Magellan Health, Inc.
Q1 2016 Earnings Call Transcript

Published: 5 May 2016

[Operator:]

Welcome and thank you for standing by for the first quarter 2016 earnings call. [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 Renie Shapiro Silver.

[Renie Shapiro Silver:]

Good morning. Thank you for joining us today for Magellan Health’s first quarter 2016 earnings call. This is Renie Shapiro Silver, Senior Vice President of Corporate Finance. With me today are Magellan’s Chairman and CEO, Barry Smith; and our CFO, Jon Rubin. This conference call will include forward-looking statements contemplated under the Private Securities Litigation Reform Act of 1995. These statements are subject to known and unknown uncertainties and risks which could cause actual results to differ materially from those discussed. Please refer to the complete discussion of risks in our most recent reports filed with the SEC and in the cautionary note in today’s press release. 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 interest held by other parties, stock compensation expense 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 as well as amortization 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 Smith:]

Thank you, Renie. Good morning and thanks for joining us. As you read in our press release this morning, for the first quarter of 2016, we produced adjusted net income of $19.4 million, adjusted EPS of $0.79 and segment profit of $59.9 million. Year to date through Friday, February 29, we repurchased approximately 284,000 shares for a total cost of $19.3 million at an average price of $67.95. To date, we have completed approximately 19% of our current $200 million share repurchase authorization. We ended the quarter with $146.9 million of unrestricted cash and investments. I’ll begin providing an overview of our pharmacy business, which started the year with solid performance, continuing its positive momentum from 2015. We continue to experience traction across all of our pharmacy markets. In the employer market, we added approximately 50,000 net employer lives during the first quarter of 2016. In addition, we were selected as one of three preferred providers by Mercer’s Rx Options, a pharmacy collective program for plan sponsors with 50 to 1,500 employees, reinforcing the market’s desire for our differentiated value-based and full-service PBM offering. On the specialty side, we continue to grow our industry-leading medical pharmacy program, adding new health plans and expanding programs with current customers. We now cover approximately [11 million] lives in our medical pharmacy program. In our specialty formulary management product, we expanded the number of therapeutic drug classes under management for both new and current customers. Our Medicare Part D prescription drug program that was launched January 1, 2016, continues to grow. We currently have over 45,000 lives, with new members enrolling each month. In the government fee for service market, we implemented a new state preferred drug list program and in the managed care market we are seeing increased activity and a growing pipeline of opportunities, most of which are for 2017 and 2018 implementations. We’re pleased with the consistent growth of our pharmacy segment. We continue to focus on developing and delivering a value-driven client and member experience, with an emphasis on care and quality in the most complex areas of drug therapy. Additionally, we continue to evaluate inorganic growth opportunities as well as strategic partnerships that would enhance our programs that offer incremental customer value. In our healthcare business, the first quarter results reflected modest progress in Magellan Complete Care of Florida. As we continue to implement our medical action plans, we expect care costs to further improve over the remainder of the year. Results for the balance of our healthcare business were in line with our expectations. Our plan to diversify growth and grow the healthcare business is multi-pronged. First, we will continue to work proactively was states to expand our integrated care benefit programs for individuals with chronic and complex conditions. We are currently focused on three populations. In the managed long-term care services and supports or MLTSS space, we expect significant opportunities over the next several years as many states will look to procure solutions to improve healthcare outcomes for those individuals, while reducing costs. A majority of this population has existing behavioral health conditions and we are particularly well suited to address their needs. Our recent acquisition of TMG, which administers the largest self-directed program of its kind in the country, has broadened our capabilities in the MLTSS space. Our groundbreaking work with individuals with serious mental illness in Florida continues to generate interest from other states. Like the MLTSS population, this population also has a disproportionate impact on a state’s healthcare spending and is often not managed effectively by traditional managed care companies. We believe the unique solutions that we are developing for MCC of Florida, including specialized crisis intervention, emergency housing and interaction with law enforcement will prove to be applicable in other states. While the pathway to implementation is slow, we believe there will be additional opportunities in the future. Finally, we are building our capabilities to manage populations with intellectual and developmental disabilities. This special population is often considered the last frontier for managed care. But our skills, approach and intensive integrated care management programs make us well suited to manage this complex population. As we further develop our state business, we believe that many of these models of care can be applied to our commercial business as well. Another source of growth in our healthcare business is the continued development of innovative products, such as our online smoking cessation, virtual care delivery and complex case management or CCM programs. As an example, the CCM product improves care coordination and outcomes for high risk individuals by placing care managers in hospitals and provider locations or the patient’s community. As a result, we’re able to focus on the most vulnerable members, while ensuring the integration of all of their health data, stabilizing cost and improving their quality of life. We believe our specialty healthcare products including radiology benefits, cardiac and musculoskeletal management will expand through continued strong sales to new and existing customers. And lastly, we are building our capabilities to support expansion of our business with various veteran, active military and other federal organizations. Our pipeline of healthcare opportunities in support of this strategy is growing steadily. In the MLTSS space, we continue to evaluate opportunities in Pennsylvania, Virginia, Louisiana and other states. We expect RFPs for behavioral health programs in three Pennsylvania counties this summer, with mid-2017 and end of 2018 effective dates. We have robust pipeline of commercial behavioral health, advanced imaging, cardiac and musculoskeletal opportunities. And finally, both the federal and state governments have focused on the epidemic of opioid abuse, which we believe will increase the demand for our unique expertise in this area. We continue to execute on our long-term strategic growth plan and I am pleased with our progress to date, as well as with the numerous growth opportunities in both our pharmacy and healthcare businesses. I’ll now turn the time over to Jon, who will provide you with more details on our first quarter results.

[Jonathan Rubin:]

Great. Thanks, Barry, and good morning, everyone. Revenue in the first quarter of 2016 was $1.1 billion, which reflects an increase of 13.9% over the first quarter of 2015. This increase is attributable to revenue from the 4D and TMG acquisitions, as well as the impact of new business and same store growth, which were partially offset by the loss of revenues associated with contract terminations. Our segment profit for the first quarter of 2016 was $59.9 million, a decrease of 7.7% from the first quarter of 2015. The decrease in segment profit is primarily due to the impact of contract terminations and net unfavorable year over year medical claims development. In addition, the current quarter includes a loss of approximately $4.5 million from our Part D Plan, most of which we project to be timing-related as a result of benefits seasonality in the first half of the year. These decreases were partially offset by the impact of new business, net same store growth and higher earnings in our pharmacy business. Included in segment profit this quarter is approximately $3 million of net favorable non-recurring items, mainly related to retroactive rate changes in the healthcare segment. For the first quarter of 2016, adjusted net income was $19.4 million and adjusted EPS was $0.79 per share on a diluted basis. For the first quarter of 2015, adjusted net income was $24.4 million and adjusted EPS was $0.94 per share. The decrease in adjusted net income between periods was mainly due to lower segment profit and a higher effective income tax rate in the current quarter. Net income and EPS for the first quarter of 2016 were $13.2 million and $0.54 per share on a diluted basis. This compares to net income and EPS of $7.3 million or $0.28 per share on a diluted basis for the first quarter of 2015. In addition to the items affecting adjusted net income explained previously, current quarter net income was favorably impacted by a decrease in contingent consideration expense and stock compensation expense related to acquisitions. Now, before I review each of our segments’ results, I’d like to remind you of a change we’ve made to our segment reporting. We’ve now revised the presentation of corporate costs to more fully allocate cost to our healthcare and pharmacy businesses, which is more representative of the earnings of each business on a standalone basis. Beginning with this quarter, we’re allocating all corporate costs with the exception of certain public company and other executive level expenses, which will remain in the corporate segment. In my following discussion of results, we’ve restated prior results to reflect this change. In our pharmacy management segment, first quarter segment profit was $28.5 million as compared to our 2015 revised first quarter segment profit of $20.4 million, reflecting an increase of 39.9%. The year over year increase is primarily due to stronger specialty, employer and government results, as well as new PBM sales. These positive variances were partially offset by seasonality in our reported Part D results. Barry noted the higher than expected membership in our Part D Plan due to higher levels of voluntary enrollment. For the first quarter, we recorded Part D revenue of $50 million and we now anticipate full year revenue in excess of $200 million. As noted, the normal seasonality of Part D will result in lower reported segment profit in the first half of the year with stronger results in the second half. Now, turning to our healthcare business, segment profit was $37.2 million, a decrease of 28.7% from the restated 2015 first quarter segment profit of $52.2 million. This decrease is mainly due to the impact of contract terminations and net unfavorable year over year medical claims development. These unfavorable variances were partially offset by new business and same store growth. Segment profit for the quarter included approximately $3 million of favorable out of period items, mainly related to retroactive rate changes. In our Florida SMI Specialty Plan, we’ve seen continued modest benefit from our operational and medical action plans and have recently added some new initiatives. We’ve strengthened clinical care programs designed to reduce avoidable admissions and readmissions and have implemented several disease-specific care management programs to ensure appropriate treatment for complex cases. In addition, we recently launched an emergency room diversion program, which is expected to produce savings beginning next quarter. Our first quarter MLR in Florida was approximately 90% on a reported basis and as we make further progress on our network, fraud, waste and abuse and care management initiatives, we expect to drive further improvement over the balance of 2016. As our plan continues to mature, we’re confident that we’re on track for long term success. Regarding other financial results, restated corporate cost inclusive of eliminations but excluding stock compensation expense totaled $5.8 million, which represents a $1.8 million decrease from the first quarter of 2015. The decrease is mainly due to lower discretionary benefit. Excluding stock compensation expense and changes in fair value of contingent liabilities, total direct service and operating expenses as a percentage of revenue were 16.5% in the current quarter as compared to 17.9% for the prior year quarter. The decrease is primarily due to lower discretionary benefit and the impact of higher revenue in the current quarter. Stock compensation expense for the first quarter of 2016 was $8.9 million, a decrease of $5 million from the prior year. The decrease is primarily due to expenses included in the prior year quarter related to restricted stock purchased by sellers from the CDMI acquisition as well as lower annual grants in 2016. The effective income tax rate for the quarter ended March 31, 2016 was 47.3% compared to 36.5% for the prior year quarter. The increase in the effective rate was mainly due to reversals of tax contingencies in the prior year quarter from the favorable settlement of state income tax examinations. Now, turning to cash flow and balance sheet highlights, our GAAP cash flow from operations for the quarter ended March 31, 2016 was $21.1 million compared to cash flow from operations of $44.2 million for the prior year quarter. Our GAAP cash flow includes the shift between restricted cash and restricted investments, which affects the sources and uses of cash from operations and from investing activities. Adjusting for the impact of these shifts, cash flow from operations for the quarter ended March 31, 2016 was $26 million compared to $30.8 million for the prior year quarter. This decrease of $4.8 million in operating cash flow is mainly due to lower segment profit and receivables of approximately $20 million from our Part D business, which were partially offset by other net favorable working capital changes. As of March 31, 2016, the company’s unrestricted cash and investments totaled $146.9 million, which represents a decrease of $13.3 million from the balance at December 31, 2015. Our unrestricted cash and investments balance after payments for year to date share repurchases of $8 million and cash used for 2016 acquisitions of $16.2 million. Approximately $84.5 million of the unrestricted cash and investments at March 31, 2016 related to excess capital and undistributed earnings held at regulated entities. Restricted cash and investments at March 31, 2016 of $357.3 million reflected a decrease of $57.7 million from the balance at year end. This decrease is primarily attributable to the use of restricted cash for the payment of claims and other liabilities associated with terminated contracts. Relative to our full year 2016 guidance, to date, we have surpassed our original forecast for new business revenue of $400 million and are revising this projection for the full year to approximately $625 million. This is primarily a result of additional anticipated pharmacy sales for our PBM and Part D products. Because of implementation costs and lower margins on new sales, we don’t expect the 2016 segment profit impact of this to be material. As a result, we’re revising our revenue and EPS guidance to reflect this new business revenue projection as well as the impact of recent share repurchase activity. We now expect revenue to be in the range of $4.6 billion to $4.86 billion. We’re maintaining our previous ranges for segment profit, adjusted net income and net income. We now expect EPS to be between $2.07 and $2.84 and adjusted EPS to be between $3.19 and $3.96 based on average fully diluted shares of 24.6 million. This updated share count reflects share repurchases and option exercises through April 29, but excludes any potential future activity. In addition, we’re revising our guidance for cash flow from operations to a range of $96 million to $127 million. This decrease of $100 million is due to the projected timing of receivables from CMS and other parties related to our Part D business. These receivables are primarily attributable to projected low income cost sharing and federal reinsurance, and reflect our higher than expected membership and drug utilization. We expect the final settlement of the amounts from CMS in the fourth quarter of 2017. Compared to the first quarter of 2016, we expect an increased segment profit run rate for the remainder of the year due to the following factors

[Operator:]

[Operator Instructions] The first question comes from Matthew Borsch of Goldman Sachs.

[Christopher Benassi:]

This is Christopher Benassi on for Matt. I was wondering if there are any upcoming drug launches that you have your eye on, specifically high-cost therapies where you can use formulary management to lower costs.

[Barry Smith:]

Of course in the area of specialty, it’s just really booming right now and there are several classes that will likely have a major impact. And some of them earlier on that we thought would have a major impact haven’t had quite the same impact. Probably the greatest – early opportunities here would be the PCSK9s, we’re being able to manage that through both the step therapy process of making sure that the stems are fully utilized, but also negotiating on behalf of our clients in rebates as well for that class. Interestingly, the whole Hep C area is still very much alive and well. We’re seeing new introductions in Hep C with various manufacturers. And so that’s also an area of opportunity for us. We continue to work with both AbbVie and Gilead Sciences in that space, but also new reductions that are coming down the pike. There are a number of specialty approvals moving and in fact it’s a very, very robust market right now, with really concentrations in oncology, hemophilia and also some orphan categories, which we can get in some detail, but probably take us some time. So we think there’s a lot of opportunity here. And if anything, the pace of specialty reduction is really accelerating right now. So we think there’s unusual opportunity here.

[Christopher Benassi:]

And if I could just ask one quick follow-up as well, I noticed the decline in unrestricted cash quarter on quarter and we were just wondering what your run rate for share repurchases would be going forward and whether you’d feel the need to raise cash since your balance sheet is relatively under-levered right now?

[Jonathan Rubin:]

In terms of the share repurchase, we really don’t forecast share repurchase because it does depend on a number of factors. It depends both on market conditions, our cash availability and also other opportunities for us to invest, both organically and as M&A opportunities arise. So we don’t really have a forecast. You can see what we’ve done historically, but we don’t forecast that as we go forward. So that would be the main comments I’d have there.

[Barry Smith:]

Chris, just to add to underscore Jon’s comments, while we believe that share repurchase program is an appropriate part of capital deployment, we also want to make sure that we have enough dry powder for M&A activity. We’re seeing a number of opportunities in this space. You never know how they’ll play out. We’re really focused on truly value as we acquire, but we want to make sure that we have the capital required to pull the trigger on those deals. So again, we don’t forecast what we’re going to do; we do monitor it very closely.

[Jonathan Rubin:]

And the second part of your question, Chris, just to make sure I round it out, you asked about borrowing and as we assess our needs going forward both on acquisitions but also to fund working capital and other payments that might be due during the year on contingent consideration, and that is something we look at. And given our current situation, I’d say it’s more likely going forward that we will further leverage our credit facility in order to manage the cash flow and timing.

[Barry Smith:]

Just because no doubt the question will be asked by somebody else, we always get asked the question of what kind of leverage we will be considering, we’re pretty conservative generally. But we think that 2% to 2.5%, maybe 3% pressing it is a reasonable range for leverage and so we do have the ability to deploy capital when we find true value that are strategically right down our fairway for potential deals. So that’s kind of how we see it.

[Operator:]

The next question comes from Ana Gupte of Leerink Partners.

[Ana Gupte:]

The first question was on the Florida MLR, which is showing a nice improvement. So it sounds like you’re getting to proof of concept on the carve out type model and I was wondering just on the carve out model, you see now new behavioral complex populations, what sort of pipeline is out there for you and are the states receptive to seeing some proof of concept, if you will, in Florida here?

[Barry Smith:]

Ana, it’s so interesting because with our experience in Florida and seeing the progress we’ve made, we have a great relationship with AHCA, the healthcare administration there in Florida. There are so many other states that are now moving forward. But in a way that’s more applicable and relevant, given their political circumstances, so for example in Pennsylvania, we talked about the [LTSS] long term support services. It’s kind of the way it’s playing out right now. Virginia also has just come out, coming out with – it just came out, I guess, with an RFP and is due in a couple of months here; Nebraska, Louisiana. So it’s typically playing out in different ways in different states. So the experience that we’ve had in Florida has been hugely beneficial to us to be really the only player nationally that has a level of experience we do with this population and we think it will give us a real edge in these potential contract awards by states in the future. There are some states that are looking at more pure play. Again, not developed, or more of a pure play in an LTSS format. So we haven’t seen it yet completely play out, but we expect it to and again it’s been a great a door-opener for us across the country.

[Ana Gupte:]

With Virginia and Pennsylvania which I wouldn’t really, maybe I’m wrong, but would you say that is pure play or carve out, maybe that’s what you mean by pure play. I would imagine all of the large managed care, Medicaid managed care companies and the pure plays like Centene and all are going after it, so there how do you see that playing out and would you go head to head with them or is there any opening for sub-contracting with some of these guys?

[Barry Smith:]

Sure. There’s absolutely opportunity for sub-contracting with these guys. And the Pennsylvania recent contract award on the more broad Medicaid business, we see opportunity in the recent award with some of the players that we might sub-contract. We’ve made [no announcements] for that, but we do see that as a real opportunity. We are not, as we’ve said in the past, we’re not a broad play entity. We’re not a [tan a plan]. So we specialize. So we do see some of these states, for example in Pennsylvania, that that bid has just got in. We don’t make commentary on the deals that we bid on or states we bid on or don’t bid on. But we’ve said we’ve given thought to Pennsylvania in the past. Pennsylvania would be more of a traditional long-term support services entity. A good portion of the population in even the long-term support services has behavioral health issues. So it does play to our strength. So when I say pure play, I would say that’s kind of a hybrid where there’s a higher density of behavioral health issues, but it is a more broad long-term support services. And yes, we would compete against larger players. But again, we think our particular strengths play well in that environment. Other states may well have and we don’t know yet until it materializes, but we’ve had discussions where there will be more of an orientation towards a seriously mental ill population plan and orientation. So again, as these states play out, we’ll be able to report more specifically. But we see some of them being more specific to the SMI population in the future.

[Ana Gupte:]

You also announced something around on Mercer Options and being selected there, what are the opportunities that offers you?

[Barry Smith:]

With Mercer Options, basically what’s happening in the – particularly in the smaller to mid-sized employer groups, a lot of the consulting firms, they’re very smart in this space, they’ve done a lot of work over a long period of time. They have great expertise. And what they’re doing basically is this, selecting out of the larger group of PBMs available, certain players which have certain capabilities that can truly deliver value and differentiation. So we’re very pleased that we were selected by Mercer for the options program there. And we think that will really be a boon to us in terms of marketing to the smaller and mid-sized groups. The challenge for any PBM is how to get your word out to all these smaller players because a sales force can’t effectively do so. So as we’re selected as one of the very few players in this space and that some large players in there, but again we were one of the very few that were selected. It really demonstrates that we’re truly an emerging power in the PBM marketplace and that we can truly deliver value. So it’s a real coup to be able to be named by them and participate.

[Ana Gupte:]

That’s sounds like a great channel. Just if I could follow-up on that, when will you know whether that is playing out well and to what degree are these small employers and even mid-market looking for a best of breed or carve out option relative to sort of the one-stop shopping that some of the other guys offer?

[Barry Smith:]

Well, to answer your first part of the question, we’ll see that play out over the course of this year and next. Usually, these are annual kinds of contracts and again, typically the big start date is January 1 [indiscernible] the second large start date, but we’re getting fairly close to July 1 now in terms of decision making. So we’ll likely see this play out through the end of this year and into the first quarter of next year and be able to see some, we think, some impact. This is just one of many strategies that we have. On the second part of your question, these smaller employers have the same pressures for increasing drug cost. In the macro, it’s interesting a lot of the health plans and the employers are seeing the same thing, the drug cost expands with the expansion, the dramatic increase in specialty is actually approaching inpatient. So it’s a huge expense. So where it wouldn’t have been on the radar five or 10 years ago or even two years ago, with specialty becoming so expensive and that expertise becoming so important, these smaller employers are now focusing in on how to control that drug cost. They don’t have the in-house expertise and so they go to people like Mercer, who guide them in this decision process. So that is, we believe, very material in our ability to penetrate that marketplace. But they are feeling the pressure. It’s pretty dramatic given the increase in specialty drug cost spend.

[Ana Gupte:]

Finally, just on a technical point, was the pharmacy margin compression just because of Part D and your increasing mix there?

[Jonathan Rubin:]

Yeah, primarily yes. I mean if you look at it and versus fourth quarter, we also had some one-time favorability in formulary management business fourth quarter, but if you look at margins, the biggest driver is Part D. Part of that is sort of a mix shift because Part D is going to have lower margins than the broader pharmacy management book that we have. And secondarily as I mentioned, there’s seasonality as well in the Part D earnings where the first half of the year is going to be more compressed in terms of earnings than the second half of the year, because as the year progresses both individuals hit their coverage gap and CMS reinsurance provisions kick in.

[Ana Gupte:]

And then you didn’t raise the guidance per the magnitude of your beat, so what exactly are you expecting? Going forward, it sounds like SMI should improve, Part D is far more seasonally skewed to the downside in the first quarter, so shouldn’t things get better going forward?

[Jonathan Rubin:]

We will definitely see increased earnings as the year goes on. Again, it’s early in the year, we feel good about the start of the year, but we still feel net-net we’re within the range on segment profit for the full year that comprised our original guidance. But certainly we’re pleased with the start of the year.

[Operator:]

[Operator Instructions] Speakers, at this time, there are no questions on queue.

[Barry Smith:]

All right, well, thank you everybody for being with us today. We appreciate you participating with us and we look forward to speaking with you next when we discuss our second quarter 2016 results. Have a great day.

[Operator:]

That concludes today’s conference. Thank you for participating. You may now disconnect.