customer conversions. Were there any in the quarter? What are you assuming for next year for IT customers moving over to full service PBM relationships?

Jeffrey Park

Yes, there was no conversions in the quarter of HCIT to PBM. We've got roughly a dozen or so that we're continuing to work on. This is the -- obviously, been an area from an acquisition perspective that we've been working as well as been very successful at driving these HCIT to PBM conversions throughout the year. We're going to continue to work away at that, Bob, and we'll hopefully be able to continue to put up some good numbers as we look into '14 on our conversions.

Operator

We'll go next to Michael Baker of Raymond James.

Michael J. Baker - Raymond James & Associates, Inc., Research Division

I was -- I just wanted to follow-up on your thoughts as it relates to the currently uninsured in terms of your expectations around their utilization and maybe do it in comparison to the commercial book.

Jeffrey Park

Michael, this is Jeff. With respect to the uninsured, the first piece that they move into is they, in many cases, haven't had access to drug coverage. So you can see a spike in utilization as they gain access to this for the first time. We also understand that being given access to prescribers and physicians in the network will also start to drive changes in the care patterns that they have, which will principally start to drive more maintenance medications, as well as more specialty utilization. So we'd expect to see a relatively significant difference in the utilization patterns in the beginning, and then would think that they would start to come closer to a 10 to 11 prescription per person as they trend out, but should see higher than that in the beginning. And as I was mentioning earlier, I think when you look at gaining access to new insurance, but having that insurance having the lowest premium levels, that's still going to leave a lot of the cost that will sit with the individual, and that will drive generic utilization and more aggressive formulary, more aggressive networks, and those are great profit drivers as well as great savings tools for our members.

Operator

We'll go next to Brian Tanquilut of Jefferies.

Brian Tanquilut - Jefferies LLC, Research Division

Mark, if you don't mind just talking about your conversations with the employers. You mentioned that you highlighted how a lot of your employees are actually middle market guys. So I just wanted to see if there's a differentiation between the middle market and the larger employers as they look at healthcare reforms, specifically the exchanges and also what you're hearing from these guys, both large and mid market, on how they view their retiree populations?

Mark A. Thierer

Yes. The -- I appreciate a question, Brian. Our conversations with our employers have been pretty consistent. And as I said in my prepared comments and in the Q&A, we're just not hearing a lot of employers talking about dumping employees onto the exchanges. For one thing, this is an important part of how you hire and attract people to your companies. And I think that there's a concept here that you're abandoning your employee base by throwing them out to the exchanges. And candidly, if you're a manufacturer, a financial services company, I don't think you can find many flagship employers who are thinking about doing that. For these middle-market employers and the notion of throwing them into the public exchanges, I think that there may be some who choose to do it. As I said on the kind of the lower-wage, lower-skilled kind of book of business, we don't have a ton of that. But if you're a labor union, if you're a high-tech company, if you're a financial services company, if you're a manufacturer, if you're a distributor, many of which we have in our book, we're just not hearing much around dumping employers or dumping employees onto exchanges.

Brian Tanquilut - Jefferies LLC, Research Division

Got it. And then, Mark, also, to your comment on the 2015 selling season being early, at least, for the health plans, is there -- and I know Jeff made a comment about how the contract structures haven't really changed, but is there anything different in terms of what they're looking for or how they're wanting you to set up the PBM service as we think about the reform in '15?

Mark A. Thierer

I would say it's a bit more of the same. And I would say, universally, all our client base is really asking us and looking to us to try and find ways to contain trend and try and find ways to actually take cost out of the prescription drug benefit. So it's the familiar subjects of specialty, of new plan designs, restricted formularies and restricted networks. That, I would say, is getting the most traffic in our discussions. We're typically being asked to configure and do geo access analysis on almost every client to restrict the network and look at ways to contain the cost. The other thing that's important and that we're being -- talking a lot about, we're showing it in our innovation center is how can you get member engagement to a whole new level. Because a lot of the cost shifting, whether they're doing -- even thinking of exchanges or not, they are moving cost sharing to the members, and so how can you engage the member at a whole new level, and we are focusing on our mobile strategy, our portal strategy and our member engagement tools to help get after that. I would say that's been the other theme that we've seen big time in the recent selling season and for next year.

Brian Tanquilut - Jefferies LLC, Research Division

Got it. And then last question really quickly. Jeff, thanks for the bridge, the 24 accounting, extending the baseline for '14. Just how should we think about the Walgreens loss in terms of trying to quantify that for you guys both on a revenue and earnings basis?

Jeffrey Park

Great. Walgreens employees came to us as part of their divestiture WHI several years ago. And as you can imagine, they fill almost exclusively at their stores. So this was really more of an HCIT type of relationship and earnings impact is really immaterial.

Operator

We'll go next to Charles Rhyee of Cowen and Company.

Charles Rhyee - Cowen and Company, LLC, Research Division

Just wanted to first clarify, Jeff, I think you made comments about the tax rate for the rest of this year, and then you made -- can you kind of clarify the comments on what we should expect for 2014? Are you saying we're going to go back up into the low 30s is the right way to think about it? Because when I read the commentary in the press release, it seems like there's a reduction in these non-tax-deductible items. Shouldn't that persist and maybe we stay in this high 20s?

Jeffrey Park

Yes, Charles, thanks. Thanks for asking the question. As we close out the year, we expect the tax rate to be 27% to 28% for 2013. As you look forward, we're not giving '14 guidance for this year. As you look forward, we're not giving '14 guidance. But if you look forward, you can see that our tax rates have generally been in the low-30s, and we expect that the tax rates will start to move back up closer towards our historical average, up from this 27% to 28%.

Charles Rhyee - Cowen and Company, LLC, Research Division

Okay. Can we talk about -- you talked about conversions a little earlier and the opportunities there. Can you talk about the rest of your M&A pipeline, what's still out there and what is sort of your ability to execute on deals, post closing Restat here?

Mark A. Thierer

Great. Well, we just closed Restat 30 days ago so I appreciate your question. We're certainly pretty active with the integration on Restat and it's off to a great start. We've really inherited a great team, and our organizations know how to drive these integrations and to make sure we can keep customers happy and drive through the full set of services that we bring to bear. And as we look forward, as you'd come to expect, we developed really an expertise in sourcing, financing and in integrating these acquisitions. We've certainly created significant shareholder value. In the last 18 months, we've done 3 transactions and we evaluate them with these 3 criteria: first, it's fit into our business; the second is the accretion that it drives; and third is the valuation. We continue to evaluate acquisition opportunities that meet these criteria, and you can expect us to continue to be active in the M&A marketplace. We're focused on driving the integration that we have today, and the commitments that we've made to our customers as we move forward. Our growth continues to come from, first, new business wins and then specialty growth. We talked about the lives from ACA and post-reform, and acquisitions are really 1 leg at the table for us from a growth perspective.

Charles Rhyee - Cowen and Company, LLC, Research Division

Great and just one if I can just squeeze one more in. On -- can you talk about cost related to ramping up Cigna that you incurred in the quarter and how much do you kind of expect that's embedded in SG&A for the fourth quarter?

Jeffrey Park

Yes, I will. This is Jeff. We've been at -- you can see, as we've continued to ramp up our SG&A has continue to grow here in the third quarter. We're expecting that to continue through the fourth quarter. We're not breaking out any specific ramps to a particular client, et cetera, but the business was going to continue to see investments as we get ready for go-live for 1/1, as well as ensuring that we're in a position to support the implementation work that we have and the volume of lives that we could expect to see from healthcare reform. So we want to be in a good position with respect to the cost and service models as we come in for 1/1.

Operator

We'll go next to Michael Cherny of ISI Group.

Michael Cherny - ISI Group Inc., Research Division

So all the questions have been answered. But Mark, I just want to go back to some of the comments you made around the 1/1/15 kind of early discussions. I think you had talked about this as early as last quarter. But as these organizations start to think about 1/1/15, how have they started to think about the relationship relative to the exchanges and the expectations? Have you any comments to them as they try to position themselves for this new environment, whether it may be in the expectations that they need in terms of who they would look at for a new potential PBM provider or PBM partner?

Mark A. Thierer

Yes. I think this is an area where we really advanced our hand. We formed a dedicated unit around exchanges and the impact on our client base, and so we embedded in our selling process now as a discussion point. So each of our clients, in particular, the health plan clients, are thinking about their strategy in the private exchanges as well as the public exchanges, and many of them are taking a wait-and-see attitude. But as we evaluate 1/1/15 opportunities, it is our tools, technology and our ability to unbundle and then create a flexible and customized service offering that is attractive, in particular, to these health plan clients. And when I talk about 1/1/15 opportunities, I'm talking primarily about mid-market and larger health plans. And so we really, I think, emerged as a preferred partner when it comes to implementing complex plan designs, as well as some of these new market initiatives. And so I'd like to think that this is one of the things that's setting us apart in the selling cycle and we've put dedicated resource with skills on this initiative.

Michael Cherny - ISI Group Inc., Research Division

Great. And then one other just quick question on the M&A side, given that you just, obviously, completed the Restat deal. Obviously, you have a large pipeline of deals with -- out on a go-forward basis. With the rest of consolidation in the space, obviously, 2 large players, you had recent private equity interest in the space, have you seen any change in the competition related to going after deals, especially since that you seem to be positioned as the most attractive or best buyer of assets currently?

Mark A. Thierer

Yes, that's a good question. This is Mark. And I -- it has been very interesting to me over the last several years to watch the playing field change. What I think we find ourselves today is we are the, I would say, the logical exit for most middle market and smaller PBMs. Candidly, these targets are just not material or meaningful to some of the larger players, and we still have a very nice runway of clients on our platform. But with the Restat acquisition, we proved that that's not the only place we can shop. And so for us, we've emerged as a very logical and preferred strategic exit. We can extract synergies, and yet the competition for bidding on these properties is way down. And so from a valuation standpoint, what we see is it's a good time to be in the market. So to Jeff's comment, we're very focused on integrating Restat, standing up Cigna, but we do not -- we're going to continue of the consolidation and the middle market roll up strategy that we've set out. We really like our opportunities there.

Operator

We'll go next to David Larsen of Leerink.

David Larsen - Leerink Swann LLC, Research Division

Could you maybe talk about Express Scripts' recent decision to exclude 44 drugs from their national formulary? How does that impact you? Is there a potential opportunity there?

Jeffrey Park

Dave, this is Jeff. First, we are focused on driving generics first formularies versus driving high rebating for brands on the formularies. Our role is to make sure that employers and health plans have a say in the formularies. This affects medical expenditures, as well as drives member disruption. We are seeing restricted formulary and networks of tools to help manage these rising benefit cost, but we work in collaboration with our health plans on these types of changes to make sure that it fits with what their needs are.

Mark A. Thierer

And Dave, this is Mark. The other thing I'll add is anytime there's a dislocation in the market from any competitor, we do evaluate these things and move as appropriate, and so I don't want to comment on any one competitor's market moves. But one of the things we've become good at is moving quickly to kind of fill gaps in the market as they present themselves.

David Larsen - Leerink Swann LLC, Research Division

Okay, that's helpful. And then as far as 2015 is concerned, I mean, our checks indicated that some health plans were maybe a little reluctant to switch PBMs with a 1/1/14 start, given ICD-10 and also these exchanges going live. I mean, are you sensing that there's maybe more of a willingness in the part of managed care plans to try new PBMs?

Mark A. Thierer

Yes. I've read some of the same things. The way I gauge this is what is the RFP pipeline? What are we filling out answers to in response to plans thinking about making changes, and then what am I hearing along with our sales organization directly from some of these prospects? Health plans are thinking about their bottom lines. They're thinking about how to get positioned in the post-ACA world, and they are thinking about making changes. And so we're active, actually, right now for 1/1/15 opportunities and the pipeline is early. It's starting to take shape nicely. So I guess I just don't agree with the fact that people are going to stand fast. Obviously, we have to earn it and create a value proposition and then ultimately win. But right now, I would say that we like how the playing field is unfolding.

Operator

We'll go next to Amanda Murphy of William Blair.

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

Just a couple of questions on specialty. So I'm curious, and you talked about the public exchange utilization here, but I'm curious in terms of private exchanges to the extent that they do get increased traction. How does the PBM ability to manage specialty change in a private exchange model or does it not? And then also, just in terms of profit per script in specialty, obviously, you've got utilization picking up there, but just as you guys go more into exclusive type network, how should we think about that affecting profit per script of specialty claim?

Mark A. Thierer

Okay, Amanda, glad you made it. On the private exchanges, I do think there's confusion around this because there are many different flavors. If you look at Towers, Aon Hewitt, Mercer and Buck, they each have different private exchange strategies. And depending whether it's a carved out fully insured strategy or an ASO strategy, many of the private exchanges look and feel just like a normal carve out, and some of them have standalone PBM opportunity, which would mean you're selling the full integrated product line including specialty as part of the solution. We are participating in all of these private exchanges directly or through our health plan clients. And so when it comes all the way through to specialty, the bottom line is the current PBMs who serve as specialty will be serving specialty in private exchanges. It's not like there's going to be a new group of players. And so we're going to, one way or another, be servicing these members, and it does depend on the configuration of the private exchange and how it's being sold. Relative to the profitability per prescription, this has more to do with what the plan design is and what the utilization is coming through. Obviously, you got to be competitive on the pricing line, but this is part of the reason we're investing in specialty to drive cost out of the system with our Jeffersonville operation, and so we're forecasting specialty margins to maintain as well as grow over time, and we think the public exchanges are going to bring new volume into the specialty space that we haven't seen in the past.

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

So just in terms of the profit per prescript-ed specialty, I mean, do you guys see -- because clearly, it's a different type of opportunity relative to the generic brand type of conversion, where there's clinical therapeutical equivalent and you can drive cost savings there. Maybe that's not quite the same in specialty. So just as you think about that opportunity over time, and what is the PBM -- what's the value add there? And what do you guys get paid for?

Jeffrey Park

Amanda, this is Jeff. With respect to specialty, there's probably a couple of pieces that you need to keep in mind. With respect to the first part that you're on to, there is becoming more formularies inside the specialty as there's some competing products inside of certain categories. That drives better rebating decisions as well as lower cost for members. Obviously, from a biosimilar perspective, it made some headway in Europe. It's not made as much headway here in the U.S. We believe it's a matter of time. To your point, that's not going to drive generic pricing, but it is going to drive increased competition for some of these brands in specialty that are driving increases to AWP of 10% to 12% to 14% annual price increases. This will help meter the growth rates, but it will also help drive more rebating and competition for these products. Our job is to make sure, first and foremost, that the prescriptions are being filled with the most effective treatment and at the most cost-effective price. But the biggest dollars in specialty are to make sure that the members are driving the right adherence. These are expensive medications and they're very complex to administer. So you want to make sure that you got a more holistic view of the patient, not just looking at their specialty medication, but actually making sure you can drive an understanding what their oral medications are, are they depressed, or what are the components that really make the best treatment for the patient.

Operator

That does conclude our question-and-answer portion. At this time, I would like to turn the call back over to Mr. Thierer for any additional or closing comments.

Mark A. Thierer

Okay, thank you, operator. Well, we're clearly -- we're energized and bullish about the market opportunities that are in front of us here at Catamaran, and I would like to take this opportunity to extend an invitation for you to join us at our Annual Investor Day, which is coming up in New York City on November 21. We're going to have a number of our strategic clients joining us to discuss how they're working with Catamaran to help them be successful in their various markets. With that, thank you, and have a great day.

Operator

That does conclude today's conference. We thank you for your participation.

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