Magellan Health Services Inc. Management Presents at 38th Annual Deutsche Bank Healthcare Conference (Transcript)

May.30.13 | About: Magellan Health (MGLN)

Magellan Health Services Inc. (NASDAQ:MGLN)

38th Annual Deutsche Bank Healthcare Conference Call

May 30, 2013 10:00 a.m. ET

Executives

Jonathan N. Rubin - Chief Financial Officer

Analysts

Scott Fidel - Deutsche Bank

Scott Fidel - Deutsche Bank

Okay, great. We will get started. I am Scott Fidel, managed care analyst with Deutsche Bank. Very pleased to have Jon Rubin, the Chief Financial Officer of Magellan Health here, to have a conversation. We are going to just do a fireside chat Q&A format here. So I am going to fire some questions away at Jon and please anyone in the audience with questions just feel free to raise your hand and we will be happy to take those. Magellan is a specialty healthcare, managed care company, focuses on a broad spectrum of end markets, including the behavioral market, specialty pharmacy, radiology management.

So I want to just kick in and maybe just to start with you recently, Magellan recently had an update just around the appeals process in Maricopa, and seems like there might be a little bit of life here to that. So maybe if you just want to give us an update on where things stand now in terms of the Maricopa appeal, given some of the recent activity there?

Jonathan N. Rubin

Sure, and first good morning everyone. Well, what led to the Maricopa appeal, where the process is, is right now our protest is in the hands of the Arizona Department of Administration which has the responsibility for ruling on the merits of the protest. So and that could take a little bit of time. I mean there's still a process going on whereby the various parties are providing information to the department to serve as the basis for evaluation of the protest.

The good news is from a process standpoint and this is purely procedural, the Department of Administration did recently put a stay in place to effectively stop any activities related to the implementation of the winning bidder which was Mercy Care in Arizona. So we view that as positive because it gives us the opportunity to focus on the protest and in a sense kind of stop the momentum of the implementation. But I would add though that the stay is purely procedural and doesn't necessarily reflect anything relative to the perceived merits of the case.

Scott Fidel - Deutsche Bank

And just in terms of the timing of the stay, would this, because clearly we are already entering into the summer here and this program's essentially expected to, originally timing wise go offline around the third quarter. Is that timetable still on place? Or do you think that the stay might push back a bit in terms of when that transition is made, if unfortunately in a scenario where your appeal wasn't upheld?

Jonathan N. Rubin

It's hard to say, I mean, the department has not given any specific timeline for the ruling. And as of now, Scott we have not heard any news relative to the implementation date. So we have to assume that's still in place. At the same time, obviously as time goes on that could have an impact down the road on the ultimate implementation, but again at this point we don't have any information to that extent.

Scott Fidel - Deutsche Bank

Okay, and just one last question on Maricopa. Clearly the company is going to have the ability to, if you do it, to access the market, be able to dividend off a pretty meaningful amount of capital overtime; could be as much as around $55 million. So maybe just give us an update on that process and from a timing perspective when you think those streams will be available for parent company usage?

Jonathan N. Rubin

First, that is correct. I mean there is regulatory surplus of about $55 million attached to the contract. And again we believe that in the event that the contract does ultimately go away and we are not successful with the protest that will be money that comes back and will become unrestricted at some point in time. The timing though is not clear because one it will depend on when the contract does wind down, and secondly we do need to get approval from the State on both the timetable for winding down the contract and when that cash can be freed up.

So at this stage we don't have a definitive date projected, but we don't have that cash in our guidance for 2013. So our kind of working assumption will be that would be early 2014, but as we get more information as the year goes on, we will certainly sharpen the estimate there.

Scott Fidel - Deutsche Bank

Okay, well we will keep our eyes focused on the Maricopa process. Maybe shifting gears over to actually a local topic here in Massachusetts and seems like there was some positive news recently where Massachusetts in conjunction with CMS did recently come out with a revised rate proposal for the dual's pilot here. I know there's been -- there were lot of concerns about rate adequacy going into that revision and it looks like in particular there were some adjustments made on the Medicare side which earn-out so just maybe boosted the overall proposed capitation rates by around 6% or 7%.

So maybe just give us an update now that you do have these revised rates. I know that you had in your public commentary in the first quarter call talked about concerns around rate adequacy and now with these new rates are you feeling more comfortable about the potential to participate in the program or even with the revised rates are you still concerned that it may not be adequate to play in the market place.

Jonathan N. Rubin

Well, first, I mean obviously all the revisions to rates are helpful as we go forward. But it's important to think about it not just in terms of the adequacy of the rates from the government's perspective but also the context of it in terms of what contracts can be obtained with providers in the various counties and communities within Massachusetts. So we are -- so this is a dynamic process. It's not just a matter of looking at the rates and evaluating the rates on their own. It's us continuing to work to structure the program, while at the same time talking to the state and CMS about the rates, to see if the program can be managed in a way that is financially viable for us.

So we are in that process now. We are not there yet. So there are some concerns remaining and we expect over the next 30 days or so probably even a little bit sooner because I think the state's requiring some decisions to be made in the sort of in the second-third week of June. We expect we will have the evaluation completed and decide which counties, if any we want to continue with. So still work underway and we will obviously give updates as those decisions are made.

Scott Fidel - Deutsche Bank

And just on that provider contracting side are there any particular elements of the hospital or physician supply stream where there are some particular impediments I guess in terms of [price] related to a few on sort of discreet contracting discussions that need to be resolved or is it still more widespread in terms of some of the issues in terms of getting to the right medical cost structure to be able to participate in the program?

Jonathan N. Rubin

It really is sort of the total equation. So while there is always pockets in terms of areas of providers, counties that are more challenging than others. It really is kind of a total equation, meaning really looking at it in terms of how do we structure it to drive competitive costs within the given counties and regions. And again we are sort of in the process of that now.

So we can evaluate it by county because that's the way that these states define the bids and obviously like I said there is some counties where things are more challenging than others. But then it's putting the plan together and also we need to evaluate the scale of it as well. So one county may look better, it's hard to do just one county because you need enough mass to make the overall program viable.

So those are all considerations as we work through it and we are working through those very things now and as we have always been we will be very thoughtful and disciplined about everything that we do.

Scott Fidel - Deutsche Bank

And is your sense that some of the provider contractor dynamics this is uniform to all of the potential participants in the program and sort of everyone is -- this is sort of a broader industry discussion within the mass dual's program right now or it's just something that's more unique just to the Fallon Total Care initiative relative to some of these contracting dynamics.

Jonathan N. Rubin

Two things, one while I can't speak for individual programs, the other ICOs, our sense is that it's definitely a state-wide discussion in that the dynamics that we are working through the same dynamics that the other ICOs are working through. And two, I'd kind of go so far to say I actually think that us in partnership with Fallon Community Health Plan are extremely well positioned competitively, meaning I think that both on the contracting side with the sort of clinical programs we have put together on specifically the strength of our behavioral health capabilities and Fallon's strength on the medical side in the community I think that we are as well or better positioned than anybody in the state.

Scott Fidel - Deutsche Bank

And just thinking about two of the particular arms, sort of drivers of costs within this population in that I think for all the plans involved you are going to have to have a really effective strategy around that. And clearly one of those is behavioral which I think Magellan has very good understanding of that part of the market. So obviously I think that's competitive advantage for you. The other is around managed long term care and clearly that's an area where if the strategy isn't correct, costs could explode on plans. And maybe talk to us a bit about sort of the Fallon Total Care strategy around MLTC and how you feel about how that's developing?

Jonathan N. Rubin

Well, first 1 100% agree with you on the behavioral health piece. I mean our data that we have gotten from the state indicates about 35% of this population, these are under 65 duals, about 35% are seriously mental ill. So that's obviously huge in the greater scheme of things. And these individuals have very significant needs and challenges.

On the managed long term care side, Fallon does have very good capabilities here. Again remember this is the under 65 duals population which is a little bit different from the over 65. And in fact Fallon does participate on their own in the -- they got the scale the overall 65 dual's program in Massachusetts and has very strong capabilities there, where as you probably know a big part of the game is actually diverting people from institutions on the long care side. So long term care has a role here. It's much more limited here than it is on the aged duals.

Scott Fidel - Deutsche Bank

Just want to check if there is any questions in the audience, someone over here?

Question-and-Answer Session

Unidentified Analyst

Yeah, I was wondering if you could talk a little bit about your Pharmacy Solutions business, kind of the strategy there and then I guess seeing you guys have guided to pretty aggressive growth targets there, whether or not you are still on track and what the sales cycle will look for a new contract there.

Jonathan N. Rubin

First, when we think about Pharmacy management, just want to remind everyone we are a player in pharmacy today. We have got in 2012, we had about 575 million of revenue on the pharmacy side, really coming from two business segments historically, one being our specialty pharmacy business which was a company ICORE that we purchased in 2006, and the other being Magellan Medicaid administration, which really has been a PBM that's been focused historically on the public sector, or direct to Medicaid contracts.

As we have again after doing these acquisitions over the last six or seven years we have really worked to figure out how do we best leverage the capabilities that we have by creating a Pharmacy Solutions business that we can market much more broadly than to the -- than just the states or just on the specialty side. So again it's leveraging the strength of our specialty or pharmacy capabilities and also the PBM platform we have with Medicaid administration.

The way that we look at it is as time has progressed more and more spend is actually moving over to the specialty just because of where the development pipeline has been on the drugs and we have strength there both on the traditional specialty side, but potentially even more importantly on the medical pharmacy side where we have got really a leading edge program to manage on those drugs that are bought and sold and administered by physicians in their offices and these oncology drugs and others which is much more of a medical management business than it is the traditional PBM business.

So we think the opportunity is really in integrated pharmacy solutions offering that offers sort of the best-in-breed specialty and medical pharmacy management with kind of core PBM capabilities as we go forward. And we have started to market that this year. So we had our first sale in January of this year, an employer that was about 40,000 lives. We have been very aggressive in marketing to other commercial employers as well as health plans.

We have seen a particular niche on Medicaid plans because we have got such a knowledge of the Medicaid pharmacy space and are actually in a relatively advanced discussions with a handful of these plans. So we feel like progress has been good. We think 2014 will at that point be sort of fully in the market. We are building out sales and marketing capabilities, now that we have got our platform in place. And think that our goal over the five-year period, of $2.5 billion of revenues is very achievable.

Unidentified Analyst

[Inaudible]

Jonathan N. Rubin

Traditional PBM I think we are 60%, January 1 maybe 40% is live or something like that. On the employer side, yes, I mean employer side in fact it may even be a little bit more weighted to January because these are large employers that tend to carve out their pharmacy benefits. On the health plan side not necessarily because health plans can switch over and it may depend on when their contracts with PBMs are up or other strategies that they are putting in place.

And there's also, again our strategy, while we'd like to take over the totality of the health plans, PBM, there's also opportunity to go in and to implement certain of our products and then build those relationships over time. So I wouldn't necessarily look at it as being as January centric, maybe it's a traditional PBMs that are mainly focused on the employer market.

Scott Fidel - Deutsche Bank

Just to follow-up to that question and you gave some insights in your prior answer but one of the questions that I very often get around Magellan Specialty Pharmacy business is what's the constitution of the customer mix currently and then where do you really see the growth being driven towards, and you did just mention in terms of growth, you mentioned the Medicaid and commercial MCOs and then some on the employers. Can you broadly help us understand what the current customer mix as you think about commercial Medicaid MCOs, state and other government customers, employers and whatever other customers you might have?

Jonathan N. Rubin

Yeah, I mean it's very simple if you look at it historically. If you were to go back kind of a year plus we would have been 90% plus on the specialty side on commercial plans. Why take commercial plans, that might include some Medicaid and Medicare business mixed in, but lion's share of commercial health plans. And on the PBM side it was almost 100% direct to state and fee-for-service Medicaid programs. So that's really been our historical customer base.

Again as we looked at our strategy though after integrating those two acquisitions, the last one we had done was mid-2009. We have really now built a platform that can be marketed really to any combination of customers, whether it be employers, commercial HMOs, Medicaid, MCOs or direct-to-state.

So where we see the biggest untapped opportunity for us really is in the employer and the commercial health plan space. And I say commercial health plan including Medicaid plans. That's where we really see the biggest untapped opportunities as we move forward and where a lot of our sales focus will be. That doesn't mean we won't continue to market to states, we certainly will. Nor does it mean we will sort of abandon our specialty pharmacy strategy but in terms of just total Pharmacy Solutions approach we are really looking at it as focused on the kind of commercial plans, the Medicaid MCOs and employers.

Scott Fidel - Deutsche Bank

And then typically the follow-up question to that is that when you look at the commercial market and the employer market, these are markets where you have some 800 pound gorillas on the PBM side and there is scale benefit perception to those markets and clearly Magellan is driving very robust growth currently in the specialty in the pharmacy strategy, it has some ambitious targets. So how would you respond that when talking about the relative value proposition and how Magellan is able to compete against these much larger companies in these end markets and be able to take market share?

Jonathan N. Rubin

That's a question we get often as we are kind of talking about our strategy. And the way I'd look at it is two-fold. One is where we have an advantage is really on the specialty side. It's really the depth of our specialty pharmacy capabilities and specifically on medical pharmacy where as you know, again we have got capabilities that allow us not just to manage the distribution of drugs but the actual benefit in total.

So we've got reimbursement structures, essentially a network management capability there. We have got clinical edits whether it's utilization management protocol or dosages edits, and we have the ability to manage claims on the medical side, which PBMs are starting to get into but we have really got probably a three or four year head start from the work we have done over the last five years in the medical pharmacy space and again the drug spend directionally is moving away from traditional oral medications and towards specialty and medical pharmacy.

So that really gives us what we think is an edge and then being able to integrate the management across medical specialty and oral drugs so that we can kind of look at things in totality and make the right clinical and cost decisions for a patient, for a customer, gives us an advantage, because remember again the PBMs are still largely focused on the distribution of drugs on the specialty side and then managing kind of unit costs on the oral side.

Having said all that we do need to have a competitive kind of PBM offering to complement the strategic focus we have on specialty and medical and the good news there is again we are a very large claims player. We have got a claims platform that processes order of magnitude 200 million claims a year. So it gives us, we believe requisite scale, maybe not to be as cost competitive on the more commoditized PBM side as like an Express Scripts is but competitive enough that we can leverage our specific strengths and find ample opportunity in the market. And today we see products and the focus we have got out there has been well received.

Scott Fidel - Deutsche Bank

And maybe thinking about customer mix and brining that a bit more broadly to your company in terms of revenue diversification and clearly in the last six to nine months Magellan you, while the business execution has been extremely strong, had to deal with the loss of two sort of mega customers here and clearly that's been one of the challenges for Magellan historically is that while the business execution has been very consistent and very solid the contracts just can often be lumpy. I mean clearly now and one element having lost Maricopa and then the large commercial behavioral customer, you sort of de-risked a bit in terms of….

Jonathan N. Rubin

Not the way we want to do it though.

Scott Fidel - Deutsche Bank

Not the way you want to do it obviously but just in terms of revenue concentration. So I guess the first question is maybe sort of update us on sort of post those significant contract losses, sort of how that revenue diversification looks. Do you still have major customers that account for a meaningful percentage of revenue that are up for renewal and then also when thinking about the business strategy as a result of this going forward, is there an emphasis that's going to be placed on trying to maybe well you can't move the needle as much on the revenue side, focusing on some of these smaller plans out there, particularly as the market is evolving.

You have the Medicaid expansion and Blues are going to be getting into that and they are not that familiar with that market, you have got exchanges, you have got (inaudible) emerging and some new entrants and sort of Magellan's thoughts about trying to really pick off a number of those smaller players and as a result being able to diversify the revenue mix.

Jonathan N. Rubin

I think that's a great question and a couple of things, one, while we are -- on a relative basis we will always have larger customers and smaller customers our reliance on individual customers will significantly lessen as we go into 2014 and beyond. And that will depend a little bit again on the ultimate outcome on the protest in Maricopa. But putting that aside a couple of things I know. One is we do believe that the opportunities for us for growth as we go forward aren't dependent on large scale wins or acquisitions or kind of big RFPs coming out.

The opportunities really are in many of the areas Scott that you mentioned. It's in Medicaid as both Blue plans and other plans are entering the market and with Medicaid MCOs, some who are relatively small and immature and are in the growth phase and others who are more entrenched in the market. So we see those in our traditional businesses as being a good opportunity.

The other thing I'd mention though if you think about our strategic areas for growth, so we have mentioned Pharmacy Solutions and Magellan Complete Care, which is our Medicaid strategy. We think those are complementary, partly because of the reason you mentioned which is our Complete Care strategy although we think there is a lot of different opportunities in multiple states will be relatively lumpy because of the nature of Medicaid. But pharmacy will be much more a matter of us penetrating the market in smaller chunks.

So in some ways we like the fact that the pharmacy business which should be a lot smoother and more predictable can help to in essence immunize against some of the ups and downs that are just the facts of life in Medicaid.

Scott Fidel - Deutsche Bank

Let's check if there is any questions on the lines. Okay wanted to ask a question, shifting over to the radiology segment, it's been an interesting situation because really since you have grown that business the margins have developed at a level that are way beyond what the company's initial thought process was. And over the last 12 to 24 months as a result of that you have re-priced some meaningful amount of business to reflect those excess returns, but instead actually in the first quarter the margins ended up coming in again much, much stronger than expected.

So clearly the cost side of the equation has been progressing very favorably both, that's I am sure company specific, also the benefit of what have clearly been very low utilization trends on a more broader basis in that end market lab diagnostics, imaging et cetera. So as we sit here today and just given the extremely robust margin performance that you just produced in this business are you going to have to go back and have another re-pricing cycle as a result of that or are the customers just going to be pleased that their underlying results are coming in very favorably, via contracting with Magellan.

Jonathan N. Rubin

Well, I think a little bit of both, meaning that I think our customers have been very pleased with the level of performance that our radiology management business has been able to drive, which has led to a very stable and in some cases a very positive cost management aspect of the relationship. At the same time as contracts come up for renewal, lets us put pressure on the rates because I mean in this word when you've got the [inaudible] ratios and everything else going on, psychologically it's hard to price things at less than 80%.

I mean it's just the -- and it probably always has been if you think about when we originally wrote our risk business on the radiology management side, we certainly didn't anticipate the level of kind of cost performance that we have been able to achieve, which has been both. I mean we have through our clinical management team and efforts in radiology management have really driven very strong clinical yields and results in utilization management. At the same time we had the perfect storm where presentation rates of people seeking services has also been lower.

So it's not sustainable. We have seen some correction on that. I do think over the balance of the year, we will see some leveling off in terms of the demand side, but I do think that the business is performing well and we should continue to see maybe not quite as good margins as we have had through first quarter but still think we should see very good margins in that business, but especially on the risk side it's not reasonable to expect double digit margins going forward. I mean I think we said before, mid to high single digits is probably the parameter that we would be shooting for, over time.

Scott Fidel - Deutsche Bank

Okay, want to ask about the cash flow and sort of optionality on that. You have -- at the first quarter ended with $11 per share of free cash and the business itself is generating robust free cash flows, no debt on the balance sheet, 55 million potentially coming back up, probably early 2014 from Maricopa. So this is very rich cash story still. Company has renewed the share repurchase program in the last couple of quarters. So clearly are putting some of that cash to work.

Just want to ask though about just given the fact that you do have a relatively unique scope of revenue cliff that occurs in 2014, because of the loss of those two major customers, and clearly I would imagine that, that cash provides some options on how to fill that. One option is clearly from the EPS side, if you wanted to do some type of accelerated buyback program that will look to try to replace some of that lost EPS.

Another clearly is if you wanted to focus more on the revenue side of the equation, through M&A to try to replace some of that and maybe help us think about, first are either of those. I mean we know M&A is a consideration here, is there a thought process at all about some type of accelerated buyback program just given the unique circumstances with these customer losses or is your view here more on sort of the measured buyback program continuing as you look for opportunities in the market place?

Jonathan N. Rubin

Those are things we have typically discussed almost quarterly with our Board and within management. So we always keep all the options on the table relative to deployment of capital. We have chosen a more sort of long term measured approach in share buyback. One, because we think share buyback is the right thing for us to be doing. But also wanting to keep some option if opportunities arise and we want to continue to be opportunistic relative to acquisitions and funding of growth opportunities within our businesses.

So and we do think kind of as we came into this year, we think both our strong balance sheet and the dynamic nature of the market and the industry in a sense creates potential opportunities for us that we want to be able to be able to capitalize on if they arise.

So we have talked about the areas that we are most focused on from a growth standpoint, Pharmacy Solutions and the Complete Care business in Medicaid. Those are areas that from an acquisition standpoint we think there could opportunities out there as we go forward. It's hard to predict especially in Medicaid because everything's so state specific and so unique in terms of how the market's evolving but hard to predict, but we think that there's so much opportunity in the markets and the capital needs are high and that could create unforeseen or opportunistic events for us.

So definitely want to keep some capacity for M&A, at the same time that we think we have got a sufficient amount of cash and capital position to be able to continue our share buyback and think that there is a good opportunity for us particularly in pharmacy and Medicaid to pursue acquisitions as they come up over the course of the next several months.

Scott Fidel - Deutsche Bank

And just the follow-up question around that is just around capital structure and clearly there's no need for you to have done [inaudible] right now, you have got tremendous amounts of cash but at the same time I mean we have been living in this very unique world the last couple of years and that might prove to be a once in a generation type situation. So as you think about that and where rates are now how do you -- but again not really needing to do anything on the balance sheet, how do you balance those thoughts out?

Jonathan N. Rubin

Yeah, now that's something again that we grapple with and I in particular grapple with, day-in, day-out, but the way I'd answer the question is from the standpoint of an optimal balance sheet and with the current environment clearly there is some benefit to taking on debt, because as you mentioned rates are great and it will help us to leverage the growth opportunities that we have ahead.

At the same time though there is no value to us in taking cash to invest it, taking debt out to invest it. So that's why again we look at it as how do we retain that capacity so opportunistically if things come up where we can use the funding capacity for acquisitions or to fund internal growth that we kind of keep that opportunity out there.

So that's something again we think about and again we will continue to move forward with our share repurchase program because we do have more cash obviously on our balance sheet then is optimal, keep the capacity in the debt side to be able to fund acquisition and if the opportunities come up you won't see us hesitate to leverage that and probably get to a more optimal balance sheet as we go forward.

Scott Fidel - Deutsche Bank

Okay, great. Jon thanks very much.

Jonathan N. Rubin

Great, thank you. Thanks everyone.

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