Seeking Alpha
We cover over 5K calls/quarter
Profile| Send Message|
( followers)  

Executives

Mark Thierer - Chairman and Chief Executive Officer

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

Analysts

Glenn Garmont

George Hill - Citigroup Inc

Paul Steep - Scotia Capital Inc.

Sylvia Chao

Michael Baker - Raymond James & Associates, Inc.

Glen Santangelo - Crédit Suisse AG

Lawrence Marsh - Barclays Capital

David MacDonald - SunTrust Robinson Humphrey, Inc.

Tom Liston - Versant Partners Inc.

SXC Health Solutions (SXCI) Q4 2010 Earnings Call February 24, 2011 8:30 AM ET

Operator

Good morning, ladies and gentlemen. Thank you for standing by. Welcome to the SXC Health Solutions Corp. 2010 fourth quarter and year end results conference call. [Operator Instructions] Listeners are reminded that portions of today's discussions may contain forward-looking statements that reflect current views with respect to future events. Any such statements are subject to risks and uncertainties that could cause actual results to differ materially from those projected in the forward-looking statements. For more information on the company's risks and uncertainties related to these forward-looking statements, please refer to SXCs annual information form.

I would like to remind everyone that this call is being recorded on Thursday, February 24, 2011, at 8:30 a.m. Eastern time. I would now like to turn the conference over to Mr. Mark Thierer, President and Chief Executive Officer. Please go ahead, sir.

Mark Thierer

Thank you, and good morning, everyone. Thank you for joining us on today's call. This morning, we released our 2010 fourth quarter and year end financial results via press release, and a copy of those results are available on our website. With me today is Jeff Park, our EVP and CFO. I will summarize the key events of the year, and then Jeff will review our financial results for 2010 as well as our guidance for 2011. We'll then close and open it up for Q&A.

Well, 2010 was really a great year for SXC. We delivered growth of more than 35% on a year-over-year basis for both revenue and net income. And we have the best selling season in the history of our company, which places us in a great position for 2011. These results did not occur overnight. It started with a vision to be the cost management partner of choice in the PBM market. We knew that in order to compete effectively in the PBM space, we had to match our high performance technology platform with a full-service PBM offering that delivered both better cost outcomes for our clients, along with better health outcomes for their members.

Over the past several years, we have systematically built out our infrastructure to deliver clients and to grow this business. It's been about identifying and positioning the right building blocks, building blocks like the NMHC and Medfusion acquisitions, the expansion of our clinical programs and the development of integrail, as the industry's premier medical cost predictive tool. And we've recruited some of the industry's best recognized leaders to our senior management team and developed our own leaders, as well as building out our sales team in order to broaden our experience and deepen our expertise.

And we are just getting started. SXC is pushing the envelope with new developments, like our recent acquisition of Medfusion, to strengthen our specialty pharmacy footprint and our new account management model, which we implemented in 2010 that delivered record client satisfaction and client retention scores.

We believe that 2010 represents just the beginning of what SXC can achieve as the leading technology-based PBM. We now have everything we need to compete on a whole new level. The success that we delivered in 2010 has opened up a large set of new client opportunities, along with acquisition targets for us to pursue.

Back in March, when we announced the HealthSpring contract, we believe that would have a sentinel effect on our selling efforts. And based on our discussions and feedback from new leads and prospects during the selling season, this in fact has proven to be true. We kicked off our HealthSpring relationship in March 2010 by managing their Specialty Pharmaceuticals. And on January 1 of this year 2011, we expanded our work with them by implementing our full service PBM offering.

Our ability to implement and manage the fourth largest Medicare Part D program in this country is an important validation of the capabilities and the scope that we can deliver. So now as we enter 2011, we possess all of the strategic assets and in particular, the skill and the scale to compete at a whole new level. SXC is now the pre-eminent middle-market PBM.

First, we have the supply chain expertise and the critical mass to buy effectively in the supply chain for manufacturers, as well as the retail and specialty channels. COGs, or cost of goods leverage, is the key to success in this business.

Second, we have the technology tools to find the right member at the right time, and we have the ability to intervene with those members with a full suite of clinical products, services. These clinical services enable our clients to control costs and focus on individual members by bringing forward the right protocols that yield good decisions.

Third, we have a new account management and retention strategy, coupled with a newly retooled member service offering to retain and grow our existing clients.

Fourth, we have our selling engine now hitting on all cylinders and is feeding this beefed-up infrastructure I just described with a pipeline that it delivered record results for us in 2010.

And finally, we have developed and recruited a first-class PBM management team that I would stack up against anybody in this business. We've attracted talent away from the largest players in the industry to join a team that they believe is setting the pace of change in the PBM industry.

So at our core, what sets SXC apart from the competition is our technology. It's the basis from which we're able to deliver customization, agility and flexibility that our clients require. Our technology platform is what allowed us to integrate the NMHC business so quickly, and that same technology platform allows us to deliver on our HCIT [Healthcare Information Technology] to PBM conversions that Jeff will comment more on later. It is our technology platform that enabled us to compete effectively and service Part D offerings as well as quickly enter new markets like long-term care and workers' compensation. And in fact, it's our technology that has allowed us to target this diverse set of markets from traditional health plans to PBMs to employers and more of the fragmented markets, such as fee-for-service Medicaid, long-term care, workers' compensation and hospice. All of these fragmented markets demand flexible PBM technology.

We continually advance our technology platform to shape the future of managed pharmacy, including predictive modeling capabilities, seamless integrations with Electronic Health Records systems as well as e-prescribing systems and advanced reporting and analytics to help our clients more accurately manage their populations. We continue to push the envelope in this business, and technology is our primary weapon to help our clients save money today and position themselves for the future.

In addition to HealthSpring, during 2010, we won another large East Coast health plan in a series of other smaller contracts that culminated in us bringing in 1.1 million new lives for our January 1, 2011 starts. We delivered on this significant new level of lives with an outstanding implementation track record that scored at 4.5 or higher on a five-point scale based on our initial feedback from our clients. I want to take this opportunity to publicly thank our operations and implementation teams for a job very well done.

In terms of our sales pipeline and looking out now into 2011 and 2012, today we have the strongest set of new opportunities that we've ever had in our history. Those opportunities span every market segment in which we compete. It includes a number of upcoming state and fee-for-service Medicaid opportunities, as well as numerous large health plan targets. And in fact, we're seeing a real spike in terms of our legacy HCIT activity.

Our client retention for 2010 came in at 99%, which leaves the industry and speaks to our retooled account management process that I mentioned earlier. The changes to our account management model that we made in early 2010 are really paying off. And I want to emphasize this point, because when you grow at the rate that SXC has, there are those of you may question whether we can scale the business. And simply put, SXC has arrived from a scale standpoint. Whether you look at our call center responsiveness or our ability to accurately clear really any type of pharmacy claim in this business or our overall client satisfaction scores, the business is firing on all cylinders. Our clients are happy and to prove it, they are renewing and staying with us. It's a testament to our client service and account management teams who've really stepped up and scale their efforts to retain and grow our client base.

Now prior to turning the call over to Jeff, I'd like to address our recent Medfusion acquisition, which we closed in late December. We pulled a page right out of our NMHC playbook and built a dedicated SWAT team to lead the integration efforts on this acquisition. Our team established a 30-, 60-, 90-day set of milestones against which to execute. We immediately engaged Medfusion senior leadership team, and we've aligned our incentives through an earnout over the next two years. It's a strong leadership team, and we really like what we acquire.

We proactively, as a leadership team, visit each of their sites in the first weeks and made a point to meet all of their staff. Early indications are, here in January and February, we are on track both in terms of volumes and the integration plan is moving according to plan.

Medfusion is a great addition to the SXC strategic footprint. As you know, specialty pharmacy is one of the fastest-growing areas within the PBM space. It represents an increasing percentage of the new treatments that are coming to market. And it's a service that our clients in the middle market recognize that the next critical area of drug spend management. The addition of Medfusion expands our presence and enhances our capabilities in the specialty pharmacy market, which differentiates us from peers in the middle-market PBM sector. And it fits the parameters of our acquisition strategy, which we have outlined previously, and it's an indication that we're pushing the envelope in the right places to grow here at SXC.

Okay, with that, I'll turn the call over to Jeff to review our financial results.

Jeffrey Park

Thanks, Mark, and welcome, everyone. 2010 was a strong year for SXC from a financial perspective. We continue to generate strong cash from operations. We are executing on our cross-selling and conversion strategies as Mark had mentioned. And we had our best selling season ever. We achieved all this while remaining extremely cost conscious and maintaining a relatively flat SG&A.

With that as a backdrop, we finished the year in line with our updated guidance on revenue, and we beat each of our gross profit, adjusted EBITDA, as well as GAAP and non-GAAP EPS guidance estimates. We accomplished this while raising our guidance 3x during the course of the year.

Revenue increased by 35% for 2010 compared to 2009, with Q4 revenue increasing 19% on a year-over-year basis. PBM revenue in 2010 increased by 38% compared to 2009, with Q4 PBM revenue up 20% on a year-over-year basis. The growth in the quarter is due in part to another successful HCIT to PBM conversion, as well as strong specialty script volumes, which occur in Q4 and Q1, but should not be annualized. The year-over-year growth is primarily due to new customer starts as of January 1, 2010, and the successful HCIT to full-service PBM conversions during 2010.

Adjusted prescription claim volume for the PBM division was $12.6 million in Q4 compared with the $11.9 million recorded last quarter in Q3. Our mail order penetration during Q4 was slightly higher on a sequential basis, up from 11% in Q4 2009. We anticipate our mail order increase on a volume basis. But as we continue to bring on new clients that did not use mail order like HealthSpring and other Part D business, our mail order penetration percentage will reset lower. With this in mind when we report our Q1 figure, we intend to disclose our eligible mail order penetration, which will exclude HealthSpring's and other Part D plans.

Our generic dispense rate during Q4 was 77%, which leads the industry. Generics continue to represent a strong opportunity for us. They are a great way to reduce costs for clients and the use of mail order aligns our interest with that of our client's to drive savings. From a generics perspective, 2011 and 2012 shape up extremely well to drive profits based on the products that already have or are scheduled to come off patent.

HCIT revenue was relatively consistent in 2010, increasing 4% over 2009. The success of our HCIT to PBM conversion strategies does impact the HCIT revenue growth. And as I indicated, we converted another HCIT client to PBM services during Q4. That's the conversion, compares to the six that we highlighted as targets on the last call. Conversions may negatively impact the HCIT growth, but are obviously accretive to the company overall.

Gross profit increased by nearly 15% for 2010 compared to 2009, and Q4 gross profit increased nearly 9% on a year-over-year basis. We received $3.5 million during Q4 related to incremental seasonal consumption of medications, as well as performance awards and incremental professional services revenue, which are not sequentially recurring quarterly items.

As I mentioned during the opening, we have been able to demonstrate a great deal of growth while still keeping expenses relatively flat. Our SG&A increased by only 4% in 2010 compared to 2009. And more than half of that increase is attributable to $2 million in charges related to the Medfusion transaction that occurred in late Q4. We anticipate SG&A to increase through 2011 based on the Medfusion acquisition, as well as to support the lives we added for the January 1 go-live.

Adjusted EBITDA was $121 million in 2010, an increase of 27% compared to last year. Q4 adjusted EBITDA was $31 million, which is relatively consistent on both a year-over-year as well as a sequential basis. The benefit from the $3.5 million in the quarter is offset by the $2 million in Medfusion transaction expenses that we occurred in Q4.

We continue to generate strong cash from operations, which reached $96 million in 2010, an increase of more than 11% compared to last year. At December 31, we had $321 million in cash, compared to $304 million in December 31, 2009.

As Mark mentioned, we are well underway with the integration of MedfusionRX. Medfusion manages approximately $270 million of drug spend annually and had approximately $11.5 million in trailing 12-month adjusted EBITDA. We have identified approximately $4 million to $6 million of synergies, including the tax benefits of the acquisition, which we expect to realize within the next 18 to 24 months. The acquisition is expected to be $0.08 to $0.10 accretive to our GAAP EPS in 2011 and excluding an estimated $7 million in amortization expense related to the acquisition, we expect the transaction to generate $0.15 to $0.17 in adjusted EPS in 2011.

Specialty Pharmacy is a great bridge between managing pharmaceutical spending and managing the healthcare cost of members. The high and growing cost of specialty are an area of increased focus for clients. Expanding our presence in specialty provides a great opportunity for us to generate more savings for clients because specialty pharmaceuticals are frequently prescribed to high-cost patients. And these are the exact patients that you need to administer using clinical care management where we can provide savings on healthcare spending, not just pharmacy spending.

Moving on to review our 2011 financial guidance that we released this morning, our revenue forecast is $3.5 billion to $3.7 billion for the fiscal year 2011. The midpoint of the range implies growth of 85%. Our 2011 target range for adjusted EBITDA is $161 million to $167 million. The midpoint in the range implies growth of 36%. In 2011, our full year target range for our fully diluted GAAP EPS is $1.35 to $1.42. The midpoint of our net income using the EPS guidance implies 35% year-over-year growth.

2010s effective tax rate was 33.6%. We expect 2011s effective tax rate to be approximately 34%, and our fully diluted share count to be approximately 63.6 million shares. The increased tax rate and higher share count versus 2010 account for approximately $0.02 of variance in EPS from 2010 to 2011.

As you think about 2011, keep in mind as we enter new plan year, some of our client's planned designs require members to use up any deductibles before they get fully funded benefits. This has the effect of tempering some gross profit at the beginning of the year as compared to how we would close the year. This occurred in the past, and I want to bring your attention to it as we start 2011.

Additionally in 2011, we expect stock compensation expenses to be $8 million, up from $6 million in 2010, due to the increase in the share price over that period. This will have an estimated $0.02 impact on EPS versus 2010.

With respect to our non-GAAP adjusted EPS guidance on a diluted basis for 2011, we are estimating the range to be $1.50 to $1.57. Our adjusted EPS for 2011 now excludes all deal-related amortization. Previously, we excluded only NMHC-related amortization. We've made this change to be consistent with our peers.

For 2010, this change would have added $0.02 to our adjusted EPS, and we expect 2011 total amortization expense of $14 million or approximately $0.14 a share, net of tax. A full reconciliation of this can be found in our press release this morning.

We believe these targets are realistic yet conservative and only reflect organic growth. We see upside to these numbers potentially coming from new business, additional HCIT to PBM conversions, our ability to increase the mail and specialty utilization and other cost-containment efforts, as well as our ability to capitalize on purchasing efficiencies provided by our new scale.

2010 was a great year for us, with revenues growing 35% and net income growing 41%, continuing to demonstrate the operating leverage of our model. We delivered growth, generated strong cash from operations and we won new business and acquired strategic assets that set us up to drive continued growth in 2011.

In 2011, using the top end of our guidance would suggest another strong year, with revenue growth of 90% and adjusted EPS growth of 41%.

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

Mark Thierer

Thank you, Jeff. Our results in 2010 demonstrate that we've emerged as the market leader in the middle market and the PBM space, and it is based on our technology platform and our service offering. I am extremely proud of the team that we've assembled here at SXC. And I believe the results are a direct reflection of this team's capabilities and their commitment to win.

Here at SXC, we're committed to growing the business by focusing on four key areas: first, in winning new clients; second, retaining all our existing clients; third, cross-selling and pulling through additional services; and finally, prudent cost management across the business. This is a simple recipe for success, and if you'll note, it has not changed. It served us very well over the past few years.

We now have all the pieces in place to continue to grow and take our company to the next level. We possess a very strong supply chain management skill set, a complete complement of PBM service offerings and a proven sales and service engine to deliver on the large set of new opportunities that are now available to us.

Three years ago, we developed a vision to be the premier cost management partner in the PBM space, and we've worked very hard to deliver on it. 2010 was a breakthrough year in the evolution of SXC, and we made great strides in terms of building out the skill and scale needed to compete for much larger opportunities. As a result, we believe the total available market to us now is much larger than it has ever been. And we are energized about the many opportunities in front of our company for 2011 and beyond.

Now with that, I'd like to open this call up for questions. Operator?

Question-and-Answer Session

Operator

[Operator Instructions] And your first question comes from the line of Michael Baker with Raymond James.

Michael Baker - Raymond James & Associates, Inc.

Jeff, I was wondering if you could give us an update within the PBM as to the mix of traditional versus transparent relationships?

Jeffrey Park

Sure, Michael. In 2010, our mix would have been roughly 50% of our book of business was traditionally priced versus pass-through. With the addition of HealthSprings and some of our new accounts, we're seeing that mix change so it would be more 2/3 to 1/3 now. But we continue to see pass-through and traditional as RFP requirements come in both sort of alternatives and from a mid-market small employer, we're seeing businesses continue to stay with a traditional or move to a traditional pricing. And on the other larger end, more sophisticated buyers are moving into a more pass-through basis.

Michael Baker - Raymond James & Associates, Inc.

So more specifically to that last comment, more and more large employers are asking for cost plus at mail. Do you see those as opportunities at this point?

Jeffrey Park

We actually don't have any cost plus at mail. It's...

Michael Baker - Raymond James & Associates, Inc.

I’m talking more in terms of the RFPs that are coming up, are those ones you're targeting? Or do you kind of have enough on your plate in light of what Mark's earlier comments were on what you're targeting for the upcoming selling season?

Mark Thierer

No, we look at anything from a pricing-model perspective if we think it can make sense cost plus. When it does come up in an RFP, as you would probably expect, they have different ranges of what's included in cost, as well as what would the dispense fees be associated with those types of relationships. We kind of look at the whole package, we look at the Specialty business, the Mail business, the Retail business and we kind of underwrite a full piece. Cost plus is definitely a topic. It's just not something that's gotten a lot of traction from a consultant perspective yet.

Michael Baker - Raymond James & Associates, Inc.

And in terms of the quarterly progression for 2011, how should we think about it relative to how 2010 shaped up?

Jeffrey Park

In what regard? Just from a profit perspective?

Michael Baker - Raymond James & Associates, Inc.

In terms of earnings perspective, how the kind of quarters contribute to the year on a quarterly basis?

Jeffrey Park

Yes. Well, we haven't given and we won't be today any kind of quarterly view for 2011. But when you think about our starts, we actually had a big January 1, so we're going to see a big bring on as HealthSpring come live and some of our other starts start, Michael, so you're going to see a jump up. As we talk about this other health plan that started, we announced last year has an April 1 start. So those would kind of be a couple of barometers for you to think about when you're looking at 2011.

Michael Baker - Raymond James & Associates, Inc.

Just one last question, can you give us a sense of how pricing appears to be shaping up kind of early into the process at least relative to last year?

Jeffrey Park

Yes, we see pricing to continue to be really very rational. In the middle market, the price competition is always a component of it. But we use our full reach of services, specialty and clinical to really differentiate for our clients. We're finding that, that's a much bigger component than what would have been in the past. Clients are looking for a more holistic solution of managing their healthcare dollars and not just worrying about the lowest price of an AWP and what the contract language may be about including on certain topics.

Operator

Your next question comes from the line of David MacDonald with SunTrust.

David MacDonald - SunTrust Robinson Humphrey, Inc.

Can you guys spend a minute and just talk about Medicaid? I know that's a business that you've liked historically. But with the states blowing up fiscally, it sounds like a lot of these governors are willing to turn over more control in terms of the pharmacy benefit. Does that business become even incrementally more attractive, given some of the financial issues that you're getting at the state level?

Mark Thierer

Dave, it's Mark. And your question's a good one. I mean, we’ve done a lot of work on a state-by-state basis in terms of our public sector and fee-for-service footprint. And as you know, we now have six states that we have customer relationships with. But as we step back -- collectively, the states are looking at $175 billion of shortfall through 2013, and that Medicaid spend in pharmacies expected to increase 7.5%. If you look at a couple of states, including Tennessee where we administer the benefits, we are managing to negative trend, literally managing pharmacy spend down through managed pharmacy techniques. So when you listen to Governor Cuomo in New York talk about saving $350 million, what's happening now in almost every state is the dialogue is being ratcheted up. And fee-for-service Medicaid is a very substantial growing opportunity for us. And so when I step back and really think about Medicaid as a growth segment, it is one of our most attractive segments. And I can assure you, everybody in our segment is thinking about how to get into this space. So if you step back and really catalog what it takes to win in the Medicaid, fee-for-service space, there's a reason that the big three today do not compete. And I would say their interest is growing. But fee-for-service Medicaid is unique. As you know, we have a dedicated unit in public sector headed up by guys with 25-plus years experience in this space. And you need three or four things to win. Number one, you need a technology footprint that is flexible. Each of these MMIS systems require a customized interface into these larger medical management systems. Number two, you need to contract on a way from a rebates and network standpoint that the state can own it. Federal and supplemental rebates are the property of the state. Number three, generally state fee-for-service Medicaid have low mail order penetration than none, and that's because they like to keep the prescriptions in this state. But the thing that we're seeing happen right now is these states are so upside down financially that the notion of introducing an exclusive specialty relationship, where basically those prescriptions have been unmanaged, this is a pretty high topic and one that we're really actively driving at the state level with a number of good-sized states. And so kind of a long answer, I'm glad you asked the question because we see this as a huge opportunity over the next three or four years. And what I like the most about it is we built out a business unit with a unique skill set. And coupled with our PBM platform, we like our chances there for 2011 for sure and beyond.

David MacDonald - SunTrust Robinson Humphrey, Inc.

And Mark, what are the states doing right now in the specialty side? I mean, is that just you go down to specialized pharmacy and pick it up? How does that work right now?

Mark Thierer

Yes, actually that is how it works. It's totally unmanaged. They're going to retail pharmacies. They're paying in some cases AWP plus, and those patients are not being clinically managed. And so not only is it a huge pickup if you could create an exclusive or funneled specialty channel, but you're going to take better care of these members. And so what we're finding is that, that discussion is getting a lot of traction with a number of our state clients. And everything takes time with the states, which we've come to know and appreciate. But once you get them and you can persuade a leader to make this change -- I mean, the timing is right. These states are all downsizing. They're taking their staffs out, and these guys are really struggling. And we're trying to step in and consulted a way and help them save money.

David MacDonald - SunTrust Robinson Humphrey, Inc.

Mark, can you just spend a quick second on the new account management and retention strategy? Maybe a couple of bullets in terms of what's different and what's really grabbing on a relative basis compared to what you guys have been doing historically?

Mark Thierer

Yes, I think at the heart of it, Dave, is we rebuilt our compensation program. And we're calling it: CLIENTS FOR LIFE. Basically everybody here is paid on two metrics: One is customer satisfaction at the account management level; and two is on retention. What percentage of our clients do we keep? So we put in place a dedicated TLC program, which is really a moniker for tender loving care. Our top 20 guys each have three or four clients themselves that they are required on a quarterly basis to make physical face-to-face visits. And the other thing that we've done is we've hired a good number of industry experts on the account management side. It turns out you can't just have relationship people managing these business relationships. You actually have to have experts who understand managed pharmacy, some of the systems issues and the clinical issues. And so I say, taken together, that's what's really driving this account management process to a new level for us. And the way you grade it is what are your scores on these account management satisfaction surveys? And we saw a very substantial spike in 2010 versus 2009, so we really are feeling like we're getting good traction there.

David MacDonald - SunTrust Robinson Humphrey, Inc.

The $14 million of amortization, does that compare to the $7.9 million this year? Is that an apples-to-apples compare?

Jeffrey Park

Yes, we've got around $7 million in new amortization related to the Medfusion acquisition, Dave.

David MacDonald - SunTrust Robinson Humphrey, Inc.

In terms of some of the, what you defined as onetime stuff in the quarter, I caught the $2 million of Medfusion transaction cost, that it sounds like it ran through the P&L and then you about talked about some benefits. Can you just touch on those again?

Jeffrey Park

Yes, so what we had, we had some help in the quarter from seasonal fluctuations. As you know, the fourth quarter has higher utilization for specialty, as well as just cold and flu seasons. And then we had performance level improvements with some of our accounts. We talked in the past about performance awards. And then finally, we had professional services increase incrementally over what would be normal for us. At the end of the year, as some of these projects wrap up, we'd been working on, we can have an increase in the final quarters. We had that last year as well.

David MacDonald - SunTrust Robinson Humphrey, Inc.

But Jeff, is it fair to say there is absolutely no reason to expect the fourth quarter of next year to not see something similar and the $2 million of Medfusion transaction costs are truly onetime?

Jeffrey Park

Yes, it's really just cautionary, Dave, when you're thinking about taking the Q4 results not to annualize those.

Operator

The next question comes from the line of Larry Marsh with Barclays Capital.

Lawrence Marsh - Barclays Capital

One, I know at Analyst Day, Rusty talked about the great relationship you guys have. They've closed Bravo, implication was there's every chance for you to fight for that business as of 1/1/12. Is there any update that you got from them as to when they hope to make a decision on that piece of business they've acquired?

Jeffrey Park

Sure, Larry, this is Jeff. Yes, we actually have been -- obviously Mark outlined in his remarks that January 1 go-live with HealthSprings, they've announced some very good, strong results as well their enrollees and enrollment increases. We're really just under 60 days with the new plan year. And we're working with them to get a plan to bring that those Bravo lives over. But that's a decision for them. They're, as you know, under contract with another PBM until January 1 of 2012. And they have reported requirements that need to get put in for CMS early in the year, and we're working to get in the spot where we're going to be able to have something to talk about. But at this point, we have nothing to say.

Mark Thierer

Larry, the only thing I'll add, and this is Mark, is that the business relationship we have with HealthSpring is very solid. And it's built on this technology platform, really a lot of history with this customer. We are implementing our integrail advanced clinical management tool. And obviously our ramp, both in the specialty pharmacy space as well as the Part D go-live, has been pretty substantial. So,I think, it's fair to say that we value this relationship highly, and I think you'd hear HealthSpring say the same perhaps.

Lawrence Marsh - Barclays Capital

Second question on Mark, probably is just maybe a clarification. When we talked about this concept of transparent pricing, there's a lot of definition and as you guys alluded to in cases, states define it differently. So some cases it's just passing through all rebates, some cases it's transparency to the retail reimbursement. In some cases, it's audit privileges back to the manufacturer. In your world, is it your view that you're going to be willing to be a participant any sort of defined, transparent bid? And is there any situation where you would just stop and say we're not going to bid on something that's defined as transparent because it's not feasible?

Jeffrey Park

Larry, this is Jeff. As you know, we have a very flexible business model. And that means in each of those categories that you outlined, we can provide full level of transparency if required by the clients. From a service delivery perspective, there's no difference between a transparent and a traditional price. It's really just a pricing algorithm for them. And we want to be able to say yes to clients in the way that they want to receive it. When you could say yes to clients and you can build up trust, you can start to build in additional services. A big piece of our business model is establishing a footprint and then having a pull-through strategy that we can drive more utilization, more clinical savings, more specialty or mail. And so to do that, we need to say yes. Now when we say yes, we also need to be able to make sure we have a low-cost infrastructure. We want to make sure that we've got a leveragable business model and an opportunity that doesn't allow us to choke by saying yes to different businesses. And I think we're unique in the industry because we can say yes.

Mark Thierer

Larry, I'll just add, the whole debate around transparency is a little bit of a red herring. I mean, it gets a lot of airtime. From our chair, at the most basic level, if you're a large health plan and you want to buy technology only and you want to clear it at the claim level, at $0.15 or $0.20 a claim, we'll take the business at 50% gross margin. And our strategy is simple. Start with that as a base and then over time at clinical products, put pull-through in place, add mail order or where it makes sense, both on specialty, fill up the technology platform and one day, if that client sees that it makes sense for their strategy, we take over the full service PBM operation. And so this notion of adding margin starting from what is the most transparent starting point, which is clearing claims at pennies per transaction, that is the business model that we bring to these clients.

Lawrence Marsh - Barclays Capital

First, if you think about this last year, it was a huge year for you in terms of new business at the health plan level. Part of that is as you said the flexible business model. If you think about the business opportunity in the next year or two, besides what you've already defined, is it fair to say -- is the health plan market still what you defined to be the most significant opportunity for you? Or should we also think about things like states and labor plans and even bigger commercial corporates?

Mark Thierer

Yes, Larry, this is Mark. And this is back to the diversity of our client base in the markets in which we compete. So to directly answer your question, the largest revenue opportunities we have are, by far and away, the health plans. And bringing on a HealthSpring at $1 billion is transformational on the top line and very nice, pulls nice margin and margin growth opportunities with it over time. But frankly, there are some much higher margin segments that we continue to like a lot and invest in and compete in. And this is where the diversity model pays its dividends. So we like the middle-market PBM space for smaller or midsize employers. It's very profitable. We really like the fee-for-service Medicaid space, which we report on our HCIT segment. For us, it's extremely profitable, and we don't book the top line drug spend. Workers' comp, hospice, the whole area of long-term care, these are profitable and fragmented spaces where at a gross margin per-claim basis, they're very high. I mean, they're order of magnitude higher than the traditional PBM business. And so that's kind of why we got this five-market segment strategy and we're pushing on each of those segments kind of in equal weights.

Lawrence Marsh - Barclays Capital

And then finally, I just wanted to clarify personally, Dave asked earlier, obviously you're already present, as you've mentioned the fee-for-service Medicaid market where your customers, the state, you're getting paid for your HCIT business. In the future, the possibility is more of that business gets outsourced to managed care companies. So do you view there to be a real opportunity for you to be in the managed Medicaid space where the customer is that health plan? And in that scenario, how do you really solve for the issue of changing behavior of the consumer when there's no co-pay restrictions?

Mark Thierer

Yes, Larry. This is Mark. So I think there has been a lot of discussion and perhaps confusion around the fee-for-service Medicaid space when I listen to the calls. And so the states, either managed Medicaid through the state and a fee-for-service model or they carve out to manage care plans and basically sell MCO model managed Medicaid, some states have a blend. And the bottom line is we're competing in both segments. We have a nice footprint in the fee-for-service space where there's really only two other competitors on the managed pharmacy side. It's ACS and it's FirstHealth. On the MCO side for managed Medicaid, we have dozens of health plans that we service in the managed Medicare market. We like it a lot. It's a place where other large-scale PBMs do compete. And we have a strong footprint in both segments. But to my knowledge, we're the only player in our space with a solid footprint in fee-for-service. Now as it relates to changing behavior, this is a big challenge in Medicaid, and you do have more limited classical plan design capability to drive behavior. Although by the way, that's changing, and there's a lot of debate on how you fund participation in the benefit from these folks. Because you know, the poverty line's gone up. It's up to 133%. We're going to have a lot more people on the plan. These people have money. And so the dialogue around planned design building drivers in it is substantial. But more importantly, the clinical interventions and the downstream patient and provider touch that you provide to steer to generics, to drive compliance and adherence, that's greenfield in the fee-for-service space. There's not a lot of work that's been done there. And there's a lot of money to be saved in fee-for-service Medicaid if you just employ, what I would call, basic PBM utilization and management techniques.

Operator

Your next question comes from the line of Amanda Murphy from William Blair.

Sylvia Chao

It's actually Sylvia in for Amanda. Can you please update us on the current trends in brand drug inflation and generic deflation? I mean, how are manufacturer pricing trends compared to your expectations?

Jeffrey Park

Sylvia, this is Jeff. When you look at -- I'll talk about brands and I'll ask Mark to maybe talk about some on the generic side. When you look at the brands last year, brand drug increases were in the magnitude of 6% to 9%. And all indications of the early start this year is that we should expect to see again another high year for brand price increases. The consolidation inside the generics are probably another more interesting area and something that's gotten a lot more questions recently.

Mark Thierer

Yes, Sylvia, this is Mark. I thought I'd just take a minute and address some dialogue around generics. I think again there's been from my chair a little bit of confusion here. The overall outlook for generic remains very strong in this business. And if you look at the industry overall, I mean, there are four primary players in the generic space. It's Teva, Mylan, Watson and Sandoz. And together they approach in excess of 50% share in the generic manufacturers space. What's been interesting over the last couple years is the growth of offshore capability. And today in the SXC book, we source about 20% of our generics offshore from Dr. Reddy and Lupin. There are about 10 reputable Indian companies. And taken together, there is a very healthy mix of generic manufacturers to basically continue to create a lot of competition on price. And so to your question about price increases, we have seen price increases in generics. But keep in mind, if a generic manufacturer takes up price and move both their AWP and WAC, I mean it's the same as the branded price increase. On our P&L, it's good news. We need to manage that for our clients, which is what we're paid to do. But it has the same effect as brand price increases on our P&L, which is good news. And so hopefully, that's helpful for you in terms of framing out a little more on the generics.

Sylvia Chao

Are you seeing any changes in underlying member utilization in fourth quarter? And what do you expect if anything will change in 2011?

Jeffrey Park

Sure. When you look at -- there's really not a lot of significant changes in member utilization in the fourth quarter, other than in relation to the cold and flu season. And similarly, with a lot of high deductible plans and a growing use of high-deductible plans, you'll see members kind of increase consumption of all healthcare services and medical services and pharmaceuticals at the end of the year as they use up their deductibles because in January 1, they have to reset their plan design. But with respect to members' activities, we also see members are increasing their utilization of our member portal and their ability to get more involved in making these pharmacy and pharmaceutical decision. They want to have more education on what is the medications that they're taking and is there alternatives? How does it fit into the treatments that they have with other areas? And we're finding that caregivers who are helping with elderly patients are taking a more holistic view of all the pieces that they've got. We've rolled out MTM programs, which are used by pharmacists to help these patients with complex, multiple medications ensure that they're getting the best utilization. Those trends are sort of ongoing trends, and they're not really related to just the fourth quarter.

Operator

Your next question comes from the line of Tom Liston with Versant Partners.

Tom Liston - Versant Partners Inc.

Just on Medfusion. Can you give us a quick sense on historical growth rates, meaning more importantly, what you estimate the growth rates are going forward? And with that, what exactly the earnout is based on?

Jeffrey Park

Sure, Tom. This is Jeff. Specialty as a drug class has been growing at between 12% and 18%. So if you look at it industry-wide, it's been around 15%. This business started from basically -- Medfusion started from cold start in 2003. So to be able to build up to $270 million over that period of time is sort of reflective of not only the skill and talent of the team, but also the growth that's generally occurring in the specialty market. We don't see any change in growth trends in the specialty space. In fact, a lot of the activity is focused also on trying to get into the medical benefit and unwrap some of the specialty spend that's going on inside the medical benefit. It's been estimated that roughly half of the total specialty spend is still carried inside the medical expense. So good growth trends historically, and we don't expect any change going forward.

Tom Liston - Versant Partners Inc.

And with that acquisition obviously getting a nice-size specialty company, is it biased more toward acquisitions in the mid-market PBM side? Or is it purely, hey, what financially makes the most sense?

Jeffrey Park

No, Tom, I want to answer the other question that you have that I missed which was earnout. So the Medfusion earnout is predicated on hitting financial objectives, growth objectives and gross profit objectives. The second question you just asked, which was around future acquisitions and where we're targeting. We have not changed our focus. We're continuing to focus on mid-market PBMs. They're the best fit for us to be able to utilize our cost of goods leverage that we've been able to achieve and drive have the highest level of synergies for our cash spent. But we're continuing to look at other opportunities. We'll take things that will fit like we did with Medfusion at the right time and at the right price. But our principal focus is mid-market PBMs.

Tom Liston - Versant Partners Inc.

Obviously, there's lots of Medicaid opportunities there. Currently, in process how many are you active with right now?

Mark Thierer

Tom, it's Mark. We're active right now. And there's a half dozen that are in the pipe at one stage or another in terms of active selling opportunities. We've been at a number of best and finals recently. We have a good feeling about this year in the State business.

Tom Liston - Versant Partners Inc.

And Jeff, two quick ones on the statements that CapEx obviously, you sort of mentioned $10 million. Obviously there's a jump up in Q4. And can you comment quickly on that lumpiness? And why did AP jump so much sequentially?

Jeffrey Park

The balance sheet jumps on a number of levels are related to just the Medfusion balance sheet. So on December 28, the acquisition we added in all of the Medfusion items to my balance sheet even though they had really no impact to my income statement. And so that's principally what you're looking at. CapEx, we expected to have CapEx in around $10 million or $11 million, we landed it at $9 million this year. As you could probably expect, the investments that we do in the fourth quarter are really from a technology perspective to ensure we've got the footprint we need for 2011. And we can achieve better pricing when we acquire near the end of the quarter and principally near the end of the year. So we don't expect to see much change in our CapEx for next year either.

Operator

Your next question comes from the line of Glenn Garmont with ThinkEquity.

Glenn Garmont

Just a quick one on the IT to PBM conversions. Maybe can you give us a sense for what's embedded in your guidance for 2011 versus what you're able to execute on in 2010? And then as we think about those conversions relative to organic growth or new business in the IT segment, should we anticipate that IT revenues will grow in 2011? Or will most of the revenue growth be obviously on the PBM side of the business?

Jeffrey Park

This is Jeff. From a growth perspective, we grew the HCIT unit roughly 4% last year, so it grew itself higher than that. But to your comments on the conversions, it actually softens the growth in overall unit. We expect the HCIT unit to grow again in 2011, and we are targeting continued HCIT to PBM conversions. So I'm expecting to see the HCIT unit grow, and I'm expecting to see conversions. From a guidance estimates and what we've kind of assumed, when we put together our guidance, we have a tendency to be conservative. And we'll put together -- and we put into our guidance numbers and start when we have a start date contracted for. When we know the client have a go-live, we've got them in. So we expect to see upside related to additional conversions, increased utilization of specialty and mail and improvement in cost of goods.

Glenn Garmont

So Jeff, would it be fair to think about additional conversions that you've yet to talk about? Those would be incremental to your 2011 guidance?

Jeffrey Park

Yes.

Mark Thierer

The other thing, Glenn, just to finish that is -- and I mentioned it in my comments. We have seen, I guess I'd call it a resurgence of open market opportunities for new footprints for technology. And this is good to see. I mean obviously, once you land a technology client, you can feed on him for a long time. And it is a central part of our model, and so we're encouraged about the fact that we've got some net new footprints that we're hoping to get forced in here during the year.

Operator

Your next question comes from the line of Glen Santangelo from Crédit Suisse.

Glen Santangelo - Crédit Suisse AG

Mark, I just had a quick question regarding your revenue growth. It seems like it's all pretty much coming directly from the addition of HealthSpring, Medfusion and OPTIMA; is that fair? Because by my calculations, that's the incremental $1.5 billion over 2010. Are you pretty much not forecasting anything else in revenue growth?

Jeffrey Park

Glen, this is Jeff. From a guidance perspective, a lot of those deals that we've announced already, which we've been clear on what the revenue consumptions would be. From what's going to get added through 2011, as you know, we've got a pipeline of deals that we're working on. Many of those opportunities have 12/1 starts, but our January 1 starts for 2012. But there's a number of deals that we've got opportunities for the latter half of the year, and so we're hopeful we're going to be able to put some more on the board.

Glen Santangelo - Crédit Suisse AG

Mark, I guess my question really is, I mean you sort of suggested that your market is expanding. Is that due to the addition of these two or three large customers that now you think there's a whole new market opportunity opened up to you? Is that the point you're trying to make?

Mark Thierer

That is the point I'm trying to make. We are being asked for the table on a much wider range of opportunities, and it's in each of these market segments. We did, through the sentinel effect that I described with HealthSpring. We have proven we can take on the largest health plans in the country. And so we're competing for any and all of those blocks of business. And we're being asked at the table on larger employer deals as well. And we're being very disciplined about where we say yes and where we actually run after it. We continue to think that going right into the backyard of the big three for their largest mail order customers is not a good place to go. And we are no bidding those opportunities. But for almost everything else, we are in the hunt.

Glen Santangelo - Crédit Suisse AG

So I guess it was important to kind of get to this point where you can start to attract those larger customers and just kind of looking at your revenue growth versus your guidance for adjusted EBITDA obviously, the gross profit and EBITDA per script is going to be a lot lower on these big customers. Was that really just the cost of entry into that market? Or do you think there's something going on with pricing? And then I guess the ultimate question is what is your existing book, look at kind of where you're bringing on these new customers have? And are they going to want some concessions over time?

Jeffrey Park

Yes, Glen, this is Jeff. When we look at underwriting business, we actually look at the overall contribution. We look at what's the gross profit contribution, what's the EBITDA accretion that we can add. As you can see, with our business model adding incremental gross margin dollars, has its fall disproportionately to the bottom line. So last year, that's when you see 35% top line and 41% on the net income. It's sort of showing that. There's no doubt about it, with the new business we're bringing in, we’re putting up some big revenue growth numbers. So as I mentioned, if you'll take the top end of my consensus, it's like 90% top line growth. And we're expecting 41% earnings growth on it. So 41% earnings growth is the punchline.

Operator

Your next question comes from the line of George Hill with Citigroup.

George Hill - Citigroup Inc

Just two quick ones, Jeff. Is there any way that you can quantify the value of the sales pipeline for the RFP process that you this year thus far? Or is it too early to tell from which RFPs have gone out?

Jeffrey Park

No, it's early. Mark had mentioned, I think in his prepared remarks, we've got a very robust pipeline. And as we've added these new accounts and Mark has explained how we've got a sort of a sentinel effect of getting invited to different opportunities than what would have previously been able to see before, the pipeline is growing very well. For February, this is traditionally not the high time for pipeline, and it's really in great shape.

Mark Thierer

George, it's Mark. I mean, it's in billions. And there’re some very sizable deals that we're taking a look at.

George Hill - Citigroup Inc

Are you guys seeing the impact at all of the discount cards and the rebate cards that are being issued by branded drug manufacturers, either through directly to patients or through doctor offices through their reps? What impact is that having on blunting benefit design and switching from branded drugs to generics? And I guess what are you guys doing to work with your customers on blunting the effect on that?

Mark Thierer

George, it's Mark. In terms of in the run rate or claims we're clearing or the discount cards themselves, they haven't had a huge material impact just yet. I will tell you, it's an interesting side note. Keep in mind, somebody's got to clear these discount card transactions, and they're basically like a mini-PBM benefit embedded with a plan sponsor being the pharmaceutical manufacturer. And so we're pretty familiar with the model. But I will tell you that the way this is handled in the benefits office is there aren't many HR benefit managers who like these cards. And so there are ways to manage it through plan design and through employee communication. At the end of the day, these manufacturers are just trying to position their branded drugs that are queued to go off patent to just incent members to stay on them. And this is about managing pharmaceutical spend, so we're going to continue to direct patients to the right therapy, moving them to a generics-first strategy and at the end of the day, we don't really think these discount cards are durable. They're a bit of a gimmick, and most employers view them that way as well.

Operator

Your next question comes from the line of Paul Steep from Scotia Capital.

Paul Steep - Scotia Capital Inc.

Mark, you talked a ton about the great opportunities you have. Maybe the question for you and Jeff really is with the incremental dollar of free cash flow, where are you heading right now? Does it go to M&A or is it all invest organically in the business on sales execution?

Mark Thierer

Yes, Paul, it's Mark. I mean we think about that a lot, and let me tell you what we're not going to do. We're not going to buy back our shares. We're not going to dividend the cash flow. We have so many opportunities to deploy the capital, and we are thoughtful about where we spend the money. So we have brought on talent. We have also deployed CapEx on some critical technology projects that are consuming capital. But at the end of the day, our most accretive use of the cash we're generating will be to deploy it on assets that we can drop on top of this COGS engine and extract earnings. And so that's where we're going to spend the money, by and large.

Operator

There'll be no further questions at this time. I'll turn it back over for closing remarks.

Mark Thierer

Great. Thank you, operator. Well I want to thank everyone for their good questions, and we will look forward to talking to you at our next quarterly call. Have a good day.

Operator

Ladies and gentlemen, this concludes today's conference call. You may now disconnect.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!

Source: SXC Health Solutions' CEO Discusses Q4 2010 Results - Earnings Call Transcript
This Transcript
All Transcripts