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Executives

Mark A. Thierer - Chairman and Chief Executive Officer

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

Analysts

Bret D. Jones - Oppenheimer & Co. Inc., Research Division

Lawrence C. Marsh - Barclays Capital, Research Division

Andrew Schenker - Morgan Stanley, Research Division

George Hill - Citigroup Inc, Research Division

Brian Tanquilut - Jefferies & Company, Inc., Research Division

Brooks G. O'Neil - Dougherty & Company LLC, Research Division

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

Robert M. Willoughby - BofA Merrill Lynch, Research Division

SXC Health Solutions (SXCI) Q1 2012 Earnings Call May 3, 2012 8:30 AM ET

Operator

Good morning, ladies and gentlemen. Thank you for standing by. Welcome to the SXC Health Solutions 2012 First Quarter Results Conference Call. The company issued an earnings press release this morning, which has been filed with the SEC on Form 8-K and is also available on the Investor Information section of SXC's website at sxc.com. Listeners are reminded that portions of today's discussions contain forward-looking statements that reflect current views with respect to future events such as SXC's outlook for future performance and the closing of the pending Catalyst transaction. 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 company's filings with the SEC for additional information and risk factors. We would also like to advise you that all forward-looking statements made on today's call are intended to fall within the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995.

During the call, we will also discuss some items that do not conform to generally accepted accounting principles, including EBITDA and adjusted EPS. We have reconciled those items to the most comparable GAAP measures in the earnings release and in the Form 10-Q that will be filed with the SEC. Neither EBITDA nor adjusted EPS should be considered as an alternative to net income or cash flows from operating activities or any other performance or liquidity measure derived in accordance with GAAP.

I would like to remind everyone that this call is being recorded on Thursday, May 3, 2012, at 8:30 a.m. Eastern Time. A replay of today's call will be available at sxc.com approximately 1 hour after the conclusion of this call. Any redistribution, retransmission or rebroadcast of this call in any form without the express written consent of SXC is strictly prohibited. [Operator Instructions] I would now like to turn the conference over to Mr. Mark Thierer, Chairman and CEO. Please go ahead, sir.

Mark A. Thierer

Well, thank you, and good morning, everyone. We appreciate you joining us today. We're pleased to report that we've had a very strong start to the new year, posting record results across the board. For the first quarter of 2012, SXC delivered $1.7 billion in revenue and $54 million in EBITDA, representing significant growth over the first quarter of last year.

I'll discuss the highlights of our first quarter momentarily. But first, I wanted to take the opportunity to comment on our recently announced merger with Catalyst Health Solutions. We are very excited about this strategic combination. By joining the industry's fastest growing middle market players, we will create the second largest independent PBM in the country in terms of prescription volume. Both companies are very successful and highly complementary. SXC's flexible and scalable Technology Solutions, combined with Catalyst's client-centric philosophy to pharmacy benefit management, will provide a true unique offering to the marketplace. The combined company will improve our competitive position by providing a scaled and legitimate alternative model to the payers searching for an enhanced pharmacy solution. The combined company will have greater ability to control pharmacy costs for our clients while offering a level of flexibility truly unique to this industry. We intend to use our skill and scale to drive better value for our clients.

I'm very pleased with the talent we're seeing at Catalyst. David Blair and Rick Bates have fielded a truly strong team. According to many of the top industry consultants, Catalyst has built one of the industry's strongest sales and marketing machines, at the heart of which is their Center of Excellence service model. Our intention is to marry Catalyst's proven service model with SXC's industry-leading technology footprint to create a truly disruptive alternative model to the big 3, now the big 2.

We continue to be excited by the opportunity to further expand and diversify our client base. Historically, both companies have been successful selling to the middle market. In addition, SXC services many of the messy markets, unique markets that we call hard to organize like Fee-For-Service Medicaid, long-term care and workers' compensation. We've experienced significant successes as well in the health plan market while Catalyst has experienced success selling to larger employers. We believe our clients, prospects and consultants alike will find the new depth and breadth of our combined capabilities to be advantageous and highly compelling.

Now from a strategy standpoint, we believe it's critically important to engage the chain drug stores and the full retail network and, in particular, Walgreens, to drive the most competitive network offering for our clients. We're seeing demand for mandatory mail-order programs, and as such, PBMs need a strong network offering in order to compete. We enjoy a strong working relationship with Walgreens, as well as the other major retailers in this industry, and we intend to keep it that way.

Finally, and importantly, the combined business will have a very strong balance sheet. Shareholders will benefit from earnings accretion in 2013 and strong free cash flow. Proposed merger is currently under review with the Federal Trade Commission and, pending a favorable outcome, we anticipate a closing date in the second half of this year.

In addition to our merger announcement, we posted several significant accomplishments in the quarter. I'd like to share some additional headlines from the quarter. First, we finished a very successful round of January 1 implementations, including Bravo Health. We've also posted impressive wins for the 2013 selling season, including Blue Cross Blue Shield of Rhode Island. And while it's still early, our pipeline is very robust in every segment in which we compete. We are off to the strongest selling season we've ever had.

I believe our robust pipeline is a byproduct of 3 market factors: first, the fact that we have grown significantly in our business and gained the respect of consultants in every business segment; second, the client disruption related to the Express Scripts Medco merger; and third, the public dispute between Express Scripts and Walgreens.

Already this quarter, we've had some good wins, and we believe this is indicative of the kind of health plan employer opportunities that we will continue to see come our way. We're able to win these new accounts because of the strength and uniqueness of our business model, and each win affirms that we're on the right course. SXC has emerged as the primary alternative to the traditional PBM model, and we are offering the largest buyers in the market a fresh solution to save money with their prescription drug plans while improving the health and wellbeing of their members.

As I mentioned earlier, in the first quarter, we were awarded a 3-year $1.2 billion contract with Blue Cross Blue Shield of Rhode Island, and this was a highly competitive win from a nationally recognized health plan. Blue Cross Blue Shield of Rhode Island has more than a 50% market share in Rhode Island and they are nationally recognized as a leader in care management. We were chosen because of our flexible approach to meet the needs of their plan, our ability to configure a patient-centered medical home offering and our ability to complement the Blues' plan, offering our tools and expertise as a hand-in-glove fit. We are already immersed in the implementation and engaged in strategic planning with their executive leadership team, and we look forward to a successful go-live 1/1/2013.

In addition to becoming a top competitor for new business wins, our CLIENTS FOR LIFE strategy is paying tremendous dividends. With very high client satisfaction scores and a 99% client retention in 2011, SXC is a company with whom health care payers of all sizes want to do business. Our ability to customize our offering to meet the unique needs of each payer, coupled with operational and clinical excellence, is unmatched. Moreover, our client base is highly referenceable, which, along with the demonstrated expertise of our team, has been key to winning new business.

In late March, we hosted our annual client advisory meeting in San Antonio, Texas. This meeting was a perfect opportunity for us to meet with our top clients and share ways we can help them manage costs through innovative programs and best practices. Our clients actually set the agenda, so they know that they'll receive tremendous value from these discussions. Well over 100 clients attended this event, and our leadership team and our health teams were highly energized by the level of client engagement. I personally attend this meeting every year, and I wouldn't miss it. It's a great opportunity for us to build long-lasting relationships with our largest clients.

We've continued to develop and to add to our management team in 2012. The fact is that SXC has become a magnet for talent, attracting some of the best and brightest in this industry. Last month, Dr. Sumit Dutta joined SXC as our Chief Medical Officer. Sumit is a true trailblazer in this industry, having received his M.D. from Michigan State University and his MBA from the Stern School of Business at NYU. Sumit was formerly the Chief Medical Officer of Medco and is recognized by many of the nation's largest health plan CMOs, and this is important. Sumit is responsible for our clinical and medical affairs, as well as health care strategy for SXC. Sumit joins an SXC team that's been steadily augmented over the past few years with industry leaders.

And as I've said before, I would stack this leadership team up against anyone in the business. And we continue to push the envelope to make SXC a standout performer amid the dramatic changes underway here in our PBM space.

As evidenced by the pending Catalyst merger, we are continuing to execute on our acquisition strategy of acquiring companies already using the SXC platform, the rolling of [ph] the middle market. And while we'll be laser-focused on integrating Catalyst, we continue to evaluate and consider potential targets. Our balance sheet, combined with ample cash from operations, provide us the financial firepower to pursue these opportunities.

I think it's interesting to note with the turmoil that exists in the PBM marketplace, there are new acquisition targets coming available, who had not considered selling their businesses in the past. As with all acquisitions, we'll be disciplined as we evaluate opportunities to deploy our capital and to drive solid accretion.

In January, we completed the acquisition of HealthTrans, a middle-market PBM, which was one of our own technology clients. I'm pleased to report that the integration is moving along ahead of plan, thanks to our integration team and our rapid consolidation process. Integration of acquisitions has become one of SXC's core competencies.

So to sum it up, we believe 2012 will be a very big year for us. SXC has emerged as a viable and scaled alternative to the traditional PBM model. The market opportunity is right; we've got the right team in place; our sales pipeline is very full; and we continue to focus on our strong track record of client satisfaction. We have built a highly leverageable model, and we like our chances this selling season.

With that, I'll turn the call over to Jeff.

Jeffrey Park

Thank you, Mark, and good morning, everyone. Q1 was the strongest quarter in the company's history. We generated record revenue growth with the new business we implemented, we converted one additional HCIT client to full PBM services and we closed on our HealthTrans acquisition, effective January 1. We announced the definitive merger agreement to combine SXC and Catalyst Health Solutions.

Now let me take you through the results for the first quarter, then I will spend a few minutes summarizing the financials related to the pending Catalyst transaction. Revenues on a combined basis were $1.7 billion for Q1 2012 compared to $1.1 billion in Q1 2011, an increase of over 56% on a year-over-year basis.

In addition to the strong PBM growth, the HCIT segment revenue was up $5.5 million quarter-over-quarter, validating the continued opportunity to grow our technology business in addition to supporting the rationale for the strategic fit of the HealthTrans acquisition. Adjusted prescription claim volume for the PBM was $34 million in Q1 compared to $24 million recorded in Q4 of 2011. Overall, gross profit increased by 74% to $110.4 million compared to $63.6 million in Q1 of last year. Gross margin for the PBM segment increased to 5.4% on a year-over-year basis, which is a slight decline compared to Q4 2011 due to the addition of new sales that start at slightly slower margins.

The HCIT segment gross margin increased to 54% compared with 46% in Q1 of 2011. We are very pleased with our margin performance in both segments and you can expect margin expansion throughout the year.

We continue to deliver strong EBITDA results, achieving $54 million in the quarter, our highest performance in the company's history, representing a 62% increase on a year-over-year basis. Non-GAAP EPS increased 58% to $0.52 compared to $0.33 in 2011. We generated $56 million in cash from operations, a strong quarter for cash flows, providing us with $260 million in cash at the end of the quarter in addition to the $100 million in drawn revolver we used to help fund the HealthTrans acquisition.

SG&A expenses in the quarter increased by $15.6 million on a sequential basis. This increase relates largely to the acquisition of HealthTrans and related operating costs.

Let me now turn to the Catalyst merger. This is a very exciting transaction for both our organizations and our shareholders. The combined company will be approximately double our current size, bringing us to $13 billion in annual drug spend on a pro forma basis. The scale and operating leverage of the combined organization will help us generate an estimated $125 million in annual synergies. These synergies will be created through efficiencies in our organizations, as well as improved leverage in the supply chain. We expect these synergies to be achieved in 18 to 24 months following the close of the transaction, which we expect to occur in the second half of 2012.

We expect 20% to 25% of the synergies to be realized in the first 6 months following the close and expect 80%, 90% of the total synergies to be achieved by the 18-month time frame. To achieve these synergies, we also expect to incur approximately $40 million to $45 million in integration costs over that same time period with an additional $25 million in transaction-related expenses expected to occur in 2012. The majority of these transaction expenses are expected to hit in the quarter we close the merger.

Finally, we expect to incur approximately $70 million per year in annual interest expense and approximately $200 million in deal-related amortization in the first 12 months. We will provide you with more clarity when the transaction is closer to completion.

As we have done in the past, we expect to highlight for you the onetime transaction costs and the cost to achieve these synergies. We are not planning on adjusting out these items for purposes of guidance, and so we suggest you only adjust the related amortization from your models.

Q1 was off to a great start, with revenue growth of 56% on a year-over-year basis, along with 74% growth in gross margin and 62% increase in EBITDA on a year-over-year basis. As outlined previously, we are reiterating guidance for 2012 which does not take into account the impact or related costs to the company's proposed transaction with Catalyst, which is expected to close in the second half of 2012. 2012 is shaping up to be a very big year for us.

We continue to be very strong in the middle market, and we like our prospects for moving into the larger employer market. Both SXC and Catalyst have posted a strong start to new business sales for 2013 with the combined companies already announcing approximately $1.2 billion in new business on an annualized basis. The market is primed for change, and SXC is poised to take advantage of the many opportunities that these changes present. Payers are looking for an alternative to the traditional PBM model, and we represent the most viable option.

With that, I'll turn it back to Mark

Mark A. Thierer

Thank you, Jeff. We feel great about our first quarter results and are very bullish about the current selling season. We're already in a great market position, and, by merging with Catalyst, we put ourselves in an extraordinary position to benefit from the multitude of opportunities in today's PBM market.

Operator, I'd now like to open the line for questions.

Question-and-Answer Session

Operator

[Operator Instructions]

Bret D. Jones - Oppenheimer & Co. Inc., Research Division

This is Bret Jones from Oppenheimer. I just wanted to ask a question on the gross margin. It came in better than I was expecting. I was expecting more the new business to have a lower margin profile and also a reset of some of the larger contracts you had in there. I was hoping you could kind of address maybe if the new business came in at a higher margin than we've historically seen or if maybe the resets weren't as big as maybe we were expecting.

Jeffrey Park

Sure, Bret. This is Jeff. Yes, we were very pleased with our gross margin in the quarter. As you know, it's up $21 million versus Q4 of last year, so it's a great start. And the business that we have, we continue to see improvement in our generics and our generic purchasing with the LIPITOR launch. We've also seen increased utilization on our specialty. As you also know, the Q4 and the Q1 are generally seasonal highs for cold and allergies, et cetera, and so you start to see increases in volume and consumption related to that. And we've been very focused on making sure we're bringing in profitable business.

Bret D. Jones - Oppenheimer & Co. Inc., Research Division

Okay. And then I just wanted to ask in terms of the selling season, when you talk about the pipeline, I was hoping you could address the sort of the size of the contracts, and you've talked about moving upmarket. And what I'm wondering is, how do you avoid entering a sort of a boom or bust, and I'm just trying to get a sense of are you still chasing the deals that are more -- that have historically been your sweet spot? Or are you seeing more of the larger deals fill up the majority of the pipeline?

Mark A. Thierer

Yes, Bret. It's Mark. We've stated publicly that our pipeline is in the range of 3x what it was kind of year-to-date last year, and that's continuing to grow. The size of opportunities that we're getting looks at have grown, and in fact, some of the wins that we've posted beyond Blue Cross Blue Shield of Rhode Island have been larger than what we've seen historically. And so we're very pleased with the outlook, and it really spans employers' health plans, workers' compensation, states, Fee-For-Service Medicaid. It's really a very broad range. And I think it's important in terms of the strategy to be very clear. We are going to continue to execute, as we have, in the middle market, kind of our bread-and-butter, where the company has really carved out a strong position in the marketplace. And as we progress and combine with Catalyst, our intention is actually to move upmarket incrementally into the new and larger opportunities that some of the largest employers in the country represent. So that's the strategy, Bret. Hopefully, that addresses your question.

Bret D. Jones - Oppenheimer & Co. Inc., Research Division

It does. And just lastly, real quick, in terms of, one of your competitors discussed seeing 2014 deals coming to market quite a bit earlier than we would normally see. I was wondering if you're seeing the same thing.

Mark A. Thierer

Yes, it's Mark. The 2014 deals, this is not uncommon in the health plan space. Many health plans are looking for 2014. In fact, I'd argue that if you haven't pulled the trigger of the health plan now, 2013 is a real push. And so there in fact are some employers looking at midyear next year. We still got employers looking at midyear this year. So the start dates are varied, but I would say as a general rule, we are seeing some larger clients come to market sooner than we've ever seen in the past.

Operator

Larry Marsh.

Lawrence C. Marsh - Barclays Capital, Research Division

And thanks for the review of the positioning pro forma with Catalyst, but maybe I'd like to get you to drill down, in specific conversations you've had with clients, the San Antonio meeting, consultants, what sort of data points, what sort of feedback are they giving to you around the combined business, and is there anything that's surprising in that feedback?

Mark A. Thierer

Yes, Larry, and I appreciate the question. We are actually hearing kind of a resounding theme with, not just current clients, but the prospects that we're talking to, and keep in mind, we have been working upmarket. We do view this combination with Catalyst as capitalizing on a window of opportunity and trying to actually address an emerging need that we're seeing. If you think about it, for the largest employers, call it the top 100 in the United States, they really only have 2 alternatives now to choose from. And in fact, we are going to emerge, once these combined companies come together, as a truly scaled and legitimate alternative. The whole theme at addressing the largest employers of the country is bringing partners together who can, with no agenda, in an agnostic way, create a service model that is new to the world in terms of servicing the largest employers in the country. But you'll see us combining the unbundled and flexible technology approach that SXC has proven to be successful with Catalyst's Center of Excellence approach, which is really a customized service model, highly flexible network, channel-agnostic and very client-centric. The combination of those 2 business models, fueled by industry-leading cost of goods, we think will be very disruptive on the high end and very compelling to the largest employers. And so what we're talking about with our prospects is a dedicated team with a brand-new message with new positioning and a new value proposition, and the go-to-market strategy for this concept is pretty simple. Number one, we'll manage our expanding at a whole new level. Number two, we'll drive employee engagement and wellness beyond anything available in the market today. And number three, for these largest employers, we'll guarantee to drive down health care costs. So you'll see us, over time as this yield gets announced, come out with a major launch and a positioning because bottom line is, what clients are telling us is the timing is right and the market is actually looking for a scaled alternative.

Lawrence C. Marsh - Barclays Capital, Research Division

Great, and just, Mark, the buzz now around open access is we could be hearing something around Express decisions, perhaps cancel the Walgreens, the legacy relationship with Medco sometime in the next months or 2013. Is that something you're hearing in the marketplace? And if so, obviously, you're positioned to benefit from that at least or be seen as an alternative. Is that something realistic? Or do you anticipate, as you go to clients, that they would still keep Walgreens in network for '13?

Mark A. Thierer

Yes, Larry, I wouldn't speculate on what the other players will do or how they'll construct their network offering. Having done this for years and having fielded a team who's been in this business for a long, long time, we know that you have to have an open-access network. We know you have to have the major providers in the network as part of your solution. That includes Walgreens at 8,000 stores and a very highly leverageable retail chain footprint that provides value. And if you're in New York City or Chicago or Florida or Texas, you really need Walgreens. And so our business model is not to favor any one retailer or channel. Our business model is to provide partners who can deliver the best solution, whether it's a network model, whether it's a mail-order model, whether it's a specialty model, and offer that in a customized way to meet the unique needs of a payer. And so we think that our agenda, which is really totally aligned with the client and not misaligned because of the business model, we think our agenda is on the high road, and that's what we plan to take to the most influential consultants in the market as well as the largest employers that they work for.

Lawrence C. Marsh - Barclays Capital, Research Division

Great, okay. Two other quick things. One, it sounds like your action is spurring additional action. I know 2 weeks ago when you announced the merger with Catalyst, somebody asked about future M&A, and so let me enjoy the day. But it sounds like today you're communicating you're already seeing some action by some other companies perhaps interested in talking when they hadn't before. Realistically, how quickly could you get back? It sounds like you could get back in the market as soon as you close this transaction. Is that again a fair way to think of it?

Jeffrey Park

Larry, this is Jeff. As Mark covered in his earlier remarks, but to your point on acquisitions and what's happening in the marketplace, this is really the best environment that I've seen. The opportunities and the interest are very high. Any time you see seismic shifts in consolidation, et cetera, it certainly drives a lot of conversations. We've always been in a good position, and I'd say that the volume and level of opportunities are really as high as they've ever been. As you'd expect, we are focused on closing the merger. We feel we're going to be in a great position once we've concluded the merger to be in a position to continue to roll up the middle market, as has been our strategy.

Lawrence C. Marsh - Barclays Capital, Research Division

Okay. Final one for me, Jeff, on your transaction volume, obviously up a lot from last year, up a lot of from Q4. You actually closed HealthTrans in the quarter. Are you breaking out how many incremental claims HealthTrans provided in the quarter?

Jeffrey Park

We didn't do that, Larry, but you have it right. We've got an increase in our PBM coming from our new go-lives, and then we've seen an increase in the PBM segment from the HealthTrans, as well as an increase in the HCIT segment from the HealthTrans from a transaction volume. I don't have those numbers related specifically to HealthTrans in front of me, but both of them are included in those 2 segments.

Operator

Andrew Schenker.

Andrew Schenker - Morgan Stanley, Research Division

I was just wondering, in light of recent network discussions and acquisitions, are you seeing any change in RFPs as a structure, putting maybe change of control clauses or guarantees around specific pharmacy chains as you go through the selling season?

Mark A. Thierer

Yes, Andrew, it's Mark. We have seen RFPs embedding language that suggest minimum access standards, if there are changes in your network construct and certain financial guarantees that it won't move. So those are new, and I'm sure they're in direct response to some of the actions that have been taken in the broader market. Relative to change of control, that's always been a provision in most PBM contracts, where change of control provisions need to be addressed and companies don't want to do business with firms unless they're protected. And so there's nothing new there that I would say we've seen in the past.

Andrew Schenker - Morgan Stanley, Research Division

And then going -- thinking about the deal and the synergy breakdown, could you give any more clarity on the breakdown between COGS and SG&A at this time?

Jeffrey Park

Sure, Andrew. This is Jeff. From a type of synergies, there's obviously a few areas. We're looking to really leverage the operating models and the footprint of these combined businesses. And as we've always talked about, it's really important to have skill and scale. Scale in our purchasing will help drive client savings, and this means cost of goods, whether it's generics or direct contracting and taking our specialty model to the Catalyst clients. That's an important component of synergies. And then really the next area is some of the overlap that occurs in 2 public companies of similar size where there's operating efficiencies that you can expect, areas that we'll be able to see achievement. We're not going to give any more data or details at this time, but as you know, we've built a record of really driving synergies and integrating that value, bring it to our clients, prospects and our employees, and we don't expect this to be any different.

Andrew Schenker - Morgan Stanley, Research Division

Okay, great. And then just following up on that, when you think of purchasing cost of goods synergies, would you be able to just maybe order how you guys think of the contributions, i.e., network discounts, specialty mail or rebates?

Mark A. Thierer

Sure, I can give you a little bit more on that. If you think about from a timing perspective and what you look at, there's obviously network contracts where you can take volumes across one contract or another, and that's an important component. The next level is really on the manufacturer agreements, where whether in through direct contracting and our mail-order or specialty, as well as through rebating, where you're going to be able to see improvements, those generally will take a slight lag in network improvements, where rebate contracts need to accumulate data, market share and information, and so those will follow the first. And then the final is really, and one of the largest opportunities for us, is in the specialty category. As you know, Catalyst does not have its own specialty fulfillment. They use a multitude of partners to be able to provide that. And when you think about scope, scale and size, specialty in the industry represents around 15% of annual drug spend. So on the book of business the size of Catalyst, that could be $800 million to $1 billion of opportunity for us, and we're really excited about our ability to go in and help to provide value to clients for specialty.

Operator

George Hill.

George Hill - Citigroup Inc, Research Division

A couple of housekeeping questions. Jeff, can you talk about the interactive HealthTrans on gross margin in the quarter?

Jeffrey Park

The impact of HealthTrans on gross margin in the quarter? Is that your question?

George Hill - Citigroup Inc, Research Division

Yes. Was it a positive contributor or negative contributor?

Jeffrey Park

It was a positive contributor in both of the segments, in the PBM segment, as well as the HCIT segment.

George Hill - Citigroup Inc, Research Division

Okay. I guess can you give some sense for -- and not the dollar amount, but was the -- I guess, was it something that materially drove gross margins up?

Jeffrey Park

No, it was a positive impact, but it wasn't -- if you look at the size of our PBM segment, $1.7 billion, HealthTrans was a nice addition to the $1.7 billion, and it carried through at the same or slightly better margins than what we've seen in our other book of business, but not significantly different on the HCIT side. We've been pretty consistent with how we've seen our HCIT business and it had a modest improvement over our historical performance, but not a dramatic shift in either of those budgets.

George Hill - Citigroup Inc, Research Division

Okay. And then SG&A came in higher than I had modeled in the quarter. I guess, are you willing to break out what were deal-related costs in the quarter or were there any other significant rollouts, whether it was related to the deal or new business starts that might not be -- that we should not think of as recurring costs?

Mark A. Thierer

Right. We went live with HealthTrans January 1. That was one of the pieces that you see coming through. I mentioned about $15.5 million increase sequentially; some of that was HealthTrans, as well as the new business launches that we had for January 1. We did have some cost to achieve synergies inside the HealthTrans acquisition. There was a few million dollars of costs related to that, George.

George Hill - Citigroup Inc, Research Division

Okay. And then, I'll say, Mark, 2 kind of selling season questions for you. Just kind of the opposite take on the restricted network question. Are you saying that you're not seeing demand for more restricted networks from plan sponsors? And then another hot topic this selling season seems to be formulary exclusions and customization of formulary. I guess could you talk about what you're seeing in the market with respect to one of your competitors looking to exclude drugs from their national formulary? How does SXC see that, and how are you guys responding to that in the market?

Jeffrey Park

George, this is Jeff. I'll answer the question on the restricted networks, and then I'll ask Mark for formulary. What's interesting when you look at the restricted networks is really clients are looking for the flexible and customized networks or delivery models that fit them. They want choice. The choice that fits their footprint or their geographic area, they don't want necessarily a mail model or a specific restricted network. But they want the choice to choose whether they would like model -- mail to serve or a restricted network with or without certain providers in it. I think the other thing that's interesting with respect to the changes in the RFPs is you're seeing a much higher focus on the member and the member agenda, where members are taking more involvement and responsibility for their care, whether that's through FSAs and HSAs or high deductible models; these are definitely taking more responsibility for how they can [indiscernible] medication. Health plans, when they consider how they want or how they need support, what we're seeing in those RFPs is the fact that they have to support multiple exchange models. There's literally hundreds of ACO models out there, and this member-centric view of information, not a claim-centric view, but a member-centric view, and these types of models are really important because our data expertise is key. Our ability to drive clinical and specialty support for these high-cost conditions is important. So we really like how the RFPs are shaping up and really coming in to what we provide.

Mark A. Thierer

Yes, George, and I think Jeff's answer is a good one. On the formulary exclusions, I think it's so interesting because it is the corollary where the network exclusions you saw that happened before the formulary exclusions were made, and they're the same kind of -- the same animal, just a different color. The influence in the power and the supply chain is, I think, an interesting calculus. And for PBMs to make wholesale changes with our clients without asking does not drive client satisfaction, does not help drive retention and, in fact, are part of why our fit process is 3x the pipeline. And so we think that choice, flexibility and letting the client drive the agenda is actually a heartbeat of what we're trying to bring to the market. It is the centerpiece of our alternative model. And the notion of making a wholesale change to every client on formulary would never happen here. Nor would it happen as a wholesale change on network. This is the job that PBMs are hired to do. We're hired to deliver on the clients' agenda to meet their unique needs in their own service area with their own employees. And so the fact of the matter is, some of these actions are driving clients to look at alternatives. And that's not the way we plan to run the factory here.

George Hill - Citigroup Inc, Research Division

That's great color. Last thing as I jump off, can you comment on demand for Retail90 as part of the benefit?

Mark A. Thierer

Yes, George, I will. It think Retail90 has hit kind of an all-time high in terms of interest and clients really looking to drive members into the stores if they can get rates that start to approach mail-order discount rates. And what you're seeing in the supply chain is you're actually seeing retailers of all sizes interested in generic prescriptions in their own facilities because the value that comes with a member, including their incremental prescriptions as well as their front of store, drives huge value to all 60,000 pharmacies in the United States. So the interest level in Retail90 is actually higher than we've ever seen it. Our volumes are higher than we've ever seen them. The Catalyst volumes, if you listen to David's comments that have been public, are very high on Retail90. So we're expecting much more in this area and have a very competitive offering for Retail90 prescriptions in the stores.

Operator

Brian Tanquilut.

Brian Tanquilut - Jefferies & Company, Inc., Research Division

Mark, you talked about -- and Jeff, you guys talked about your appetite for acquisitions and the opportunities coming up. But as we think about how much business you guys are bringing in for next year, $1.2 billion already in the books between the 2 of you guys, and obviously, the rest of Catalyst, how should we think about your capacity to take on a big client or a number of large clients, let's just say for a 1/1/13 start or a mid-2013 start?

Mark A. Thierer

Brian, this is Mark. I appreciate the question because I think from a distance, it could look like, "Gee, these guys have taken on so much, how can they digest it?" I just want to remind everyone that when we acquire a company that's running on our own platform, our integration risk is very low. And as a good example, I'll just use a couple of the smaller ones we did last year: PTRx and MedMetrics. It's easier for us to acquire and bring those companies on than it is to start a new win on the employer side. Because when you have a new win on the employer side, you've got to set up a plan design. You've got to set up the benefit, you've got to test the benefit, load the formulary, you've got to card the membership. You have costs that you incur, you've got to get a call center queued up. It's tough, and you have to do the work to install new clients. On the other hand, when we acquire a firm running on our platform, their claims [ph] are being cleared 2 floors below us here in our headquarters. And the integration risk, there is no reinstallation. They're already on the machine, they're already running an Rx claim. It's so important in terms of the relative integration risk and it's so much lower, which, by the way is a pretty central thesis on why the Catalyst acquisition makes so much sense and why, from an integration standpoint in the selling season, we're going to have such a better argument to make for prospects who are concerned about the disruption that comes from large-scale conversions. And I have to tell you, a couple of these guys out there, have the healthcare industry's largest conversions facing them here over the next 12 to 24 months. I do believe that, that in and of itself will spit a number of client opportunities out that we'll be able to move on.

Brian Tanquilut - Jefferies & Company, Inc., Research Division

Okay. And then just as we think about the selling season, historically, we talked about you guys adding $300 million of business. Catalyst has talked about $400 million to $500 million, and you've already booked a good chunk. But how should we think about internal goals for the current selling season beyond what's already been announced?

Jeffrey Park

Internal goals, Brian, for our selling season?

Brian Tanquilut - Jefferies & Company, Inc., Research Division

Yes.

Jeffrey Park

As you would expect, we have very aggressive internal targets we set. Our sales team is driven by not only revenue growth, we're really focused on gross margin growth. 75% of the commission base for these targets are gross margin achievement, not revenue achievements. So we're looking at bringing in the right business, not always just big business. It's important for us to continue to add business that is very leverageable. When we look at underwriting businesses, we want to make sure we understand the gross profit contribution, but more importantly, how much EBITDA is going to be added for the new business that we bring on. And that's kind of the way to think about it. But unfortunately, I'm not going to be giving you internal sales targets. But hopefully, that helps you sort it out better.

Brian Tanquilut - Jefferies & Company, Inc., Research Division

Sure, it does. And the last question for you, you talked about Walgreens and really partnering with Walgreens and wanting to have them in the network. But as one of the more expensive pharmacy chains in the network, does it help you today to negotiate better with them, to bring down the rates, or -- obviously the combination makes you a larger entity and gives you more leverage. But how should we think about that relationship being a two-way street with Walgreens?

Mark A. Thierer

Yes, I think you're asking a good question here, and let me be clear. Obviously we've had a long-term relationship with Walgreens, have a long-term contract. We were the technology engine in their PBM before they divested it and have a great relationship with the leadership team. But in fact, we've got a great relationship with the CVS leadership team. They're a major component in our PBM network. We've had numerous strategic dialogues with the folks at Wal-Mart, Target, Rite Aid. And so our job is to bring the right network model to our clients, and I'm not talking about partnering at the advantage of one, at the disadvantage of another. Our job is pretty simple. We're trying to create value for our clients with a channel-agnostic model, and the reason I'm talking about Walgreens is there are people out there who think they're not important, and I can assure you they are. But again, back to our job. Our job is to create value for the clients, and that's how we build our network strategy here at SXC.

Operator

Brooks O'Neil.

Brooks G. O'Neil - Dougherty & Company LLC, Research Division

So given the strong Q1, I know you've talked with a lot of investors about why now the Catalyst deal, but could you just go through, one more time, sort of the key points of why you see now is a great time to do this deal?

Mark A. Thierer

Yes, Brooks, I will. I think there's 4 primary reasons why now made a lot of sense, and let me just rattle them off for you. The first is, I do think that the merging of the 2 largest players in our markets created real opportunity from a client standpoint, and that was an important dislocation in the marketplace. Number two, I do think, as we've talked about, that the public dispute with Express Scripts and Walgreens also had the effect of clients wanting to look for an alternative if they, in fact, had an interest in Walgreens, and many clients do. I actually think the third reason of why now is so compelling is what's going on in Washington, D.C. And obviously, you've got the Supreme Court opining on the constitutionality of the Affordable Care Act. And whether they approve it in whole, exclude perhaps the mandate or guaranteed issue or strike it down, what you actually see happening, you see some of the largest consolidators in the industry trying to position for 2014 by acquiring bellybuttons. And so you see major players in this market, health plans as well as PBMs, acquiring individual insurance contracts through PDP and MA-PD type acquisitions. And so when we think about our strategy, and we've got a very strong footprint, Medicare Part D, managed Medicaid and individual-based plans, we really see that driver as an important reason on why now, kind of covering our bets on any eventuality that comes out of 2014. And I would just say the fourth reason, and I guess probably the most important reason, is where SXC and Catalyst were in their own maturation. I mean, both companies have had a very heck of a run. We've been the 2 fastest-growing companies in the space, and we've got very complementary models. They're very strong in the service and sales side. We're very strong on the operations and technology side. And marrying those 2 together now and entering the market at a time of unprecedented dislocation, we just thought the timing was perfect. So that's the complete story on why now.

Brooks G. O'Neil - Dougherty & Company LLC, Research Division

That's a perfect answer. I just have one more. Obviously, even under the merged scenario, Cigna's going to remain a big client. So could you just update us on what you're seeing and hearing from them and how that relationship is evolving?

Mark A. Thierer

I guess I probably should have just finish why now with one last point, and that is $125 million of synergies are going to accrue to the shareholders, and that's a big driver on why now. But relative to HealthSpring and our friends at Cigna, we had a very good go-live with the Bravo component of HealthSpring inside Cigna now for 1/1. The report card was very good. They were very satisfied, and they're satisfied with the financial results that we're delivering them. So we've got a strong service model in place with a strong financial model and a dedicated team taking care of the HealthSpring-Bravo relationship. And we're not going to comment on Cigna's strategy, but you can assume that we're helping them execute against their go-deep strategy in every way. We know and respect the leadership team. Obviously we're working hand-in-glove with them across many fronts, and we've got a very large team deployed to help them execute. And so as they evolve in their thought process and what the next chapter is, we like our chances, and we're not nervous about the prospect of them going away.

Operator

Amanda Murphy from William Blair.

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

So I had a couple more on the selling season, if I may. So just thinking about it from a high level, the 2 businesses are -- it seems Catalyst and SXC is very complementary, but perhaps you had slightly different marketing messages that are the IT capabilities versus local delivery model. So I'm curious, as you're out there this year, how are you rationalizing the 2 marketing messages at this point?

Mark A. Thierer

Yes, Amanda, well, obviously, right now, SXC is selling to the prospects we've had in our pipeline, and Catalyst is doing the same. And the good thing about that is regardless of who wins, it's coming on the claim platform. So we've got our bets covered there, and we like that. Relative to our marketing and go-to-market message, we're really not changing, for the short term, our strategy on how we deliver value. It is about flexibility, it's about unbundling the traditional model and it's really putting the clients' needs front and center. What's going to change when we have the combined entities and we have a rather big splash with a PR campaign and a kind of coming out party is we're going to enter a new total available market and we're going to move upstream; in addition to our base strategy of covering up the middle market, we're moving upstream with the largest employers in the country. And there, the business proposition changes. Here, we're going to combine the technology and the service-oriented customization that Catalyst brings to create a new to the world model, and we will be emphasizing a whole new level of value creation for the largest employers: number one, saving them money; number two, engaging their members at a whole new level; and number three, effectively guaranteeing a reduction in their health care costs. And so that marketing message will be brand new, will be focused on the most influential people in the market, some of the leading consultants in the high end. And obviously, we'll be taking it directly. The decision-makers in the Fortune 100, primarily key financial officers, are grappling with high spending in pharmaceuticals.

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

Okay, that's helpful. And then just thinking about the Health Plan segment, I just wanted to follow-up there as well. So I'm assuming those goods are very competitive, and I'm wondering if you can help us understand why you and Catalyst have been so successful in competing against the larger players for those accounts. And obviously, you've build some more key [ph] client wins there, but just curious if you can provide more color on that.

Jeffrey Park

Sure, Amanda. This is Jeff. One of the things that's really unique, as Mark was outlining, our business model is ripping apart the offering, allowing health plans in particular, who are very sophisticated buyers, to have us wrap around their infrastructure. In many cases, health plans want to look at how they can influence and control the member experience and how we can support what they're doing, how they can influence and manage the medical expenses and how pharmacy plays a complementary role to it. All that is, is basically ripping apart the PBM model. That's one of the reasons why SXC has been successful selling into these health plans, it's because we're not bringing them a mail strategy and hoping they buy the rest of the components in a fixed basis. So this is a key success factor for us. It's not changing; it's one of the reasons we've been successful, and I think what you're seeing as we've been able to win larger and larger health plans is it has an effect across a larger swath of the U.S. Referenceable accounts is so important, and larger and larger customers bring with them bigger and bigger reach across the country, and it's why it's so important when we bring these clients live and how we service and support them that they're happy clients. Otherwise the selling activity can't be successful.

Mark A. Thierer

Yes. And you can't go to one of these leadership health plans and make an arbitrary change without their consent. It just doesn't work. So, I mean, hopefully you're getting a feel for our strategy and how we're going to take it up market.

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

And then just last one, switching to the gross margin side of things. I think one of the things that's been interesting to us, who's watching the space, is how much incremental purchasing efficiencies your PBMs gain from out of leverage. So I'm curious, just even above and beyond the merger of the 2 companies, how much more room is there to run as you continue to build scale; is this something that's going to be a long-term benefit for you?

Jeffrey Park

Sure, Amanda; this is Jeff. Purchasing, the ability to buy drugs effectively from all the different components in the supply chain, wholesalers, manufacturers, retailers, generic manufacturers, biotech, it's really one of the central themes. We never forget that our job is to save clients money first. And so to do that effectively, we really talk about the skill and scale of the organization. We're really proud of the skill that we have. As the combined organization comes together, I think you're going to be able to see not only just additions to the skill but more importantly, significant improvement in the scale. That will allow us to be increasingly competitive in the marketplace, whether it's health plans or the largest employers. It is one of the central tenets of our growth strategy.

Operator

Rob Willoughby from Bank of America.

Robert M. Willoughby - BofA Merrill Lynch, Research Division

I guess, Mark, to Brooks’ question on the why now, a lot of the responses you gave would be true if you did the deal a year or 2 from now. I looked at the Catalyst results this morning; it looks like they missed a GAAP revenue in earnings expectations and avoided providing any revised guidance for the year. I mean, does this really meet your view? Or I guess I'm trying to drill down on the why now even further because the synergies are here next year, the opportunities for share are there next year. I just, again, why now?

Mark A. Thierer

Well, Bob, I want to handle the strategy piece of why now because that is why we did it, and the strategy piece that we outlined would suggest that now is the absolute perfect time for us to take advantage of this window of opportunity that's open and move this business model upmarket. And at the center of it, that is why we did it. If you look at Catalyst's run over the last 3, 4, 5 years, you'd be hard-pressed to find any common stock in the Healthcare Services space that would've kept pace with them, and the only one I can think of is us. And so the notion of combining the 2 best performers in the marketplace is a pretty good why now. And at the heart of it, that is why we did it, for strategic reasons, to really launch this combined business model into a new strata and take it to a new place. I'll let Jeff talk about -- we're not here to comment on Catalyst earnings, but go ahead, Jeff.

Jeffrey Park

So Bob, we're not going to be commenting on Catalyst earnings, but with respect to our diligence, our expectations, we've gotten very comfortable with what we've seen through our diligence process, and the numbers today were in line with our expectations.

Robert M. Willoughby - BofA Merrill Lynch, Research Division

Okay. And maybe a separate question for Mark; you're obviously very positive on the Walgreens role they play for you. But isn't your model a bit more unique? I guess 2/3 of your business is Medicare Medicaid and workers' comp, which are harder populations to manage, and Walgreens is clearly helpful to you in that respect as it's very difficult to restrict those networks. Were you a much larger corporate entity, would you still have that same view?

Mark A. Thierer

Those are pretty good questions, Bob, and the fact is our business model looks different than the big 3. We do have disparate client base. We do service Fee-For-Service Medicaid. We do have roughly 1/3 of the Medicare Part D prescriptions touching our platform in one way or another. So you've raised a very relevant point. But I have to tell you -- and it was part of our calculus, but I have to tell you, even if we didn't have those messy markets, the notion of just wholesale excluding one provider, and I don't care whether you exclude CVS or Walgreens, it doesn't matter, that is not the way to manage the network because clients who have people in those service areas need those stores. The way you build restricted networks is you first look at the client population and then you decide who should service the members, not the other way around. So even if we didn't have these messy markets, where Walgreens is in fact, helpful, we would not have wholesale excluded. I mean, the notion of just eliminating a major player in the supply chain forever, that doesn't make business sense to me.

Robert M. Willoughby - BofA Merrill Lynch, Research Division

Do you ever envision, though, Mark, if the demand was there, would you build a product that might be a tiered pharmacy network of some sort? I see some of your competitors going down that course.

Mark A. Thierer

Yes, I mean, Bob, we have those. We've been selling those. There's been less interest in those in years gone by, and more interest now. Walgreens, as well as CVS and Rite Aid, are all part of our tiered network and it has to do with where the members live. And so nothing particularly new there from a strategy standpoint. We have it in our network menu of services.

Jeffrey Park

Yes, Bob, this is Jeff. Just to add a little bit to that. We have restricted networks that are focused on grocery chains. We have restricted networks that are focused in the Kroger area marketplace or restricted networks for long-term care. We have restricted networks for some clients that are focused on CVS and other clients that are focused on Walgreens. So we have restricted networks that we offer to our clients. The point Mark was trying to just reiterate is it's not one network.

Mark A. Thierer

Let me just thank everyone for participating. These were great questions. Obviously, we're optimistic about our chances and look forward to talking with you upon the closure of our transaction with Catalyst. Thanks, and have a great day.

Operator

Thank you for joining the SXC Health Solutions 2012 First Quarter Results Conference Call. You may now disconnect.

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