Magellan Health, Inc.
Q2 2018 Earnings Call Transcript

Published: 27 Jul 2018

[Operator:]

Welcome and thank you for standing-by for the Second Quarter 2018 Earnings Call. At this time all participants are in a listen only mode. [Operator Instructions] Today’s conference is being recorded. If you have any objections, you may disconnect at this time. Now, I will turn the meeting over to Joe Bogdan. Please go ahead.

[Joe Bogdan:]

Good morning and thank you for joining Magellan Health’s Second Quarter 2018 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 26. 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, Friday, July 27, 2018, and have not been updated subsequent to the initial earnings call. During our call, we’ll make forward-looking statements, including statements related to our growth prospects and our 2018 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 costs, 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 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 non-GAAP financial measures to the corresponding GAAP measures. I will now turn the call over to our Chairman and CEO, Barry Smith. Barry?

[Barry Smith:]

Thank you, Joe. Good morning, and thank you all for joining us today. This morning, our comments will focus on a few key areas. First, I’ll provide a summary of the quarter and our revised guidance. Then I’ll give you an update on key areas of our healthcare business, followed by some [Audio Dip] business including a summary of our response to the RFI from HHS on the blueprint to lower prescription drug prices. Finally, Jon will put additional color on the second quarter results and our revised full year guidance. For the second quarter of 2018, we reported net revenue of $1.8 billion, net income of $13.6 million and EPS of $0.53 per share. Our adjusted net income was $23.3 million or $0.92 per share, and we received segment profit of $68 million. For the full year, our lowering guidance due to delays in new business and recent termination they were specialty carve-out business as well as healthcare earnings pressure in New York and Virginia. Jon will provide further details on our guidance update later in the call. Now let me provide you with some current developments in our Magellan Complete Care portfolio. As you know, we are currently implementing RFP wins in a couple of markets and completing the integration of the Senior Whole Health acquisition. In Virginia, we are having a successful implementation while progress on our ramp to profitability during the second quarter was slower than expected. We remain focused on effectively managing the healthcare spend of members under our care while increasing the quality of services provided. The leadership team at Virginia continues to make progress in this area as they also work on implementation-readiness for the Medallion 4.0 program scheduled to go live next week. In addition, we are pleased that the legislature passed a budget that included Medicaid expansion. This will provide us with additional membership growth in Virginia beginning in January of 2019. In New York, we are on track with our integration with AlphaCare and Senior Whole Health. We have moved to one claims system, consolidated the network and updated our care coordination policies. We experienced slightly less growth than anticipated over the first half of the year as a result of the integration. Our updated full year outlook includes less membership growth that was included in our previous guidance. Finally, the state released annual rate changes effective second quarter, which were lower than we expected. Through continued effective care management initiatives, we were able to offset a portion of the rate impact over the balance of the year. As you will recall, our MCC strategy has been to build scale through a diversified portfolio of markets. We’re pleased with the Senior Whole Health acquisition as it further enhanced our scale and position in the New York market and created a new entry for us in Massachusetts. In Arizona, as a reminder, the state recently awarded us a contract to participate in the Medicaid Managed Care program covering the central region. We continue to meet our readiness-related milestones in preparing for the October 1 effective date. We recently completed the five week IT demo testing with the state and had staffed key leadership positions. While there will not be an initial assignment of a block of existing members to Magellan, the state will auto-assign new members to smaller plans until they reach 80,000 lives. Given that the initial membership will be modest, we are not expecting a material financial contribution from the Arizona plan in 2018 or 2019. We believe the foundation we are creating in Arizona will position us for a specialty plan opportunities in the future. For example, Arizona released a Medicaid Managed Care RFP for persons with intellectual and developmental disabilities on June 25. Now let me update you on Florida. As you may recall, Florida’s Agency for Health Care Administration or AHCA did not choose MCC at Florida to continue operating as a serious mental illness, or SMI specialty health plan, effective January 1, 2019. As a result, we filed a protest with AHCA on May 7. We continue to have discussions with AHCA as we progress through the protest process. In our federal healthcare business, we are pleased that Magellan federal has been selected to continue serving as the contractor for the Military and Family Life Counseling Program, or MFLC, which delivers non-medical counseling services worldwide. We are one of three contractors selected to serve this 10-year contract. The award of this contract is a recognition of our unwavering commitment to improving the wellbeing of our nation’s servicemembers and their families in all branches of the military. Now turning to pharmacy. We are seeing earnings pressure in our specialty carve-out business as a result of contract losses as well as delays in closing our pipeline at new business opportunities. Our core PBM business continues to perform well and our pipeline of opportunities remains very strong. In our Part D business, we submitted our 2019 bids last month. In order to focus on those geographies with a greatest concentration in membership and profitability, we reduced our bid footprint from the current 20 regions to four regions in 2019. As we’ve mentioned in the past, our participation in the PDP business is primarily to strengthen our operating experience in Medicare in order to compete successfully for managed care PBM business. Let me offer some perspective on how we differentiate ourselves in the PBM marketplace. The historical measure of success for the PBM industry has been the ability to leverage scale to drive down unit cost savings. With the rising cost of prescription drugs, the explosive growth of specialty drugs and the changes in the healthcare delivery system as a result of the Affordable Care Act, that measure of success, while important, is no longer sufficient. While some industry players continue to drive savings through buying discounts, our vision has been different from the start. We solved complex pharmacy challenges by leveraging our industry-leading expertise to move beyond the traditional volume-focused market and deliver true value-driven differentiated solutions. We used targeted clinical programs, powerful member engagement strategies, advanced analytics and our comprehensive specialty drug management expertise to deliver proven cost savings for payers and improved outcomes for members. We understand Magellan Rx’s role in lowering prescription drug pricing and reducing out-of-pocket cost for consumers, and we recently submitted our response to the Health and Human Services RFI blueprint. In our response, we highlighted three principles. First, the primary factors driving pharmacy trend are high launch cost of prices for new drugs and large price increases by drug makers. Of these, specialty drugs have seen the largest overall price increases. The clinical utilization of these new specialty drugs is often not managed, and they face limited competition in the market. Advancement of biosimilars as alternatives to high-cost specialty drugs needs to be a priority. Secondly, PBMs like Magellan play a key role in lowering overall healthcare costs through market-driven practices. Magellan helps create and promote innovative solutions and evidence-based clinical practices. These solutions drive better decision-making and curb the impact of rising drug prices for Medicare, Medicaid and commercial payers and lower cost for consumers while improving access to care. And thirdly, public policy solutions should focus on ways to improve competition, support market-based private sector solutions to lower drug cost for consumers and create an environment to encourage pharmaceutical companies to lower list prices. We commend the administration’s call to action for a national focus on lowering drug prices and look forward to working with stakeholders to find innovative solutions to deliver high quality and cost-effective pharmacy benefits. Before turning the call over to Jon, let me add a few comments about our Magellan Complete Care business. I am confident in our strategy and optimistic about our continued growth trajectory. We acknowledge that MCC earnings improvement has been slower than expected. We have the right people and plans in place to drive margins to industry-competitive levels as the MCC business matures, which combined with our strong revenue growth will create meaningful, long-term value for our shareholders. 2018 will continue to be a year of focused execution for Magellan, and our strategy remains unchanged. Now I’ll turn the call over to our Chief Financial Officer, Jon Rubin. Jon.

[Jon Rubin:]

Thanks, Barry, and good morning, everyone. In my comments this morning, I’ll review the second quarter results and discuss our outlook for the full year. For the quarter, revenue was $1.8 billion, which represents an increase of 28% over the same period in 2017. This increase was mainly driven by net business growth and the annualization of revenue from the prior year acquisition of Senior Whole Health. Net income was $13.6 million and EPS was $0.53. This compares to net income and EPS of $5.5 million and $0.23 respectively for the second quarter of 2017. Adjusted net income was $23.3 million and adjusted EPS was $0.92. For the second quarter of 2017, adjusted net income was $14.1 million or $0.59 per share. Segment profit for the quarter was $68 million compared to segment profit of $54.3 million for the second quarter of 2017. Now for our healthcare business, segment profit for the second quarter of 2018 was $43.9 million, which represents an increase of 46% over the same period last year. This increase in segment profit year-over-year is driven by the following factors

[Operator:]

Thank you. [Operator Instructions] Speakers’ our first question comes from Dave Styblo from Jefferies. Dave your line is now open.

[Dave Styblo:]

Thanks. Hi there and good morning. I wanted to just start out on the pharmacy side and get a better understanding of what formulary contracts did you guys lose. And when did you know that? When does that become effective? Is that starting in the second quarter? And if you just talk a little bit more about why is this suddenly happening? I don’t think you guys have had a material contract loss, especially in the specialty carve-out that I can think of going back in time.

[Jon Rubin:]

Let me start. Then Barry, I’ll ask you to add some additional color. In terms of the specialty pharmacy pressure, Dave, a couple of things. One, it is concentrated again in the formulary management line. We’re continuing to see very good results and progress in medical pharmacy. What we’ve seen in the very short term is that the pricing has become more competitive. And we’re seeing, in some cases, pricing that we deem as not being rational. And again, we think it’s temporary. We believe in the long term, things will settle and play out in a more sustainable way. But short term, we are seeing some pressure there. It’s not a large number of accounts, but it is meaningful. And to answer your question, yes, it really has begun in – yes, second quarter is where we began to see pressure. But we do expect that the pressure will continue, at least until late 2018, early 2019, just based on the sequencing of things. But again, we feel good about the capabilities we have. We feel good about the value we’re adding. Again, we’re seeing some short-term pressure on the pricing side. I don’t know, Barry, if you have anything to add?

[Barry Smith:]

Dave, I would just add. Good morning. I would just add to Jon’s comments. This is a very recent development. And it takes just a few contracts from very large PBMs, very large, large payers to have a kind of a negative impact like this. We do think that the pricing that was offered to these accounts, appears to us, to be quite irrational. And we think that those things will normalize over time. We’ve seen the same kind of thing in the past. It hasn’t really impacted these larger specialty contracts in the past to this extent, but we see that also normalize over time. So you kind of understand what’s going in the marketplace today. And so we don’t expect this to be a long-term trend. We do think that our medical specialty capabilities, which really have been unimpacted, we’re very successful in that space. That still offers us great opportunity. And as we combine further these medical specialty pharmacy capabilities with formulary management, it makes these contracts stickier over time. So – and that’s essentially what we’re doing. We’re also looking at creating, maybe with a few initial price concessions, contracts that are longer term to really bridge this period of volatility, to make sure that we don’t have volatility both on top and bottom line for the company.

[Jon Rubin:]

Yes. The only one last thing I’d add is that from a new business standpoint, even in formulary management, our pipeline remains strong. So even though we have seen some pressure on some of the high-margin business within our existing book, we are continuing to see good opportunities in the market.

[Dave Styblo:]

Okay. And how much total earnings or revenue exposure do you have from this segment of the business, the specialty pharmacy carve-out that’s being affected right now?

[Jon Rubin:]

Well, I mean, if you look at the revenue in total for the formulary management business, I think, in 2017, it ran about $90 million in round numbers. Now, again, not all of that is standalone, meaning some of that – we could have other business, whether it’s medical pharmacy or PBM attached to it. But at least, that gives you the total picture.

[Dave Styblo:]

Okay. And then more broadly, with the administration’s drug proposal, and we don’t have all the details yet, but just to get a sense of your PBM rebates, how much PBM profit comes from the rebates? So I guess, when I look at your 10-K, it looks like you generated about $90 million of rebates in 2017, right? And your pharmacy management segment profit was $140 million. So how much of that $90 million is in that $140 million?

[Jon Rubin:]

So let me make sure I’m answering the question correctly. But the $90 million I think you’re referring to is largely the carve-out rebate business, the specialty side of it. There are also rebates – I don’t have the number at hand, but there are also rebates in the traditional PBM business. It’s – in terms of the profitability impact, it’s a smaller number. But still, there are rebates in that business. So again, I just want to make sure we frame that accurately.

[Barry Smith:]

I would just add to that, that the proposed rule-making is just coming out now. The Department of HSS received a lot of comments on this, and they just received the last of these comments this last Monday. And they said – we understand there are more than 3,000 comments received. So we really don’t know yet what the impact of that rule-making would be on the removal of safe harbor protection for rebates. We do think that, given this is an executive order and not legislative action, which we think will be much more difficult to implement, we don’t think that it will likely impact the commercial business, but will be focused, if there’s any, on the public sector Medicare and Medicaid business. Interestingly, in terms of our contracts with the public sector, states in particular, we do work with the 25-plus states, plus the District of Columbia. Most of those contracts are passed-through contracts or fixed fee contracts, where we receive a certain fee for the work that we do for the state. So I guess my point here is just that, while we don’t know what the rule-making will be, and no one really does, it’s hard to comment until it really is exposed so we can make comments on it. But a lot of the pricing within the public sector is already fixed price.

[Jon Rubin:]

Yes. And even with other health plans and all relationships we have, Dave, we’ve got virtually no rebate exposure of any magnitude on government programs. So that piece, I can say with confidence, is immaterial.

[Dave Styblo:]

Right. So of all the effects flips over to commercial, right?

[Barry Smith:]

Right.

[Dave Styblo:]

Okay. And then last one, and I’ll let others get in, is just moving over to healthcare side. So the Virginia year one implementation costs, that’s obviously not really a new issue. It just seems like costs are continuing to run higher than expected. Can you help us understand, is this an MLR issue at this point? Do you have enough visibility on the population that has ramped on last August and starting in January this year? Or is it more along the lines of it’s just taking longer to implement some of the medical cost initiatives than you had expected?

[Jon Rubin:]

Yes, mostly the latter, meaning – we have a good handle now on both the MPLSS population that came on last year and the ABD ph population that came on in January. So we’ve got a good handle now on the run rates. And we also have developed very detailed action plans to achieve the managed care savings appropriately as required to meet pricing assumptions under the contract. But we haven’t yet seen the impact of those initiatives in the results. So while we were hoping this to begin to see impact in second quarter, it’s been a little bit slower emerging than we expected. But again, we’ve got, as Barry said in his prepared remarks, both significant expert resources and people in place and detailed actions that are being executed. So we’re very much optimistic in terms of being able to get that book of business to kind of a more mature loss ratio beginning in the second half of this year.

[Barry Smith:]

Dave, I would just add to Jon’s comments, everything right on target. But the fact is, we have one incremental business, and we have an exceptional team, Kate Massey is General Manager of our Commonwealth of Virginia plan and MCC Virginia. And these are very experienced, capable managed care people. But the lives that have been coming on – we started just about a year ago, it will be August 1. We had a few thousand. So those very initial lives haven’t been on for quite a year. We did get the larger bolus of those individual members on the 1st of January. But as we’re implementing, we’re learning about them, and we think that we’ve got that understanding pretty well locked in. And as Jon mentioned, we’ve got medical action plans that give appropriate care to these individuals. But properly managed care, the cost of these individuals as well, that’s actively in place now. So we think that we’ll see and are seeing underlying traction with those medical action plans. The other factor, though, that I mentioned in the last call is the fact that fortunately, we’ve been very well received by the Commonwealth of Virginia, by the state. And we’ve received incremental awards for additional populations. Now the next population goes live this week, this next week, Medallion 4.0. And then the Medicaid expansion happens on the 1st of January. So unlike other states where we have one implementation, in this case, where – we’ve implemented, we’re winning business and we’re implementing yet again, winning business and implementing yet again. So I would say, this is a great trifecta. It’s a high-class problem to have, where you have this level of growth within the state. It gives you some sense about how the state views Magellan. We’re the only new entrants in the market. And so we’re very pleased to be able to be at the table. And our goal has been to make sure that we hit the implementation and ready to start this dead-on as we have with the state. I think the state is very, very pleased with us. But it has caused pressure in terms of the resources required to both implement and meet all these timelines for implementation-readiness, and at the same time, make sure that we fully implement the medical action plans. But again, we’re well underway with those. And that’s why it gives us some level of confidence we’ll achieve those and do well in the state ultimately.

[Dave Styblo:]

Okay. Thanks.

[Barry Smith:]

You bet. Thanks, Dave.

[Operator:]

Thank you. Our next question comes from Michael Baker from Raymond James. Michael your line is now open.

[Michael Baker:]

Yes. Thank you. I was wondering on the Virginia expansion, can you give us updated thoughts on the membership opportunity and what impact there might be for work requirement.

[Barry Smith:]

Well, there is, as a part of the expense in Medicaid expansion, there are both some work requires, but also there’s a funding for incremental social services and health for the population as well, for helping them find a job and helping to do some fundamental social issues that affect quality of life and allow them to rise up out of the Medicaid roles. So it is a robust, very well thought out, very thoughtful plan designed by the Commonwealth of Virginia. In terms of the numbers and implementation, initially, our initial number of enrollees, about 6,000 lives, which are going live this week in Virginia, that will increase in this Medicare – the Medallion 4.0 program, region by region by region. The first one is just implemented again this next week. And we’ll see how the lives roll out over time, but we think it will yield the proper number of lives. Clearly, that’s – they’re all labeled on to our current – our current chassis there. The Medicaid expansion includes 400,000 – up to 400,000 additional lives, which will likely be allocated to the six players. Now, again, we’re a newer player there in the state. So we would expect to get, reasonably, our prorated share, but that might need to happen over time as well. But it’s a nice add to our book of business there in Virginia. That business for the Medicaid expansion, of course, goes live starting on January 1, 2019.

[Michael Baker:]

And then can you talk or give a little bit of color on the – you, obviously, you had – sounds like you won some business in the specialty pharmacy side that – there are kind of delays and how that’s going to come on. Maybe a little bit on color on that.

[Barry Smith:]

Well, it’s interesting. There’s a lot of emotion and a lot of finger-pointing by both pharma manufacturers to the PBMs. Clearly, there is a real political issue and a real issue of drug cost escalation. It’s most – it comes from largely, in our view, from how the consumers are impacted ultimately. Health plans, we work in the system. And we have a very sophisticated system, where we put pressure on manufacturers to make sure that the drugs are properly valued for the utilization within the health plan. So – and we’ve been doing that for years. And we think it works and works very, very well. The manufacturers have pushed back, of course, and said that others like the PBMs are the problem. But we think that the pressure applied by PBMs for both cost concession as well as clinical programs and clinical effectiveness is very effective. So we would stand that the PBM plays a very important role. Now as far as the administration is concerned, they proposed a blueprint for Rx. We think it has great validity. We think it’s important to focus on the cost. We do think, however, the issue is more of a pharma list price, both new introduction launch list prices as well as increases on existing list prices. And we’ve seen that historically. We don’t think – and in the blueprint, it talks about safe harbor, it talks about putting pressure on the rebate management. Again, as I mentioned earlier in the call to Dave, we think that the focus will likely be, if there is any focus, on public sector programs, Medicare and Medicaid, because that can be done by executive order. The legislative process would have to kick in to have that go across the board for commercial health plans. We see that as much, much less likely. And we think that it’s working well within the commercial market. So the comments were just in. Again, we understand that HHS had over 3,000 comments that they’re just now reviewing. They typically have 30 to 60 days to review those. But there’s no finite time limit, as we understand it. We’ve commented and given the HHS the blueprint, our suggestions for the blueprint for Rx, as of other PBMs. And we think that they’ll take those comments as they come up with the final proposal for a rule. Once that rule comes out, there will be another public comment period. So we don’t think anything will happen overly quick and fast. But we do think and we’re hopeful that there will be a very thoughtful process. That might have been more of an answer.

[Jon Rubin:]

Yes, well, I think – and Mike, I think the second part of your question was around some of the delays we’ve been seeing on the new business opportunities. It’s hard to know how much of that is tied to the decision process as well as it might be tied to other stuff that Barry mentioned, going on in the industry. But we are still seeing, on the specialty side, good new business opportunities, opportunities that we had hoped would be closed and implemented this year, have slipped a little bit in timing. Again, it’s hard to attribute the exact cause of that. But we’re still very confident in terms of long-term trajectory there.

[Michael Baker:]

And then I just had one more, any sense of timing on the Florida protest in terms of decision time line on that?

[Barry Smith:]

Well, we kind of gave you some parameters. This is kind of a long story developing here. As you know, the end of April, 1st of May, we were told that we weren’t part of the plan, going forward, for our specialty, our SMI specialty plan. We filed a protest on May 7. We were – we spoke to AHCA on, I think it was the 17th of May, and had initial dialogue. They went through the process and focused in on the general health plans, which they concluded and announced late June. And then we’ve reengaged with AHCA because then they moved on to the special needs plan, which we were one of. And as I mentioned during my prepared comments, we’re in current discussions with them. We do have an administrative law judge hearing on the 8th of August. And between now and then, and through those discussions, we – AHCA has the capability of settling. We hope that the discussions with AHCA are productive. We’re clearly hopeful for a good outcome. We really can’t say definitively because it’s just not resolved. But our sense is, is that things will happen relatively quickly, given the fact that, that an administrative law judge hearing is scheduled for August 8.

[Michael Baker:]

Thanks a lot for all the updates.

[Barry Smith:]

You bet. Thank you, Michael.

[Operator:]

Thank you. Our next question comes from Ana Gupte from Leerink Partners. Ana, your line is now open.

[Ana Gupte:]

Thanks. Good morning. Following up on the contracts on the specialty carve-out, who is gaining share here? And can you give us some color on what the criteria are? Is it more of a price bid in the selling season? And who’s winning contracts here? And what are the drivers of any contract losses for you? I hadn’t even realized that you had exposure there for loss, at this point, really.

[Jon Rubin:]

Yes. And I’ll start, and Barry can add additional color. Again, this is a small number of contract. So it’s not as if we can talk about any large ways in respect to trend. But we really are seeing sort of aggressive pricing from PBMs, from some of the larger PBMs, who have PBM relationships with health plans, who in a sense are aggressively pricing to consolidate the formulary management business on the health plan relationships. And again, the way I would think about it is it’s not sustainable, because we can see from the pricing that it clearly is not standalone. It’s not standalone pricing that could hold and be rational in the market. So I would look at it as – and there may be a number of reasons for it. And I don’t want to necessarily go into the specific competitors, but there’s a lot, obviously, going on in the industry. But what we’re seeing is, again, people in a sense trying to grab revenue, potentially maybe leveraging the profitability they have in other parts of the relationship and willing to take a loss on this part of the business. So again, for those reasons, we look at it as temporary and something that we’re not going to chase from a financial standpoint. But we’ll wait until the market stabilizes. As I mentioned earlier as well, we’re still seeing new business opportunities in this area. So it’s not as if the market is drying up by any means. But we do look at it as a short-term challenge to the business.

[Barry Smith:]

And Ana, I’d only add to Jon’s comments that some of these very accounts, they look at us as being clinically sophisticated and have always appreciated the relationship they’ve had with us. And so we do think it is price pressure. And some health plans – and many health plans are very pressured economically. And so it’s very appealing. We do think, as Jon points out, it’s a temporary – it’s a – we think that long term, that level of pricing is not sustainable. But we shall see. That’s our view.

[Ana Gupte:]

So you’re losing the contract losses where – with your health plan clients. So it wasn’t with your employer clients, I guess? And then with your last comment around health plans are pressured economically, and I know you can’t get into specific competitors, but is this coming from more captive PBM-like organizations or standalone at this point?

[Jon Rubin:]

Well, I – let me put it this way. I mean, these are, again, large PBMs that have the full-service PBM relationships with the health plans and – where we may be, again, the specialty carve-out vendor for formulary management. And Ana, again, I don’t want to get into guessing games on who they are. But like I said earlier, I think you’re aware, there’s a lot going on in the industry, and there could be pressures on certain PBMs to retain or grow revenue. And I think that there may be some short-term dynamics playing out there. But I don’t want to be specific in terms of the competitors.

[Ana Gupte:]

But as, I guess, as you go forward, we are in a state of a lot of disruption in the market, with two big potential mega mergers closing by the end of the year. And what might make things better? Next year, you’ve got now – but then, let’s just assume big deals closed. Three very large integrated PBMs are going to be potentially fighting for share because they gain on the medical side. I mean, why is this going to get any better?

[Barry Smith:]

I would offer this, Ana, that I think that there is a need to demonstrate success. And that’s great. And we get that. I also think that the channel conflict issue is rather significant, and that people would prefer not to buy from certain players if they are a direct competition with them in certain markets. So we think that those two elements are likely to cancel each other out in terms of the market. And so we just don’t see that aggressive pricing makes sense, long term, for all players in the marketplace and that it will ultimately rationalize as it virtually does in any market.

[Jon Rubin:]

The other thing I’d add, Ana, is that if you look at our formulary management book, there are some accounts, and some of the accounts where we’re seeing some of this pressure are purely standalone formulary accounts. Our strategy is, really, not necessarily to have one product. Like formulary management in a relationship, but rather bundle products. And when we’re going to market, we’re often selling multiple product bundles that have medical pharmacy or high degree of clinical capabilities sold in, which are much stickier. So I’d look at some of this, also, just being legacy business that we’ve had that truly is sort of standalone formulary management, where our strategy, long term, is absolutely to have multiproduct bundles, which create much more stickiness and stability. So I wouldn’t look at it as the book being homogenous or being exposed to the same degree. But we do, short term, again, have these challenges that we’re managing through.

[Barry Smith:]

And the last color commentary on this is that, again, it is more focused on health plan, not employers, number one. Number two, formulary management isn’t necessarily the entire array of drugs. You will – it might be one drug that the competitors are going after or a couple of drugs or a class. And so it’s not as monolithic as one might think. And we do battle, on a regular basis, with a competition across the country. And we’ll compete for the entire formulary for certain drugs, certain classes. And so it isn’t, again, monolithic. It’s very, very granular, the competition and how we go about it.

[Ana Gupte:]

Okay. Thanks for all that color. That’s helpful. The next one, and just a quick one on the care management capitation rates that you saw issues on. And can you just give me more color on that? And what is this? Is this a trend? And what’s driving it?

[Jon Rubin:]

Ana, I think you’re referring to comments on New York. Is that after we talked…

[Ana Gupte:]

Yes, yes. At this point only New York or is elsewhere? It’s part of your management commentary and your press release as well.

[Jon Rubin:]

Okay, yes. No, it really was specific to New York. And in New York, a couple of things. One, we went through the integration with the Senior Whole Health, which was very successful. But because we had two separate entities that were competing in the market, we did have a period where we had to transition from doing business as AlphaCare and Senior Whole Health to integrated marketing. And during that period, we did have some temporary restraints on membership growth as we came through the year. And our expectation is that, now that we’re consolidated and operating and getting the synergies we have as a combined entity, that we’ll see growth as we go through the year. But we were a little bit slower in second quarter in the ramp-up of that membership than we originally expected. But we are now seeing growth being reignited in the market. So that was one piece of it. And that’s the smaller piece. The second item we noted is we did, in second quarter, get capitation rates, which were sort of retroactive to the beginning of the quarter, in New York, which again were a little bit lower than what we expected. And that, again, there’s – the rating process is an annual process, de facto 4/1 every year. And often comes after 4/1, and retroactive. Now, again, we’ve actually been running favorably on care management in New York, so that allowed us to offset a good part of the capitation, the lower capitation rates. But that’s the picture. And again, it was specific to New York.

[Ana Gupte:]

Okay. Thanks that’s helpful. Then back to drug pricing reform. So as you said, it’s executive order, more likely in Medicare and Medicaid. In Medicaid, what is the business model for you right now? Are you making any money at all, a profit on the rebates for the carve-out?

[Barry Smith:]

We don’t really discuss account-specific information at all. But I will tell you – I will characterize the nature of these Medicaid contracts. They are typically fixed-price contracts. And again, we talked about the whole drug management and how we contract. The clients can pick any kind of contract they wish, and the commercial side, typically, will choose the more traditional, where we share risk and they share risk. In the world of Medicaid, particularly, the typical model is that they will pay us a fixed fee to manage their formulary. And we negotiate on behalf of the state, a state or a number of states, but a state, to those prices for that formulary. And we then administer that formulary for the state through claims adjudication or whatever mechanisms we have in the state. And so the profitability of the state doesn’t vary by the drug at all. It is a fixed-price contract. So it’s very high – it’s a lower total profitability in terms of a – there’s not a per claim payment. It’s a fixed price for the contract. So in those particular cases, which is the vast majority of our world, there really is very little to no exposure on the formulary or management of the drug. We don’t get compensated that way.

[Jon Rubin:]

Right, the rebates are 100% faster.

[Ana Gupte:]

Okay. Make sense. Okay, in Medicare, your exposure is pretty much immaterial, right, I would think? And then – and they also passed-through? Or can you give us any color there?

[Jon Rubin:]

That’s right.

[Ana Gupte:]

Okay. And commercial, what is the percentage of rebates that are passed through to different entities? And can you give – I know that this is probably a stretch for them to do without Congress, but that’s the question that we keep getting from investors. And any color will be helpful – how much advantage of profit does it comprise for you?

[Jon Rubin:]

Yes, I don’t have that number. It does vary. It does vary customer to customer. And we have some of the contracts that are 100% pass-through and somewhere – and we disclosed all of it. But there is somewhere the customers want us to be paid through a fee or a portion of the rebate. So it does vary quite a bit. The point I’d make, though, is we do disclose the nature of those contracting relationships. And to the extent all the contracts were to become transparent, we can make that adjustment and be compensated in a number of different ways. So it’s not, long term, a concern to us.

[Barry Smith:]

And we typically Ana, have clinical services combined with formulary management and rebates. And some folks would rather have us provide this whole series of services and not write a check, and we’re compensated through the rebate mechanism a certain percentage of the rebate. So as Jon points out, there are just a host of different ways that we work with our clients. But it’s up to them. And we’ll give them the menu, and they can select however they like to make the arrangement.

[Ana Gupte:]

Okay. Then on the other two things they’ve talked – I mean, one of them seems really far down the road, but the AWP plus 6% to AWP plus 3% for new drugs starting January, and then potentially, I’m assuming that’s impacting adoption of drugs in the buy-and-bill model, like any thoughts on that and what that means for you? It’s a different rule than the rebate rule. It came out May before. That’s the first thing that came out from Medicare.

[Barry Smith:]

Yes. I don’t know, really, that we have necessarily a view. I think that in terms of how these drugs are managed, and compensation for our services, it can be done a number of ways. And so we believe that we can work through any such way it’s formulated. So I don’t know that we could give you a specific view at this point.

[Ana Gupte:]

And then on the competitive acquisition, they proposed this two days ago with the third rule they’ve got out there, with the outpatient prospective payment rule. And as it’s an RFI, that’s going out to everyone. I mean, are you part of that? I believe they’re responding.

[Barry Smith:]

I can’t comment at this point in time. We would typically respond. I can’t really comment at this time.

[Ana Gupte:]

Okay. Then on Amazon, you’ve been really quite helpful telling us your thoughts. And since we spoke last on the call, which has been with PillPack, any thoughts on PillPack and how Amazon’s coming in or not? And their decision is not to do hospital-based order fulfillment.

[Barry Smith:]

Well, PillPack I think is a good and smart move for Amazon. There are very smart people there. And PillPack is interesting in that it gives very customized ability to pack pills in a way that are user-friendly by consumers, particularly the elderly, who have a challenge with the pills, with the way they are. In a way, it’s kind of taking institutional pharmacy to the consumer because this – the work that PillPack does has been done in institutional pharmacy for many years now. And so by having Amazon pick up that capability, I think it’s a good and smart move. And it’s very Amazon-esque, in our view, in that it’s programmable, it’s predictable and – but it’s not overly clinically sophisticated from the standpoint – from the patient. It doesn’t require special administration. It is very standardized chronic medication. If there were – if it was a medication that changed often, PillPack, this PillPack solution wouldn’t work. And then thirdly, I would say, in terms of the drugs that are dispensed, they will still fit within the construct of the PBM world. So if someone orders a product from PillPack, and they’re covered by a benefit, that would come through the PBM. So they act just like a pharmacy – any retail pharmacy would. So I think it’s a very interesting concept. And I commend Amazon for taking that step. I think it’s – I think it will be interesting to see how that plays out.

[Ana Gupte:]

But you don’t think that they – so you think that they will try to contract with existing PBMs, either through the PillPack only platform or combined Amazon-PillPack or whatever. Because some contracts have been coming up for renewal and so on. So do you think that’s the way they go? Or do they try to control the PBM?

[Barry Smith:]

I think that they – it’s difficult to have a PBM model, I think, with PillPack directly. Because PillPack is sold to consumer. Then the question is what PBM does the consumer have or is covered by? And so Amazon doesn’t dictate what the consumers PBM is, the payer does or the employer does. So I don’t think that, that’s necessarily the play. Although, in their own initiative, clearly, they could have PillPack be a primary provider for their own services. But again, that’s normally dictated by the payer or the employer. And so if I’m a consumer, and I order from PillPack, I would just essentially turn that into reimbursement, whatever the cost was to my existing PBM or insurance plan. So I don’t know that necessarily crosses over into the PBM world as such. We’ll see how that develops.

[Ana Gupte:]

Okay. All right. Thank you. That was helpful.

[Barry Smith:]

Great. Thank you, Ana.

[Operator:]

Thank you. And speakers we have a follow-up question from Dave Styblo from Jefferies. Dave your line is now open.

[Dave Styblo:]

Thanks again. I just want to come back and understand how much implementation costs for Virginia are part of the segment profit reduction. I think it was $30 million or $35 million segment reduction for guidance this quarter. So how much of – I think it was $25 million, how much of that is attributed to Virginia?

[Jon Rubin:]

Well, if you look at the guidance reduction, I think, overall, it’s about $35 million. I would say roughly about a third is Virginia, Dave, in round numbers.

[Dave Styblo:]

Okay. And just to get our arms around this, what – do you guys feel like you’ve taken enough out of that guidance to look ahead and make sure that this doesn’t happen a third time? I mean, what gives – what can you say to investors that gets us more comfortable that you’ve identified all the bumps in the road that could happen, especially since you’ve got an implementation coming up in August? And then another one with Medicaid expansion in January. I think this should helpful for us to understand what assumptions you thought through, bumps in the road that could happen, so that this issue doesn’t arise again in the future.

[Jon Rubin:]

Yes, I guess a few things. One, as it relates to Virginia, Dave, we’ve got now – it takes a couple of quarters to get a good handle on run rate, as we’ve talked about, in past implementations on new members coming on. And with Virginia, again, the vast majority of the members and revenue came onboard by January 1 of this year. So we have a good handle now on the run rate and also good visibility to the implementation of the actions we’re taking to affect results over the balance of the year. So while you’re right, the Virginia Medallion does start to phase on August through January, the actual exposure on that book in 2018 is relatively immaterial because, one, they’re lower-cost members; two, we expect the revenue and membership to be lower for that program and for the first two phases of the implementation. And third, it’s a much lower acuity population. So we’re not counting on as much savings since that’s already in the managed care arena. So we see Virginia now – not that there isn’t some volatility, positive and negative, but we think we’ve taken a relatively prudent view of that population over the balance of the year. So we feel good about that. And relative to the implementation for the Medicaid expansion, again, the exposure doesn’t really start till 2019. We’ve got cost built in for readiness and the early stages of implementation in the third and fourth quarter of this year, but that is largely predictable. So we don’t see, again, relative to Virginia, the same level of volatility. And again, as we look ahead over the balance of the year, while there’s always the potential for some positive and negatives on all the different facets of the business, we really think we’ve built into guidance a pretty prudent view of what the volatility could be.

[Barry Smith:]

And Dave, Barry here. I just want to say that we take guidance very seriously. And we feel that this is truly – is prudent. But I just want to let you and all of our investors know how serious we feel about this. We want to be very respectful. We want to make sure that we deliver and not disappoint in any way. And so we don’t feel good about having to reforecast as we have and give you guidance. And so again, all I can say is we don’t like it. And we hope never to do it again. The future will tell, but we’re pretty convinced that we’ll do well this go-around.

[Dave Styblo:]

Okay. That’s helpful. And then I guess, by my tally, if Virginia is adding another $12 million or $13 million of start-up costs this year – the total start-up cost across both Virginia and Arizona, if I tally it all up, I think, going back from first quarter comments is upwards of $45 million or $50 million is what’s assumed in guidance for this year. Is that seemed about right?

[Barry Smith:]

Yes.

[Dave Styblo:]

Okay. And the only other part that I wanted to slice was that $35 million segment profit cut besides Virginia being a third of it. Can you break down what the other two-thirds are more specifically? Obviously, we’ve got – you mentioned broadly the specialty business and the pressure in New York. Can you help us quantify the magnitude of those contributing to the remaining part of $35 million cut?

[Jon Rubin:]

Yes, it’s actually pretty – it’s split pretty evenly between those three just by coincidence, Dave. So if you look at the $35 million, again, it’s split pretty evenly between Virginia New York and the specialty pharmacy issues. In New York, again, it’s both the impact of the rate reduction and slightly lower membership, I’d say, maybe it’s 3/4, 1/4 between the rate reduction in membership in New York. That’s the way I break it down.

[Dave Styblo:]

Okay. That’s great. Thanks.

[Barry Smith:]

All right. You bet Dave.

[Barry Smith:]

Well, thanks, Dave. And thank you, operator. And thank you all for your participation in today’s conference call. Take care.

[Operator:]

That concludes today’s conference. Thank you for your participation. You may disconnect at this time.