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Executives

René Lerer, M.D.- President, Chief Executive Officer, Chairman

Jonathan N. Rubin - Chief Financial Officer

Karen S. Rohan President, Magellan Health Services

Renie Shapiro - Senior Vice President of Corporate Finance and Investor Relations

Analysts

Carl McDonald - Oppenheimer & Co.

Joshua Raskin - Barclays Capital

Gregory Nersessian - Credit Suisse

Michael Baker - Raymond James & Associates

Daryn Miller - Goldman Sachs

Magellan Health Services Inc (MGLN) Q3 2009 Earnings Call October 30, 2009 11:00 AM ET

Operator

Welcome and thank you for standing by, at this time all participants have been placed on a listen-only mode until the question and answer session. (Operator Instructions).

I would like to introduce Renie Shapiro, Senior Vice President of Corporate Finance. You may begin.

Renie Shapiro

Good morning, and welcome to Magellan’s third quarter 2009 earnings conference call. This is Renie Shapiro, Senior Vice President of Corporate Finance for Magellan Health Serivces. Here with me today are Magellan’s Chairman and CEO, René Lerer, our new President Karen Rohan, and our Chief Financial Officer Jon Rubin. They will discuss the financial and operational results of our third quarter ended September 30, 2009.

Before we proceed with this call, let me read our disclosure statement. Certain of the statements that will be made during this conference call are forward-looking statements contemplated under the Private Securities Litigation Reform Act of 1995. Forward-looking statements are subject to known and unknown uncertainties and risks, which could cause actual results to differ materially from those discussed.

These forward-looking statements are qualified in their entirety, but a complete discussion of risks set forth under the caption Risk Factors in Magellan’s annual report on Form 10-K for the year ended December 31, 2008, which was filed with the SEC on February 27, 2009, and in the form 10-Q which will be filed with the SEC later today.

In addition, please note that during this call we refer to segment profit. Segment profit is disclosed and defined in our quarterly reports on Form 10-K and is equal to net revenues plus the sum of cost of care, cost of goods sold, direct service costs and other operating expenses, excluding stock compensation expense.

Segment profit information referred to in this call may be considered a non-GAAP financial measure. Included in the tables issued with this morning’s press release and on our Form 10-Q to be filed later today is the reconciliation from segment profit to the line item income from continuing operations before income taxes. We encourage you to review such reconciliation for an understanding of how segment profit compares to that GAAP measure. Our Form 10-Q for the quarter ended September 30, 2009 can be found later today on our website www.magellanhealth.com under for investors.

I will now turn the call over to our Chairman and CEO, René Lerer.

René Lerer

Thank you Renie and good morning everyone and thanks for joining us today. Before we start and discuss this quarter’s results, let me again introduce and welcome to Magellan, our new President Karen Rohan who joined us this on August 1. Each of the five strategic business units now reports directly to Karen, and she’s fully engaged in her role. She’s brought great energy, enthusiasm and additional strategic vision and discipline to these areas and I am delighted to have her as part of the Magellan team.

For today’s discussion, I will offer some brief comments on the third quarter results, provide an update on the progress of our share repurchase program, and review highlights for each of our business segments. Following my remarks, Jon will provide more details of the quarter and our full year outlook as well as some brief commentary on 2010.

After Jon’s done, I will discuss briefly our strategic focus and priorities and make some observations on the current state of healthcare reform as an impact for Magellan and other developments in the Medicaid environment.

I am very pleased to report you a strong results for the third quarter 2009 that reflect good performance across all of our biggest business segments, and we’re now forecasting 2009 results to be in the upper half of our guidance range. For the quarter ended September 30, 2009 we produced net income of $31 million, diluted earnings per share of $0.88 and segment profit of $64.5 million.

For the nine months year-to-date period, we produced net income of $62.9 million, diluted EPS of $1.77 and segment profit of $150.3 million. We ended the quarter with $220.1 million of unrestricted cash and investments, which is after the purchase of First Health Services. Jon will provide more details on our financials later in the call.

During our last earnings calls we announced that the Board of Directors on July 28th had authorized a share repurchase program of up to $100 million over a two-year period. To the close of business yesterday, we repurchased approximately 431,000 shares under this current program at an average share price of $30.43, for a total cost of $13.1 million.

The program remains in place and the pace of further repurchases will take into account share price opportunities, projected capital needs, M&A prospects, and the status of the current markets in our 2010 cash flow outlook. I’ll turn in a moment to the highlights for each of our segments. But first want to comment on care trends in our behavioral health business. Previously, we discussed the increased cost pressures we have been seeing in certain accounts in our behavioral health book of business.

While we continue to experience higher than initially expected cost of care for those accounts, primarily in the outpatient setting, our cost of care improvement initiatives have been in place for several months now. And we are beginning to see a positive impact from them.

As evidenced by our improved results this quarter. While there is typically a lag until the full impact of these initiatives are realized, we believe that the positive benefit of these efforts will continue going forward. As always, we maintain our strong focus on quality care while appropriately managing costs.

In the commercial behavioral health segment, we’ve had strong results this quarter due and part to improve care cost, and Jon will discuss this in greater detail in his segment. Also we’re very pleased to announce that you saw in this morning’s press release that we have signed the binding letter of agreement with WellCare Health Plans to manage behavioral health services for their entire book of business. There is one slight correction to that.

From our press release, we will be managing their entire book of business as we go through this with the exception of the state of Hawaii which is not included in this current contract. We currently manage behavioral health for WellCare in their Georgia market, and this new agreement builds on the track record we’ve established in serving this portion of WellCare’s business since 2006.

This new three-year contract would add approximately 900,000 Medicare and Medicaid beneficiaries to our current contract with a total of approximately $1.4 million lives. Implementation of services has already begun and we expect to go live in our first location in January of 2010. We would expect that we would be fully operational in all markets by the end of the first quarter.

Total annual revenues from all regions including the Georgia market, are estimated to be approximately $100 million, which adds approximately $60 million in annual revenues to our existing business. Approximately 95% of the revenues would be provided on a risk basis with remainder on an ASO basis.

Let me emphasize, however, that this agreement is subject to regulatory approval in each of the states, each state will have own separate contract and the states will not go live and will not be implemented until we have full approval from each state.

We are delighted to expand their relationship with WellCare and look forward to providing our clinical and operational expertise, and to delivering great cost savings and enhance behavioral health programs to their members. The public sector also had an excellent quarter, due and part to better of management cost of care, as well as increasing membership. As you may have seen last we announced that our Maricopa County contract has been extended through August 31st, 2011.

The initial three year contract included two optional one-year extensions. We are very pleased in this vote of confidence from the State. With this extension we will have the opportunity for our fourth full year to continue to execute on the transformation of the system of care in Maricopa to on focused on achieving positive outcomes for service recipients and their families.

With this renewal as we have mentioned on previous calls, we continue to have no known material terminations in our behavioral health segments. With respect to our direct care facilities, we completed the divestiture of all of the 26 clinical centers on schedule. These facilities are now under the operation of four locally owned and manage PNOs or provider network organizations, and an urgent care provider.

Our focus having the best of the direct care clinics is now on global management in oversight of the behavioral health system and providing tools and resources to providers and the community to support the effective and efficient delivery of care. As an example, we’re working with the PNOs to collaboratively design and implement outcomes and productivity-based resources that will bring transparency to performance and promotes choice for consumers.

In our work in Maricopa, we maintain our focus on system changes that emphasize and support the principles of resiliency and recovery. Over the past several months, we have implemented several partnerships within the community that support positive outcomes for individuals. Some examples are alliances that develop housing units for people with serious mental illness, for our homeless and innovative models to bring private business together with behavioral health providers to create jobs, a critical element of recovery. These efforts are solidifying Magellan as an innovative clinical leader and a committed community partner.

The radiology benefits management segment performed well on the quarter as well. Medical cost trends moderated this quarter and we are focused on driving further enhancements in other medical management capabilities with particular emphasize on utilization.

As you know, we fully implemented our new Medicaid based health plan and their results are included in this quarter. Consistent with what we are seeing in our other Medicaid based business units, they are experiencing membership growth beyond our original expectations. This growth is partially offset by continuing membership declines in our two prior risk health plan clients, implementation of the five commentary markets with annual first-year revenue of approximately $150 million is progressing as expected, and we are on track to the first of these markets to go live prior to year end.

The specialty pharmacy management segment produced solid results particularly, in our formulary optimization and distribution businesses. Our first comprehensive oncology contract is now fully operational in all aspects of the program, including fee schedule clinical and claims management capabilities. Early results show that we are demonstrating significant value creation for our customers. We are now fully engaged as well in the implementation of the Coventry Oncology contract. And expect those initial markets to go live prior to year end.

Turning now to our newest SPU or business unit, the first two months have resulted in our Medicaid administration segment, First Health Services have been inline with our expectation. Integration and centralized functions have gone well, and we expect to complete the migration to the Magellan IT platform in the first quarter of 2010.

As it relates to the First Health Services products, we are in the midst of our strategic review of the various business lines and their ongoing opportunities. We remain focused on customer retention and service, and have begun introducing other Magellan products to the First Health Services customers. We are pleased with the speed and effectiveness of the transition to-date.

In summary, I’m delighted with our results this quarter, and across all of our segments. Let me now turn the call over to Jon Rubin our Chief Financial Officer who will discuss the third-quarter results and full-year 2009 guidance in greater detail, as well as provide some directional commentary on our preliminary 2010 Outlook.

Jonathan Rubin

Great. Thanks René and good morning everyone. As indicated in the press release issued this morning, and as René as mentioned. Our net income for the third quarter of 2009 was $31 million or $0.88 per share on a diluted basis. This compares to net income of $23.5 million or $0.58 per share on a diluted basis for the third quarter of 2008.

Revenues in the third quarter of 2009 were $667.6 million compared to $656.5 million for the same period last year. The year-over-year increase resulted from same-store membership increases of $38.3 million, revenues in the current year quarter from First Health Services of $25.8 million.

New contract added since the prior of quarter of $12.4 million, increased revenue from business growth in the and specialty pharmacy segment of $11.5 million. Net rate increases and contract funding changes of $10.3 million in our commercial public sector and radiology segment, and other net favorable variances of $2.1 million.

These increases were partially offset by the loss of membership due to contract terminations of $73.9 million, primarily due to the loss of Tend Care. And the impact of minimum loss ratio requirements in public sector contract, which resulted in $15.4 million adjustment to revenue.

Now, turning to our operating segment, segment profit for the commercial business was $38.4 million, reflecting a decrease of $1.4 million from the prior year’s third quarter. This decrease was mainly due to terminated contracts of $1.8 million Care Trend in excess of rate increases of $0.9 million the impact of out of period care development affecting the prior year quarter of $0.8 million. Favorable retroactive rate and membership adjustments recorded in the prior year quarter of $0.5 million, and other net decreases of $2.6 million.

These decreases were partially offset by favorable prior period care development recorded in the current year quarter of $4.3 million. And new contracts implemented after the prior year quarter of $0.9 million. Now our care trends for our commercial health plan business modestly improved during the quarter, we continue to expect full year trends to be between 7% and 9%.

Third-quarter segment profit for public sector was $25.8 million for the quarter, representing a decrease of $0.1 million from the prior year third-quarter. This decrease was due to the net impact of contract terminations and same-store growth of $4.1 million and the impact of out of period care development affecting the prior year quarter of $1.2 million.

These decreases were partially offset by prior period care developments recorded in the current year quarter of a favorable $3.5 million and other net increases of $1.7 million. For the full year 2009, we’re now expecting our care trends to be slightly below or previously stated range of 3% to 5%.

For the radiology benefits management segment, third-quarter 2009 segment profit was $10.8 million representing an increase of $2 million over the third quarter of 2008. This increase was mainly due to favorable prior period care development recorded in the current year quarter of $1.1 million, and other net increases of $3.9 million, partially offset by the impact of out of period care development affecting the prior year quarter of $1.6 million, terminated contract is $0.9 million, and net new contracts in same-store membership decreases of $0.5 million.

We now expect 2009 care trends for radiology to be in the high single digit, which is below our previous care trend range of 10% to 13%. For the specialty pharmacy management segment, third-quarter 2009 segment profit was $9.9 million compared to $8.1 million reported in the prior year quarter. With the increase mainly due to higher earnings in both our re-based and distribution businesses in the current period.

The results of First Health Services have been reported in the new segment Medicaid administration. Third-quarter segment profit for this segment was $4.0 million, which was in line with our expectations. Note that First Health results exclude approximately 900,000 of year-to-date transaction in transition cost that are reported as corporate expenses.

Corporate cost and total for the current quarter, excluding stock compensation expense were $0.6 million less than the third quarter of 2008. Excluding stock compensation expense, total direct service and operating expenses as a percentage of revenue increased from 14.9% in the prior year quarter to 17.7% in the current year quarter, mainly due to the addition of the Medicaid administration segment.

Excluding First Health services revenue and direct service and operating cost from miscalculation yield the ratio of 15% for the current year period. In the third quarter of 2009, we recognized $4.1 million of stock compensation expense compared to $7.8 million in the prior year period. The decrease was mainly due to certain grants which became fully expensed during the current year, increased forfeiture activity and the 2009 grant pool being lower than 2008.

Depreciation and amortization expense was $12.2 million for the third quarter of 2009, compared to $16.1 million in the third quarter of 2008. This change was mainly due to assets that became fully depreciated as of December 31st, 2008 partially offset by as an additions since the prior quarter. Inclusive of assets related to the acquisition of First Health.

Interest expense was about 700,000 for the third quarter of 2009, which is comparable to the third-quarter of 2008. Interest income was $1.2 million for the current year quarter, compared to $4.1 million for the prior year quarter with a decrease primarily due to lower investment balances and lower yield.

The effective income tax rate for the quarter ended September 30th 2009 was 36.5%, which is comparable to the prior year quarter effective rate of 36.8%. Our effective income tax rates varies from the several statutory income tax rate, primarily due to state income taxes and the permanent differences between book and tax income.

Now turning to cash flow and balance sheet highlights. Our cash flow from operations for the nine months ended September 30, 2009 was $100.6 million, which compares to 236.8 million for the prior year period. Cash flow for the nine months ended September 30th, 2008 however, included the positive impact of a shift of restricted cash into restrictive investments in the amount of $126 million, which is reflected as a source of cash from operation and use of cash from investing activities.

The current year periods included the negative impact of a shift of restricted investments into restricted cash in the amount of $5.6 million, which is reflected as a use of cash from operations and a source of cash from investing activities. Absentee transfers, the cash flow from operations for the current year period and prior year period was $106.2 million and $110.8 million respectively.

As of September 30, 2009, the company’s total unrestricted cash and investments were $220.1 million, which represented a decrease of $101 million from the balance at September 30th, 2008. This decrease in unrestricted cash and investments includes the impact of stock repurchases during the nine months ended September 30th, 2009 of $67.1 million, as well as the net cash used for the acquisition of First Health of $115.4 million.

This net cash amount comprises the $110 million purchased price for First Health and $7.4 million of estimated excess working capital, less $2 million of cash acquired. Our unrestricted cash and investments of $220.1 million at September 30, 2009 consisted of $142.2 million of unrestricted cash, $72.7 million of unrestricted short-term investments, and $5.2 million of unrestricted long-term investments.

Approximately, $36 million of the total unrestricted cash and investments at September 30th, 2009 relate to excess capital and undistributed earnings held at regulated subsidiaries. The company’s restricted cash and investments balance at September 30th, 2009 of $300.7 million reflect a decrease of $16.3 million since December 31, 2008.

The majority of this decrease is attributable to lower restricted cash associated with the company’s regulated entities, that is offset by changes in other assets and liabilities, primarily medical claims payable and other medical liabilities and thus have no impact on operating cash flows.

As Rene indicated, due to our strong results to-date, we are increasing our guidance for the full year to the upper half of our previously disclosed ranges. Specifically, including our estimates for the First Health Services, our guidance now comprises full year segment profit in the range of $207.5 million to $217.5 million, and net income between $85.3 million to $95.5 million. This equates to diluted earnings per share of $2.41 to $2.70.

As Rene mentioned earlier through yesterday, we’ve repurchased 431,000 shares under our current share repurchase program. And this EPS range includes the impact of these repurchases but excludes any further repurchases that may occur over the balance of the year. And our guidance continues to include the assumption that we will be able to recognize the full Maricopa performance revenue for fiscal year 2009 by the end of the calendar year.

Now turning the focus to next year, we’re working on our business plan for 2010 and we’ll provide guidance in December. In advance of that however, I will provide some initial commentary. We believe that we will see increased segment profit for 2010 as compared to our current guidance range for 2009. This reflects a full year’s result from First Health Services in 2010 as compared to 2009, which will only have five months of activity. Continued improvements in cost of care for our behavioral health segments resulting from initiatives started this year.

Annualization of new business sold in 2009, particularly relating to be Coventry Radiology and Oncology contracts and our expanded WellCare relationship and behavioral health. Expected continued increases in Medicaid membership and our public sector behavioral business, and continued growth in specialty pharmacy. We do expect these improvements to be partially offset by anticipated membership declines in our health plan customer base, affecting both of our existing radiology and commercial behavioral businesses, primarily resulting from the impact of the economy.

The inclusion in 2009 guidance of performance revenue for Maricopa for the initial two contract years, whereas current 2010 expectations only reflect performance revenue for one contract year, and continued margin pressure resulting from economic strains on health claims volumes in the States. Again, we plan to provide detailed guidance regarding 2010 during our December call.

In summary, I’m very pleased with our strong results for the quarter and outlook for the year. Our initial progress in improving cost of care management in our behavioral segment, and our newly expanded relationship with WellCare. And I look forward to further discussing our prospects for 2010 earnings growth in December.

With that, I will now turn the call back over to René. René.

René Lerer

Thanks Jon. We are pleased with the further diversification of our business mix, as well as the potential to leverage our cross selling capabilities. To-date, eight out of our top ten health plan customers had contracts with multiple business segments. The acquisition of both First Health services which gives us an even greater presence in the growing public sector market, further augments our ability to market total cost savings to customers across all products and services.

Most importantly, as health plans increase their focus on their core businesses, they are expressing a greater interest in outsourcing medical and administrative management capabilities to us. Additionally, as a result of legislative mandates driving benefit structures, such as those dealing with mental health parity and autism spectrum disorders. There were numerous discussions with health plans regarding our medical management services.

Lastly as health plans seek to find cost savings and focus on their core strengths there maybe additional opportunities for us. With respect to the public sector behavioral health opportunities, the state of Arizona has issued RFPs for the five RBHAs, Regional Behavioral Health Authorities encompassing the entire state with the exception of Maricopa County. Responses to these RFPs are due in December with the anticipated implementation dates of July 1, 2010.

As we’ve said before, it is quite difficult to unseat the incumbent. The public sector behavioral health sector has unpredictable procurement cycles and aside from the Arizona regions, there are no other significant RFPs expected in the near term. Interest in our radiology products remains strong. We maintain our focus on new product development and further enhancements to existing products.

We continue to see additional opportunities for growth in the Medicare and Medicaid space, and we’re awaiting the RFP for the Medicare demonstration project for advanced imaging services. We currently expect the RFP now to come out in early 2010 with vendor selection and implementation expected sometime during the first half of the year.

Regarding our specialty pharmacy business, we continue to see opportunities in our rebate and distribution business. In addition given the cost trends in oncology that are in the 14% to 15% range, we have seen a higher level of interest in our oncology management products.

In the Medicaid Administration segment, obviously through the transition, we are focused primarily on client retention and up selling activities. And we’re also seeing an active pipeline for new business with some prospects interested in multiple products offered by First Health Services and Magellan.

With respect to M&A activity we’re continue to be actively engaged in analyzing and reviewing acquisition opportunities in addition, as mentioned earlier, we continue to act on our commitment to return capital to shareholders through our repurchase program.

Turning now to legislative matters that stands to affect of our business. It’s impossible to escape the current speculation on when and what shape healthcare reform will take. Rather than add to that speculation I will not comment on the various alternatives being discussed, but rather provide insight on our related activities.

We continue to monitor healthcare reform developments in Washington and at the state level. That said we view positively the recognition of behavioral health within the proposals. We see the emphasis on cost management and program integrity as reinforcing the inherent value about specialty management services for both public and private payers.

Recent attention to controlling imaging cost is an example of one area where we can bring value to our expertise. We continue to analyze the potential business and tax of any final healthcare reform legislation and to build strategies to deal with various alternatives. Given the expected growth in Medicaid live as a result of reform, we expect opportunities across all of our business lines.

In other developments last week the Governor of Arizona submitted a response to the Court’s request for a proposal related to the mental health delivery system in Maricopa County in conjunction with the decades old [RL Bissarn] case. One of the governor’s recommendations could lead to the transition of some of the population we currently manage in Maricopa County to the responsibility of the Arizona Medicaid Agency known as AHCCCS.

It is important to remember though that this is only a proposal and requires evaluation based on what is in the best interest of Arizonans facing life challenges as a result of mental illnesses, substance abuse. Any final proposal would require legislative approval and we expect this process to take quite some time.

We support a holistic approach to mental and physical health, but also a model that provides the concerted attention required by those experiencing behavioral health issues. We look forward to getting more details, that’s the Governor’s proposal and lending our expertise to ensure that individuals with mental illness or substance abuse issues get the attention and care they expect and deserve.

In closing we are quite pleased with our results this quarter, and we are particularly pleased with the expansion of our WellCare partnership as well as the extension of our Maricopa contract and the confidence the state of Arizona has shown in us. I am excited about the opportunities that lie ahead for us and I continue to be optimistic about growth prospects in all of our businesses.

Karen, John and I are happy to respond to your questions at this point. Operator.

Question-And-Answer Session

Operator

(Operator Instructions) Your first question comes from Carl McDonald - Oppenheimer & Co

Carl McDonald - Oppenheimer & Co.

First question, thinking specifically about the WellCare contract, but maybe you can speak more broadly in terms of the early termination clauses that’s normally included in these contract. I’m sure there is an opt out provision, but how onerous are the terms if there is a change of control at some point in the future with any of the contracts?

Jonathan Rubin

We obviously don’t disclose individual contract requirements. We’re obviously aware of the market and consolidations of the marketplaces. In the state contracts, states often have the ability to terminate at their discretion, which is typical of any state contract as it relates to our health plan contracts we build in protections that we think are appropriate as it relates to the current conditions.

Carl McDonald - Oppenheimer & Co.

And second question is on the, if there is a deal expected for the release of the next audit for Maricopa County?

Jonathan Rubin

There has not been any dates scheduled as far as we know.

Carl McDonald - Oppenheimer & Co.

Okay. The last audit was released?

Jonathan Rubin

About a year ago. I think actually maybe in January, so maybe 10 months ago. January or February something like that, but it represented the study that was done I think in October 8th. So we would and it represent the data from before that, so it only represented a few months of our actual involvement.

Operator

Your next question comes from Joshua Raskin - Barclays Capital.

Joshua Raskin - Barclays Capital

Maricopa just curious René, what was the catalyst for the triggering of the extension year, I guess, more than a year out from when the original one would have expired. So did they come to you or did you go to them, what was sort of the process rational there?

René Lerer

As we’ve said, the first three years of the contract would have expired in the middle of next year, obviously the state has in their budget discussions as we speak ongoing and obviously the process of doing any kind of RFP transition is important, so it takes a lot. So we settle along and we’re in constant discussion with the State of Arizona and with the Public Behavioral Health Services, we meet with them literally everyday.

Obviously it was a concern of, the Arizona concern of our, so I won’t suggest there was a precipitating event, it was just normal course of the contract and negotiation of ongoing expansions.

Joshua Raskin - Barclays Capital

Then you talked about the performance revenue recognition that you are expecting, it sounds like in the fourth quarter. Could you remind us what that is and then can you also remind us how much was the ‘08 portion in the current year, obviously sort of the amount that won’t recur for 2010?

René Lerer

Well, we announced the fiscal year ‘08 portion in the second quarter this year, which we identify to be $6 million. As far as what is it, it relates to documentation of services within the community that we must prove to the state as well as other performance metrics that are required under the state contract for us to recognize this revenue.

Joshua Raskin - Barclays Capital

Would the ‘09 number be a similar number to the ‘08?

René Lerer

We haven’t disclosed that, Jon.

Jonathan Rubin

Josh, the only thing that we said during second quarter is that we’re building in the expected full value of 2009 revenue that was deferred, where 2008 was the majority, but not all. And there has also obviously been membership growth over the course of the year, but beyond that we didn’t specify the number.

Joshua Raskin - Barclays Capital

Okay. Sounds like it would be higher even. And I guess last question on the 2010 segment profit you guys are commenting that you expect it to be up on a year-over-year basis. If you excluded First Health from ‘09 and ‘10, five months this year and 12 months next year, would you still have sort of that more organic operating growth, segment profit there?

Jonathan Rubin

Josh, we didn’t specifically say one way or the other. In aggregate we expect growth; we’ll give more details in December. The only thing I would add is this year versus prior years we don’t have any known terminations, so clearly we feel good about our position heading into next year.

Joshua Raskin - Barclays Capital

In the past I know you guys have included potential new contracts. Do you guys have new RBM included in here if your 2010 plan?

Jonathan Rubin

Josh, we usually do that in our December guidance when we talk about new businesses and new growth, we’re not ready to really have that discussion.

Operator

(Operator Instructions) Your next question comes from Greg Nersessian - Credit Suisse.

Gregory Nersessian - Credit Suisse

First question is I assume with the WellCare contract. Do you have any, I guess, start up cost built into your updated 2009 guidance in the fourth quarter that would be covered by revenue next year, would be non-recurring next year?

Karen Rohan

Greg its Karen. We have no implementation cost in the fourth quarter. I think we have a pretty strong claims management and IT capability that we can leverage for new customers going forward.

Gregory Nersessian - Credit Suisse

No network build out costs or anything like that?

Karen Rohan

Not material.

Gregory Nersessian - Credit Suisse

Are there any provisions in there to address the WellCare’s Medicare sanctions or not listed in time for open enrollment?

Karen Rohan

As you know Greg, we don’t go through details in any given contracts.

Gregory Nersessian - Credit Suisse

Then if you could just give us an update on the large commercial account that you have talked about in the past, how are the trends developing there, was any of the favorable reserve development attributable to that account and what are your thoughts going forward?

Karen Rohan

Greg, on that specific account we implemented cost to care initiatives earlier this year, we are trying to see some favorable impact of those cost to care initiatives, I will let Jon talk about the financial part of it.

Jonathan Rubin

Thank you again. We didn’t specify the amount, but you can see in the segment, the commercial segment that cost did improve and that one account that we talked about previously was key area of focus for us as we looked at implementing those initiatives.

Gregory Nersessian - Credit Suisse

Then just last clarification, the worker contract will be in the health plan segment, right?

Jonathan Rubin

Yeah.

Operator

Your next question comes from Michael Baker - Raymond James & Associates.

Michael Baker - Raymond James & Associates

I was wondering if you could give us a sense, a little bit more detail in terms of the pipeline of opportunities, maybe rank order the segments where you have seen kind of what I’ll say is a meaningful increase. And then just kind of talk about whether or not reform has kind of impacted the timing of decisions?

Karen Rohan

I’ll take the first part of your question. Relative to the overall pipeline, just commenting briefly as Rene said in this opening remarks, we have been encouraged by some of the activity that we are seeing with respect to health plan increase across all of our lines of businesses as they are focusing on their core businesses, they’ve been asking us a lot of questions around our expertise in each of our business segment that how me might be able to help them improve overall cost and the quality and case with respect to their overall health plan membership.

And so I would say that in the First Health business, we are seeing a fair amount of activity on existing customers as the states have been really looking at ways to improve their overall performance, and given the state budget crisis and we’ve been working very closely with them to offer additional processes and services to our First Health capability.

And then on the public sector, I think Rene commented on in his opening remarks, they have a significant opportunity within the Arizona rebuzz, however it’s very difficult to unseen incumbent, I mean, there is nothing material in the rest of the public sector to speak up and add on especially the healthcare.

René Lerer

On healthcare reform, obviously it is still quite a bit of uncertainty of where things are going. And we don’t see in our discussions with current customers, the potential customers, any impact directly on decision making at this point. I think there is greater impact based on their result and their concerns and their focus on their core businesses which drive those discussions, but not really driven particularly at this point by reform.

Michael Baker - Raymond James & Associates

And then just a question as it relates to one specific aspect of reform, the $6.7 billion annual fee at least in one proposal. Is there any expectation in any way that could impact you?

René Lerer

At this point it’s not clear enough for us to know that.

Michael Baker - Raymond James & Associates

Okay. And then finally, obviously states are under pressures outlined by what’s going on in the Arizona. Can you just comment in general what you are seeing in terms of kind of rates and anticipate our potential impacts along those lines?

René Lerer

Most of our rates for calendar year ‘09 are most states are in fiscal years and generally not on calendar years. So most of the rates for 2009 have already, we’ve already seen them, they are already baked into our fortes for 2009, so they’re there, not much to say. For 2010 rates we don’t start seeing many of them till the latter half of the year and it really is way too early for us to know where the states will be at that point.

Operator

Your final question comes from Daryn Miller - Goldman Sachs.

Daryn Miller - Goldman Sachs

This is Daryn Miller with Goldman Sachs. Rene question regarding your M&A strategy, historically you’ve said you’re looking for things that are growing above trend or growing more than other things within healthcare. I was just curious if as you look out towards healthcare reform how potential legislation might change some of the items that you’re looking at? And then specifically thoughts on Medicaid HMOs as an area within healthcare reform that might be growing faster than other area?

René Lerer

Well, as you know you are right, Daryn, we’ve always looked at those areas that we are growing either because of membership or they are growing because they had medical trends that exceeded general average and that their medical cost is growing at differential rates.

Clearly I think as demonstrated by the acquisition of First Health which is obviously quite focused in the Medicaid space we clearly believe that regardless of which healthcare reform proposals passes every one of them demonstrates a material increase not only in the Medicaid population but in a population of folks that will have subsidies by the government.

I think all other proposals have both increases in Medicaid membership and subsidy. So clearly as we look at opportunities of M&A, that area is an near of great interest to us. It represents a significant portion of our revenue to Medicaid space as evidenced by again First Health and the WellCare deal. So we’re always looking at those areas as going forward.

As it relates to Medicaid HMOs, obviously we’re not an HMO and we are not first a dollar coverage kind of company. We look at specializing in services that we believe we can provide to the managed care community. So at this point our focus is primarily in those areas that we think continue to either, will differentially grow because of cost management, because of medical cost in an area that we can cost manage or because of increasing membership. But we are not a Medicaid HMO to that.

Daryn Miller - Goldman Sachs

Got you. And one follow up, thank you for that response. Just in terms of size, historically you’ve done some deals that were more in the $200 million range about a year or two ago, you said you are possibly looking larger maybe $500 or $600 million, any thoughts just given where we are today in terms of potential size of acquisitions?

René Lerer

I don’t think during over the last couple of years we really talked about a strategy for a particular size. We talked about a strategy for the kinds of companies we are interested and the capabilities they could bring. And we’ve never really said whether we’re looking for $100 million or $500 million. I think we’re looking at opportunities that we believe fit within our capital structure and that support our current business or quarter vision. So there isn’t a focus on a particular dollar value, it’s really the value.

Operator

There are no other questions at this time.

René Lerer

Well thanks very much operator. Thanks everyone for you participation on the call today. Again we’re very pleased with the results that we’ve been able to deliver this quarter. And we look forward to speaking to you again in December with more detail on our 2010 guidance. Thank you.

Operator

Thanks for participating in today’s conference call. You may disconnect at this time.

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Source: Magellan Health Services Inc Q3 2009 Earnings Call Transcript
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