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Catamaran Corporation (NASDAQ:CTRX)

Q2 2014 Earnings Conference Call

August 1, 2014 08:00 ET

Executives

Mark Thierer – Chairman & CEO

Mike Shapiro – CFO

Analysts

Brian Tanquilut – Jeffries

Michael Baker – Raymond James

Glen Santangelo – Credit Suisse

Robert Willoughby – Bank of America Merrill Lynch

Elizabeth Nolan – Bank of America Merrill Lynch

Brooks O'Neil – Dougherty & Company

Lisa Gill – JPMorgan

Robert Jones – Goldman Sachs

George Hill – Deutsche Bank

Steven Valiquette – UBS

Zachary William Sopcak – Morgan Stanley

Charles Rhye – Cowen and Company

Amanda Murphy – William Blair & Company

Michael Cherny – ISI Group

Operator

Welcome to Catamaran Corporation’s second quarter 2014 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 today's discussion contain 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, uncertainties and assumptions that could cause actual results to differ materially from those projected in the forward-looking statements. Please refer to the cautionary language in the earnings release and in Catamaran's filings with the SEC, as well as Catamaran's most recent annual report on Form 10-K.

During the call, there will also be a discussion of some items that do not conform to Generally Accepted Accounting Principles, including adjusted EPS and EBITDA. Catamaran has reconciled these items to the most comparable GAAP measures in today's earnings release. (Operator Instructions).

I would like to remind everyone that this call is being recorded on Friday, August 1, 2014 at 8:30 A.M. Eastern time. A replay of today's call will be available on Catamaran's website approximately one hour after the conclusion of the call.

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

Mark Thierer

Good morning everyone and thank you for joining us on our call today. This morning we released our second quarter 2014 earnings and I’m pleased with our strong performance in the quarter. During the first half of the year we successfully implemented a number of new business wins, put in place strategic service initiatives. Continued to integrate our Restat acquisition, ramped up the integration of Cigna and are driving to a solid performance in the selling season. I’m confident in our ability to deliver client centric solutions in a complex and changing healthcare environment which is evident in our success so far in the selling season.

The selling season this year has been very busy with a lot of activity in every sector. Some decisions has been inked with the contract while others are obviously still pending. At this point in the year we have signed roughly the same amount of new business that we had signed at this point last year. We’re now in the mid-sized employer selling season as well as with the TPA markets and we have always been had solid traction in those segments of the market.

The competitive environment remains intense with incumbents having the upper hand due to early renewal strategy and switching costs. With that said we performed well in this environment which is a testament to our differentiated model, our flexibility and our plethora of client and member centric being utilized more now than ever.

We continue to invest to maintain the industry leading technology and service platforms in the PBM industry.

The Affordable Care Act continues to drive changes in our industry Catamaran remains very well positioned to succeed in the post-ACA environment due to our breadth and depth of offerings. Our strong health plan client base and our flexible configurations. As we have said in the past we expect 2015 and beyond to deliver a more material impact to the PBM industry and to Catamaran more than in 2014.

As we have mentioned on our first quarter call we gained roughly half a million exchange lives in the first year of enrollment and separately we have seen strong growth in our Medicaid segment. Utilization within our exchange membership continues to track in-line with traditional commercial utilization although there is a slightly higher percentage of specialty utilization in this population than the average commercial population.

We see this as a precursor to what we believe will happen over the next few years. Specialty drug utilization will continue to increase as more drugs are approved by the FDA, a biosimilar pathway is approved and more accurate diagnosis will drive earlier detection and treatment of chronic diseases. We’re very focused on growing Briova RX within our current PBM book of business and through continued penetration in the open network. Our member centric specialty approach is Catamaran’s main differentiator in the marketplace and we believe we’re the only in the early innings of harnessing the opportunities that exist in this sector.

The Catamaran team continues to deliver while at the same time putting in place strategic initiatives to drive growth in our core business as well as evaluating a broader set of go-to market offerings. We continue to evaluate M&A opportunities which we believe is the most effective way to deploy capital on behalf of our shareholders. And as I reflect in the first half of 2014 I’m very pleased with the team’s execution and I’m confident that we’re well positioned for a strong second half and beyond.

The alignment of our business model enables Catamaran to prosper when we control the healthcare costs for our clients which is needed now more than ever. Newly introduced therapies in certain categories as well as the growth of compounded drug costs are driving pharmacy trends dramatically up in certain areas and it is our job to place appropriate controls to make sure the costs are married to clinical effectiveness.

We remain very excited about the growth prospects in the PBM industry and Catamaran continues to lead the field. Now I would like to turn the call over to our CFO, Mike Shapiro who will provide a more detailed look into the quarterly results and the underlying assumptions on future growth. Mike?

Mike Shapiro

Thanks Mark. Good morning everyone. Overall we’re very pleased with the strong financial results that the team delivered in the second quarter. I will take a few minutes to walk through the results and provide an update on our expectation for the full year. For the second quarter Catamaran posted revenues of 5.4 billion representing 58% growth over the second quarter of 2013. The strong growth was generated through continued ramp in Cigna drug spend, our new client implementations and the inclusion of Restat.

Revenue was up sequentially over the first quarter by roughly 470 million primarily due to incremental Cigna drug spend, strong specialty growth as well as the satisfaction of deductibles under high deductible plans. Gross margin increased $15 million over the first quarter as a result of strong specialty growth in overall operational execution. The reported gross profit percentage declined relative to Q1 entirely attributed to the incremental Cigna revenue which carries little to no margin at this point.

Excluding the incremental Cigna revenue our gross profit percentage expanded slightly in the quarter as expected. In the second quarter EBITDA expanded 19% over the second quarter last year to a 189 million. EBITDA for the quarter reflects our margin performance and continued discipline control of SG&A. As you can see with our 2014 guidance we expect EBITDA to continue to expand in the second half of the year relative to the first half. I want to take a minute to highlight the impact Cigna had on the second quarter.

In Q2, we recognized approximately 200 million of additional drug spend from Cigna bringing us to roughly $5 billion in annualized run-rate with respect to incremental Cigna drug spend under our expanded relationship. As we have admittedly ramped up network management quicker than expected we’re now transitioning to the next stage which focuses on migrating Cigna off their legacy platforms and on the Catamaran’s RxClaim platform starting in 2015. As a result we’re investing to ensure seamless transition and now expect Cigna to be slightly diluted to earnings for 2014.

I want to reiterate that the overall partnership is progressing very well and our ultimately financial expectations remain intact. Separately the Restat integration effort continues to progress very well and we remain on track to deliver approximately 20 million in annualized run-rate synergies over the 18 months integration period.

Now I want to take a minute to walk through our updated financial outlook for 2014. For the full year we expect to generate between 20.5 billion and 21 billion in revenue and between 770 million and 800 million in EBITDA. We expect our effective tax rate to be closer to 28% for the full year and we now expect to deliver GAAP earnings per share of a $1.40 to a $1.50 and adjusted EPS of $2.12 to $2.22.

We’re bringing up the floor of our revenue range and bringing down the top-end of our EBITDA range primarily due to updated expectations regarding Cigna. With respect to EPS favorability and expected tax rate should offset the EBITDA adjustment and as a result we’re bringing up the bottom end of the EPS range while maintaining the top end.

So overall we’re pleased with the second quarter results and continue to expect to deliver strong results for the year. The team continues to execute on our strategic priorities to deliver the very best service offering in the industry as well as the Cigna and Restat integrations.

And before opening up the call for Q&A I want to make a few brief comments regarding M&A. Today we have both the financial and operational capacity to deliver capital through acquisitions. We continue to actively manage a robust pipeline of opportunities across a spectrum of PBMs, complementary technologies and specialty capabilities.

As all of you know we have executed eight highly accretive deals in six years and expect to continue that track record. We won't spend capital simply for a headline and we need to ensure that the opportunity is both strategic and economic.

Given the level of M&A activity, I believe it’s more likely to -- you will see a transaction by us in the second half. With that operator we would like to open the line for questions.

Operator

Question-and-Answer Session

(Operator Instructions). Our first question comes from Brian Tanquilut of Jeffries. Please go ahead.

Brian Tanquilut – Jeffries

Mark congratulations on the contract win success so far. You mentioned in a competitive landscape, if you don’t mind just giving us some more color on what the push backs you’re getting, I mean you have talked about services level in the past and what the pricing environment looks like and what your clients are looking for as you go into these best and finals.

Mark Thierer

Sure Brian. The selling season so far this year is feeling pretty good and in terms of push back we’re feeling pretty good about the points we have got on the Board. Clients are continuing to pound [ph] the table on finding ways for us to save the money and I would say in every best and final that we attend and our hit rate is up. Specialty is front and center argument as well as formulary and cost containment strategy is relative to plan design and so in that sense you know nothing has changed in this business in terms of clients continuing to meet the demand, cost containment strategies and I would say the other thing that’s really resonated in this year’s selling season is there is a lot of talk about service and at the end of the day this is a funny business, you’ve to be on par in pricing and if you can win on service it is the reason clients leave [ph] and so those I would say are the two big themes that we’re seeing this year selling season.

Brian Tanquilut – Jeffries

To that point Mark, we noticed that SG&A declined sequentially and I know you’ve been investing in this service side of the business. So what are the moving parts there and then that’s the feedback so far on the investments that you’ve made and how far that is resonating already with the client base?

Mark Thierer

Brian, I can help you with that, we’re pleased that as you have mentioned SG&A sequentially declined in the quarter that doesn’t mean we’re not focused on investing in service. The investments we’re making in the Catamaran difference in the service offerings continues to be in that $4 million to $5 million range and we continue to invest to ensure successful integration for Cigna and Restat and at the same time we continue to be very disciplined and prioritize our spending.

Operator

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

Michael Baker – Raymond James

I was wondering, obviously it sounds like in the selling you’re thinking about at a similar level in terms of wins. I’m just wondering if you can kind of give us a sense of how the mix is in terms of customer segment relative to last year and maybe just some general commentary on margin profile.

Mark Thierer

I would say the mix looks very good to us. It's a nice mix of the six segments that we compete in from employer to smaller health plan. We have got some nice workers comp opportunities on the board as well as I said some nice Medicaid pickup. So in terms of the margin profile of this new business I think you can think of it in the 2% to 4% gross margin contribution range. I would also say that you know obviously no big health plans traded hands this year and the decision is relative to health plans for the largest health plans for 1/1/15 are buy and large behind this and so for us we’re already focused on a number of large opportunities in the health plan space for 1/1/16 and we’re lining up very well. So we like the mix, we like the profit profile and we’re still kind of midstream in the selling season.

Michael Baker – Raymond James

And then just some general sense on when what we might hear a decision on Humana. I know it's just kind of started and my guess is that it will be kind of like the Cigna situation kind of standout but there is any general time frame you’re willing to kind of give a sense of that would be helpful if you can.

Mark Thierer

Well you know obviously we’re not going to comment on any specific client opportunities that are in the market. I will say though broadly from a health plan standpoint I think Catamaran has emerged as the best of breed competitor and we have proven in terms of our results and the points we have on our Board. Our flexible model fits these large health plans really hand in glove in large part because we can easily break a part, our service offering to align with the business requirements and the needs of a specific health plan and so as you know we’re very strong in Medicare Part D, we’re a five star (indiscernible) plan and obviously have a full complement of Medicare products and we don’t compete with our Medicare health plan clients and I think I would finish that off by saying our center of excellence model which is our service model we deploy in the health plan space gets very high marks from the reference basis and client satisfaction basis.

So there is nothing precluding us from competing at the highest level for the largest opportunities and as I said I do think we have become a very competitive and hard to beat player in the health plan space.

Operator

Our next question is from Glen Santangelo of Credit Suisse.

Glen Santangelo – Credit Suisse

Mark I just wanted to kind of confirm what you said in 2013, I think if we go back to this quarter you suggested that you had already signed over 600 million of net new business and then as we talked about the selling season in totality I think you suggested that we weren’t even at the 50 yard line at that point in time on the second quarter call. Would you say those metrics are roughly similar to this year?

Mike Shapiro

Glen, it's Mike I think if you look at where we’re with and again what we talk about on the second quarter call is the book of business that we have in-house with a signed deal and we’re right about $600 million which admittedly is right where we were last year at this point.

As Mark mentioned we’re still in the middle market and small employer space. Again there is markets that we do very well in so we would anticipate to build upon our wins to-date. We think that there is additional room to build on the books here yet this year.

Glen Santangelo – Credit Suisse

And Mike maybe if I can ask you just one follow-up question on the guidance I think if you look in 1Q you all raised your EBITDA guidance a little bit now this quarter kind of (Technical Difficulty) EBITDA guidance down at the top end of the range and I heard your prepared remarks so you seem to suggest maybe that some incremental integration cost if I heard that correctly related to Cigna might have been the difference maker but if I kind of go back to 1Q I think you were suggesting that the revenues from the Cigna contract probably ramped up a little bit faster than what you would have anticipated. So could you maybe talk about the puts and takes and what’s different with respect to the Cigna contract and how that might have impacted your EBITDA guidance?

Mike Shapiro

Yes absolutely Glenn, naturally as we progress through the year we’re going to continue to tighten the range as we get additional visibility on the variables that go into our outlook. You’re absolutely right and as you’ve mentioned this morning, what we have cumulatively done since our initial guidance was we have tightened EBITDA by 10 million on both end and effectively narrowed 10 million on the bottom end and the top end around the same midpoint. As I think about do the update that we posted this morning.

It really revolves around Cigna, the good news is that admittedly the drug spent has ramped quicker than we expected and again those revenues are primarily us managing their network drug spent through our retail channels and there is little to no margin associated with that. So the good news is we have ramped that phase of the integration. Again we’re one year in on the three year integration effort and we’re continuing to focus on hitting the milestones.

As we look forward the next phase of the relationship is really focused on a migrating Cigna off of legacy platforms, again at this point they are adjudicating on RxClaim. So as we have looked to staff up and resource those technology migrations which will begin in 2015. We want to make sure that we’re geared up. So the good news we continue to track our milestones and what we continue to pace on track but as we move forward we want to make sure that we resource and as a result that will impact in the near term the Cigna profitability for 2014.

Operator

Our next question comes from Robert Willoughby of Bank of America Merrill Lynch.

Elizabeth Nolan – Bank of America Merrill Lynch

This is actually Elizabeth in for Bob Willoughby today. You stated an inventory build is cooking [ph] cash flow in the quarter. Can you break that out for us.

Mike Shapiro

Yes if you look at our cash flow we generated $57 million of cash in the quarter admittedly with the growth in our specialty space and in an anticipation of some mid-year price increases for some of the select specialty compounds. We made a conscious decision to add to our specialty inventories in the quarter.

It's really an interim blip and we continue to expect to generate roughly $0.5 billion of cash for the year.

Elizabeth Nolan – Bank of America Merrill Lynch

Any way to quantify the inventory impacts specifically?

Mike Shapiro

It was around $40 million to $50 million in the quarter.

Elizabeth Nolan – Bank of America Merrill Lynch

And then when should we get that back or is inventory balance still trending higher?

Mike Shapiro

With the growth in our specialty space we usually get that back in the third quarter. Again as we build our inventories we maintain a couple of weeks of inventory on hand and given the growth as we continue to build inventory obviously with the recent opening of our Jeffersonville, Indiana facility there is some investments to resource that properly but we will get that back in the third quarter.

Operator

We will take our next question from Brooks O'Neil of Dougherty & Company. Please go ahead.

Brooks O'Neil – Dougherty & Company

If I remember correctly you don’t have a lot of big contracts up for renewal this year but could you just comment on what you expect your retention rate to be for 2015?

Mike Shapiro

Yes, we have said that we have no material renewal exposure for the balance of the year. We’re targeting a 98% retention rate which we think is and in around the best in the business and I think it's maybe the best indicator of our client satisfaction and obviously the reference ability of the customer base because we’re aggressive on renewing and extending contracts and that’s really what this whole initiative that we talked earlier about the Catamaran difference that’s what it's all about. This is a business where if you keep your clients for the long term you can really build value creation and so 98% is our number.

Brooks O'Neil – Dougherty & Company

So just following on that question and your comment Mark, I hear a lot of noise in the marketplace apparently consultants are saying you’re having service issues in the marketplace today and perhaps that’s what’s driving your Catamaran Difference initiative but could you just talk about how recent integrations have gone and whether in fact you’re hearing feedback from clients on service issues now?

Mike Shapiro

Here is kind of a reality check on service. The biggest marker on service is do your customers stay with you and are they satisfied and so from a client satisfaction standpoint our scores from the industry score keepers are among the highest in the business and our retention rates we just spoke about, they are among the best in the business. So we’re feeling very good about our service levels. Now is it perfect? No. Did we have a little chop in the 1:1 conversion on some implementations? Yes, we did there were a number of complexities around Part D that the industry felt broadly and at this point I would say most of that chop is well behind us but the reason we initiated the Catamaran Defense is because we went through the acquisition of Catalyst. We on-boarded Cigna. We have doubled this business twice over in the last 2 and 3 years and so the investment we’re making in infrastructure is to scale us for the next run in terms of growing this business to a $30 billion, $40 billion, $50 billion PBM and that is why we’re investing in the infrastructure work and the Catamaran Difference.

It's really positioning us for growth from what is already a pretty strong service platform. So I hope that helps answer your question.

Brooks O'Neil – Dougherty & Company

It really does. Can I just ask one last one, I’m curious if you can provide any color on whether it was your call or Cigna’s call or what was really behind the delay in transitioning to your claims engine IT with Cigna?

Mark Thierer

There really hasn’t been a delay actually. We laid out a 3 year roadmap, again this is a very complex integration and we always had intended that the first phase focused around managing the retail drug spend. We have admittedly accomplished that on-schedule or a little ahead of schedule. So there is never an intentional delay. Again one of the things when you think about migrating Cigna on to RxClaim, it's an extraordinarily complex client with a number of clients and plan design setup and we need to be very thoughtful and ensure there is absolutely no member or client disruption so that’s why we sequenced it accordingly in the integration roadmap.

Operator

We will take our next question from Lisa Gill of JPMorgan. Please go ahead.

Lisa Gill – JPMorgan

Mark I thought if maybe you could seize the rest of the selling season, you said we’re moving into your best part of the selling season as we this to midsize player [ph]. Any idea around roughly what size that opportunity is if we think about the back half of the year?

Mark Thierer

Lisa, I actually I didn’t fully hear your question. I’m sorry.

Lisa Gill – JPMorgan

Is there any way to size what the opportunity is for the rest of the selling season as we move into the middle market?

Mark Thierer

Yes, I mean we have got 100s literally 100s of RFPs in the pipeline that we’re dealing with that are still open and have not been decided. The bulk of them are mid-sized and we have a handful of very large Fortune 500 employers in fact the best and final this afternoon and so it's large, it's as large as it has ever been in terms of kind of a second half pipeline set of opportunities and our challenge is obviously to land them and bring them across the finish line. So we’re very busy, the other thing I will say about our book of business is we’re not quite so dependent on 1/1 starts and you know the business we win in workers’ comp, fee for service, some employers in fact. We have a number of mid-year starts that have -- there is nothing magic about 1/1. So I would say on a percentage basis some amount of our wins is sort of an outsized percentage are not necessarily tied to 1/1 so that’s an attribute of our model that we like.

Lisa Gill – JPMorgan

And then my second question is around your comments rather Mike’s comments around the transaction in the second half of the year. Any indication or any thoughts around the type of size of transaction that you’re thinking about that you think you should be able to complete by the end of the year?

Mark Thierer

As you look at the portfolio of opportunities that we’re looking at, there are a number of what I would characterize as a reached out like opportunity somewhere in the $25 million to $50 million run-rate that we believe that we obviously we can generate synergies upon but frankly speaking as I mention here we’re looking across what would historically be the pond that we would fish with subscale PBMs. We’re also looking at adjacent technologies and specialty capabilities and when you look today we have a $1.5 billion of liquidity. We feel very good about where we’re in pursuing not just looking for one transaction but again we view this as managing an ongoing pipeline.

Operator

We will take our next question from Robert Jones of Goldman Sachs. Please go ahead.

Robert Jones – Goldman Sachs

Actually just a follow-up on the back half potential acquisition comments I was just wondering in light of this Cigna integration and the Restat integration, is there anything we should think about or anything you guys are thinking about as far as your comfort level on deal size or the risk about doing a deal in the back half.

Mark Thierer

We have kind of being out of the acquisition market share, this is the longest growth that we have experienced and I just want to remind you that Mike’s comments earlier are important. We’ve been very disciplined we haven't had a miss since for a very long run on the last eight deals. We have met or exceeded the commitments we have made relative to synergy and timing in the rest and you could expect more of that.

There is nothing that would preclude us from being active today and from a capacity and ability to onboard we have got a lot to room to run here at Catamaran. So there is really no governor including the liquidity comment that Mike made so I would say the range of things we’re looking at kind of spans the spectrum.

Mike Shapiro

The one thing I would add is you know as we think about how we deploy human resources we’re very thoughtful as you know around dedicating resources. We have a dedicated team on Cigna, on Restat, on supporting the base book of business. And so when I say we have operational capacity, we’re very thoughtful around what resources we can deploy without jeopardizing any of the other strategic priorities.

Robert Jones – Goldman Sachs

I have a second question, I know it's early. If we think back to last year and the street numbers were 14 kind of got away from you. It sounds like you have your hands around Cigna, the integration is a lot better at this point it sounds like you’ve a pretty good sense of how the selling season is going and the mix of that business and any sense you can give us or help us out with directionally how you’re thinking about EBITDA per claim for next year at this point?

Mark Thierer

Bob, it's really too early to even think about it. When you think about the number of opportunities and initiatives that we’re driving obviously the new book of business is going to be a critical variable as well as the possibility of Cigna ultimate timing of when we wrap up the Restat integration and frankly speaking you know we’re going into year two on the ACA enrollment and as in the size [ph], we’re obviously partnering with our health plan clients today as they pursue opportunities for growth and we think there is an opportunity to also grow through our health plan clients as they execute their gross strategy.

So again all of that combined with the overall margin dynamics it's just too early to comment on ’15.

Operator

Our next question comes from George Hill of Deutsche Bank. Please go ahead.

George Hill – Deutsche Bank

A question, say Mark, with all that deal activity it sounds like a big day for you guys. Just I guess Mark as we think about the Cigna contract and it being little bit diluted this year. Is there any change in how we’re thinking about the longer term profit potential of that contract? Should we be thinking about your profitability on that contract I --

Mike Shapiro

George there is really no change in the ultimate profit expectations for that relationship we still feel it's going to be a great relationship for us for 10 plus years. Admittedly we’re one yea, in a three-year integration. So we still have a lot of work to do but again it's progressing well and while there is going to be some puts and takes in the integration period our ultimate expectations remain intact.

George Hill – Deutsche Bank

And then maybe a quick follow-up, I want to combine Glen’s question and Brooks’ question and is it right way to think about kind of where we’re from the business additions perspective at this point? Is it 600 in net new or is it 600 in gross new and 98% retention?

Mike Shapiro

The 600 is a net number.

Operator

We will take our next question from Steven Valiquette of UBS. Please go ahead.

Steven Valiquette – UBS

The color on the PBM gross margins in the incremental Cigna business is definitely helpful to clarify things but just secondly there has been a lot of discussion in the industry on the generic inflation trends which we have seen spiked up again.

So just curious whether you guys are seeing that but if so it sounds like it may not really been impacting your business but just looking for more color on that topic in particular. Thanks.

Mark Thierer

Yes Steve we know there has been a lot of discussion and interest in that, we’re seeing pockets of inflation and a handful of drug classes. I would say it's less than 10% of the NDCs, but it's not prevalent across the Board. Frankly as we look at our book we are not seeing a material impact on our overall economic.

Steven Valiquette – UBS

The retail side it would be primarily a pass for you guys if I’m guessing right, so really if there was any impact if all would it just be within your mail order is that the way to think about it?

Mark Thierer

Yes, you’re thinking about right.

Operator

Our next question comes from Ricky Goldwasser of Morgan Stanley. Please go ahead.

Zachary William Sopcak – Morgan Stanley

This is Zac for Ricky, a question back on the 600 million and net new. Can you give color on how of that is coming from new clients that Cigna may have won or would those clients be excluded from that total?

Mark Thierer

That’s our win, that’s not any wins through our health plan clients. So I would exclude any Cigna wins.

Zachary William Sopcak – Morgan Stanley

And then back to your specialty, Briova a well, can you talk about how much of a I guess exceeding of your expectations came from Sovaldi or other drugs growing in the quarter versus greater insourcing of your clients with the specialty product?

Mark Thierer

Sure. We don’t provide specific results for Briova or within the drug classes but clearly we saw a nice volume uptick from Sovaldi and our overall Hep C category in the second quarter. I would say that the growth that we saw was very well balanced across both upsells and our PBM book with a number of clients enrolling in an exclusive specialty arrangement with us in the first half of 2014 as well as very strong growth in the open network. So specialty has continued to be a great story for us. It's something we’re spending a lot of time in investing in. As I mentioned on the first quarter call, we’re well on our way to exciting this year to $2 billion top line run-rate.

Mike Shapiro

And I will just add on the specialty front, we have made investments aside from the Jeffersonville investment which was big capital for us to get, we think is the state of the art specialty operation in Jeffersonville. We have also invested in human capital in terms of directly calling on physician offices where heavy writers [ph] for these biotech drugs and so from an infrastructure standpoint we’re placing big bets on specialty and from a penetration standpoint I would say we have the lowest industry penetration in terms of pulling our PBM book through to exclusive or preferred specialty and that continues to be a focused initiative for us with a lot of running room.

So look for continued investment from us in specialty. I mean we think this is a 3,4,5 year opportunity for us to drive outside your earnings growth.

Operator

We will take our next question from Charles Rhye of Cowen and Company. Please go ahead.

Charles Rhye – Cowen and Company

Mike just wanted to ask a little bit about Cigna here, so we were obviously ramping up the drug (indiscernible) RxClaim next year. Does any of this work if I recall correctly the Part D business for Cigna was come on later than the commercial, is that still correct and does that delay when the Part D comes on, because you’re trying to do the RxClaim then?

Mike Shapiro

We’re not going to get into specifics on the commercial on the Med D books or sequence but you know it's given the broad range of products that Cigna offers and given the large client base that they have. We’re going to be very thoughtful around staging that over multiple ways of clients coming on board. So there is really no impact Med D have to precede or follow the commercial ways but we’re going to be very thoughtful and collaborate with them on how to do that. Again with the absolute goal of no client disruption whatsoever.

Charles Rhye – Cowen and Company

Okay. And just to clarify as we think about how we’re investing here to start the RxClaim is it right to think that if it had kind of being at the pace you had initially expected earlier this year, the investments for moving the RxClaim would probably hit more next year than this year?

Mike Shapiro

That’s exactly I should think about it Charles, I mean going forward some of the resources that would have been required next year.

Operator

We will take our next question from Amanda Murphy of William Blair. Please go ahead.

Amanda Murphy – William Blair & Company

Just another follow-up on the selling season discussion, I’m just curious in terms of the branded rebate side of the world. So I think you have mentioned that you’re not or you don’t have plans to pursue more restrictive formulary. So I’m curious just given that and given sort of rebate management I think it's still external. Do you guys feel like you’re competitive on the branded rebate side this selling season?

Mark Thierer

We’re competitive, you cannot be competitive and win in this market and rebates are still an important component but just a component. The overall spend management. So you know our approach on formulary and our exclusion strategy is very straight forward. We bring this flexible and customized model. Keeping in mind our health plan 70% of our book is wrapped up in health plans, many of them have kept the clinical and formulary management components and so our employers do vary but have less of a say about or less of a concern around formulary and keep in mind that like in the workers’ comp space formularies are very different in that space and so our strategy is not to sort a layout my way or a highway set of exclusions but if you’re client who wants to really ratchet it down plan design and put exclusions in place. We have a full exclusion list that looks and feels like some of the bigger players in our market and our focus here has always been on low net cost and that’s how we win on a consolidated basis in terms of low net cost and we bring a combination tools to do it which is plan design, mail, formulary and rebating. Obviously generic dispensing which we are leading the market on our GDR and so you need to model this all in total and this is our clients and consultants do look at it and it's a long way around the answer to tell you, we’re competitive in rebates you have to be.

Amanda Murphy – William Blair & Company

And just thinking a bit longer term, with the way we have always thought about PBM contracting is that the profitability of the contracts increases over the typical three year period? So I guess I’m curious just given sort of the focus on service levels and maybe generic penetration rates that are bumping up potentially against peaks offset by like you said specialty run-rate. Should we still think about that the same way in terms of new business wins each year becoming more profitable over time?

Mike Shapiro

Yes I think you’re thinking about it right Amanda. As we approach our new book of business, as Mark mentioned we think we’re going to post a book that’s in the low to mid-single digits from margin contribution. And every client, we’re continuously reviewing how we drive margin expansion and the new book of business we’re bringing online in 1/1/15 is no different. We’re confident we will be able to expand the margin profile over the life.

Again naturally as you bring on new clients you hit a cadence with them and you get better experience with their claims experience as well as we’re in the right to talk to them about expanding relationships with clinical upsells and exclusive specialty arrangements and while I take your point there will be an ultimate cap on the generic utilization rate. We view helping our client to think about their specialty spend is probably the next frontier and we think we’re uniquely positioned to help them with that.

Operator

Our next question comes from Michael Cherny of ISI Group. Please go ahead.

Michael Cherny – ISI Group

So I want to ask a question regarding where you’re relative to selling season and I apologize for repeating this but one of your main competitors this week said how the selling season was pretty done relative to our fee perspective. Mark, you highlighted numerous RFPs you’re still very active in, is that just a matter of the various books of business you guys pursue? I’m just trying to reconcile those two comments? It seems like you guys have a lot of activity still pursue. Obviously we’re waiting on the third big one to hear what they have to say next week but it seems like the two companies we have heard so far don’t really dovetail at each other.

Mark Thierer

I’m sorry the selling season question here in terms of the second half, the fact is everybody is busy right now with best and finals. This from an employer standpoint it's going to be alive for another better part of a quarter and in particular the lower end of the employer market as well as the TPAs are active well into the fourth quarter and so, yes, we remain busy.

Now I need to be clear, don’t look for any big health plan decisions for 1/1/15, those have been made. And candidly the health plans that we’re talking to are looking for mid-year 2015 and 1/1/16 type plan starts and so our sales team is in the field and very active right now in best and finals as we speak.

Michael Cherny – ISI Group

And then Mike just a quick question regarding your M&A comments, you talked about stuff long lines of Restat, also some other ancillary services. As you think about how maybe far afield you would go, like how do you think about the overall service mix and the overall offering mix. Is there anything from an M&A perspective do you really try to build on or is this just more expanding your capabilities if it's not traditional PBM contract or PBM you’re buying?

Mike Shapiro

As I think about it in my prepared remarks as we think about it, we used a lens -- is it strategic for what we’re trying to provide to our clients as well as it economic and does it return an after-tax return in excess of our cost to capital, really exceed ROIC hurdles. So as we look at those obviously if we’re looking at a subscale PBM we obviously have a high degree of confidence with how we drive synergies in that and as we start to look broader in terms of how we can add adjacent capabilities whether it's specialty or from an HCIT perspective. Again it has to hit both of those and if it's a little bit further out of our wheel house [ph] we’re going to be very thoughtful on the strategic value but absolutely can we generate an economic return for the shareholders as well.

Operator

Ladies and gentlemen that concludes today’s question and answer session. At this time I would like to turn the conference back over to Mr. Mark Thierer for any additional or closing remarks.

Mark Thierer

Okay. Thank you very much for your questions and everybody have a great day.

Operator

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

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