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Catalyst Health Solutions (NASDAQ:CHSI)

Q2 2011 Earnings Call

August 03, 2011 10:00 am ET

Executives

Richard Bates - President and Chief Operating Officer

David Blair - Chief Executive Officer and Director

Deirdre Kramer - Interim Chief Financial Officer, Senior Vice President of Finance and Corporate Controller

Analysts

George Hill - Citigroup Inc

Michael Petusky - Noble Financial Group, Inc.

Glen Santangelo - Crédit Suisse AG

Elliot Feldman - Barclays Capital

Eugene Goldenberg - BB&T Capital Markets

Michael Minchak - JP Morgan Chase & Co

Amanda Murphy - William Blair & Company L.L.C.

Brooks O'Neil - Dougherty & Company LLC

Operator

Good day, everyone. Welcome to the Catalyst Health Solutions, Inc. 2011 Second Quarter Conference Call. Today's call is being recorded. This conference will contain forward-looking information. Forward-looking statements are made pursuant to the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995. Forward-looking statements may be significantly impacted by certain risks and uncertainties described in the company's filings with the Securities and Exchange Commission. With that said, I would now like to turn the conference over to the Chief Executive Officer of Catalyst Health Solutions, Inc., Mr. David Blair. Please go ahead, sir.

David Blair

Good morning, and thank you for joining our second quarter investor call. Also Rick Bates, our President and Chief Operating Officer, and Deirdre Kramer, our interim Chief Financial Officer, are joining us.

Clearly, the company is hitting on all cylinders and executing on the growth initiatives we've previously described to you. The company had another solid quarter. Revenues increased 39% and adjusted earnings per share increased 15% over the prior year. Again, our earnings growth extended around margin expansion within our installed customer base, the successful implementation of new business, outstanding client retention and integration of our recent acquisitions.

Catalyst has secured new PBM business representing more than $325 million in annualized revenues. Looking at our sales pipeline, we fully expect to add to that total over the next several months. At this point in the year, we have retained 94% of our existing customer base for 2012. I would note that this percentage includes both Catalyst and WHI business and only assumes 6 months of contribution in 2012 from our state of Maryland contract. As we have discussed before, the state of Maryland contract has been extended for a 1-year extension through June 2012, and we anticipate a longer-term decision to be made by the state late this year. We fully expect the percentage of our clients retained will continue to increase during the balance of the year, and we will keep you apprised of renewals and the percentage of business that we retain.

Also during the quarter, we announced that Tim Pearson has been appointed to Chief Financial Officer and Executive Vice President, effective August 22. We're absolutely thrilled to have Tim join the Catalyst team. His proven CFO leadership, experience acquiring and integrating companies, extensive public company knowledge and healthcare background will be invaluable as we continue to execute on our long-term growth strategy.

So with that, I'll turn the call over to Deirdre to review our second quarter financials.

Deirdre Kramer

Thank you, David. In the second quarter, we continued to deliver strong earnings growth with significant year-over-year revenue and adjusted income gain. In the second quarter, revenue grew by $0.3 billion, or 39%, to $1.2 billion from $0.9 billion in the prior year. The increase in revenue is due to the increase in claim volume and price inflation on brand drugs offset by the impact of increase in generic utilization. Total unadjusted claims processed in the second quarter increased to 21.3 million from 16.2 million for the same period in 2010. The increase in prescription volume was primarily due to the addition of new clients, the growth of existing clients and the acquisitions of FutureScripts and WHI. Generic utilization also increased from -- to 74% from 71% in the second quarter of 2010.

In the second quarter, Catalyst expanded upon the metrics it provides to investors in order to facilitate greater visibility into the underlying drivers for the business and to facilitate comparisons to our historical operating results. For the quarter, Catalyst processed 4.1 million administrative-only claims, which are reported on a net revenue basis. As a reminder, administrative-only claims are those that receive a limited scope of services. We typically collect a transaction fee for this business ranging from $0.10 to $0.50 per claim. The company also provided utilization data for 90-day retail prescriptions in addition to mail order and 30-day retail claims in a schedule attached to our press release.

Gross profit for the second quarter increased $13.9 million to $69.6 million from $55.7 million in the second quarter of the prior year. The increase in gross profit is primarily due to the increase in revenue, higher generic utilization, the contribution of performance management fees, higher formulary compliance and improved contract performance related to drug manufacturer rebates and pharmacy reimbursements. Second quarter gross profit is reported net of $30.1 million of FutureScripts' intangible asset amortization. Excluding this noncash charge, gross profit would have been 30 basis points higher, or 5.9%.

As previously stated, the company is also reporting financial results on the basis of adjusted EPS. Adjusted EPS is our GAAP EPS excluding 2 things: transition and integration expenses related to WHI and the amortization of acquisition-related intangible assets. We believe this non-GAAP measure of adjusted EPS represents our core operating performance and will provide useful information when using our past financial performance to help estimate future financial results.

In the second quarter, transaction and integration expenses were approximately $16.4 million, or $0.21 per diluted share. This includes $10.3 million of transaction expenses related to the closing cost and professional fees, including banking, legal and accounting, as well as $6.1 million of integration expenses for transition services, integration and other acquisition-related expenses. Amortization of acquisition-related intangible assets was approximately $5.7 million, or $0.07 per diluted share. In total, this gets you to our adjusted EPS for the second quarter of $0.53 as compared to $0.46 per diluted share in 2010, or a 15% increase.

From a cash flow perspective, CapEx for the quarter was $9.6 million, and depreciation and amortization was $8.4 million, which once again includes the amortization of intangibles. We ended the quarter with $42 million of cash on the balance sheet and $324 million outstanding on our credit facility. Cash flow from operations was negative $1.1 million for Q2, which reflects the impact of lower GAAP net income due to the WHI-acquisition-related expenses, 2 tax payments made in Q2 and a timing difference in working capital. We continue to expect cash flows for operations for the year to be approximately $100 million.

David, with that, I'll turn the call back to you.

David Blair

Thanks, Deirdre. In summary, we're poised to deliver another year of solid financial results. We've executed on our growth initiatives, and we're well positioned to capitalize on the opportunities emerging in the rapidly changing PBM environment. And so with that, we'll open up the call for your questions.

Question-and-Answer Session

Operator

[Operator Instructions]

We'll take our first question from Brooks O'Neil with Dougherty & Company.

Brooks O'Neil - Dougherty & Company LLC

I have a couple of questions. I guess I'd start off with were the nonrecurring expenses different than what you had anticipated in the quarter? And if so, was it an issue of timing? Or was it some substantial increase or decrease in the amount you spent?

Deirdre Kramer

Hi, Brooks, this is Deirdre. I think the expenses were in line with what we expected. The breakdown of the expenses in the quarter was approximately 20% on transition-related services and 80% on integration.

Brooks O'Neil - Dougherty & Company LLC

Great. Secondly, I'm just curious if perhaps Rick could give us an update on the integration activities with both FutureScripts and WHI and maybe how you see those playing out during the balance of 2011.

Richard Bates

Sure, Brooks. I'll start with FutureScripts. And as I've indicated in our last call with a brief update, we continue to move forward very successfully there. The heavy lifting has been done. And I think we've got just some stuff around the edges that we need to get organized and finalized through the balance of this year. So I have complete confidence that we'll be able to deliver on our financial commitments there as we move into 2012. And then as it relates to WHI, we continue to make a lot of progress. As you can imagine, we're completely focused on this. And I think that the areas where we've had the greatest amount of progress so far has been in organizing how we go to market and aligning the organization, in strengthening our external communications and looking at the synergies and efficiencies we can get out of staffing in addition to further development on all of the IT planning, whether that's call center integrations, platform consolidation, et cetera. So meaningful progress has occurred over the last 30 days, and I expect us to continue to be right on target with the estimates that we've given around synergies and the timing.

Brooks O'Neil - Dougherty & Company LLC

Great. Maybe a different question for David. How does the $325 million of new sales compare to where you were at the same time last year, David? And could you just comment briefly about the status of your pipeline as it relates to potential wins here for the balance of the year?

David Blair

Sure, Brooks. So at this point last year, we were at about $250 million, and so we're doing better this year. And I'd also comment that the pipeline that we see and the opportunity that we have over the next several months is better than where we were this time last year. So we fully expect to continue to add to that $325 million total, and we'll have another update for you during our November call.

Brooks O'Neil - Dougherty & Company LLC

Great. And then maybe just the last question I would ask is, obviously, big changes in the PBM marketplace with the proposed acquisition of Medco by Express Scripts. Maybe you could comment on how you see that affecting Catalyst in both the short and the intermediate term.

David Blair

Sure. Obviously, this transaction is yet to play out. I would tell you that over the last 7 or 8 years, we've seen tremendous consolidation in the PBM industry. And the uncertainty and chaos is generally good for Catalyst. It drives new sales and better client retention. I mean, that's just clients are typically less likely to select a company when there's uncertainty about their future or they're being acquired. Generally, we pick up talented individuals, right, so when 2 companies come together, oftentimes, folks leave, and so will look for to add to our management base here. And then lastly, we also compete -- we compete with these companies for the same types of acquisitions. And so, certainly, we expect that these types of companies will be on the sidelines while this transaction is pending. So certainly, for the short and intermediate time frames, this should benefit Catalyst.

Operator

We'll take our next question from George Hill with Citigroup.

George Hill - Citigroup Inc

David or Rick, maybe just first to clarify. The 94% retention rate, is that including or excluding how we're thinking about the state of Maryland or, I guess, kind of nonrepresentative? I couldn't tell whether or not those comments were meant to be linked.

David Blair

So George, the 94% anticipates all -- or actually, includes only 6 months of revenues from the state of Maryland in 2012. So put it another way, if we've extended Maryland for the full 2012, that number would jump up by roughly 3%.

George Hill - Citigroup Inc

Okay. And maybe speaking to another client, I guess, can you remind us how big the contribution from WellCare is? They were on their call this morning talking about the PBM business. I believe that expires at the end of 2012. But I guess, have you had any early conversations with those guys? And just in general, how are you feeling about the relationship, and what's the level of exposure there?

David Blair

Sure, and so, George, so we generally don't talk about specific clients. I would tell you that we've had an opportunity to meet with all of our major customers, whether they be Catalyst or WHI clients, and we're in kind of continual discussions around contract extensions and those types of things. And you can expect that WellCare wouldn't be any different than our other clients.

George Hill - Citigroup Inc

Okay, maybe just one more. Can you tell us what that 94% retention rate would be x the state of Maryland?

David Blair

So that is, that would be x the state of Maryland.

George Hill - Citigroup Inc

Okay, all right. I'm sorry that I misunderstood that. And then lastly, before I let you guys hop, maybe just some more color on the pipeline. I guess, what types of plans or customer types are you seeing strengthen the selling season? And I'll leave it at that for now.

Richard Bates

So this year, in particular, George, we're seeing strength in the managed care segment as well as the large employer group segment. And there's been much more activity for us this year in those segments than we've seen on the state and government side of the business. While we still have a pretty healthy pipeline in that segment as well, it's definitely been weighted towards managed care and employer.

Operator

And we'll go next to Amanda Murphy with William Blair.

Amanda Murphy - William Blair & Company L.L.C.

Just a couple of follow-ups. In terms of the new business number that you've talked about, that obviously is sort of trending higher than last year and towards the high end of the range. Just curious if you can point to specific reasons why you're doing so well this year.

David Blair

So I would just offer a couple of points. I think our success with FutureScripts has helped us in the managed care space. So that's led to some very positive results for us. And I think our acquisition of WHI has opened up more opportunities in the large, national account employer space. And we've been fortunate to pick up a few pieces of business there that are meaningful.

Amanda Murphy - William Blair & Company L.L.C.

Okay. And then just if you look at the retention rates that you gave, is it fair to say that you're sort of net positive from a selling season standpoint this year if you take into account new business and losses?

David Blair

Yes.

Richard Bates

Yes.

David Blair

And Amanda, just to clarify, that 94% number isn't a final number. We'd expect that to increase over the next several months. The 94% kind of reflects what is booked and retained as of today.

Amanda Murphy - William Blair & Company L.L.C.

Got it, okay. And then I guess as a follow-up to Brooks' question on FutureScripts. One of the opportunities, if I remember correctly, was to look at the lags [ph] that weren't using FutureScripts from a PBM standpoint. Have you had any success in upselling those lags [ph] this selling season?

David Blair

So we've had some success. We're still involved in that. A lot of times, when you're selling the integrated medical and pharmacy product, the decisions are often made a little bit later, and they aren't always the large national account customers. Much of that is the middle market customer in the Greater Philadelphia marketplace. In addition to seeing some success, though, I want to be clear that we have invested and built out a very good sales and marketing infrastructure to support IBC and their growth initiatives. And we're working incredibly well with them, and their business is performing well.

Amanda Murphy - William Blair & Company L.L.C.

Okay, and then, last one, just in terms of the Walgreens business. How should we think about that from a margin standpoint as we go through the rest of the year?

David Blair

In what respect, Amanda?

Amanda Murphy - William Blair & Company L.L.C.

I guess I'm thinking about if you think about the standard drivers of profitability, whether that's generic or -- I guess they have low mail penetration. But I'm assuming that you'll have an opportunity to kind of increase the underlying Walgreens profitability over time.

David Blair

So that's right, Amanda. So the opportunities with the WHI client base are largely similar to the Catalyst base as far as margin expansion opportunities. They also benefit from -- about 50% of that business is traditionally priced, so they'll benefit a little bit disproportionately better as these brand drugs move to generic status. So whether it's formulary compliance, strong generic utilization, driving higher mail or specialty store driving [ph] the specialty volume, those are the types of things that will increase those margins.

Amanda Murphy - William Blair & Company L.L.C.

And that's an opportunity for this year as well?

David Blair

Yes, absolutely.

Operator

Our next question comes from Glen Santangelo with Credit Suisse.

Glen Santangelo - Crédit Suisse AG

Dave, just a couple of quick questions. One is just to follow up on the Walgreens integration and see how that's going. There's been some noise in the marketplace that maybe customer retention wasn't so great, and I just wonder if you could give us an update, now that you're kind of 2 months in, what are you're seeing on the retention front.

David Blair

Yes, so we've experienced very high client retentions. In our original projections that we put together 6 months ago or so, we had anticipated that they might lose some business, and that hasn't materialized. The client retention figure that I gave you included both WHI and Catalyst business, so clearly, they're performing very well.

Glen Santangelo - Crédit Suisse AG

Okay. So you didn't explicitly say it in the press release, but you said you're comfortable with your financial targets. So I guess the message is you're still comfortable with the $75 million of incremental EBITDA contribution sort of a run rate by the end of 2012. Is that the right way to think about it?

David Blair

Glen, that's right. $75 million is our target, and we are very confident that we will reach that within the 18-month period.

Glen Santangelo - Crédit Suisse AG

Okay. Then maybe if I could just ask one more question on this retention percentage. I mean, basically outside of the state of Maryland, have you lost anybody noteworthy that's kind of worth calling out?

David Blair

No. And like I said to Amanda, we're going to continue to improve upon that metric over the next several months as we finalize some of our contract negotiations.

Glen Santangelo - Crédit Suisse AG

Right. So it's not necessarily that you lost 6% of your business. It's just that there's some business that's yet to be resigned.

David Blair

You got it.

Glen Santangelo - Crédit Suisse AG

And then lastly, given the selling season, we're seeing a reasonable number of contracts changing hands amongst all the PBMs. Could you maybe just give us your sort of macro thoughts on the pricing environment out there? Because, obviously, everyone's watching margins pretty closely.

Richard Bates

So Glen, this is Rick. And I think we have found pretty disciplined pricing in the mid-market and in the lower end of the large account marketplace. But when you get into the largest deals that are available in the marketplace, we've seen much more aggressive pricing there. And certainly, those have been some of the accounts that have been pretty major headliners. But generally, in our sweet spot, we've found the market to remain pretty disciplined and competitive.

Operator

[Operator Instructions] And we'll go next to Eugene Goldenberg with BB&T Capital Markets.

Eugene Goldenberg - BB&T Capital Markets

David, I hopped on the call a little bit late when you mentioned the $325 million in new sales. I'm sorry, is that a net number? Or is that a gross number for new sales?

David Blair

That's a gross number.

Eugene Goldenberg - BB&T Capital Markets

Okay, got it. And Deirdre, this is a question for you. On the SG&A side of things, can you, perhaps, share with us how much was the incremental cost for the 6 senior management additions that were made in the quarter, I mean, between salary, signing bonuses and replacement fees, all-in?

David Blair

So Eugene, I'll jump in for Dee. Our SG&A was largely in line with what we had anticipated at the beginning of the year, and those new hires is part of our planned growth strategy. And I don't know that we're prepared to break specifically out what that SG&A was.

Operator

We'll take our next question from Elliott Feldman with Barclays.

Elliot Feldman - Barclays Capital

Most of the questions have been answered at this point, but just maybe a quick one here. Just maybe your assessment on the current M&A environment, maybe in light of the ESI-Medco announcement. Obviously, you've indicated you hope to remain in the hunt for some future acquisitions, obviously with a focus now on WHI. But maybe you can just give a sense of sort of what you're seeing out there from an M&A perspective.

David Blair

Sure, Elliott. So as you mentioned, so our focus is clearly on the WHI integration. But based on the progress that were made, we're confident in the next 30 to 60 days, we'll be in a position where we'll want to start looking at additional acquisition. As we look at the M&A pipeline, it's still evenly kind of split up between either captive PBMs of managed care facility or revisions similar to the FutureScripts acquisition. There are also a number of independent PBMs out there that would make attractive targets. And then lastly, we'll continue to look at strategic acquisitions, complementary services that we could provide to our clients.

Operator

And we'll take our next question from Michael Minchak with JPMorgan.

Michael Minchak - JP Morgan Chase & Co

Just a couple of questions. First, maybe just following up on Amanda's question. In looking at the WHI book, is there any opportunity to drive some of the admin-fee-only of the Medicare business to drive that incremental profitability by upselling additional services into those accounts over time?

David Blair

Sure there is. Michael, we believe that there is an opportunity to do that. We also think that this administrative services product line will help us get in and drive growth in businesses or a business segment that we didn't typically penetrate as well. So it has created some new business opportunities for us in addition to upselling opportunities.

Michael Minchak - JP Morgan Chase & Co

Okay, great. And then, obviously, there's a number of moving parts with WHI coming on partway through the quarter. I was just wondering if you could give us some more color on where the underlying script trends currently stand. Are you seeing any impact from the economy at this point?

David Blair

Michael, the script volumes from WHI were largely in line with our expectations. It's a little bit difficult to look at the 2.5 week period that we had in the second quarter and extrapolate that over the full year. But script count should be right in line with what we anticipated.

Michael Minchak - JP Morgan Chase & Co

But if you look x the WHI business, with your underlying business x sort of net wins and losses, are you seeing script trends positive at this point?

David Blair

Yes. Script trends have not been negatively impacted by the economy and are trending as we expected.

Michael Minchak - JP Morgan Chase & Co

And then just one quick last one. I know you didn't call any out, but were there any FutureScripts integration costs in the quarter?

David Blair

There were. So the total FutureScripts for the first 6 months was roughly $3.5 million. Deirdre, is that right?

Deirdre Kramer

Yes, the total is expected to be $6 million to $10 million for the time period.

David Blair

For the whole year?

Deirdre Kramer

For the whole year.

David Blair

Yes. So I think, Michael, for the 6-month period, there's probably about $3.5 million of FutureScripts integration expenses.

Operator

[Operator Instructions] And we'll go next to Mike Petusky with Noble Financial.

Michael Petusky - Noble Financial Group, Inc.

A couple of questions. The first one, I did not catch, I'm sorry, the CapEx number for the quarter.

Deirdre Kramer

Sure, it was $9.6 million.

Michael Petusky - Noble Financial Group, Inc.

Okay. And I guess, on the $325 million, how much of that business -- and, again, forgive me if this was said. But how much of that business has a January 1 start date?

David Blair

I'd say in excess of 80% of that is January 1.

Michael Petusky - Noble Financial Group, Inc.

And then would the bulk of the rest of it be mid-year?

David Blair

Yes, or even beginning of the second quarter.

Michael Petusky - Noble Financial Group, Inc.

And then another question I had, when you guys gave your guidance earlier or, I guess, about a month ago, you had a GAAP EPS number, I think, $1.63 to $1.73. Does your reaffirmation of your financial guidance, does that include reaffirmation of that guidance? Or is it more on the adjusted EPS side?

David Blair

Yes.

Michael Petusky - Noble Financial Group, Inc.

Okay, all right. Great. And I guess the only other question, David, I had is I wasn't able to hook up with you post the Express Scripts-MHS deal. And I guess I was just curious on your thoughts, if you'd be willing to share them, in terms of is this deal from an FTC standpoint, is it appropriate in your view? Or any thoughts you have on it.

David Blair

Well, I think, like many of you, we were surprised with the announcement. And certainly, as to the FTC, we have no comment. I wouldn't want to speculate on what they may or may not do.

Operator

And we'll take our next question from George Hill with Citigroup.

George Hill - Citigroup Inc

David, just a quick follow-up on the 94% retention rate. How are we measuring that? Is that a percentage of dollars, percentage of lives, percentage of scripts? How are we thinking about that number?

David Blair

Revenues. It's revenues, George.

Operator

There are no further questions in the queue at this time. I would like to turn the call back to Mr. Blair for any additional or closing remarks.

David Blair

We'd just like to thank you for your interest and support of Catalyst, and we look forward to speaking with you next quarter. Goodbye.

Operator

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

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