Magellan Health, Inc.
Q4 2018 Earnings Call Transcript

Published: 28 Feb 2019

[Operator:]

Welcome and thank you for standing by for the Fourth 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. And now, I turn the meeting over to Mr. Joe Bogdan. You may begin, sir.

[Joe Bogdan:]

Good morning and thank you for joining Magellan Health's fourth quarter and full year 2018 Earnings Call. With me today are Magellan's Chairman and CEO, Barry Smith; and our CFO, Jon Rubin. The press release announcing our fourth quarter earnings was distributed this morning. A replay of this call will be available shortly after the conclusion of the call through March 28, 2019. The numbers to access the replay can be found 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, Thursday, February 28, 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 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 GAAP financial measures to the corresponding non-GAAP financial measures. I will now turn the call over to our Chairman and CEO, Barry Smith.

[Barry Smith:]

Thank you, Joe. Since our 2019 guidance call, we've been focused on our earnings improvement plan that we detailed in December, one we are confident will position us for margin improvement this year and beyond. But first, let me be clear. We are disappointed in the results we reported today. In my remarks, I will touch on four general areas. First, I will review our full year financial performance and provide color on events that negatively impacted our results. Second, I'll review our guidance for the full year 2019. Third, I will provide an update on the progress of our multi-year margin improvement initiatives, which we introduced in December. And last, I'll comment on the Health and Human Services' proposed rule on rebates. For the full year 2018, we reported net revenue of $7.3 billion, net income of $24.2 million, and EPS of $0.97 per share. Our adjusted net income was $61.7 million or $2.46 per share, and we achieved segment profit of $228 million. Relative to our previous expectations, the fourth quarter was negatively impacted by approximately $50 million, both of out of period and non-recurring items, primarily related to retrospective rate adjustments in New York, which occurred subsequent to our guidance call in December. We do not expect these items to have a material impact on 2019 earnings, and therefore, are confirming 2019 guidance. Jon will provide more details later in the call. While the New York rate adjustments were unforeseeable, I am disappointed to end the year in this manner, particularly as we are beginning to see a positive benefit from our investments in talent and progress in Virginia. Looking forward, we are focused on our multi-year margin improvement plan we outlined in December, which has a long-term goal of over 2% adjusted net income margin. The initiatives that are part of this plan include

[Jonathan Rubin:]

Thanks, Barry. And good morning everyone. I'll begin by discussing full year 2018 results, as well as key items affecting results for the fourth quarter. Then I'll provide more details surrounding our 2019 guidance. For the year ended December 31, 2018, revenue increased more than 25% over 2017 to $7.3 billion. This increase was mainly driven by the full year impact of the acquisition of Senior Whole Health and the impact of net business growth. Net income for the year ended December 31, 2018, was $24.2 million and EPS was $0.97 per share. The decrease in net income was primarily due to lower segment profits and a higher effective income tax rate. Adjusted net income for the year ended December 31, 2018 was $61.7 million and adjusted EPS was $2.46 per share, compared to $144.8 and $5.92 per share for the year ended December 31, 2017. Segment profit declined from $311 million to $228 million year-over-year. As Barry noted, relative to our previous expectations, fourth quarter segment profit was negatively impacted by approximately $50 million of both out of period and non-recurring items, which I'll now describe in more detail as I review each of our segments results. For the full year, we reported 2018 health care segment profit of $149.1 million versus $202.7 million in 2017. The 2018 decrease was primarily driven by cost of care pressure in MCC Virginia, rate reductions in MCC Florida and unfavorable revenue adjustments in New York, partially offset by a full year contribution of Massachusetts from the Senior Whole Health acquisition. Results in the quarter were unfavorably impacted by significant out of period and non-recurring adjustments to revenue for our New York contract. We received communication from the state regarding several items impacting our rate. First, the state has delayed implementing the updated retroactive risk order adjustments for the 2018 contract year published in November. This would have been favorable to Magellan and would appropriately reflect the increase in acuity of our population. As such we continue to discuss this matter with the state. We expect that the updated risk order adjustments will be included in the 2019 contract rates and therefore this should not materially affect our 2019 guidance. In addition, there is a separate 2% risk adjustment pool exclusively for high-cost high-needs individuals. In January, the state released a methodology and final calculation for the 2017 contract year, which was worse than we expected. Beyond the adjustment for the current year, we also have modified our estimates for the current contract year through March 2019 accordingly. We also received in January the final settlement for the 2017 contract year on the supplemental capitation we received for members transitioning to a custodial nursing home setting, which was lower than we anticipated. As a result, we also modified our estimate for the 2018 contract year. Since this population is scheduled to transition out of the MLTC program, we don't expect this to have a material impact in 2019. Finally in February, the state modified the quality incentive payment methodology and communicated our relative ranking for the 2018 contract year. As a result, we reduced our estimate for the bonus we'll receive. We continued to improve our quality results since the baseline period used for the recent ranking and while the bonus is also affected by other plans results, we're not making any changes to our 2019 expectations. The collective impact of all the changes for New York in the quarter was $43 million unfavorable to our previous revenue expectations. We still believe in the strength of our New York Medicaid plan and our ability to deliver a long-term profitable growth at market competitive margins for this product. We reported Pharmacy Management segment profit of $104.4 million for the year ended December 31, 2018, which was a decrease from the $139.9 million in 2017. The year-over-year decrease was primarily due to the loss of specialty carve out business during the first half of 2018 as well as $7 million of unfavorable non-recurring items in the fourth quarter related to inventory rebate receivables and prior year customer settlement. Regarding other financial results, corporate cost inclusive of eliminations, but excluding stock compensation expense totaled $25.6 million for the year compared to $31.8 million in 2017. The decrease is mainly due to lower discretionary benefits in 2018, higher corporate development costs in 2017 related to the Senior Whole Health acquisition and litigation settlement recorded in 2017. Excluding stock compensation expense and changes in fair value of contingent consideration, total direct service and operating expenses as a percentage of revenue were 14.2% in the current year as compared to 15.5% for the prior year. The decrease is primarily due to economies of scale from growth in acquisitions, the impact of other business mix changes and lower discretionary benefit. Stock compensation expense for the year ended December 31, 2018 was $29.5 million, a decrease of $9.6 million from the prior year. This change is primarily due to the vesting of stock related to the Armed Forces Services Corporation and CDMI acquisition during 2017. The effective income tax rate for the year ended December 31, 2018 was 44% compared to 18.6% for the prior year. The increase was due to a number of factors, including the reinstatement of the nondeductible health insurer fee, the favorable impact of reducing the net deferred tax liabilities in the prior year for the lower future corporate tax rate, the reversal of valuation allowances related to AlphaCare net operating loss carryovers in the prior year and an increase in 2018 in the amount of nondeductible executive compensation as a result of the Tax Act. The effective tax rate was higher than our previous guidance as a result of lower segment profit and the leverage impact of the non-deductibility of health insurer fees and executive compensation. Our cash flow from operations for the year ended December 31, 2018 was $164.8 million compared to $162.3 million for the prior year. As of December 31, 2018 the company's unrestricted cash and investments totaled $130.4 million, which represents a decrease of $130.8 million from the balance at December 31, 2017, largely due to the pay down of debt in share repurchases. Approximately $63.3 million of the unrestricted cash and investments at December 31, 2018 is related to excess capital and undistributed earnings held at regulated entities. Restricted cash and investments at December 31, 2018 of $527.7 million reflect an increase of $62.3 million from the balance at December 31, 2017. This increase is primarily attributable to the growth in MCC Virginia. As a result of the shortfall in earnings during 2018, we recently amended our 2017 credit agreement with our lenders to allow for a maximum net leverage ratio up to 3.25 times trailing 12 month EBITDA until September 30, 2019, 2.75 times at December 31, 2019 and 2.5 times thereafter. As Barry noted earlier, we are confirming our 2019 guidance. I note that the majority of the unfavorable developments in the fourth quarter results are related to prior periods are nonrecurring in nature. Of the balance, we expect the unfavorable run rate impact in 2019 to be offset with several favorable items, which have developed subsequent to our December guidance call, including 2019 rates for several contracts. With that I'll now turn the call back over to Barry to conclude. Barry?

[Barry Smith:]

Thank you, Jon. While 2018 was challenging, we're only midway through our work to create a stronger, more sustainable foundation for the company. For decades, Magellan was a leader in the carve-out specialty and behavioral health space. While these capabilities remain valuable and relevant today, the reality is that the market has changed to a much more integrated model. We recognize this and proactively took steps to transform our business in a significant way. We've made solid progress in shifting our revenue stream into growth markets over the past five years, including creating and expanding Magellan Complete Care, which now represents over 50% of our health care revenue, and transforming our Pharmacy business into a full service PBM. Had we not made this pivot, both our top line and bottom line would have been a fraction of what it is today with little prospect for growth. Instead we have two major growth platforms well-positioned for the future. As you heard us say in our third quarter call, following these changes to our business, we have taken the opportunity to pause and consider where we are in our evolution and our priorities for the future. We are gaining more discipline in operational knowledge and we've added key resources with specific expertise to help us better digest what we've taken on. Looking to the future, this team is focused on addressing our operational issues and driving margin improvement over time while enhancing value for all shareholders. Despite our challenges, Magellan is needed in today's marketplace. Our decades of work in behavioral health, substance use disorder and specialty pharmacy management have created a wealth of unique expertise that can possibly effect most of the - the most costly health programs in the nation. In both Healthcare and Pharmacy Management, the awareness of the impact that behavioral health plays in an individual's health, the decision making helps us design valuable health care solutions for health plans, government, employers and our members. Integrating this knowledge with cutting-edge technology and commitment - and committed staff is a recipe for success. I believe our recent staff additions to the reorganizations that we've completed in the fourth quarter will drive our margin recovery strategy. I look forward to sharing future updates and on all of our execution priorities and as the year progresses. With that I would like to take the opportunity to acknowledge Magellan's 10,000 plus associates on the front lines every day. They are truly leading humanity to healthy vibrant lives. With their support in the more diversified healthcare platform we've built, I remain confident in our mission in our team as well, as well as our ability to deliver sustainable growth and value creation over the long term. I'll now turn the call over to the operator for questions. Operator?

[Operator:]

Thank you. We will now begin the question-and-answer session. [Operator Instructions] And our first question comes from Ana Gupte with SVB Leerink. Your line is open. You may ask your question.

[Ana Gupte:]

Hey, thanks. Good morning. Appreciate you taking the questions. I'll ask a few questions on the segments first and then I had some more broad questions as well. And starting with the Complete Care business, you've missed now I believe four quarters, and largely I think with some of the pressures in Virginia, but also in New York. And this quarter, you're attributing it to out-of-pocket costs in New York. But out-of-pocket and prior year favorable or unfavorable development is kind of far for the course in these businesses. So does this signal in any way that there may be an estimation issue on your cost itself? Why you feel confident that in 2019 there wouldn't be anything recurring either in New York or anywhere else, because I get it that $43 million may not be huge, but on your P&L it is?

[Jonathan Rubin:]

Hi, Ana, It's Jon. A few things I'd note relative to your question. One specific to MCC and let me start with New York. The unfavorable out-of-period non-recurring items that we referenced this quarter were actually revenue items, not related to cost of care or - what you were referring to as normal prior period development. So specifically, in January and February, we got new guidance from New York and the different components of the rate reconciliation and adjustments that I noted earlier. So it really is very confined to the one contract to specific actions by the state and not related to execution. On the other hand, when we look at actually the cost of care, we've actually made very good progress in the quarter. As we talked about in both third quarter and in December, we were expecting based on the actions we had implemented, specifically in Virginia, where as you know we had pressures throughout the year, an action plan that really has started to take hold. So, for example, as we've discussed previously, we were running over a 100% loss ratio in Virginia over the first three quarters. We've got that down into the low-90s in fourth quarter and we're in good shape, we think as we turned the quarter into the year in 2019 to achieve our objectives to get that down closer to the mid-90s or better. So in terms of progress, I just wanted to note that that again the non-recurring items were rate related. The progress on the loss ratio is actually in line with our expectations, and again, creating positive momentum as we go into 2019.

[Barry Smith:]

I'd also add to that, just the leadership changes and kind of a much more tight operating metric and following up on specific details of execution that have been very productive for us. I don't think I was able to say, because we - let's go around some of the changes we've made in leadership. We've made global healthcare changes in leadership, but importantly, for MCC specifically, we have a new President, Chrissie Cooper, who has joined us several months ago as the CFO of MCC and has stepped up to be the new President. Chrissie is a well-seasoned executive with the health plans and on the provider side as well. She ran WellCare in Florida for the turnaround, California and Hawaii. She's just a very experienced healthcare executive with health plans. And so, with Chrissie's leadership and the team that we - that I think I mentioned in the last go around, Sajidah Hussain who's the Chief Medical Officer. Kristen Goetze who is responsible now, new addition to the team over the last several months in [medicon] [ph] and analytics. Ashok Sudarshan who is - Ashok came to us with great operating experience, he was the COO, worked for Herb Fritch. And so, we just have a new very experienced team that we think has enabled us to up our game, and as you're seeing now, some really great progress in Virginia. So we remain cautious certainly, but confident that we'll be able to make some material advances in Virginia, and across MCC for that matter.

[Ana Gupte:]

Yeah, I hear you. But, I mean, I get it on the numerator and the denominator on the loss ratio. But risk adjusters, quality scores, they do fluctuate. There is always volatility and, I mean, companies deal with it. It's again [far for the course] [ph]. And the out-of-period issue, maybe this time around, the numerator jump, but it's been in the past often times on the - on the cost of care issue as well. Sorry, I missed that - I mean, right now, you're seeing this on the denominator, but it's been on the numerator, the loss ratio as well. So I just - I would just point out that they're in other companies that have had these issues, when they were not at scale, and it just hits the P&L harder and not to say that you can predict what the state might do. But, I guess, you could maybe have a wider range of guidance or just be more conservative. It just still seems a little bit challenging to me that you after four misses, you feel confident about the guidance in 2019. Then moving on to pharmacy, again, here too, maybe the miss wasn't as dramatic. But again, here too there are issues around the loss ratio. And is your pricing seeing any pressure here and what is driving the pressure on the pharmacy margins as well?

[Barry Smith:]

Ana, that's a good point. It's certainly a very competitive environment in the pharmacy world. And we've seen it become even more competitive in certain segments of the market. We've seen very good success on the employer side. And we continue - we expect to see that success. On the MCO market, it's been very, very tight. And there's a lot of cost and pricing pressure there. I would say that the recent combinations of both CVS and Aetna, and Express and Cigna, have introduced a new dynamic into the market. And we're looking forward to seeing how that ultimately shakes out. We do think that the pricing ultimately will rationalize. We think that both CVS and Cigna are very rational market players. We think that we can be competitive in the marketplace as evidenced by one of our recent substantial wins of a - over a Fortune 100 employer. And so, we think we do have staying power because of our clinical expertise. But, Ana, there is no doubt that is a very competitive market for pricing for the PBM.

[Ana Gupte:]

Got it. Thanks. Thanks, Barry. Thanks, Jon. I appreciate the color.

[Jonathan Rubin:]

Thank you, Ana.

[Operator:]

Thank you. Our next question comes from Dave Styblo with Jefferies. You may ask your question.

[David Styblo:]

Good morning. Thanks for the question. I'm going to - I guess, I'm trying to - having a hard time reconciling a couple of different parts, hearing Virginia is better, but then it just doesn't seem like we're seeing that in the numbers. So maybe at a higher level, I'll take it this way. So if I take the reported 2018 segment profit of $228 million and add back a $50 million of noteworthy items that gets us back to about $278 million. However, that's below the $290 million to $310 million guidance range you guys gave in December. So the first question is I'm wondering what caused the shortfall to that. And the second question is why wouldn't that shortfall in the core performance cause you to lower your 2019 outlook or at least by segment profit and EPS the low end of the ranges? I know you mentioned rate increases, but it seems like rate increases would need to be pretty significant to offset some of that core shortfall.

[Jonathan Rubin:]

Dave, just to clarify, the guidance for 2019 in segment profit is $270 million to $290 million, so that probably explains a little bit of…

[David Styblo:]

No, I was going back just to the fourth quarter of 2018 to what you guys had thought you were going to get for 2018.

[Jonathan Rubin:]

Okay. Okay. So in terms of - so two different questions and for 2018, in terms of the miss, again, think about $50 million being the non-recurring items. There are some other smaller deltas that impacted us as well on the behavioral and specialty utilization side. We had some higher seasonality in the quarter. I would say it's not outside the norm of normal fluctuations, but we did see a seasonally higher quarter, and then some impacts on the pharmacy side in volume and customer settlements. Again, these weren't individually big items, but they did contribute in the quarter. I think the second part of your question was, as we think about 2019, what gives us confidence. And again, in terms of what's changed, there is some impact from some of the items we mentioned in the run rate. I wouldn't say it's big. Again, most of what hit us in the quarter was onetime or nonrecurring in nature. But again, those items are offset by slightly higher rates going into 2019. And also a little bit of positive utilization on select contracts as we go into the year in - on the MCC side. So, again, there's a number of puts and takes. And while the rate - the rate delta, the rate benefits we're seeing relative to our original guidance in 2019 is relatively modest. You're probably talking 0.5% or so across the MCC book. It does aggregate to a material number, just given the volume of revenues. So that's sort of the quick version.

[David Styblo:]

Okay. I mean, I know you said it's not - it's a little this and that, but it does seem pretty material when you're at $278 million in full year 2018 and that's 20 - it's over $20 million below the midpoint of what you guys were thinking you're going to land at for the year. It just seems like it's more than a little this little that and the higher utilization and behavioral and so forth and some of the things I guess. I just don't - it provides less clarity as to why we would have confidence in the 2019 guidance, is there more there that you can elaborate on. I know you hit on a few things. It just seems like a pretty big bridge for us to walk.

[Jonathan Rubin:]

Yeah. Well in terms of getting - the range again - in terms of the range for 2018 versus the actual, it is the items I mentioned. When I say it's a little, there weren't items that were - I mean they were all sort of single digit million items, but again behavioral specialty utilization was higher, Pharmacy PBM settlements both on the customer network side based on what our settlements were at year end and some lower script volume and membership on the Pharmacy side in the fourth quarter versus expectations. Those were specifically the three items - you're right, if we're going back to the midpoint and aggregate to close to $20 million in those buckets. And there is some carryover - it's not dollar for dollar since these settlements –some of it relates to prior quarters and whatnot. It's not dollar for dollar, but there is some impact in the 2019. Again based on our current estimate, those items are offset by the things I noted. The rates we've received already for 2019 and some favorable utilization in other contractors as we're heading into 2019 based on our current estimate, so that's the full picture.

[David Styblo:]

Okay. And then flipping over to the Pharmacy side. It sounds like you guys had some progress there with the new employer win on that. And I think you said you had no additional pharmacy, specialty pharmacy carve-out losses, so I think those are important points that investors are keeping their eye on. Is there anything else as we look forward that you can share about retention material contracts that are coming up are now on the 10-Q, you guys do have a pretty sizable contract. I think that comes due at the end of the first quarter, has that one been renewed? And any other color about wins or losses that you guys see that are impacting or could impact 2019 or beyond?

[Barry Smith:]

Yeah, we have made some very good progress. As you pointed out Dave, we've had no losses on the specialty contract side and we have had some nice wins on the employer side particularly. We don't have any large exposure we think in terms of any notifications and we are depending upon retention of our client base in the PPM world and we remain cautiously optimistic that we will do so. So there are really no major developments. I think the key is in these various markets, you've got - in the states we've done very well in terms of our ASO contracts and Medicaid programs. We don't have real exposure there to any rebate safe harbor issues there in terms of what the administration is proposing. These are ASO contracts largely, where the vast majority of the rebates go back to the states directly today, so that really should not create a cloud or an issue for us going forward. We don't think that the rebate issue will bleed over into the commercial market that would take legislative action. We think that's unlikely to take place. So I think in the Pharmacy side, we see that - it's just a very competitive world. On the MCO side, as I mentioned to - responded to Ana's question, it is a very competitive marketplace right now. And so we are seeing traction, but not the same level of tractions we're seeing in the employer market. And so we'll just have to see how that plays out. The employer market remains robust, but competitive market for us as well. I think with our clinical programs and ability to serve our clients, we will likely to continue to do well. We're one of the few remaining independent PBMs out there. I think that's a big positive feature. And that we don't have the channel conflict that others have. So we think that the Pharmacy business, while there is no doubt pricing competition out there that's tough, we think that we'll be able to go through the cycle of pressure and move forward.

[David Styblo:]

Okay. And specifically - I should maybe a bit more specific, but I think you guys have listed customers that you've had at upwards about $260 million of year-to-date revenues in the third quarter. Has that contract been renewed?

[Jonathan Rubin:]

Yes.

[David Styblo:]

Okay. And then the last one I had, which is the - on the - the incremental cost savings and efficiencies that you guys are targeting after 2019. Can you give us a little bit more color on where you are in the planning phases for realizing those savings? Have those been earmarked and identified at this point and it's just a matter of okay, you're going to start to move on those next year or maybe even get implement them later this year.

[Barry Smith:]

We're already moving on them, Dave. There are a number of opportunities that we have throughout the company both on administrative cost as well as managing cost of care. Fortunately, we've had great success to bring in some very strong operating leadership that have been able to bring us new ways of thinking about things. We've already launched significant changes in the in the - and how we are going about the business itself. And we think that through automation and through different processes that we're putting in place today that will not only yield positive results this year, but will bleed into 2020 as well. So I wouldn't say that it's just a one year, this is what we're doing in 2019. The changes we're making will really have a very positive run rate going into 2020 as well. But again their fundamental operating metrics and operating ways of doing things, all the way from the claims systems to automating things we are using labor significantly and how we run those systems all the way through the fraud and waste and abuse. Systems and capabilities, we've been putting in place. That have been very effective for us already. And in some cases about stricter expectations in terms of savings. And so we just think that there are whole host of opportunities and low hanging fruit here that will take advantage of. A part of the issue I think we've been facing, Dave and I mentioned this in the script is that we've grown dramatically. And I think it's very challenging when you've got the growth rate that we've had to keep up with the fundamental operating, both administrative expenses and general operating expenses of the company to keep up with the efficiencies. We've kind of taken a bit of a pause and are taking the opportunity to create these efficiencies and improve margins and that's what we're largely focused on this year, which will yield benefits this year and next.

[David Styblo:]

Okay, thanks.

[Barry Smith:]

Great. Thank you, Dave.

[Operator:]

Thank you. Your next question comes from Scott Fidel with Stephens. You may ask your question.

[Scott Fidel:]

Hi. Thanks. Good morning. I wanted to start out, just had a question on - just on the HHS rebate proposal and I know one of the areas where there's a lot of concern in the industry is just around the timing of the proposal and now they are proposing for 1/1/2020 implementation. Barry, just interested sort of what you're hearing and whether there's a dialog here from or any recognition from the administration around how aggressive that timing is and whether there's a potential that at the least, if they were going to move forward with this proposal that they would accommodate a more I think reasonable timeline for implementing it?

[Barry Smith:]

It's a very good question, Scott. We think that that timeline is very aggressive, you never know. But with the recently published proposed rule on the [sixth] [ph] to amend it in an effective - January 1, 2020, this whole discount safe harbor regulation as it relates to public sector Part D of Medicare, given particularly the interests that are lobbying at this point in time, we think it's a very, very aggressive timeline. And our sense about it is that while there are legs to it and I think that there will be some impact in the industry particularly for the public sector business not necessarily Medicaid as much. We do think it will take longer to implement. And so we would be surprised if it went effective January 1, 2020.

[Scott Fidel:]

And then in the meantime, has there been any guidance from CMS just in terms of, given that again how short this timeframe is in terms of - with the bid commissions are - the guidance that you should be sort of preparing two different sets of bids with and without this regulation or what's the feedback that you're getting from CMS even on sort of bid preparation at this point?

[Barry Smith:]

That's part of the challenge Scott. There is some general advice and counsel, but not enough specificity to really inform us on how we should go through with the bids. And so it's very difficult given the fact that we have to really submit those bids mid-year. And we need far more direction and understanding as to what the final rule will be so we think it's difficult so that's why we think the timeline is difficult.

[Scott Fidel:]

Yeah. Okay. Then just on the business side, just trying to keep track of the different moving parts here. On Senior Whole Health, maybe can you give us an update on how that business performed in 2018? And then specifically relative to sort of the revenue and earnings accretion targets that you had laid out for 2018.

[Jonathan Rubin:]

Yeah, Scott, it's Jon. Let me start with that. First, the business from a fundamental standpoint has performed well throughout 2018 with the important exception what we just discussed today on the New York REIT. So if you put aside some of the one-time impact of these rate adjustments, some of which actually go back to prior, even to 2018 in terms of the reconciliations on the businesses performed well. Now - and we think as we go into 2019, we'll be at or ahead of what the original acquisition models or business case would have ascribed. But again 2018, we did see temporary pressure in New York. Massachusetts though has done quite well, in fact beyond our original expectations.

[Scott Fidel:]

Right. And Jon, just to sort of clarify, the negative items that you saw in New York in the fourth quarter, does that pretty much all relate to Senior Whole Health or because I know you guys said AlphaCare, there's two different businesses in New York, is it all Senior Whole Health or spread across a few different things there?

[Jonathan Rubin:]

It is spread up. And in fact, we were fully integrated now so it's hard for us even to decouple it completely, Scott, but the majority would obviously be connected to Senior Whole Health given that they were larger coming into the acquisition or in the merger.

[Barry Smith:]

And the other thing I'd say Scott, as you recall going from 2017 into 20018 when we were going through the regulatory process of integrating the two, we were not allowed to do marketing. We weren't allowed to have two-owned entities market. So we had to stop the marketing for AlphaCare as Senior Whole Health continued to move on. What that did was initially create a lower run rate in terms of lives up front, but ultimately we've been able to catch up and do well.

[Scott Fidel:]

Okay. Then just one last question for me. Just an update on Florida MCC and just sort of as you're transitioning to the reduced membership profile. How that transition is going and sort of how the cost structure is absorbing the below revenue profile at this point?

[Jonathan Rubin:]

In terms of the - in terms of Florida and the transition into 2019, Scott, We are much on track so that's part of the administrative and operating model improvements that we're making into 2019. Obviously, we've got, first and foremost reduce the cost proportionately for Florida and we're on track. Now and I think as we talked previously in 2019, we're not going to fully get to where we need to in Florida on administrative costs, because there are staffing levels we need to maintain through first quarter to manage the runoff volumes on the larger contract, but in terms of executing on our plans and getting to our ultimate targets we're on track.

[Scott Fidel:]

Okay, that's it for me. Thanks.

[Barry Smith:]

All right. You bet Scott.

[Operator:]

Thank you. And our final question comes from Kevin Fischbeck with Bank of America. You may ask your question.

[Catherine Anderson:]

Hi, this is Catherine Anderson on for Kevin. You touched on this a bit, but I was wondering if you could give us an update on how margins are trending in each of your MCC markets versus your expectations and sort of outside of Virginia where you see the most room for improvement?

[Jonathan Rubin:]

Yeah, I'd say - so if you look across the plans, as we head into 2019, I would say we're on track overall. If you think about the plans individually, Florida as I just talked about we're on track. Massachusetts has continued to run well. Virginia, on cost of care and on revenue we are running as expected as we go into the year. Again I'd say that that the market that was the most challenge fourth quarter was obviously New York. That's something that we're paying close attention to and working very closely with the state on as we go into 2019 to make sure that particularly on the REIT side everything plays out as we anticipate. And again as I said in Massachusetts, we're actually seeing some favorability as we go into the year. So net-net, again, I'd say on track versus expectations. From a profitability standpoint, again Virginia, we're feeling good about. Massachusetts, we're feeling good about in terms of where we are versus target margins. New York, we expect to get back to where we need to this year. Florida, again, will be a little bit dampened because of the transition to the smaller contract. And Arizona will be ramping up margin through the year as the scale and membership grows, but that's the picture, I'd say, largely on track.

[Catherine Anderson:]

Okay, thanks. That's helpful. And can you give more detail on the non-recurring pharmacy items in the quarter. At what point did you have visibility into those and how confident are you that they will reoccur in the future?

[Jonathan Rubin:]

Yeah, so in terms of the items in Pharmacy, there were a few areas that we noted. First is inventory, where - for our specialty pharmacy, we kind of updated inventory at year end. Part of it relates to one particular pharmacy location where we closed down and sort of consolidated where we had to write off some inventory. That's obviously one time in nature and shouldn't be an issue at all as we go forward. The other areas are sort of rebate receivables, where again, we had some cleanup related to old periods that shouldn't have an impact as we go forward. And the third area being settlements, customer settlements that related to the full year. So in those areas, again, we feel good about our ability to manage it going forward and, don't expect any issues related to these items going forward. In terms of the timing, really, this came to light fully when we were closing the books during the last 30 to 60 days, so that's kind of the time period when all these settlements were done. And obviously, we go through a very thorough process at year end to ensure we've got all the balance sheet items where they need to be.

[Catherine Anderson:]

Okay, thanks. And then can you give some commentary on earning seasonality for 2019? Should we expect the net margins and earnings to ramp throughout the year or how should we think about that?

[Jonathan Rubin:]

Yes, yeah. And again, that's consistent with the normal pattern. Obviously, fourth quarter this year was an anomaly, but if you look at the normal pattern, we've roughly seen in the past. And again, these are round number not intended to be a precise estimate, but about a 40-60 split between first half and second half of the year. And that relates to a number of things. One, just the normal seasonality in earnings with certain contracts, for example, Part D has a natural seasonality built into the benefit. Also growth as we go through the year. And then obviously the impact of the margin improvement initiatives that continue to build as we come into year and go through 2019. So those are the key item. But I wouldn't expect, to be significantly different from that pattern that we've seen historically.

[Catherine Anderson:]

Thanks. That definitely helps. I appreciate it.

[Jonathan Rubin:]

You bet.

[Operator:]

Thank you. And at this time, I'd turn the call back over to the speakers.

[Barry Smith:]

Thank you today for your participation in the conference call. We look forward to speaking with you again in April, when we will discuss our first quarter 2019 results. Take care.

[Operator:]

And this does conclude today's conference. We thank you for your participation. At this time you may disconnect your line.