Magellan Health, Inc.
Q2 2019 Earnings Call Transcript

Published: 30 Jul 2019

[Operator:]

Welcome and thank you for standing by for the Second Quarter 2019 Earnings Call. At this time, all participants are in a listen-only mode. [Operator Instructions] Today’s conference is being recorded. And if you have any objections, you may disconnect at this time. And now, I will turn the meeting over to Joe Bogdan. Thank you, sir. You may begin.

[Joe Bogdan:]

Good morning and thank you for joining Magellan Health’s second quarter 2019 earnings call. With me today are Magellan’s Chairman and CEO, Barry Smith and our CFO, Jon Rubin.The press release announcing our second quarter earnings was distributed this morning. A replay of this call will be available shortly after the conclusion of the call through August 30. The numbers to access the replay are in the earnings release. For those who listen to the rebroadcast of this presentation, we remind you that the remarks made herein are as of today, Tuesday, July 30, 2019 and have not been updated subsequent to the initial earnings call.During our call, we will make forward-looking statements, including statements related to our growth prospects and our 2019 outlook. Listeners are cautioned that these statements are subject to certain risks and uncertainties, many of which are difficult to predict and generally beyond our control. These risks and uncertainties can cause actual results to differ materially from our current expectations and we advise listeners to review the risk factors discussed in our press release this morning and documents we filed with or furnished to the SEC. In addition, please note that Magellan uses certain non-GAAP financial measures when describing our financial results. Specifically, we refer to segment profit, adjusted net income and adjusted EPS, which are defined in our SEC filings and in today’s press release.Segment profit is equal to net revenues less the sum of cost of care, cost of goods sold, direct service cost and other operating expenses and includes income from unconsolidated subsidiaries, but excludes segment profit from non-controlling interests held by other parties, stock compensation expense, special charges or benefits as well as changes in the fair value of contingent consideration recorded in relation to acquisitions. Adjusted net income and adjusted EPS reflect certain adjustments made for acquisitions completed after January 1, 2013 to exclude non-cash stock compensation expense resulting from restricted stock purchases by sellers, changes in the fair value of contingent consideration, amortization of identified acquisition intangibles as well as impairment of identified acquisition intangibles. Please refer to the tables included with this morning’s press release which is available on our website for a reconciliation of these GAAP financial measures to the corresponding GAAP measures.I will now turn the call over to our Chairman and CEO, Barry Smith.

[Barry Smith:]

Thank you, Joe. Good morning and thank you for joining us today. This morning, I will discuss our results for the quarter, which showed the strong sequential improvement from the first quarter that we anticipated, progress on our multiyear margin improvement initiatives for healthcare and pharmacy businesses, which are on track with our expectations and the regulatory environment relating to our pharmacy business.Finally, I will provide some thoughts regarding the leadership succession plan announced this morning before turning it over to John to provide additional details on the second quarter financial results and full year outlook. For the second quarter of 2019, we reported net revenue of $1.8 billion, net income of $13.6 million and EPS of $0.56 per share. Our adjusted net income was $21.1 million or $0.86 per share and we achieved segment profit of $62.1 million. As a company, we remain focused on our multiyear margin improvement plan initially outlined this past December. During the quarter, we made good progress in our initiatives in both our healthcare and pharmacy businesses. Our long-term goal is to increase our adjusted net income margin to over 2%.Now, let me provide you with an update on key second quarter developments within our healthcare segment. Across our Magellan complete care portfolio of managed Medicaid health plans. We continue to invest in medical analytics, care management, claims recovery and operational resources to identify and execute against our medical action plans and achieve industry competitive Medicaid managed care margins. In addition to reducing necessary care and costs, our healthcare team has been focused on improving the quality and associated outcomes from the medical services provided to our members.Let me provide you with some examples on both of these fronts. In Virginia, our year-to-date medical loss ratio ran in the low 90s, which includes the impact of some favorable prior period reserve development. We continue our work towards fully achieving more competitive profitability levels of Virginia and the team has made good progress this year. In New York, we are seeing improvement across all quality measures in comparison to 2018 levels. The training and monitoring activities we have put in place with our care management staff have started to materialize in the reported quality results. It is also worth noting that we have not yet received our capitation rates in New York with the contract year beginning April of 2019.For the second quarter, we continue to record revenue based upon prior year’s capitation rates. Our expectation is that the new rates will be communicated within the next few weeks and will be applied retrospectively to April 1 consistent with the department’s historical practices. We had experienced year-over-year net revenue growth in our existing MCC markets despite the reduction of our footprint in Florida. This growth has been fueled by the addition of the Medicaid expansion population of Virginia and in-plan growth in our other MCC markets. In Arizona, I am pleased to report that Magellan will continue to receive preferred auto assignments through September 2020. We continue to see opportunities for future growth both within our current MCC portfolio plans and through targeted geographic expansion.Now, turning to pharmacy, last quarter, we discussed our expectation that pharmacy earnings would steadily grow over the balance of 2019 as a result of our initiatives to lower cost of goods sold adding new business throughout 2019 and the normal margin seasonality in our pharmacy business. We are pleased that our second quarter results reflect the progress we anticipated in these areas. The improvement in terms of our wholesaler major retail network pharmacies and drug manufacturers are on or ahead of target in our PBM and distribution business. New PBM business implemented in the second quarter or committed to in the third quarter is consistent with our forecast and employer retention is solid and meeting our expectations for the year.In our specialty pharmacy business, we implemented our medical pharmacy management program for a new regional health plan with over 2 million members on July 1. As experts and managing specialty span on both the prescription and medical benefit, Magellan Rx offers forward-thinking and innovative formulary management and clinical programs. For example, Magellan Rx is introducing a new medical pharmacy program focused on biosimilar alternatives to the high cost autoimmune therapy for oncology. The management program is designed to help our health planned customers realized cost savings, while ensuring clinical efficacy and safety for their members. The program is based upon the collaboration with network oncologists, our helpline customers and Magellan’s oncology advisory board and expert clinical network of key opinion leaders.Together, we developed protocols, educational materials and utilization management programs to curb pharmaceutical spend while enhancing the quality of care. With the start of the 2020 Presidential campaign, there remains a significant level of activity and attention by the Congress and the White House on the issues of high cost healthcare. Both the House and the Senate are advancing legislation of these issues, including bills to address surprise medical building, Medicare Part D cost sharing and drug pricing. We all share the common objective that Americans should have access to affordable and comprehensive health insurance as well as accurate real time information about costs so they can make the most informed decisions. But publicly disclosing competitively negotiated proprietary rates and limiting the market driven tools used to-date to lower cost as some of the legislative proposals have recommended with reduced competition and only push prices higher, not lower for consumers, payers and for taxpayers.We remained concerned over the unfruitful disruption of some of these proposals that they would cause and continue to believe a number of them do not address the fundamental issue of high drug prices. Congress is likely to struggle with these contradictions over the coming months as it grapples with various pieces of legislation and how to reduce drug prices. At this point however, we do not expect any material impact on our operations for the foreseeable future. As the process moves forward, we will continue to work with Congress and the administration to educate them on the essential role of PBMs and payers in improving access to quality care and managing cost with the overall healthcare market.Before I turn the call over to John, I would like to talk about the leadership’s succession we are announcing this morning. After several months of careful consideration, I have informed our Board that I will be retiring from my role as CEO of Magellan. This is not a decision that came easily or without a great deal of thought, it’s important to note how honored I am to have had the privilege of leading this tremendous organization as Chairman and CEO these past 6 years. It is simply a time for me to dedicate more time to my family, my community and my philanthropic work. Magellan’s board will launch a CEO search immediately and I will assist in the search and remain as CEO and as a board member to ensure a smooth and orderly transition. Steve Shulman, our current board member and former Magellan CEO and Chairman has been appointed Chairman of the Board. I have known Steve for more than 30 years as a friend and as a colleague. Steve actually recruited me to join the board of Magellan many years ago. He is well respected in the healthcare community for his expertise and well-known inside Magellan as someone who understands the complexities of our business. I am particularly happy that he is part of our succession plan.I cannot say enough about the talented dedicated team of professionals I have had the pleasure of working with over these many years at Magellan. And I am proud of the work we have done together to help transform healthcare and possibly impact the lives of our customers, members and team members. The work that we do together in the healthcare markets in which we provide products and services is important and I am looking forward to continuing to support this work until we find the right successor to lead this great company. I have discussed the relevance of Magellan in past calls. As our healthcare system continues to evolve, the need for what we provide to clients and members will continue to grow. I remain excited about our future and look forward to working with Steve and the board on our leadership succession plan.In closing, I am pleased with the results in the second quarter across all of our business segments. Our leadership team remains focused on the execution of our multiyear margin improvement plan and I remain confident in our mission, our team and our ability to deliver sustainable growth and value creation over the long-term.Now, I will turn the time over to our Chief Financial Officer, Jon Rubin. Jon?

[Jon Rubin:]

Thanks very much, Barry and good morning, everyone. In my comments this morning, I will review our second quarter results and discuss our outlook for the full year. For the quarter, revenue was $1.8 billion, which is roughly consistent with the same period in 2018. Growth in MCC Virginia and new business were essentially offset by footprint reductions in MCC Florida and Medicare Part D as well as the previously discussed PBM health plan contract loss due to an acquisition. Net income was $13.6 million and EPS was $0.56. This compares to net income and EPS of $13.6 million and $0.53 for the second quarter of 2018. Adjusted net income was $21.1 million and adjusted EPS was $0.86. For the second quarter of 2018, adjusted net income was $23.3 million or $0.92 per share.Segment profit for the quarter was $62.1 million compared to $68 million for the second quarter of 2018. Our results reflect strong sequential improvement from first quarter consistent with what we discussed in our last earnings call. From a healthcare business, segment profit for the second quarter of 2019 was $41.1 million, which represents a decrease of 6% over the same period last year. Results include approximately $12 million of favorable out of period reserve development and $6 million of favorable retroactive membership and rate changes. This decrease in segment profit year-over-year is largely driven by loss business including the footprint reduction in Florida, a higher MLR in New York primarily due to the delay in receiving rates for the current fiscal year and higher discretionary benefits. These decreases are partially offset by MLR improvements in Virginia and larger favorable out of period items in the current quarter versus the prior year quarter.Now, turning to pharmacy management, we reported segment profit of $30.8 million for the quarter ended June 30, 2019, which was an increase of 3% from the second quarter of 2018. This year-over-year increase was a result of improved costs of goods sold in our PBM business and strong medical pharmacy results partially offset by the impact of the previously discussed customer losses and higher discretionary benefits. As Barry noted, these results reflect the significant progress we have made in improving our cost of goods sold as we anticipated and discussed in our first quarter earnings call. Regarding other financial results, corporate costs, inclusive of eliminations with excluding stock compensation expense totaled $9.8 million versus $5.8 million in the second quarter of 2018. This increase was largely due to higher discretionary benefit expenses.Total direct service and operating expenses, excluding stock compensation expense and changes in fair value of contingent consideration were 14.7% of revenue in the current quarter compared to 13.7% in the prior year’s quarter. This increase is primarily due to changes in business mix and an increase in discretionary benefit expenses. Stock compensation expense for the current quarter was $5.4 million, a decrease of $5 million from the prior year’s quarter. This change is primarily due to timing related to divesting of certain equity awards.The effective income tax rate for the 6 months ended June 30, 2019 was 36.7%. This is higher than the 16% effective income tax rate for the comparable period in 2018 mainly due to book to tax differences related to stock compensation expense partially offset by the suspension of the health insurer fee in 2019. We expect a full year effective income tax rate of approximately 31%. Our cash flow from operations for the 6 months ended June 30, 2019 was $29.4 million. This compares the cash flow from operations of $21.1 million for the prior year period. This increase is mainly attributable to lower tax payments partially offset by lower segment profit.As of June 30, 2019, the company’s unrestricted cash and investments totaled $176.5 million versus $130.4 million at December 31, 2018. Approximately, $73 million of the unrestricted cash and investments at June 30, 2019 is related to excess capital and undistributed earnings held at regulated entities. Restricted cash and investments at June 30, 2019 was $478.4 million versus $527.7 million at December 31 2018. We are maintaining our guidance for full year 2019. As we mentioned in the first quarter call, we expect our segment profit will be higher in the second half of the year as a result of the following items

[Operator:]

Thank you. [Operator Instructions] Our first question today is from David Styblo from Jefferies.

[David Styblo:]

Hi, there. Good morning. Thanks for the questions. Hi, Barry. Congrats on the retirement. I know family has always been a priority for you and doing some of other activities they are involved. And I guess I am wondering how long you are willing to stay online for as the Board searches for a CEO to replace you? And along with that, as you can imagine there comes some questions about the reviewing kind of the strategic options process and the headlines with Magellan being announced as a potential or being speculative take-out candidate, would you be willing to update us on sort of where the company is in that process?

[Barry Smith:]

There is a whole bunch of questions there to unpack here, David. Number one, thanks for the comments on the personal issues and you are right family is very important, a lot of the philanthropic work I have been doing for years is very important to me. In terms of any specific timeline that I have given the Board, I told the Board that I would absolutely not be willing to go beyond the year 2050. So, it basically is in all seriousness here that I don’t have a specific timeline whatsoever nor have we discussed a specific timeline with the board. I think it’s more oriented towards finding the right CEO for our succession plan. I feel very strongly about the work that we do. We just have a great team with a great opportunity for the future. And I want to do nothing that truncates that opportunity for shareholders, for our employees, for our clients and the members we serve. So there is no timeline whatsoever there. And yes, I think it’s going to take some time and I am pleased to serve as long as it takes to do so. So, again there is no limit whatsoever. Now relative to any rumors in the industry, we don’t as you know make any commentary on rumors never have and won’t. I will simply say that we are focused on shareholder value, building shareholder value and we evaluate opportunities from time-to-time that would make sense for shareholders and we continue to do so. I would say that what we are most focused on is really the more long-term opportunity we have to increase our net margins to at least 2%. We are very focused on that. We made great progress in MCC and Virginia, for example, which was challenging this past year. We have got great leadership in place there. So I am more – we use the company and be personally in the team. We are just very focused on execution. We are pleased to see the strong performance in our pharmacy segment in particular. I know, it was a weaker first quarter, but we also knew that we would have a much stronger second and going into the last half of the year, we believe we are going to have a pretty strong year. So, I haven’t really been contemplated other than the fact that we will start to search for a CEO letting up of the gas and I say pedal to the metal, so let’s go full tilt forward. Again, there are no specific timelines.

[David Styblo:]

Okay, that’s helpful. And then just segue into the PBM, I think the results there, sharp increase were faster than I was expecting you guys to rebound. Just want to make sure that there is nothing out of period to call out there and then can you speak to the visibility on the PBM retention for both this year and next year as also growth pipeline?

[Jon Rubin:]

Yes, Dave, let me start and then I will turn over to Barry to give some comments on the pipeline in the sales activity. First if you recall first quarter, we were very clear that first quarter, although the reported results were poor and below our expectations, included significant around $14 million of unfavorable timing and non-recurring items. So I think as we guided in first quarter you really had to run rate that to get into something that was more of a quarterly run-rate in sort of the low 20s. Also at that point, we have noted a lot of activity that was going on and Barry alluded to in his prepared remarks around cost of goods sold improvement, both with respect to drug manufacturers and rebate terms and scope, the wholesaler contract and negotiations with retail pharmacy those all did play out as we expected in the quarter and provided lift even from the run-rate. So again we are very pleased with the results and as Barry said very well positioned as we go forward.In terms of the actual retention of business, we actually are seeing strong retention really across the board. In the PBM segment, the employer retention is played out favorably and consistent with our expectations. As we talked about last year, year ago, we had a spike on the specialty side in some customer terminations, but we really haven’t seen any additional challenges based on all the efforts we took to stabilize that book of business since at this point a year ago. So, all has progressed very well on that front. Barry, let me turn it to you to give some comments maybe on the pipeline and what we are seeing on the sales side.

[Barry Smith:]

We are seeing a strong – we have got a very strong pipeline and that’s just another comment about the retention we are a bit unique in the industry and that we are independent. We have very strong clinical programs as evidenced by the 2 million lives just add into medical pharmacy to the very substantial account. It has done. They did a great devaluation of the market and we just are heads above the rest of the industry and given the fact that over 40% of the spend across the board is specialty. That’s our strength and that’s where the money is and that’s where people want to see these clinical tools. Products like our oncology product for example I mentioned in the script of where we have a very sophisticated approach to appropriately managing utilization way that benefits the individual as well as controls the costs, those are the kinds of program that we think are quite unique in the industry and gives us great strength. To John’s point on the specialty front, what we have done over the last year on the retention, we have increasingly tied our rebate contracts to clinical programs and so that it isn’t just a rebate by itself standalone out there with a quick out and there is still contracts like that. So I am going to say that they are not, but increasing what we are seeing and doing is tying these clinical programs to the contract. So you are seeing much higher rates of retention. We think there is far less risk in that business doing it in this fashion. And we also think in terms of new clients coming onboard, we find that we are having greater success not only on the employer side, but also on the MCO side in terms of the pipeline. I think that again it’s these clinical programs that are making the difference. And the last thing I would say is that we have talked about this in the last few quarters, I think this is accelerating with all the excitement of some of the combinations of the past meaning the CVS, Aetna and Express Scripts and Cigna, again, great strong competitors. The reality is the MCOs, particularly employers as well will want to see competition, want to see a player that’s independent that can compete very effectively and we do that. We answered that. And so I think a lot of what we are seeing is the market is settling down. A pricing is still competitive, there is no doubt about it, but it does not preclude us. And given our straights in the clinical side, we are able to earn how what would ordinarily be a scale issue and so that we could be competitive on the pricing. So we are winning and anticipate winning deals based upon those clinical capabilities. So both from a pipeline standpoint or retention standpoint, we think the business is in quite good shape.

[David Styblo:]

Okay. And the last and real quick is just on understanding the healthcare evolution for earnings there if I take up the 18 million of favorable out-of-period items, it seems like core results were lower more like $20 million to $25 million for the quarter which is a margin just under 2%. I know you have still got drags from Virginia and New York in there, but can you help me understand anything else that’s weighing on the results and what’s going to cause that to ratchet backup besides some of the things that you mentioned with New York rates?

[Barry Smith:]

Yes, let me take that, Dave. So yes what you are describing is correct if you were to look at what we reported as prior period rather period items in the quarter, I would say is that, one, we did have – if you are looking quarter one to quarter two, we did have some favorable prior development in the quarter one as well. We had in spite to that, because it wasn’t as material. In addition what I would say is we did have some isolated pockets where utilization was high in second quarter, but we don’t think is something that will affect us to a large degree going forward. So a couple of examples, a couple of key examples are in Virginia we actually had some new in enrollees this year new folks are involved in our plan on the ABD side that had a higher risk profile and we believe higher utilization as it is emerging beginning of the year now that over time should be compensated for in the form of risk adjustment but as you know risk adjustment always lags actual enrollment so it does take a little bit of time for the revenue to catch up with the utilization but we are seeing again some of those new enrollees having pressure now, the good news is we have already been able to impact similar utilization patterns in Virginia based on our care initiatives that we have implemented so we are focusing those care initiatives on these new members over the balance of the year and we are confident we will make progress there as well secondary note is we did have some higher than seasonally normal utilization early in the quarter on in patient Massachusetts we actually saw that improve in June so we think it was just a spike in some sort of seasonal type admissions and seems to have settled down since then so again we don’t think will be a problem for the year as we run rate so those are the things I have mentioned again on second quarter we did not get the increase we have anticipated in New York yet although you know New York has continue to say that rates will be coming in the very near future so we are expecting that will get news and over the next few weeks.

[David Styblo:]

Alright. Thank you.

[Barry Smith:]

You bet.

[Jon Rubin:]

Great. Thanks, David.

[Operator:]

[Operator Instructions] And our next question is from Kevin Fishback from Bank of America/Merrill Lynch.

[Adam Ron:]

Hi this is actually Adam Ron filling in for Kevin. You definitely answered a lot of the questions I already had but I may be shifting gears little bit how does the recent consolidation in the behavior space change the competitive landscape in the business if at all are you worried that this larger competitor will be able to leverage additional G&A synergies and undercut on price are there any offsetting factors? Thanks.

[Barry Smith:]

Thanks Adam. It’s a good question I would say that normally having larger competitors certainly brings certain economies of scale that could be transfer pricing internally. The reality is however we have been enormously successful in the behavioral health business both on a standalone business as well as an integrated care basis. With the acquisition of Beacon by Anthem was probably which you are referring to, that’s a great thing in terms of Anthem’s ability to execute. Anthem is a good high-quality MCO and again we have great respect for them, but the fact is being acquired by Anthem, it puts Beacon in a situation where they have a heck of a lot more channel conflict versus being independents they were before. So while there is some benefit certainly to having the times of scale operationally by Anthem. There is also the offsetting, which I think is very substantial of the channel conflict if that introduces and so even within the Blues, where other are those who would not buy from a fellow Blues plan and there is also consortium of Blues plans that actually own a behavioral health entities is a capable one. So, I just don’t think that – and that’s a factor in terms of how even the Blues within themselves think about buying from each other. In the larger market, I also think that that we have been very competitive competing with Beacon over the last several years. Again, we have great respect for them and their leadership, but if you looked at the hit and miss rate, we have a very high batting average. And so we remain confident. We think the fundamental product that we have is of a different nature and integrated in nature that is unique to us and that we are able to customize it to our client in a very meaningful way. So, again, we have great respect for Anthem high-quality company great respect for Beacon, but we haave done well historically. I think the channel conflict will offset the benefits from being acquired by Anthem competitively.

[Adam Ron:]

Thanks. Definitely appreciate the color. If I could just ask one more as you work through improving margins on your existing book of business, how do you think about bidding on new RFPs, especially given high startup costs that you have cited in the past, should we expect a focus more on improving margins on the existing book in the near-term, is there an appetite to grow? Any color on that dynamic would be appreciated?

[Barry Smith:]

You bet. We clearly – we have grown dramatically over the last several years. And part of the issue as you point out, Adam, was very difficult to grow at that enormously quick pace and also keep up capabilities we needed internally to managed care and costs. We have come a long way this last year and Virginia was challenging there is no doubt about it, but as you have referred and seen it, we will see it going forward, we have had a pretty substantial step up in our capabilities in Virginia and we see some great progress there in Virginia. So those same tools that we have developed for Virginia that we have for New York and Massachusetts those will allow us to address new markets in a very thoughtful and I think productive and profitable way. That said, we mentioned last quarter that we would likely put up – and the quarter before that that we would likely pause for a moment, so that we can make sure that we have capabilities. I do think that we are becoming ready to take on new business, but we would not do that and haven’t set ourselves up to do that until we get our fundamental chassis in order both from the efficiency standpoint and the quality standpoint which we are doing in very quick order. So I would expect by the end of this year we will be very ready to take our new business, particularly in the public sector, it’s important to think about the timelines. We try not to bundle up new wins I have said it overwhelms us. And so we think about 2020 – later 2020 into 2021, we think we will be well positioned to grow and continue that growth path more so than ever. The other thing I would say, Adam, it depends on the nature of the wind. So there are some winds that spread you out across a very large geography where you don’t have the density to build networks, to build a care team that can focus and concentrate on the population, those are much more difficult winds than having a more concentrated urban area for example or being in a state for example, where it is understood that there needs to be continuity of health plans over long-term for the benefit of the citizens of the state. Therefore, margins are acceptable. The states will typically have a very probe business orientation to them. Those are good environments for us. And so it’s not just winning, but it’s winning in the right place that matters. These public sector contracts aren’t contracts you win in 2 and 3 months, they typically require years of work to prepare either legislation on some cases or the relationships to be able to compete effectively and we are out there doing that. But again, our goal and our planning is focused on not doing that too soon, but allowing those winds to occur in 2020 – for implementation later in 2020 into 2021.

[Adam Ron:]

Alright. Thanks so much. That was helpful.

[Barry Smith:]

You bet.

[Operator:]

Thank you. And I am showing no further questions at this time.

[Barry Smith:]

Great. Well, we thank all of you for joining our call today. We are grateful that you joined with us. We look forward to meeting with you on our third quarter conference call. Thank you so much for joining us.

[Operator:]

Thank you. This does conclude today’s conference. You may disconnect at this time.