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Executives

Barry M. Smith – Chairman and Chief Executive Officer

Analysts

Mike A. Newshel – JPMorgan Securities LLC

Magellan Health Services, Inc. (MGLN) 32nd Annual JPMorgan Healthcare Conference Call January 14, 2014 5:00 PM ET

Mike A. Newshel – JPMorgan Securities LLC

Okay. Good afternoon. My name is Mike Newshel. I am part of the team covering managed care and healthcare facilities here at JPMorgan, and now it’s my pleasure to welcome to the podium the CEO of Magellan, Barry Smith.

Barry M. Smith

Thank you, Mike. It’s a pleasure to be here with you today. This is obviously a kind of a wild and crazy healthcare conference. I guess we had about 7,500, the largest number ever I hear during the session of this conference here. So it’s going to be here with you today. I am particularly excited to talk to you about kind of the, what I would call the new Magellan or Magellan 2.0. We’ve done a lot this last year to transition the company to a high growth company. We’ve got unique strengths in behavioral health that you’re all familiar with no doubt as well as pharmaceutical care and the radiology benefit management.

So I’ll talk about how we’ve round these three products together plus physical medicine to create what we call Magellan 2.0. You are seeing for the first time kind of the new branding of the company. We’ve announced some of it for our pharmacy businesses, but you’ll see the new theme kind of representing again the new look and feel of Magellan. We feel that we have a unique vision of care in the way that we combine these three through advanced data analytics predictive modeling to provide a much higher level of quality of care, but also very effective cost management for our clients.

What I like to do today is go through a general overview of where we’ve come from as a company. Up unto 2006, we were largely behavioral health company, where we had very advanced techniques and we were still, we believe, the most advanced in the industry to provide behavioral health services, but we do that both in the public sector as well as commercial clients. From 2006 to 2012, we decided to and started to expand the product line of Magellan. We acquired in 2006 both NIA, a medical radiology company as well as ICORE specialty pharmacy company, and in 2009, we acquired MMA or Medicaid pharmacy administration. We acquired that from Coventry, was a first half product line. We combined those two to have a very robust product line as far as pharmacy is concerned.

Starting in 2013, we’ve really repositioned the company to focus on two big areas of growth, which I’ll talk about in more detail, both the Medicaid – Magellan Complete Care, which is a combination of all these product lines to focus on the special needs population of the SMI population and others and I’ll talk about that in a bit more detail, but also the integration of all of our product lines from radiology through behavioral health through pharmacy services. These are all the services that we today offer at Magellan. Again, the common linkage is their focus on special population management.

We believe in behavioral health, we have very advanced enhanced capabilities, because the technology we’ve deployed and we’ve also expanded the product line to include autism and we’re exploring going into the intellectually and – and development of disabled population as well, special populations. In radiology, we believe we have a market leading solution. Again, advanced technology focused on special needs populations, but also we have a very capable carve-out products offering that we offer to the market. We’ve more recently focused on expanding our product offering to include cardiac cath and pain management in the radiology segment.

I’ll talk more about pharmacy, but we have a complete drug solution in pharmacy, again, I’ll hold off on that product line, and Magellan Complete Care is really the sum total of these three areas combined with physical medicine networks, where we are a health plan to the special needs populations typically focused on the special – the seriously mentally ill population, but also similar populations. In terms of growing the business, we really have three fundamental paths. We can expand and do expand with our current customers. We’ve got a very robust pipeline to organically grow our business. We’re building our sales force and all of our product lines and feel we have great opportunity to just organically grow the business with both new and existing customers.

We also have done a lot in terms of product innovation. Magellan Complete Care is a prime case of that, where we combined what we’ve done in radiology, pharmacy and behavioral health to combine those into a new product offering to manage the seriously mentally ill in a more holistic way, and of course with new populations that we manage, we’re looking at, as I mentioned before, the IDD population, the intellectually development disabled populations. And in terms of some of our strategic initiatives here, we believe that there is great opportunity in both the expansion of the Medicaid markets that’s going on nationally here, but also with Medicare with the dual eligibles.

We’ve focused largely on the SMI population, the dual eligibles. For the dual eligibles under 65, roughly 35% of that population has serious mental illness issues and then – and the over 65 population is typically about 20%. So this is a population, again, that we understand have had great success in managing overtime. We look at doing this business through joint venture, acquisition, but also greenfield startups, and so you’ll see us rollout Magellan Complete Care in a number of ways.

Now in terms of the spend, we’ve said publicly that we expect to grow to $2.5 billion over the next five years and there’s really four years now, we said that last year. So by 2017, we would like to penetrate at least 5% of the $50 billion overspend in the targeted states that we’ve identified. We again think there is great opportunity to enter these states and each state will have the unique way that they establish these plans, and I’ll talk more about state-by-state how we’ve done that.

In Florida, for example, we just recently won a five year contract as the first integrated special population plan focused on the seriously mental ill population. In the State of Florida, where we’ve been managing the behavioral health for 10 years plus, we believe there are 160,000 to 170,000 seriously mental ill individuals. We have we bid on eight regions in the State of Florida as roughly 40 of the 63 counties in Florida and in those counties, we believe there are just at a 100,000 seriously mental ill individuals. We’re now working with the state to define that population through pharmaceutical data, claims data, through the behavioral health data, which we have, because we perform that service in the State of Florida and have for many years and also the medical claims data.

So we have a pretty good idea of who this population is. We’re working through the state on two fundamental issues, setting the rates, and we should have that worked out in the very near future and we’ll be announcing what those rates are. We expect those rates to be between $15,000 and $20,000 per year per enrollee. We also expect in terms of the penetration to be about 20% our first full year there. So we would expect 20,000 enrollees there in the State of Florida for the first full year of operation and then increase and grow from there.

So if you do the math quickly and say it’s at midpoint, $75,000 or $80,000 per enrollee, this business in the State of Florida year one annualized will roughly be $330 million to $350 million annual dollars of revenue, which we think is a pretty exciting opportunity for us. We’re also going through the contracting process, as I mentioned, on the pricing and we’ll be able to announce that hopefully in short order. This is due to go live in May. It could be delayed a little bit, but we expect it to start around that timeframe. The State of Florida has been just spectacular to work with. They’ve hit all their timeframes and so we expect this to go on pretty much as we envisioned.

Now in the State of Iowa, where we’ve been doing behavioral health for the State for some 18 years, we have a strong and good relationship with the State and we’ve expanded that business from being roughly a $150 million managing the behavioral health in the state, to this year, we’ll likely have an excess of $300 million in revenue in the State of Iowa, so we’ve grown pretty dramatically. We won and have rolled out and are rolling out a special demonstration project for the seriously mentally ill, it’s a medical home health that we lead, and again, that’s in the process of being rolled out, where we essentially manage for both the 26,000 behavioral health SMIs, but also those children with SED, 16,000 of these individuals, we manage and coordinate their healthcare.

So in many ways we do what we’re doing in Florida in the State of Iowa, except that we’re not at risk for the total healthcare spend of these individuals. We do direct the care of these individuals. We’ve announced publicly that we will be applying for a Medicaid license in the State of Iowa and we would expect to work with the State to establish a similar plan in Iowa as we have in Florida. Again, a lot of details to work out, but that’s what our objective is.

Now in the State of New York, there is a tremendous opportunity. We believe there are roughly 460,000 seriously mentally ill throughout the state. We believe that in the five borough area of New York City, there are roughly 126,000 SMIs. So that’s a very substantial opportunity for us. We recently announced the completion of 65% acquisition of AlphaCare, which is an MLTC or managed long-term care plan in New York.

Now in New York, we’re going after the dual eligibles again, under 35 – under 65 years of age, these dual eligibles are likely about 35% SMIs; over 65, about 20% SMIs is the kind of population that we have experience with and will love to manage. We believe we can really help the quality of their healthcare, at the same time, control costs. Now in the State of New York, they've established the FIDA program to go live this year to be based upon this MLTC program. That’s the kind of the ticket to play. So we acquired AlphaCare 65%. We have an option to acquire the remaining portion of AlphaCare in January of 2017. We’re rolling out not only the FIDA program, but also an I-SNP and D-SNP, of course, Medicare Advantage plans in the State of New York and the five borough area there.

So we’re pretty excited about what’s happening in New York and we’ve also announced last year and we still are quite optimistic about entering five to seven states in total. We’ve announced publicly of course Iowa. We also do the behavioral health and just recently won a full-risk contract in the state of Nebraska, where we have gone from – well, from something we didn’t announce, but about a little over $100 million in revenue per year for the state of Nebraska. We also feel it's an opportunity to establish an – a Medicaid HMO and to hopefully work towards a full risk plan for the SMI population there in the state of Nebraska.

We've also targeted the state of Louisiana, where we do the behavioral health for the last couple of years, and also the state of Pennsylvania. Pennsylvania is a little bit different, because the healthcare society county-by-county, so it’ll be a little bit different format, but we believe there is a real opportunity there. We feel like we can identify states where there is great opportunity to have these full-risk plans for special populations, and given our expertise with behavioral health, with the pharmacy, as well as with the radiology, we have today $0.70 of every premium dollar already within Magellan, our assortment of services and by simply billing out the physical medicine network, we can take full risk for these populations.

Just an aside, to give you some idea of the importance of having expertise across these various product lines, as it relates to the pharmaceutical spend, if you will have a non-SMI Medicaid enrollee in the State of Florida, that enrollee would spend roughly $0.09 per premium dollar in pharmaceuticals. If that individual is an SMI individual, you will spend roughly $0.32 or nearly a third of the premium dollar you spend on pharmaceuticals. So having a deep understanding of the pharmaceutical use and compliance is critically important in managing these populations. Plus the fact – given the fact that we have the PBM as well, and again, I’ll talk more detail about that, if in the State of Florida, the business grows to a $0.5 billion, $1 billion, we don’t know, we’re not forecasting that, but let’s just say that it does, that’s again roughly a $300 million spend on our PBM – in our PBM product line. So we think there is a real opportunity to enhance the quality of care, but also control costs through our expertise in each of these areas of specialty care.

Moving on to the Magellan Rx Management strategy, we are very excited about where we’re going, what we’ve accomplished this last year. As many of you will recall, we have owned a specialty business, ICORE for many years, acquired that business in 2006 again. We acquired the Medicaid Administration business. We provide services for 26 out of 50 states. We are the big players in that industry, where we have these relationships with state Medicaid directors and deliver services in 26 out of 50 states. We’ve combined those two entities with a recent acquisition Partners Rx, which was closed on the 1st of October of this year.

Our objective here is to able to manage any drug whether it’d be spent on the medical claims side or in the traditional PBM pharmacy side, at any site of service, whether it’s in a physician’s office, a facility, an institution or at home or any method of administration. So whether it be an infused, oral or inhaled medication, we want to be able to manage the entire drug spend. In terms of the spend, historically roughly 25% of the spend of the last several years was – were specialty drugs, that’s expected to go to 50% over the next few years, so the specialty drug management capability and opportunity is pretty substantial.

The other side of this is the ability to manage, and we kind of go forward a little bit here, the medical pharmacy component. You’ll notice on the left hand side of the slide, it talks about many of the features that we have as a service that is more typical of a PBM, all the way from network services to utilization management, formulary management, all these kinds of things, as well as the specialty pharmacy management. The thing that makes Magellan unique is that we believe we’re one of the largest medical pharmacy management companies in the country. We have over 8 million lives enrolled in our plans.

It’s a very different product than the typical PBM product. We have relationships and work with physicians’ offices and the patients directly. So for example, a patient who might be on oral chemotherapy agent in an oncologist’s office, medical oncologist’s office, these are medications that can cost $10,000, $20,000, $30,000 a month. So the traditional PBM would typically ship out and say, we’re going to save some money, we’ll give you the PBM discount and we’ll ship these drugs into the physician’s office. Well, the problem is many times these patients can’t tolerate 90 days of medication, many times, they can’t, and so much of the medication is wasted. Also the office – the doctor’s office, in many cases, for these drugs, is a different class of trade, so the discount is different in a doctor’s office, so you may not even be getting the best unit price.

From our perspective, we look at what’s the best unit price, including what is the best deal, the discount on the drug itself, where are the highest rebates, and what is the least expensive drug in the same therapeutic class, that’s bioequivalent as far as the FDA is concerned. We then take that drug on the lowest possible unit cost and we then work with the patient and the physician’s office to manage the amount of drug that goes out. So instead of setting 90 days out, we’ll send out 15 days of medication and we will check to see how the patient tolerates that medication, and as they tolerate the medication, we’ll send in more medication, so that we're not wasting medication. So it’s a very different orientation.

This is very effective for these very high cost drugs, autoimmune drugs, human growth is another area of drug class that’s very high cost and needs to be managed much more aggressively than you would typically find in a typical PBM. So it’s a real great capability that we have that helps us distinguish our drug offerings. So in terms of our progress here, we’ve gone, these are some of the more recent announcements here. Last year, we went live with a major employer of 46,000 employees and we continue to focus on both small, middle, and large employer markets.

Historically we at Magellan, didn’t focus on the employer market at all and didn’t have a sales force focused on the employer market in the drug world as well, and so we’ll continue to expand in that. We then closed TennCare, we took that business last June, 1.1 million lives, it’s a $35 million contract in three-year – over three years with two-year – two more optional one-year extension, so that was a very smooth implementation and so we again extended our reach into the public sector as far as pharmacy benefit administration.

Again, we manage over 50% of the states in the country now in this space, so it’s really great relative to this business, but it’s also great in terms of relationships with the states on the Medicaid side for other behavioral heath as well as health plan business. As I mentioned, we closed the Partners Rx acquisition on the first of October. Bob Field, who was the CEO of Partners, was named the CEO of Magellan pharmacy management, Magellan Rx, again, rebranded to pull the – all these companies together within Magellan under Bob’s direction, and we fully integrated that acquisition. As I mentioned, we did not have a focus before on either managed care organizations, particularly mid level between 50,000 and 150,000 lives or the employer market. The Partners team was very focused on both the smaller end of the PBM market, which is very profitable, working themselves up into the middle employer bracket. So we are very pleased with that acquisition, it’s gone very well. It’s accretive, $0.20 per share, we believe in 2014 and again extends our leadership and our market expansion with these markets that we haven’t touched before. So we’re very excited about that.

Now, we’re also very focused on additional organic and inorganic growth and I’ll say a few more words about that kind of growth as well. So we’ve gone from a Total Drug Solutions; any drug, any benefit, any method of administration, we’re targeting clients, we’re cross-selling our clients and growing, but focusing largely in this world in an area we haven't before; in the employer market and the MCO market. We just recently announced just a few weeks ago, the win of a 140,000 MCO. We hope that you'll see and hear more of these as we continue on with our efforts here. The sales cycle for the PBM is probably 12 to 18 months. We're already starting to see traction, but you'll see more as time goes on. We’ve radically expanded the sales force of this area, and again, our goal is to have a very fully featured PBM. So no matter who the client is, whether they’d be a state agency, we’ll have the full array of services from standard PBM services to highly specialized pharmacy services and distribution as well as medical pharmacy management.

Now, let me just talk for a few moments about the few financial highlights here. We have given full year guidance of between $3.5 billion and $3.7 billion this year and we believe we’ll be well within that range. We've given guidance for 2014 between $3.6 billion and $3.8 billion. And so, in terms of segment profit for 2014, we’ve given guidance of $215 million to $225 million, again, EPS of $2 to $2.56. Now, in terms of our growth long-term, we’ve made some fairly aggressive comments and we are fairly confident, we don’t want to be arrogant about it, but we believe we can grow two large pillars of our business; both the pharmacy business and the Magellan Complete Care health plan services business, both sides to $2.5 billion.

We believe on the pharmacy side, we’re likely to grow at 50% organically and 50% by acquisition. We are very active in the M&A world now and the PBM world. We’re also very active on the health plan side. We believe that’s a great strategy to enter the certain markets that are particularly attractive to us. What we've said recently is that we expect a long-term CAGR of roughly 20% going forward and again you’ll see a lot of activity that will be focused both organically and inorganically on that growth.

The other thing I would say is that the customer base is far more stable. I’ve been in this position for about a year. This is my one year anniversary. I came here and spoke a year ago and I had been on the job for five days and let me tell you that was not as much fun as I though it might be. So I feel a lot better this year and a lot more confident about where we’re going. We’ve got a great company with great clinical capabilities and great market presence. The great thing about our business going forward is that the client base, the large customer, the lumpy nature of the business has largely worked out in 2013. So we’re fairly optimistic about maintaining the base and growing on that base going forward. In terms of, we get asked about this all the time, we've got a lot of cash. We range between $250 million and $350 million depending on what deal we’ve done. We are a large cash generator and – which is a positive thing and I’m typically giving a little bit of grief, because maybe we’re not buying our shares back fast enough. We’re all for buying shares back. We’ve got a $300 million authorization. We’re about a third through that, so we’ve got a lot of upside to purchase our own shares, but I would tell you that we’re much more focused on M&A. I think there is a great opportunity to build upon the business, expand multiples, multiple of the business. We’re trading like we were maybe 10 years ago, as a standard BH business. We think there’s a lot more excitement around special population management and the PBM business, so we’ll build on that strength and so I feel strongly about M&A activity, really building strength and capability and market presence in both the PBM side as well as the plan services side. So we’ll continue to do that. We’ll be very disciplined about it, and I am not a believer in something that an acquisition that might be accretive in three or five years. I think it has to be accretive immediately and given the acquisitions that we’re looking at, they are great synergies, operating synergies, I think there is great opportunity.

So in terms of our priorities, number one priority is to execute, execute, execute. We’ve got a lot going on, we’ve made great strides in terms of our transition into 2014, 2015 and 2016. We’ve got a long-term view of what we want to accomplish and so we need to make sure that execute today. Florida is very important to us. There are a lot of eyes on Florida across the country. We want to make sure that goes very well both from the implementation, but also from the cost management, the MLR in the state of Florida.

We want to really focus on growing our businesses. A year ago we had less than eight sales people total in Magellan with $3.5 billion revenues. I can tell you we need a sales force and we’ve been developing a sales force to deliver our message effectively to the marketplace with alongside the products that we’re developing, so you’ll see that continue to expand our ability to deliver the message. We also feel that there are really interesting growths for opportunities. We talked – I didn’t talk about in this presentation, but autism is a very interesting area; the IDD population, very interesting area. We have a lot of opportunity to create these special needs plans for populations where we can mange them on our existing chassis. We also think that the, in terms of capital deployment, again, there is a lot of opportunity for M&A activity to build shareholder value.

The last thing I would say and focus on the most and leave you with a message that leadership and people are everything. Having vision to where we’re going is everything. I wish and we’re going to arrange an Investors Day here in the near future and we will certainly invite you to attend, we just recently hired Sam Srivastava, who is the – came from us – to us from Cigna. He had headed up all national accounts, public sector, and senior markets, reported directly to the CEO there, just an outstanding talent, very knowledgeable, he is a great visionary guy and great here in the company. We’ve hired several like people. Bob Field, a very senior level executive in the PBM world I’ve known for over 20 years. He ran sales and marketing when I was operating the Operations at what is now CVS Caremark. So a long distinguished experience in his career. So we have some just stellar leaders in the company. We will continue to drive to always upgrade and have the best of class leaders within Magellan.

Again, I thank you for being here today. I think we’ll adjourn to a room not far from this place; Sussex, we’ll be available in Sussex answering any questions you might have. Thanks again.

Question-and-Answer Session

[No Q&A session for this event]

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