Description

Systems Xcellence is a software company that trades at approximately 10X this year’s EPS and is growing around 20% a year with 20+% EBITDA margins and 70% recurring revenues .The real overlooked value in SXC is its high percentage of recurring revenue and solid backlog. Management currently expects 70% of SXC’s '05 revenue to be of a recurring nature and has a $50+M backlog which it expects to realize over the next 3 years. While the company is only listed in Toronto, SXC does 95% of its business in the US, has most of its employees and top management based in the US, and reports its numbers in US dollars.

Systems Xcellence provides pharmacy dispensing and benefits processing solutions to the pharmaceutical benefits industry. The company’s suite of software products combines webenabled transaction-processing technologies with healthcare benefits expertise to offer end-to-end pharmacy management solutions. The company’s customers include the major competitors in the North American pharmaceutical supply chain, such as managed care organizations (MCOs), pharmacy benefits managers (PBMs), and retail and mail-order pharmacy chains.


Note: For clarity purposes: the stock price is in Canadian dollars, but I have converted that to a US $ number using current exchange rates and all the financial numbers below are in US $ , as the company reports in US$.



SXC.TO - C$ 1.60

60M Shares outstanding fully diluted @ $ US 1.30 = US$ 78M market cap

Pro forma- US$ 10M of cash and US$ 13.6M of debt = US $ 82M EV





Drug spend in the US is expected to double from the $200B spent in 04’ to $400B by 2011. The market is being driven by a number of factors including the aging population, rising drug prices, life style drugs and many other factors. SXC has a number of offerings that address the whole pharmaceutical supply chain including both payers and providers.



1. RxCLAIM- Claims processing: RxCLAIM is an online transaction-processing system that provides instant online adjudication of third-party prescription drug claims at the point-of-care. The software processes pharmacy claims and payments against such parameters as plan eligibility, drug utilization review, formularies, price, prior-authorization and rebates.



2. RxTRACK- Data warehousing: RxTRACK is a reporting tool that transforms transaction-processing information into usable data to enable informed decisions. The data warehouse, in conjunction with RxCLAIM and RxSERVER (see below), analyzes all aspects of an online pharmacy transaction-processing system.



3. RxMAX- Rebate management: RxMAX helps healthcare plans better manage their relationships with pharmaceutical manufacturers. The system allows the user to track and manage contractual arrangements to ensure maximum rebates for their beneficiaries and the receipt of performance-based incentives.



4. RxPORTAL- Web interface: RxPORTAL is a web interface that allows client-members to track their prescription benefits through the Internet.



5. RxSERVER- Transaction distribution: RxSERVER functions as a mechanism for real-time collection, control and sharing of prescription claim information between pharmacies within a participating group. The system stores customers’ medical information and pharmacy benefits data with a central host. Pharmacies are then able to access these data online to determine deductibles, benefit maximums, defined contributions and medical savings accounts.



6. RxEXPRESS- Dispensing systems: RxEXPRESS is a Windows-based pharmacy management system for retail, mail order, managed care and central-fill pharmacy operations. Its services include online patient order refills, compliance and profile applications, and e-prescribing and refill authorization.



7. RxVIEW- Claim information: RxVIEW presents RxCLAIM clients with abbreviated access to claim information. This tool, designed for the customers of Systems Xcellence’s clients or select help desk staff, allows access to view and make minor benefit changes within the claims-processing system, according to the users’ security and access levels.



8. RxSOLVE- Resolving rejected claims: RxSOLVE assists major pharmacy chains to resolve rejected claims. System Xcellence’s MCO partners are allowed claims access to major pharmacy chains to accelerate the resolution of claims that have been denied. RxSOLVE acts as a “Virtual Pharmacy Help Desk” to speed rejected claims resolution and increase member satisfaction.



In late November, SXC announced the acquisition of Health Business Systems, a private company that is a provider of retail pharmacy management systems and solutions for about 6X trailing EBITDA. This acquisition has bulked up SXC’s revenue base to $50M+. Conservatively, (based on management guidance), SXC will have $53M of rev, $10.5M of EBITDA and $0.11 (at a 10% tax rate) in 05’. SXC should be able to grow their top line over the next 3-5 years at 15-20% and the bottom line at 20%. These numbers are very conservative. There is $1-2M of easy cost synergies post this acquisition and some immediate cross-selling revenue opportunities that are also not in the projections. Some of these opportunities include taking HBS’ pharmacy product that has only been sold until now to small pharmacies and use SXC’s sales/marketing/financial clout and close on some deals with mid-size pharmacy chains. This would transform HBS’s typical deal size from $75k – $150k to $200k – $1mm. Over the past two years SXC has made a significant investment (about $2M per year in R&D) in RxExpress for Windows – its next generation workflow product for the pharmacy market. The acquisition has changed SXC’s strategy and now R&D spending on RxExpress has been capped. In late 2004 SXC let go about 15 employees that were focused on that development work. SXC will now focus on driving incremental sales of HBS’ existing pharmacy workflow application to mid-size pharmacies. Management claims these opportunities currently exist in the sales pipeline. HBS currently generates $4mm of switching revenue that is processed through NDC. NDC is the biggest switcher of pharmacy claims in the U.S. SXC generates switching revenue of about $1.5mm annually. SXC plans to take HBS’ switching business out of NDC and run it through its own facility. This move should help margins immediately.



Finally, management has indicated that SXC is looking at some much larger deals and has a few $2-4M deals and some $1M deals in their pipeline. Historically a $500k deal was considered big for this company. Few if any of these deals are “in the numbers”.



SXC has a solid balance sheet and should do $6-7M of FCF is 05’. This is not a capital intensive business and the company should be at a net cash position well before the end of the year.



Conservative 05’ (company Upside Scenario guidance)

Revenue $53M $55-60M+

EBITDA- $10.5 $12-14+

EPS- .11 .13-.16+


SXC is compelling here as it currently trades at 10X this year’s earnings, even though it plays in a large market, is growing at 15-20% per year, and should have 20+% EBITDA margins. From a risk/reward perspective the stock has 50-100% upside over the next 12 months and limited downside as there should be no big misses given their large portion of recurring revenue and highly visible backlog and pipeline.

Catalyst

Recent acquisition provides immediate revenue and margin opportunity
Announcement of one of the many large deals currently in the pipeline
High amount of recurring revenue provides visibility and limited downside in stock
Valuation extremely compelling
As the company approaches $100M, management believes they have enough size to become a takeout target and they are willing sellers