Magellan Health, Inc.
Q2 2015 Earnings Call Transcript

Published: 27 Jul 2015

[Operator:]

Welcome and thank you for standing by for the Second Quarter 2015 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 Renie Shapiro Silver. Ma’am you may begin.

[Renie Shapiro Silver:]

Good morning. Thank you for joining us today for Magellan Health’s second quarter 2015 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 cost and other operating expenses and includes income from unconsolidated subsidiaries but excludes segment profit from non-controlling interest held by other parties, stock comp expenses as well as changes in the fair value of contingent consideration reported in relation to acquisitions. Adjusted net income and adjusted EPS reflects certain adjustments made for acquisitions completed after January 1, 2013 to exclude non-cash stock compensation expense resulting from restricted stock purchases by sellers, amortization of identified acquisition intangibles, and changes in the fair value of contingent consideration recorded in relation to acquisitions. Please refer to the tables included with this morning press release which is also available on our Web site 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 today. Today I'd like to provide an overview of our second quarter results and an update on our overall strategy. As you read in our press release this morning for the second quarter of 2015 we produced adjusted net income of 14.7 million, adjusted earnings per share of $0.56 and segment profit of 53.2 million. For the six month year-to-date period, we produced adjusted net income of 39.1 million, adjusted EPS of $1.47 and segment profit of 118.1 million. Our results for this quarter reflects strong performance from our Pharmacy segment, solid results in Specialty Solutions and some weakness in Care results in the Commercial & Public Sector segments. We have planned sequentially to address these issues and expect that the results will improve in the second half of the year. Jon will discuss our results later in the call. Year-to-date through Wednesday July 22, we repurchased approximately 1.2 million shares for a total cost of 76.3 million at an average price of $64.91. To-date, we have completed approximately 45% of our current 200 million share repurchase authorization. We ended the quarter with 270.6 million of unrestricted cash and investments. Next I want to talk about the previously announced realignment of our business units, as well as the recent progress on our Magellan Complete Care and Pharmacy Management initiatives. Several weeks ago we re-organized into two primary business units, Magellan Healthcare and Magellan Rx Management. Effective July 1st our Specialty Solutions business was integrated into the Magellan Healthcare organization to allow the combined business to focus more broadly on integrating care management for special populations as well as our other specialty areas in healthcare. This new structure provides a unified approach to customers or an entire suite of healthcare products and will help drive enhanced services and solutions as well as administrative efficiencies. This enables us to better align our resources across the enterprise in support of our health plan, employer and government clients. We are strengthening our government relations effort to approach public market opportunities in a proactive and disciplined manner with John Littel leading this function. Within the context of the public market pipeline, we are working to address opportunities with special population, behavioral health and pharmacy management. Regardless of whether they are planning to carve in or carve out services we continue to have discussions with states to make them aware of the ways in which we can manage the care of individuals with serious chronic conditions and help shape the direction of their healthcare strategy. Jon will discuss future changes in our business segment reporting as a result of this realignment. As you know Magellan Complete Care operates in two of the countries’ largest Medicaid markets both Florida and New York. In Florida, membership in our SMI specialty plan has remained steady at approximately 41,000 members. We have implemented various activities to support membership retention and new enrollment in our plan. We are continuing marketing and educational efforts to build awareness of our capabilities and have initiatives structured to motivate stakeholders to recommend our plan which will enable us to achieve member growth and retention goals. We put a number of management initiatives in place to enhance clinical outcomes and improve the cost. These include both network contracting and utilization based initiatives. We have a comprehensive plan in place and expect the impact of these actions to improve results in the second half of the year. The Florida Agency for Health Care Administration or AHCA has released draft based capitation rates for the 12 months beginning September 1, 2015. AHCA has not released the risk adjustment methodology for the general or SMI population. We are currently in the process of working with the state on rates and we are not able to quantify the relative rate increase for Florida Specialty plan at this time. We expect to have new rates in place by September 1st and we'll update you on the impact of this change during our next earnings call. In New York AlphaCare has shown modest growth over the past quarter as of June 30th we had approximately 3,200 members across all product lines with about 1,900 in the Medicaid MLTC plan. Our FIDA membership has remained relatively modest consistent with the experience of other plans participating in the program. Drawing our membership in New York is a critical priority. We are developing strategic risk contracting relationships with large provider organizations in order to drive Medicare membership and prove doctors’ receptivity to FIDA and increase channels for MLTC referrals. We have also developed innovative contract with several key licensed homecare services agencies or LHCSAs to drive additional MLTC members. Consolidation of existing plans may also provide inorganic opportunities for growth. As we streamline our internal sales and marketing capabilities we are also addressing operational efficiencies in our call center functions, enrollment support technology and internal infrastructure. We are in the process of rescaling healthcares’ organizational structure to align with their existing membership level while maintaining the flexibility to grow. It is important to note that even with the initial lack of acceptance of the FIDA program, AlphaCare can still be very successful solely with its MLTC, Medicare advantage and D-SNP products. The experience gained surveying New York's MLTC members can also be leveraged in other markets that are looking for managed solutions for long-term care. Turning to other market opportunities as expected the RFP for the Iowa High Quality Healthcare Initiative was extremely competitive, with 11 responses and eight proposals for January 1, 2016 as a start date. The state is now expected to make its announcement of the winning bidders on August 17th. In Louisiana the anticipated RFP to manage individuals eligible for long-term services and support is currently on hold. We continue to have discussions with the state about opportunities to help manage the healthcare of their special populations. Several new opportunities are emerging as states continue to deal with rising healthcare costs, particularly for their complex populations. The state of Virginia is contemplating moving their MLTC eligible members to managed care and may put out an RFP later this year, likely or in mid-2016 or early 2017 start. In Pennsylvania the state has put out an RFI for re-procurement of their general Medicaid population as well as an RFI to move their MLTC population into managed care. Our current behavioral health carve out business in Pennsylvania will continue. And this will present an opportunity for us to demonstrate our MLTC capabilities in a state that we know well. State of Nebraska where we currently have a behavioral health contract will be re-procuring its Medicaid program and is discussing carving in behavioral health and pharmacy. We view this as a potential opportunity for us to -- and expect an RFP to be released sometime this fall or in January 1, 2017 start date. In Arkansas a recently released, an RFI for a potential program focused on behavioral health, MLTC and intellectually and developmentally disabled individuals. The pipeline of opportunities remains strong and we continue to be focused on expanding our presence to other states and in populations. In our Pharmacy business we continue to grow and enhance our capabilities in the PBM space. The integration of 4D Pharmacy Management systems which closed on April 1st is progressing well. We have fully integrated certain functions such as sales, finance, and HR. And we are continuing to transition the remainder of the operations. During the quarter, we closed several significant sales. In the employer market, we had net increases of 27,000 lives bringing us to a total of 102,000 lives added year-to-date. In our Specialty business several health plans signed contracts for hep C rebate product. We're also developing clinical programs for the new cholesterol PCSK9 drugs as well as working with manufacturers to optimize rebate terms and for our medical pharmacy product we have expanded the scope of services and added additional regions with two existing health plan customers. We remain on-track to begin operating these standalone Part D plan directly to Medicare beneficiaries starting in January of 2016. We've obtained insurance licenses or waivers and submitted rates to CMS in approximately 20 regions and expect to receive information on the pricing benchmarks during the next quarter. In addition we are making progress on expanding our distribution capabilities that include mail order of traditional drugs and are scheduled to go live in the fourth quarter of this year. As we grow our Pharmacy business we continually focus on developing innovative services to differentiate ourselves in the market. As an example our new comprehensive oncology management product includes management of drugs covered under the pharmacy as well as the medical benefit, outpatient side of care and radiation therapy. We believe that we are uniquely positioned to offer such a product when you are seeing significant interest in this from health plans. Our pipeline of opportunities across all of our pharmacy products is robust and we remain confident in a revenue goal of 2.5 billion by 2018. It's important to note that we now have all the pieces in place to achieve that target without material incremental acquisitions. We continue however to evaluate potential acquisitions to supplement our capabilities and scale which would and could accelerate our progress and enable us to exceed these growth targets. In summary I feel good about the progress to-date in our multiyear growth strategy. We've realigned our businesses to enable us to focus on our key growth initiatives and implemented plans to improve the efficiency and performance of our business. I believe that we are well-positioned for the future. I'll now turn the call over to our CFO, Jon Rubin, who will discuss our results in greater detail. Jon?

[Jon Rubin:]

Thanks Barry and good morning everyone. Before I comment on our second quarter results I’d like to discuss our business unit realignment and its impact on our segment reporting going forward. As Barry spoke about it earlier, we’ve now reorganized our Company. And to align our financial reporting with our new management structure beginning with the third quarter of 2015, we’ll report our results in three segments, healthcare, pharmacy management and corporate. Our new Healthcare segment will combine the results of our previous commercial, public sector and specialty solutions segments. And in our public filings we will provide supplemental details to give additional visibility to the key drivers of each business. Now turning to results, revenue in the second quarter of 2015 was $1.2 billion which reflects an increase of 30.4% over the second quarter of 2014. Approximately half of this year-over-year revenue increase is attributable to revenue from acquired entities. The remaining revenue increase resulted primarily from the impact of new business, same-store growth and rate increases which were partially offset by the loss of revenues associated with previously announced contract terminations. Our segment profit for the second quarter of 2015 was $53.2 million, an increase of 18.2% from the second quarter of 2014. The increase in segment profit is primarily due to new business, same-store growth and the inclusion of 4D results in the current year quarter. These increases were partially offset by the previously announced contract terminations, including the segment profit for this quarter or approximately $4 million of net favorable non-recurring items mainly related to medical claims development in public sector and specialty solutions. Now to remind you, adjusted net income and adjusted EPS are non-GAAP measures which exclude certain non-cash items relating to acquisitions completed after January 1, 2013. We believe these adjusted financial measures are critical to evaluating our ongoing performance. For the second quarter of 2015, adjusted net income was $14.7 million and adjusted EPS was $0.56 per share on a diluted basis. For the second quarter of 2014, adjusted net income was $11.8 million and adjusted EPS was $0.42 per share. The increase in adjusted net income between periods was mainly due to the increase in segment profit. Net income for the second quarter of 2015 was 4.6 million or $0.17 per share on a diluted basis and for the second quarter of 2014 net income was 5 million or $0.18 per share on a diluted basis. I’ll now review each of our segment’s results and growth opportunities beginning with Commercial. Segment profit for our Commercial Behavioral Health business was $24.8 million, a decrease of 36% from the first quarter of 2014. This decrease is mainly due to the impact of terminated contracts, care trends in excess of rate changes and favorable customer settlements in the prior year quarter, partially offset by the same-store growth and new business. The current quarter’s results include some care pressure in one of our health plan accounts primarily related to in-patient utilization. We’ve implemented corrective actions, have already seen improvement in the July results and expect further improvement over the balance of the year. We had good sales success during the quarter as we sold our ASO-based behavioral product to two reasonable health plans and sold our EAP product to a large employer. Our pipeline of traditional and new products offerings is strong for both existing and perspective customers. We continue to pilot new products dealing with the comorbidity of medical and behavioral issues, virtual care models, substance abuse solution and suicide prevention for the military. Turning to public sector. Our second quarter segment profit was $9.8 million, an increase of 9.5 million from the second quarter of 2014, an increase of 9.5 million from the second quarter of 2014. This increase was mainly due to the favorable prior period care development partially offset by care trends in excess of rate increases and the impact of contract terminations. Segment profit in the quarter included the benefit of $3 million of favorable other period items primarily-related to favorable and medical claims development. This quarter in our public sector behavioral business we experienced some out-patient cost pressure in one of our contracts. We’re in the process of developing and implementing care plans to mitigate this. In Florida our year-to-date medical loss ratio was approximately 92% on a reported basis. We still expect to have a full year in MLR of approximately 90%. We expect the improvement in the second half of the year is a result from a number of action items including in-patient utilization management, facility re-contracting, fraud, waste and abuse recoveries and rate increases from the state. Pennsylvania is currently in the midst of implementing their state Medicaid expansion with the first phase completed and the second in progress. The third phase is scheduled to begin in September. The net impact to us of the expansion program is expected to be approximately $30 million of incremental annualized revenue. In our Specialty Solutions segment second quarter 2015 segment profit was $12.8 million, an increase of 6.6% from the second quarter of 2014. The year-over-year increase was mainly due to the impact of new business partially offset by previously negotiated margin reductions on contract renewals. We continue to grow this Specialty Solutions segment from new sales and upsells in both new products as well as in our core radiology program. We sold the new risk-based radiology management contract to a regional health plan as well as our ASO musculoskeletal product to a single-staged health plan, both of which will go live later this summer. In addition we sold an expanded cardiac management program focused on left heart left heart catheterization to an existing national health plan customer in multiple markets. Overall, we continue to have a very high level of interest in our musculoskeletal management product. Second quarter segment profit for the Pharmacy Management segment was $31 million, an increase of 39.5% over the second quarter of 2014. The year-over-year increase is primarily due to new employer and PBM sales, as well as increased Specialty earnings. In addition, the current year quarter includes the results of 4D Pharmacy Management and an additional month of earnings from CDMI. These positive variances were partially offset by terminated contracts. As Barry mentioned the pipeline of opportunities across our employer, health plan stage and specialty market is robust and positions us well for the future. Regarding other financial results, corporate cost excluding stock compensation expense totaled $25.3 million which represents a $3.1 million decrease in the second quarter of 2014. The decrease is due to lower benefit and acquisition relation cost. Excluding stock compensation expense and the change in fair value of contingent consideration total direct service and operating expenses as a percentage of revenue were 15.1% in the current year quarter as compared to 19.1% for the prior year quarter. The decrease is primarily due to the impact of higher revenue in the current year quarter. The current quarter includes a net $2.6 million increase in the fair value of contingent consideration mainly related to the accretion of the discounted earn out liabilities. Stock compensation expense for the current six month period was $27.7 million, an increase of 13.7 million from the prior year period. The increase is primarily due to a whole six months of expense included in the current year related to restricted stock purchased by sellers from the CDMI acquisition. The effective income tax rate for the six months ended June 30, 2015 was 46.8% compared to 52.6% for the prior year period. The decrease in the effective rate was mainly due to the inclusion of more significant evaluation allowances in the prior year on certain deferred assets and the reversal effect contingencies in the current year from the favorable settlement of state income tax examinations. Turning to cash flow and balance sheet highlights, our GAAP cash flow from operations for the six months ended June 30, 2015 was $112.7 million compared to cash flow from operations of 137.1 million for the prior year-to-date period. 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 six month ended June 30, 2015 was $49.5 million compared to 124.8 million for the prior year period. The decrease of 75.3 million in operating cash flows is mainly due to net unfavorable working capital and other changes between periods of $80.8 million. The prior year included favorable cash flows from working capital of $43.5 million primarily related to the release of restricted cash from the terminated Maricopa contract. The current year period includes unfavorable working capital changes of $37.3 million mainly related to the timing of cash flow from certain receivables and payables. As of June 30, 2015 the Company's unrestricted cash and investments totaled $270.6 million which is after year-to-date share repurchases of $68.8 million and cash used for 2015 acquisition activities of $55.9 million. Approximately 76.2 million of the unrestricted cash investments at June 30, 2015 related to excess capital and undistributed earnings held at regulated entities. Restricted cash and investments at June 30, 2015 of $370.6 million reflected decrease of $20.8 million from the balance at year-end. This decrease was primarily attributable to the Company's regulated entities. Relative to full year 2015 we are maintaining our current guidance with the exception of updating our EPS guidance to reflect the impact of recent share repurchase activity. We now expect fully diluted EPS to be between $1.69 and $2.28 and fully diluted adjusted EPS between $3.45 and $3.90 based on average fully diluted shares of 26.7 million. This updated fully diluted share count reflects share repurchases and auction exercises through July 22nd but exclude any potential future activity. Compared to the first half of 2015 we expect the second half of the year to produce stronger earnings due to the following factors. Improved results in MCC mainly driven by care management initiatives, network re-contracting and rates, the impact of business growth primarily in pharmacy and seasonality in timing of care results and customer settlements across our businesses. Note that we expect an increasing pattern of earnings over each of the last few quarters of the year. I'm pleased with our continued progress in executing our growth strategy. While our results this quarter reflected some isolated cost of care pressure, we have comprehensive plans in place to address this and as a result expect to meet our full year earnings objectives. Barry and I are now available to answer questions and I'll now turn the call back over to the operator, operator?

[Operator:]

Well, thank you. We will now begin the question-and-answer session. [Operator Instructions] So our first question is coming from Mr. Josh Raskin from Barclays, Mr. Raskin your line is open.

[Josh Raskin:]

I was wondering if you could just talk a little bit about the pressure in both commercial and public segment I just want to make sure I understand the commentary and sort of the magnitude and size of these, it sounds like it's one specific account on both sides. I don't know what the health plan customers and commercial and then I guess in the public sector, it sounded like it was one as well. So could you just maybe give us a little bit more color on each of those just what's causing inpatient utilization on the behavioral health side for the commercial plan and then maybe the out of the $3 million, no I'm sorry the public segment pressure as well?

[Jon Rubin:]

Sure and good morning Josh. Let me first start by giving you an overview and say that again these were two sort of different accounts in different situations so as we looked at this I think it's important to point out that this isn't an overall care trend issue we're seeing but really two very isolated circumstances. Starting with the health plan situation, there with this particular customer we've had a number of new populations come into the plan and some overall growth over the period and as a result what we've seen is, sort of pressure on our care management organization which in turn has caused some uptick in inpatient utilization. Now the good news is we're now fully staffed to handle the populations and the members and as I mentioned in my prepared remarks Josh on, we actually have seen utilization come down subsequent to taking those actions. So again I look at that as sort of a short-term issue that we faced, and somewhat operational in nature, we've gotten our hands around it and are confident moving forward. On the public sector side again I noted it was on the outpatient side again different category of care and different situation. In that particular circumstance we've actually seen over the past several months you know an expansion of services in this particular account and as we've gotten our hands around out what we've found is the mix of services is a little bit different than we had initially anticipated and as a result you're seeing a little bit of a different intensity of services and with the way the fee schedule which was implemented in concert with the state to pay providers for this services, the overall cost is higher than was anticipated and higher honestly than what was funded in the contract. So in that situation we're working with the state, working with the providers to develop and implement the right plan. But again I want to, I want to emphasize Josh in both cases we're getting our hands around the issue, they are isolated issues and feel like we will be able to see progress over the balance of the year.

[Josh Raskin:]

Okay. And just a follow-up on the health plan situation, so is it, this is an existing customer that's been around for a while but it's the new populations where people are seeking inpatient treatment is that what's coming on?

[Jon Rubin:]

Yes well, there's a new, right, there's a new population here and you have got exchanges and other things that have grown materially over the last year or so, and then again it's our ability really to be fully staffed and take on those members in the most effective way, so again that one, somewhat operational in nature and again that one we feel is immediately correctible and again we've seen progress in the results subsequent to the uptick that I mentioned earlier.

[Josh Raskin:]

Okay and then you mentioned the Part D bids obviously those were in the first week of June. I know you don't the benchmark at this point but the benchmark's been relatively steady, I don't know which 20 regions you guys are looking at, so as you compare your bids to say the 2015 benchmark. How do you guys feel you are from a competitive standpoint in Part D?

[Jon Rubin:]

Yes Josh on the benchmarks I’d say if anything overtime we’re seeing the benchmarks get slightly more competitive, so we would be well positioned both relative to last year’s benchmarks and more importantly with the work we’ve done on the actuarial side, both with our internal team and leveraging some external experts. I feel as good as we can about we’re positioned relative to benchmarks again we went region probably not because there is always some volatility that’s hard to predict but we expect to be competitive in those markets.

[Josh Raskin:]

Okay. And then just the last question, could you help us just remind us of your Pennsylvania and Nebraska exposures? I know the RFPs are coming there and I know there is opportunities that come out of it. But what are the potential exposures there?

[Jon Rubin:]

Well, I’d say those are two different things. So, with Pennsylvania as I think we noted earlier, we’re actually at this stage not expecting the behavioral health to be carved into the bid that’s our understanding. And again there is never any certainty but that’s the understanding based on discussions with the state and the RFIs that we believe are coming out. And so we really think there is significant exposure there.

[Josh Raskin:]

Okay and Nebraska?

[Jon Rubin:]

Nebraska, round numbers we’re talking 100 million of revenue and that one again we don’t know exactly what’s going to happen but we think there it could be a similar situation to what we have seen in Iowa from the standpoint of the behavioral being carved into the health plans.

[Barry Smith:]

And Josh Barry here that contract on the -- the risk contract in Nebraska goes through the end of or the basically the end of August in 2016 with two one year renewals potentially against the 100 million in revenue. We’ve been meeting with state officials we’ve met with the governor there we’re in good state there we’ve been there in the state for due some 20 years on behavioral health side we’ve increased the risk -- went from ASO to risk just a couple of years ago so we think we have very good relationships there. Clearly they will make the decision based upon what’s best for the state. I have to say that I am very impressed with the governor there administration and these are very forward taking state leaders. And again we think we have a really good relationship there and have had on both the drug side and the behavioral health side.

[Josh Raskin:]

And it’s only 100 million I assumed Nebraska’s margins are not unusual relative to the rest of your public sector?

[Barry Smith:]

That’s right.

[Operator:]

Thank you. Our next question is coming from Mr. Dave Styblo from Jefferies. Sir, your line is open.

[Dave Styblo:]

Just the first one a follow-up on the actions that you’re taking, can you help us understand a little bit more when you say you’re fully staffed to correct the issue in the commercial health plan. What does that mean or are there other initiatives that you’re doing whether it’s price increases or network adjustments just to help us understand the more immediate impact that you started to see and are continuing to see there?

[Jon Rubin:]

Yes hi Dave it is Jon. Really I mean we’re always looking to opportunistically improve networks in all aspects of care. We’ve got an outstanding both network and clinical team in place there. The primary issue here was really again uptick in inpatient utilization primarily around length of stay. And again it was related more to changes in population sort of increases in overall activity in terms of inpatient utilization and our ability again to staff up quickly to meet the activity level. So, it really is very manageable we believe through the actions we’ve put in place. And again it’s encouraging because simply we’ve implemented the actions in a sense think of it as sort of being fully staffed to handle the volumes there. We’ve seen results come down, so we’re optimistic we’re not declaring victory yet but optimistic that we’ll see the improved run rate that we’ve experienced over the last 30 days or so continue as we go forward.

[Barry Smith:]

And Dave Barry here as you recall last year may be a quarter earlier there was also a commentary about a public sector large client that had a very similar circumstance. And challenges as you see the utilization upticking in inpatient particularly you want to make sure it’s real before you pull on the staff to be able to manage it down which is exactly what we did. And so this is a cycle we’ve been through many times. As Jon reported we’ve already seen some very positive movement in management of the inpatient utilization. So we would fully expect to achieve our forecast for the year for the account.

[Dave Styblo:]

And then the public sector situation that sounds like that might take longer to correct if you need to go back to the states to discuss rates or the mix of business. Can you talk about what you’re doing, how fast the improvement can come there and the action items maybe that you can do in the meantime while you’re waiting for perhaps a change in rates or fee schedule?

[Jon Rubin:]

Yes Dave couple of things, one, we’re already very engaged and so it isn’t like we’re just starting now we’re already very engaged with the state and providers and trying to affect the solutions, so we’re not starting from ground zero but you are right I mean we have a strong partnership there and we will absolutely do the right things with the state and with providers and members. At the same time we're also making sure that we're managing the inpatient and other outpatient services to try to also mitigate the pressure we're seeing on the account. So we're not fully reliant just on the discussions with states and providers we also have a number of other inpatient and outpatient issues that we're putting in place at the same time to try to mitigate this change. So we're not yet at a point where I can like where the commercial account point to improve results but based on all the different initiatives we've got in place and again the strength of the relationships we have in the market with all constituents I'm more confident that we'll get there over the balance of the year and see results consistent with what's in our guidance.

[Dave Styblo:]

And then just in terms of helping us bridge to the segment profit guidance I think at this point we are about 40% of the earnings at this juncture. So as I look forward obviously there are some things that are going to help you I'm assuming you're still thinking quarter rate increases come September 1st will probably the mid single-digitish maybe perhaps higher anything different there from my math that might add $8 million to $10 million at the back half of the run rate earnings. And then it seems like you guys typically get some hefty performance fees especially in the public sector. I think you sort of talked about that being and maybe a little bit less than $10 million so just off the bad call it $15 million to $20 million of improving earnings especially loaded into the fourth quarter. Am I thinking about that the right way and are there any other major puts or takes to contemplate in that?

[Jon Rubin:]

Well yes I mean I think on the items you mentioned Dave you're thinking about it the right way. The other thing that I would point to though is -- are in addition to the rates in Florida we also in MCC have a number of other initiatives on care management initiatives to try to manage inpatient remember again we've had a lot of new membership come on during the years especially in Florida. And in an initial period you're limited in terms of -- limited by the state in terms of being able to manage people that are in treatment at the time. So we're really continuing because we saw growth through the first quarter of this quarter we're really ramping continuing to ramp-up our care management initiatives specially around the inpatient side in Florida. We also are re-contracting on certain facilities in Florida where we are seeing high volume of admissions now that we've got the membership base to fully capitalize items. So I would look at MCC results in the second half of the year to improve not just by rates but by care management. The other item I mentioned that you didn’t is on growth I mean we're continuing as we go through the year to see good growth, I mean pharmacies where you get the most growth throughout the whole year and that’s the biggest component of it but we're seeing early growth across all of our business and I'd say that also a material item. And then lastly you mentioned the seasonality in terms of some of the performance revenue and customer settlements we see it towards the end of the year there is also some seasonality and care trends towards the very end of the year as well with the holiday season which generally helps us. So you put that together and again we feel good in terms of our expectation of meeting the guidance range.

[Dave Styblo:]

And just to be clear the Florida there is nothing unusual going on in Florida I mean factor MLR trend I think it's 92 % year-to-date that sounds like it's doing pretty well in fact maybe even running ahead of schedule and the when you lop on the extra initiatives. And we expect that rate increased towards the back half sounds like you're running well on track there just want to make sure there is no changes there that we put them out ahead of our guidance?

[Jon Rubin:]

No I wouldn’t say that there is any material change in Florida over the last couple of quarters. Again we're continuing to look to improved results over the balance of the year through the care management initiative. We are expecting some rate increase in terms of what is built into the guidance right now is a range built in sort of a low to mid single-digit increase obviously we’d love to get more but that’s what we've got built in right now. But aside from that really again we're within the range of where we need to be in Florida with good execution on the balance of the year getting us to the objective.

[Operator:]

Our next question is coming from Matthew Borsch from Goldman Sachs. Sir your line is open.

[Matthew Borsch:]

I was hoping you could just touch on AlphaCare in New York. And maybe give us a little more detail what you are doing in terms of cost restructuring. And is the lower than anticipated or lower than hoped for acceptance rate on FIDA if you can talk to that a little bit. I think you’ve touched on it before but maybe what's causing that and have you given up on addressing that through your own initiatives?

[Barry Smith:]

Barry Smith here, the short answer on New York is that we would like to enhance our membership there in the market with MLTC. We believe we could be very successful without the FIDA program although we'd love to see the FIDA program roll out. There's been very low acceptance of FIDA across the country, in fact in California, we're looking at some of these markets they have basically 50% opt out rate. And the challenge in all of these markets is that there is a very low rate of physician acceptance and with the relation with the physicians it is one of two things. They could either say, gee, if you want us, if you want that bigger physicians to provider they can't have it because you're going to managed care in many cases. So the network becomes an issue and then the other issue for the individual enrollee they have to have a clear benefit of either financial or care or system benefit and that is not overly clear to most of the FIDA recipients and so, the FIDA program generally has had a kind of an uphill battle to try to gain acceptance in the population. Having said that there are things that we can do in terms of our marketing and relationships to increase our both MLTC and FIDA membership, again our focus is on, we'd love to see FIDA take off, we haven't built in to our future numbers great FIDA acceptance, we just don't know how it's going to go. But the key for us is developed incremental contracts with licensed home care and service agencies. We would like to have those relationships and have them see us as a great members of the community, providers of MLTC services. We also would like to through our sales efforts just to increase the channels, the distribution channels for MLTC, we think there's real opportunity there. I do think that the acceptance by physicians is a difficult task, if you see that naturally and I don't expect to see a great change from physician acceptance there and then we also want to make sure that we develop risk contracting relationships with large provider organizations again to increase penetration and brand recognitions in the marketplace. The reality is in some of these markets such as AlphaCare, the potential for inorganic growth acquisition is very significant and we will always, we have a pipeline of these kinds of opportunities, we'll pursue those. Now relative to the existing infrastructure that's there it was built anticipating a significant FIDA opportunity and that simply hasn't panned out. So we'll look to normalize the infrastructure and the overhead of the organization to reflect the current membership but also to allow us the flexibility to move into FIDA should it take off unexpectedly. So it's really both building, both in terms of volume through these distribution channels, it's potentially looking acquisitions that would build the member base there but also we've already reduced our cost there and our infrastructure and we'll likely do a bit more as time goes on to right size the overhead relative to the membership.

[Matthew Borsch:]

If I could ask it, do you think it's realistic to expect any time in the near future we might see some of these programs become mandatory, because that's obviously what by and large what's worked across the managed Medicaid programs generally. And is there something that states can do that's short of making it mandatory that would substantially help with the acceptance rate do you think?

[Barry Smith:]

Well, I don't, we haven't seen a move towards making it mandatory I think there's a real political pushback in the industry by certain providers. For example in New York, most of the MLTC providers have not been excited about moving to FIDA because they don't want the incremental expenses of the Medicare overhead and compliance that the structure required for the FIDA program. So if you were a smaller MLTC and these folks are politically very strong you're not going to push for FIDA, you'll actually push against FIDA politically. So my sense is that's true across the country. They just don't want to add -- nor they have the financial wherewithal and the reserve demand to move into the Medicare portion of the benefit. So for all those reasons you see pushback politically each of these states and so I would expect that to continue, I don’t see that changing anytime soon. That's certainly true in New York. So will states go to mandatory? I don't think they will, I think that there is potential for some structural change that offers clear benefits in acceptance of MLTC and FIDA particularly. But again I don't see a quantum change or a mandatory form really emerging any time soon for FIDA. But it's been a real challenge as you recall Melanie Bellard who headed up the whole project nationally there. I think a very capable individual was just very frustrating with the rate of roll out and the cooperation with the states. So I just, just given the political lack of inertia I wouldn't see that changing materially.

[Operator:]

Thank you. Our next question's coming from Mr. Michael Baker from Raymond James, Mr. Baker your line is open.

[Michael Baker:]

Yes, thanks a lot. Barry you mentioned your comprehensive oncology offering, obviously there's been a lot of discussion in new approaches in that area. I was wondering if you could give us some additional color on how your take differs and whether there or not there any key elements you still need to add to it and then finally if we're starting to see the approach to contracting with planned sponsors change around Specialty Pharmacy.

[Barry Smith:]

You know it's very interesting that these integrated approaches as you know Michael we’re very strong in our whole medical pharmacy management capability bucket and capabilities again. We have over 10.5 million capitalized the largest in that space that is the benefit that goes through the medical benefit rather than the PBM largely specialty products very high dollar products. That market the whole PBM market right now is really looking for solutions that are more intelligent solutions that integrate in a clinically sound way and economically advantageous way these products to make a difference. As you know oncology has been an area where there has been this explosive growth in terms of cost and utilization of these products. Our unique capability we just used oncology as an example what Jon and we spoke about earlier our reorganization we’ve combined our capabilities internally at Magellan built common eligibility systems for example going to claim systems, integrating the data because there are a lot of opportunities to integrate products that create a new category of product and capability to the marketplace, oncology is a good casing point. You typically have the PBMs who focus on oncology as a mail service or specialty drug opportunity which is good and fine. But the reality is health plans our payors are looking for full solutions that span the traditional PBM benefit to the medical pharmacy management benefit but also because of our capability in radiology, again we’re one of the largest providers of radiology benefit management in the country and we have the networks in place and the expertise in place. We’ve essentially bridged the gap between not just PBM and medical pharmacy but also the provision of radiology services in the marketplace. And so this product reflects the demand in the marketplace where these integrated products so that the health plans themselves don’t have to mitigate a product we deliver that to them in a full solution. We believe we’re very unique in the industry I am not aware of other providers providing such a product in the marketplace and we are getting a lot of traction in the marketplace. We do think it’s difficult for PBMs to wait into the water of physical medicine side because that’s just not their expertise it’s what we do however between compliance of behavioral health and our health plan and are integrated to Magellan complete care products. So it’s a new approach, it’s a very different approach. We think it’s more difficult to replicate. We do it on the oncology side. We’re looking at several other areas like musculoskeletal that is a great and direct connection between the physical medicine, compliance behavioral health as well as the pharmacy approach. Again these are very intelligent solutions that are analytically driven that deliver superior results.

[Operator:]

Our next question is coming from Ms. Ana Gupte from Leerink Partners. Ma’am your line is open.

[Ana Gupte:]

So a couple of questions that are more granular and then a more big picture question. The first one is just going back to the Florida SMI MLR I think you’re pointing to 92%, can you tell us where you are tracking this and what you’ve built into guidance is it 90% for the full year or this is extremely or your earnings are very sensitivity to it I am just curious to see what the up and down side case is around this? And you’re still talking about low to mid single-digit rate increases and what your level of confidence is as you will get something in that range or even better breadth?

[Barry Smith:]

With Florida again the full year loss ratio built into our guidance is approximately 90%, so it’s taking it from 92% year-to-date to 90% for the full year. And we believe we’ll achieve that really through both the rate increases that you acknowledged as well as care management initiatives and some re-contracting initiatives, and we’re just largely underway already in fact the re-contracting piece is mostly not 100% but mostly implemented. So, we have -- we believe I mean look there is always the account of volatility but we believe we’re well positioned to achieve the full year objective. In terms of the rate increase, we’ll know more as we go through third quarter there is a lot of complexity in terms of the calculation of rates because it’s not just the base rates but other risk adjustment plays into the base rate and we’ve got another complicating factor of being that’s my plan and the new rates are calculated separately for SMI versus the balance of the kind of core Medicaid services. So, we feel good about the range that we’ve got built in but it’s too early for me to give you the heavy talking of where we’ll fall within the range or what the over and under but it is on balance again we feel good about the plan and the outlook.

[Ana Gupte:]

So for a blended first half 2015 loss ratio where have you been tracking this 92% for 2Q?

[Barry Smith:]

That 92% is year-to-date.

[Ana Gupte:]

92% is year-to-date, okay.

[Barry Smith:]

It was reasonably just a little higher in the first quarter but it’s been reasonably consistent over the month so far. I mean there has been ups and downs in individual months but on a year-to-date basis.

[Ana Gupte:]

Okay, and the 6% to 7% that you had talked about at a conference given just the low income program got some funding and all that. Is that blended for the MMA or was that to your point just carved out for the SMI?

[Barry Smith:]

The roughly 6% is sort of an aggregate market increase and it doesn’t reflect any specific book of business characteristics or SMI or what the difference between plans and risk adjustment might be. So I would look at that as sort of aggregate and we're still again in the process of working with the state to understand how at all it is going to come together and specific of our book of business will play into that. So again we'll know more as we through the next couple of months. Obviously these rates are scheduled to take place that should take effect in September. So we'll know more over the next couple of months and certainly we will update everyone when we have more information.

[Ana Gupte:]

So second question on a more granular level on the Iowa contract I think Barry talked about is a very competitive environment. Since these booking in the first quarter what more color do you have and what is your level of confidence that relationship will win out relative to more integrated behavioral health medical capabilities going into these RFPs?

[Barry Smith:]

Well Ana it's really important and a good question about the relationship there. There really haven’t been no changes in the status but we maintained a very positive constructive and we've got a great working relationship with the state officials. Relative to the RFP we are not allowed to engage in discussion nor is the state allowed to engage in discussion with us about the status of the RFP or unless there is an official change. As you have probably seen in our press release CMS have been working with the state and we're currently working through the rate book with questions relative to the rate book for the state of Iowa. But relative to the details of the RFP again we remain cautiously optimistic given our incumbent status there in the state and the strong relationship that we have had we feel positive about it, but again in terms of material change it is exactly as we've stated last quarter last call.

[Ana Gupte:]

And the third question is on pharmacy where it sounds like there is growth and you sound confident about the 5000 to 10,000 employee market and medical and specialty and all that. What type of margins do you think make sense on a normalized basis with the types customer, the type of competitive landscape you're dealing with in the business segments and products where you're going in?

[Barry Smith:]

Well Ana I will give you a quick overview. Again our total aggregate long-term view is that this business is a 3% to 5% business. We've been running above that we do so because we do have a great bulk of employer business and a smaller TPA employer business where the margins are much more healthy, and I would say in that segment on the employer the smaller employer TPA business are between five and 10 points on average typically. And then if you're looking at the rebate business of course these are contracting services and they are very high margin contracts you might recall from the CDMI acquisition there were a lot of those revenues which were rebate revenues. And again you have huge margins on those on that business. So that’s again positively affecting our overall margin above the industry. And then you take a look at the MCO business as we grow overtime the MCO business this is true for all PBMs is typically a much, much lower utilization per enrollee typically about half the typical enrollees for an employer group will have around 12 scripts per enrollee and in the MCO world it is roughly six scripts per enrollee. So revenues are less on the MCO per life and also the margins are typically very competitive so a manager type in utilization and the margins will typically be and we are basically about a point in contrast with the -- and that’s just not for us but that’s just industry wide for any PBM that focuses on any material sized MCO. The specialty business is a good business for us there is a distribution side we have spoken to the rebate side distribution and specialty is typically about a point as well. So the distribution portion is not high but the absolute dollars are quite high you are talking about medication that are $5, $10, $20, $30,000 a month. So that’s just a general overview of the granularity by segment.

[Jon Rubin:]

And Ana the other thing and it is Jon that I would add is that obviously our historical book of business have been high margin because of the nature of the products both on the specialty side with the formulary optimization with the medical pharmacy which is more of a fee-based product. Same thing with our government business if you think about our fee for service Medicaid business because again you are really recognizing the fees as revenue and not the cost of drugs your margins are higher. So the way I look at it is when Barry says you are typical PBM is 3% to 5% more on the employer business less on the health plan business. I would look at it overtime as we grow that business you are almost ready to look at the incremental revenues being in that 3% to 5% range obviously our objective is to maintain the high margin business that we have historically as we do that. So that’s the way I think about it as we go forward.

[Ana Gupte:]

Okay.

[Barry Smith:]

It's interesting Ana to Jon's point if you look at us including all the drugs under management we're over 15 billion in drug spend management we’re huge. To manage half a state’s of Medicaid pharmacy products have contracts with them so we do have quite a bit of heft claims volume we do all the claims so to Jon's point that's ASO business, we don’t include the ingredient cost in the top-line, so it’s very high margin business.

[Ana Gupte:]

So again, just kind of pulling it together there are so many things that have happened in the last several years. if Medicaid's, that price discounting was extended to managed Medicaid with Obamacare and now you've got more states carving out, carving in behavioral health if you will, there's been huge amount of merger activity, in fact Centene has bought health meds. Maybe on the positive side I guess there's more specialty pharmacy as part of the pharmacy spend but there are several headwinds for you which would sort of point to you either merging with the medical entity or something. I'm just wondering how are you all thinking about this as players like Molina or WellCare ro whatever might be looking at a behavioral health or you know pharmacy in health capability.

[Barry Smith:]

Well what is actually true, this is an incredibly dynamic period of time for healthcare given both the ACA and what's going on economically in the marketplace and how things are just evolving. And the world is changing also because technology is changing, our ability to do the analytics in target populations and provide more intelligent solutions which are required given the cost pressures in the industry globally. Having said that we have not positioned ourselves in any other way other than to maximize shareholder return for the long-term and build and pivot into businesses which we believe are the future. The drug business in our mind is a great opportunity to have the next generation PBM capabilities and intelligent management of those costs, which are rising dramatically. To your point there are these new drugs that are coming out, some cost over $50,000 a year, relatively modest but the PCSK9 cholesterol inhibitors these also 10,000 but huge populations, so some are forecasted in the next 10 years, that'll be a $20 billion market. So these are changes around radically new technologies in terms of services. And then the other, to your point about mergers and those things that are going on, a lot of happening and the elephants are dancing on the dance floor and there's an opportunity out there as this happens. These players will look for enhanced capabilities, many of these players are acquiring large Medicaid population plans and these large players will need enhanced behavioral health as well as specialty drug and other services that we offer. So it's hard to know where it's going, it's hard to know if someone comes after us financially and again we'll do whatever is best in shareholders' interest to maximize that value for them.

[Operator:]

Thank you. At this time there are no further questions and now let me turn the call over to Barry for some closing remarks.

[Barry Smith:]

Well, we thank you all for joining us today. We look forward to speaking with you in October when we discuss our third quarter results. Have a great day, bye-bye.

[Operator:]

Thank you. And that concludes today's conference, thank you for participating and you may now disconnect.