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Centene (NYSE:CNC)

Q2 2010 Earnings Call

July 27, 2010 8:30 a.m. ET

Executives

Michael Neidorff - Chairman, Chief Executive Officer and President

Edmund Kroll - Senior Vice President of Finance and Investor Relations

William Scheffel - Chief Financial Officer, Executive Vice President and Treasurer

Jesse Hunter - Executive Vice President of Corporate Development

Mark Eggert - Executive Vice President of Health Plan Business Unit

Analysts

Darren Miller - Goldman Sachs

Brian Wright - Collins Stewart LLC

Thomas Carroll - Stifel, Nicolaus & Co., Inc.

Chris Rigg - Susquehanna Financial Group

Scott Fidel - Deutsche Bank

Scott Green -Banc of America Merrill Lynch

John Rex - JP Morgan Chase & Co.

Joshua Raskin - Barclays Capital

Melissa McGinnis - Morgan Stanley

Operator

Welcome to the Centene Corporation Second Quarter 2010 Earnings Call. (Operator Instructions.) I would now like to turn the conference over to Ed Kroll. Please go ahead.

Edmund Kroll

Thank you and good morning everyone. I’m Ed Kroll, senior vice president of finance and investor relations at Centene Corporate. Thank you for joining us on our Q2 earnings call today. Michael Neidorff, chairman and chief executive officer and Bill Scheffel, executive vice president and chief financial officer of Centene will host this morning’s call. The call is expected to last about 45 minutes and may also be accessed through our web site at centene.com. A replay will be available shortly after the call’s completion, also on our web site at centene.com, or by dialing 877-344-7529 in the U.S. and Canada or 412-317-0088 from other countries, and for both of those the playback number is 442132.

Any remarks that Centene may make about future expectations, plans and prospects constitute forward-looking statements for purposes of the Safe Harbor provision under the Private Securities Litigation Reform Act of 1995. Actual results may differ materially from those indicated by these forward-looking statements as a result of various important factors, including those discussed in Centene's Form 10-Q dated July 27, 2010, today, and other public SEC filings.

Centene anticipates that subsequent events and developments will cause its estimates to change. While the company may elect to update these forward-looking statements at some point in the future, we specifically disclaim any obligation to do so.

We would also like to announce that our next annual Investor Day will be held June 14, 2011 in New York City. Please mark your calendars.

With that, I'd like to turn the call over to our chairman and CEO, Michael Neidorff. Michael?

Michael Neidorff

Thank you Ed. Good morning everyone and thank you for joining Centene’s second quarter 2010 earnings call. As has become our practice, I would like to take a moment to discuss certainly timely topics for our company and industry before I begin to comment on another solid quarter.

First, I’d like to reinforce our commitment to an important new part of our strategy that we have been communicating to you for this past year. In order to be responsive to the needs of our state customers, we have expanded beyond our historic focus on managed care. Centene is now offering cost-effective healthcare coverage for under- and uninsured low income populations, significantly expanding our addressable market.

It is the combination of Centene’s Medicaid experience and Celtic’s individual and small group skill set, recently enhanced by Nova Systems, that gives us the ability to leverage our networks and infrastructure by offering hybrid health plan solutions. We can effectively serve these populations as they move in and out of Medicaid eligibility, from fully subsidized to partially subsidized, and even to tax-subsidized small group plans. We have been talking to states and are seeing more and more heading in the direction of setting up state-based exchanges or other coverage solutions for their uninsured and underinsured populations.

Our first experience with the state-based exchanges is with the Massachusetts Connector Authority. We have built on our initial efforts in Massachusetts, now have a hybrid plan in place in Arkansas, and in 2011 will commence Healthy Indiana, the state-mandated participation in this Healthy Indiana program and its recent Medicaid re-procurement. We foresee other states following suit in the future. In summary, this experience gives us the ability to serve both Medicaid and exchange-based populations of approximately 32 million people in 2014.

Next, let me discuss some state budgets. State budgets remain under pressure and the big concern right now is the expiration of extra FMAP funding at December 31, 2010 and whether or not it will be expended through June 30, 2011. If it is not extended, it will likely serve as a catalyst for states to move more quickly to embrace cost-effective managed care solutions. While I cannot answer whether or not the FMAP funding will be extended, I can say at Centene we are proactive and have already reached out to our state partners with scenario planning that assumes no FMAP extension. We are managers not victims, and believe it is important to plan for all eventualities.

Our medical management tools, including predictive modeling and the dashboard, allow us to demonstrate to states where there is an opportunity for cost-savings while enhancing quality. This is how one becomes a total low-cost producer while maintaining fair reimbursement for providers. There are a few states that are considering an (inaudible) the status of some programs to FMAP solution or extension. For example, Massachusetts is reviewing whether it would continue our Commonwealth Bridge contract for legal immigrants without the extension. We are currently working with the Commonwealth on alternative ways to continue the program in the event of no FMAP extension.

On the rate front, as we have discussed before, we have known rates representing approximately 70%of our projected 2010 member months. We previously said that once the other 30% of the book was finalized, we expected the overall rate increase of 0% to 2% for 2010. However, our most recent discussions with the state that represents the remaining 30%, while not yet finalized, have been more constructive than previously expected. So we now believe that our 2010 overall rate increase will be in the range of 1% to 3%, up from the prior 0% to 2%.

This offers fresh evidence of rational pricing environments, despite strained state budgets. Our ability to deliver measurable cost-savings to states, while enhancing quality of care, makes us a good partner and as such we seek only to offset medical cost trends and maintain actuarial soundness.

Now I’d like to discuss some of the highlights of the second quarter. In May 2010 our Texas health plan was awarded a new ABD contract in the Dallas service area, subject to final contract negotiations. This new contract is expected to commence on February 1, 2011.

In May 2010 we announced the acquisition of certain aspects of Nova Health Systems, LLC, a third-party administrator in Arkansas that will complement our existing Celtic business by adding back-office skills and regional PPO capabilities that we believe can be leveraged and expanded as part of our overall strategy. Nova Systems manages a hybrid program in the state of Arkansas for employees of small business. This acquisition closed on July 1, 2010.

On June 1, 2010 we completed the acquisition of certain assets of Carolina Crescent health plan, the addition of which gives us a total of 92,600 (inaudible) members in South Carolina at June 30.

In June of 2010 our Indiana plan was selected and entered into contract negotiations for a statewide managed care contract effective January 1, 2011. Upon completion of the contract, we will continue to serve Hoosier Healthwise members as well as begin serving Healthy Indiana plan members on January 1 of 2011. Healthy Indiana is Indiana’s hybrid program for underinsured adults who earn less than 200% of the federal poverty level, do not have access to employer-sponsored health insurance coverage, and have been uninsured for the previous six months.

Now we’ll discuss the financial highlights of the second quarter and Bill will provide additional details in his comments.

Second-quarter premium and service revenue grew by 12.8%, driven by at-risk membership growth across all states as well as the continued conversion of members to the at-risk plan in Florida. Our consolidated second-quarter HBR increased 70 basis points year-over-year and improved 20 basis points sequentially to 83.8. Our long-term consolidated HBR guidance remains in the range of 84 to 86, based on the inherent volatility of this metric, but as Bill will discuss, we have narrowed our guidance for the second half of 2010 at a slightly improved rate.

Turning to general administrative expenses, the G&A ratio for the second quarter of 2010 was 12.7% compared to 13.9% in the second quarter of 2009. Further G&A reduction beyond 2010 remains a top priority and our ongoing systems investments should enable us to accomplish this goal.

We reported $0.45 of earnings per share from continuing operations for the quarter and this number was impacted by higher share count from our 2010 follow-on offering and the previously-mentioned drug carve outs in Ohio and Indiana.

Before I turn the call over to Bill, let me offer some final comments. We continue to be successful in a difficult economic environment. We continue to increase the diversity of our enterprise by both product and geography. Our growth drivers are multifaceted: new business in existing states; new states, for example Mississippi will be our eleventh state; and prudent M&A. We also used legislative changes like DRE as a catalyst for doing more business in our existing states.

There is an active M&A pipeline with ample acquisition opportunities available in the current environment. We are pleased to have already 50% of the run-rate dilution of our offering in January by deploying just 25% of the offering’s proceeds. However, we remain selective, prudent, and cautious about every project we evaluate. We will not take unacceptable risk in order to grow our top line. Protecting our earnings stream is crucial and we will continue to be bottom-line focused.

We appreciate your support and interest in Centene and I’ll now turn the call over to Bill.

William Scheffel

Thank you Michael and good morning everyone. For the second quarter of 2010 premium and service revenues grew to $1.05 billion, an increase of 12.8% compared to the second quarter of 2009. This year-over-year increase was driven by three factors. First, membership grew in each of our states, particularly in Florida, with the continued conversion of non-risk managed care membership from Access Health Solutions to an at-risk basis with Sunshine State Health Plans. At quarter-end we served 113,100 members on an at-risk basis while Access served 46,800 on a non-risk basis.

Second, the commencement of operations in Massachusetts under the Commonwealth Bridge and Commonwealth Care programs at June 30, 2010, CeltiCare Health Plan of Massachusetts served 30,100 members.

Third, in June we completed the acquisition of certain Medicaid assets of Carolina Crescent Health Plan, which served 40,000 Medicaid members in all 46 counties in South Carolina. This acquisition brought our South Carolina membership to 92,600 at June 30, representing 13% of the state’s eligible Medicaid population.

It should also be noted that the 12.8% year-over-year increase in revenue was moderated by the effects of the pharmacy carve outs in Indiana and Ohio, which took effect at the beginning of the year and reduced revenue by approximately $48 million in the second quarter of 2010, compared to the second quarter of 2009. Excluding the pharmacy carve outs, premium and service revenues would have grown by 18% in the second quarter, consistent with our at-risk membership growth.

Our consolidated health benefits ratio was 83.8% for the second quarter of 2010, compared to 83.1% in the second quarter of 2009, and 84.0% in the first quarter of 2010. The 70 basis point increase between years was primarily due to new markets reserved at higher rates, which accounted for 60 basis points of the increase. The 20 basis point sequential decline in HBR is primarily due to normal seasonality.

Our general and administrative expense ratio for the second quarter of 2010 was 12.7%, compared to 13.9% in the second quarter of 2009. The 120 basis point improvement in the G&A ratio reflects the impact of our ongoing efforts to contain costs and our ability to leverage our expenses over higher revenues.

For the second quarter we did not incur the level of startup costs in Mississippi that we had previously anticipated, which benefitted the quarter by approximately $0.03 per share. This is primarily a shift from the second to the third quarter as we ramp up our efforts for a fourth quarter startup.

Our second quarter investment and other income was $4.1 million, a $276,000 decrease year-over-year. The decrease in investment and other income reflects decreased investment balances. Interest expense of $3.9 million declined $291,000, reflecting the reduction in debt outstanding.

Excluding the effects of non-controlling interests, our second quarter tax rate was 42.9% compared to 36.3% in the second quarter of 2009. This increase was primarily driven by legislation enacted in the second quarter in the state of Georgia, which replaces the state income tax with a premium tax for Medicaid managed care organizations, effective July 1, 2010.

As a result of the new legislation, we will be unable to realize the future tax benefit from deferred assets related to state net operating loss carry-forwards. Accordingly, a deferred tax asset of $1.7 million, or approximately $0.03 per share, was written off during the second quarter of 2010. As a result of this write off, for the full year of 2010 we expect our tax rate to be approximately 40%.

Our diluted earnings per share is $0.45 this quarter, versus $0.47 a year ago. The 2010 results reflect the dilution from the additional shares issued as part of the stock offering in the first quarter of 2010.

For our discontinued operations, we recorded a pre-tax loss of $316,000 related to New Jersey health plan operations in the second quarter as we wind down operations and pay the remaining claims. Regulatory capital will be returned over the next 12 months, after receiving regulatory approval. It is currently estimated that statutory capital to be transferred to the company’s unregulated cash will be approximately $10 million.

In June 30, 2010 we had cash and investments of $852.4 million, including $813 million held by regulated entities and $39.4 million held by unregulated entities. Our subsidiaries, including New Jersey, had aggregate statutory capital and surplus of approximately $480 million, compared with the required minimum aggregate statutory capital and surplus requirements of approximately $280 million. We have estimated our risk based capital percentage to be approximately 360% of the authorized control level at June 30, 2010.

Our total debt was $252.8 million and our debt-to-capital ratio was 24.5% at June 30, 2010, compared to 33.2% at December 31, 2009. Our medical claims liability totaled $455.4 million, representing 48.2 days in claims payable. This is a 0.5 day increase from the first quarter of 2009, and a reconciliation is provided in our press release.

For the second quarter, and the first half of 2010, operating activities used cash, resulting in negative cash flow from operations of $59.8 million for the second quarter and $98.3 million year to date. As we mentioned on our fourth quarter call, certain states pre-paid their January 2010 capitation payments in December 2009, in the amount of almost $92 million. These pre-payments caused a decrease in our cash receipts in the first half of 2010 as reflected in the lower amount of unearned revenue at June 30 of $5.7 million.

In addition, there were $57.7 million in receivables related to state capitation payments at June 30, 2010. Since June 30 is the fiscal year end for many states, several of our states deferred their June capitation payment for all managed care companies in their states until July. All of this $57 million was received in early July. We expect our second half 2010 operating cash flow to be strong, although the level of premium payments received prior to any quarter end may vary from period to period.

Now I’ll give some updated guidance numbers. For 2010 we expect premium and service revenues of $4.35 billion to $4.45 billion. We are increasing our earnings per share guidance from $1.75 to $1.85 to now $1.78 to $1.86. We expect an HBR ratio of 83.5% to 84.5%, a G&A ratio of 12.4% to 12.9% and 50.5 million shares outstanding for our earnings per share calculation. The HBR ratio for the year has been decreased to reflect the actual results incurred in the first half of 2010 and the impact of a fourth quarter start date for Mississippi operations.

Operator, you may now open the line to questions.

Question-and-Answer Session

Operator

We will now begin the question and answer session. (Operator instructions.) And our first question is from Darren Miller of Goldman Sachs. Please go ahead.

Darren Miller - Goldman Sachs

I was wondering if you could remind us what states are remaining this year that you’re expecting to see rate increases on, and what would the effective dates of those rate increases be?

Michael Neidorff

Texas, September 1. Florida, September 1. Jesse? And Georgia, which is July 1 and is always retroactive.

Darren Miller

And can you comment on the higher claims inventory at the end of the quarter?

William Scheffel

I think that’s just really just a function of the processing at the end of a quarter. We try to pay the high-dollar claims and get those out quicker and the level of inventory can vary from month to month-end. Nothing special about it.

Darren Miller

And then lastly, what states deferred their payments from June into July?

Michael Neidorff

I think we had Georgia . .

William Scheffel

And Wisconsin were the primary ones. And again I think we received all of that by July 7.

Operator

The next question is from Brian Wright of Collins Stewart. Please go ahead.

Brian Wright - Collins Stewart

Can you help us with the quarterly premium tax levels kind of going forward?

William Scheffel

I think a couple of things to maybe mention there. The volatility in the premium taxes is one reason why we focus on premium service revenues as our measure of revenue growth. In the second quarter of 2009, for example, Wisconsin paid us about $84 million for what they call their hospital tax assessment, which we then turn around and pay out to the hospitals. And that was almost a year’s worth of payments received in the second quarter of 2009. And in the second quarter of 2010 they paid us even less than the normal run rate that we would have anticipated, and so a lot of that is just dictated by when they pay us the amounts. So Wisconsin has a higher rate than most other states so that shows some volatility in the premium taxes and going forward we would expect them to go back to their normal process and run rate, but again that’s subject to actually how they manage that.

Michael Neidorff

Yes, it really is a direct pass-through. It has absolutely no earnings impact. That’s why we really when you look at our statements, as Bill said, the revenue . . .

Brian Wright

Yeah, no, no absolutely. I just want to, just for modeling purposes, and I know it doesn’t matter to EPS but just wanted to see clarity on that. So I guess it’s kind of closer to the first quarter kind of levels then? For the back half of the year?

William Scheffel

I think that’s a reasonable, somewhere between the second and third quarter amounts.

Brian Wright

And then can you give us some help on breaking out the Massachusetts enrollment between the Bridge, and the Celtic exchange based lives and everything?

Michael Neidorff

Jesse?

Jesse Hunter

I would say Brian that we have three products at this point between the ComCare program, the Bridge program, and then the ComChoice program, as you know ComChoice is the most recent and therefore the smallest population. ComCare has continued to grow because we are the low-cost producer within that product. And Bridge has been relatively stable. So as it stands right now, I would say Bridge is the biggest, but not really growing. The growth that we’re seeing is in the ComCare product.

Brian Wright

And then, if another question, did the Carolina Crescent, that was an asset purchase so there was no additional medical claims payable that came over from that, correct?

Michael Neidorff

Correct.

Brian Wright

And then one last one, actually two more, sorry. The Novasys, how many lives is that going to be on closing and how will we break out between risk and non-risk?

William Scheffel

Not sure we measure that with lives on the Novasys side.

Jesse Hunter

Non-risk.

William Scheffel

Right, so that’s not something you’ll see adjusted in our tables for that.

Brian Wright

Okay, so then it will be just total fee revenue then.

William Scheffel

Yes.

Brian Wright

And then lastly, if I can, the Ohio and Texas pharmacy carve out has there been any movement recently on getting those carved back in?

Michael Neidorff

It’s fair to say we’re in ongoing discussions. And don’t expect to see anything immediate. Some of it may be based on their fiscal year. So we’ll just continue to talk to them and respond to their questions and (inaudible).

Operator

The next question is from Tom Carroll of Stiefel, Nicolaus. Please go ahead.

Thomas Carroll - Stifel, Nicolaus

A couple quick ones. First on the Mississippi costs, what was the primary rationale to shift them into third quarter, and then will the cost be higher in third quarter than prior expectations or is this a scenario where setup costs were just lower than you expected?

William Scheffel

I think that the costs will be higher in the third quarter because we didn’t incur the costs in the second quarter but we’ve been working with the state on the startup date and all of the functions that need to be ready to go at that point in time and until they had done a couple of things on their end we weren’t actually ready to ramp it up. That’s now in full, full speed ahead, so that’s all occurring right now and so there’ll be costs that you normally incur prior to the first day of generating revenue, which is you have to build the staff and have the offices ready to go, in advance of, before you generate revenue. So those will all be incurred higher level. The $0.03 that we benefitted in the quarter two we expect to expend in quarter three along with other amounts that we previously intended.

Thomas Carroll

Great, and then Michael, follow up on your comment about FMAP extension. Do you believe, as you reach out and talk to states, do you believe that states have a plan A versus a plan B if you will? Would they rather just have more money or are they really going to do something, if FMAP is not extended, differently than perhaps you expect right now.

Michael Neidorff

I think a lot of depends on the states, and the governors and the election timetable. Are they up for reelection in November, or are they on a different cycle? There’s a lot of variables there. But I think clearly they recognize that the FMAP will, they have to wean themselves from it. And the states we’re talking to clearly recognize that and are talking more aggressively about moving to managed care as the alternative to save the necessary funds.

Thomas Carroll

Is the fact that this FMAP extension is not finalized yet, is that preventing you from making further comments about upcoming rates, like Texas, like Florida, like Georgia? I think you’ve given us a little more clarity on second quarter rates.

Michael Neidorff

No, I don’t think that’s the issue. We’re really just working with the states and what we’re finding is, because of some of the systems, the fact that we have real time data, virtually every day that we can look back on. We’re supplying this to the states, our actuaries are working with theirs and trying to get to the right answer. So I don’t think it’s FMAP.

William Scheffel

I think also CMS, they have to submit rates that are approved by CMS, they have to go through a process and until that’s all completed we really don’t have final rates.

Michael Neidorff

It’s never done until it’s done, but all indications are that it’s more rational than some what people recently thought.

Thomas Carroll

Will the tax rate of 40% continue into out years?

William Scheffel

I think that the 40% tax rate is our blended rate for 2010, which reflects the $1.7 million in write off we took on the Georgia NOL. So if you took that out of there we think our underlying tax rate would probably closer to 38%, 38.2%, somewhere in that range. So that’s probably the rate that we would expect to see for example in the second half of the year, but for the whole year it will be close to 40%.

Thomas Carroll

So in 2011 we should go back to your more normalized run rate.

William Scheffel

We believe that the write off was a one-time event.

Michael Neidorff

If you have a good window on what all taxes are going to do in ’11, we’d all love to hear it.

Thomas Carroll

I don’t.

Operator

The next question is from Chris Rigg of Susquehanna Financial Group. Please go ahead.

Chris Rigg - Susquehanna Financial Group

I was wondering if you could just talk a little bit about the Healthy Indiana program and how we should expect that to ramp and a little bit of the specifics there, whether there’s an auto-assignment component to it, or if people have to select you guys to utilize your plan.

Michael Neidorff

Mark, you want to take that?

Mark Eggert

Yes. So there’s going to be an open enrollment period in fourth quarter for the January 1 start date, so members will have to choose us. And we’re the new player, so we’re going to be engaged in a lot of activities to encourage that choice, but I think we expect it to be a fairly slow ramp.

Chris Rigg

And how big is Healthy Indiana today?

Mark Eggert

Approximately 45,000 total in the state.

Chris Rigg

And then just looking at the P&L here in the quarter. The service revenues had ticked up sequentially and it looks like the cost of those services had come down sequentially. I’m just wondering if you could explain the dynamic there and what happened on the cost side in particular.

Thomas Carroll

The primary thing there is we receive, Access Health Solution receives certain performance incentives based on the results of their medical experience in Florida and that’s usually on a 9-12 month lag, and so they receive some of their performance bonus money in the second quarter, which there would be no associated cost with that, and so that was the primary reason for the increase on the service revenue.

Chris Rigg

And then my last question again goes back to FMAP. Michael, you had commented that you’ve obviously been having proactive discussions with the states and what you would do in the event that you don’t get the moneys renewed. In your opinion, having a six-month fix, if you just get something through June, does that really materially solve the problem or do you think that the states need a longer-term solution? And if they need to be weaned of that money how much time do they need to get to where they need to be or at this point it’s just . . .

Michael Neidorff

That’s a great point because we’ve been saying for some time now that that money will come to an end and when some of the states that are recognizing and seeing the activity are dealing with that. But I think they would need a minimum of six months to start to, to get things in place. If they started right now from a dead start it would probably be a minimum of six months, but some of these states we’ve been talking to they haven’t been sitting still. They’ve been starting to work through a process. We talked to one state where they said they’re looking at RFPs and things of that nature.

Operator

The next question is from Scott Fidel of Deutsche Bank. Please go ahead.

Scott Fidel - Deutsche Bank

First question, just in Massachusetts, how much of your enrollment up there is in that immigrant program that may not be extended because of FMAP?

Thomas Carroll

The current enrollment is a little over 20,000 members.

Scott Fidel

Then, second question, just some more color on the change in view on the rates and it looks like you have three major states that are still yet to be finalized and you have a bit of a better rates there. Is it that all three of the states might be looking a little bit better or is there one or two of the states that are sort of driving that better view of 1% to 3% rates?

Michael Neidorff

I think they’re all showing the responsible approach to dealing with the data.

Scott Fidel

So it’s sort of all three of them look a little bit better than what you initially were . . .

Michael Neidorff

Yeah. Some have been, and others it’s just what we’re seeing is they recognize when we show them the data we have that there are some issues. And so we’re not asking for, in all cases, vastly greater rates. We just want to, here’s what’s a responsible rate to keep things in an actuarially sound position.

Scott Fidel

Okay, and help us think about what you think the underlying medical cost trends are in the TANF business. Obviously there’s a lot of mix shifts in the business but if we just sort of break out TANF and you think about that underlying trend versus the 1-3% rates and sort of break that out in terms of what you think underlying unit cost trends are right now relative to utilization.

Michael Neidorff

I think it’s really in that same low single digit area.

Scott Fidel

And is it low single digit for both the unit cost and utilization?

Michael Neidorff

Yes.

Scott Fidel

Okay. And then just one last question. Thinking about the hybrid products, which are probably going to be a bigger mix of business for you over the next couple years, can you talk about what the PMPM premiums are in that business relative to let’s say a traditional TANF member and sort of how you think about the margins so as we think about modeling longer term how should we think about the premium trends in that business?

Michael Neidorff

Jesse?

Jesse Hunter

So I would say, it’s hard to tell obviously at this point given the variability of benefit design and some of the other things in these programs but by definition these are going to be somewhere in between a Medicaid program and a commercial program and I would expect that the premiums would be somewhere in between a Medicaid, you know paying a premium and a commercial premium.

Scott Fidel

So you think somewhere like $150 to $200 PMPM?

Jesse Hunter

I mean it’s hard to put a number on it I would say at this point. If a state is going to kind of design a richer benefit I would expect the premiums to be higher than that.

Michael Neidorff

There’s cost sharing they do, there’s just really, we call it a hybrid because it’s really just as Jesse said between the Medicaid and commercial and it’s how they design and what features they put in will drive that, Scott.

Scott Fidel

Okay, so maybe more like $200 to $250. And then just on the margin side. Do you think about that again, sort of running in between what you think if we think about Medicaid margins maybe being 3-6% pre-tax and commercial at least traditionally being sort of mid to high single digits that the hybrid would be somewhere in between that or would it be closer to Medicaid?

Michael Neidorff

We’ve said that we see margins going forward in the 3-5% range, so I think they will contribute in that range.

Operator

The next question is from Scott Green of Banc of America Merrill Lynch. Please go ahead.

Scott Green -Banc of America Merrill Lynch

Could you update us on your interest in the Louisiana market. There’s no RFP there so I think health plans need to start building networks there sometime soon if they’re interested.

Michael Neidorff

Okay Jesse, you’re doing development.

Jesse Hunter

I would say that we’re intimately aware of the activities in Louisiana and we continue to look at all states and evaluate if these are good opportunities for us.

Scott Green

Do you think Louisiana’s a good opportunity for you?

Jesse Hunter

I think generally we would not, we don’t comment on our decisions in our states before we actually enter the states.

Michael Neidorff

We usually let the states announce who has entered. That’s just a safer position to take. It avoids a lot of speculation.

Scott Green

Okay, and then a follow up question on Massachusetts. Was the Commonwealth Care auto-assignment suspension lifted, or is that still in place?

Jesse Hunter

It’s kind of both I would say. So there was a removal, or a reinstatement of auto-assignment in the second quarter of, calendar second quarter of 2010. At this point, in the context, as Michael mentioned, of the state budget, they’re reevaluating the auto-enrollment for the current quarter, so third quarter, of 2010.

Scott Green

Okay, so maybe could you help us out directionally just on your enrollment outlook in the state there. Do you think it should continue to slowly rise like it did this quarter, or . . .

Jesse Hunter

I would expect continue. Given our cost position in the market, I would consider there to be a slow but consistent increase in our ComCare enrollment.

Scott Green

Okay, and then lastly just to clarify, so is your Bridge contract good through year end now, and then maybe longer depending on what happens to FMAP? But at least through year end?

Jesse Hunter

The current contract was renewed from July 1, 2010 through June 30, 2011. We’re working with the state on the funding for that contract and any implications on time.

Scott Green

But your understanding is now it’s still in place and should be in place through the end of the year at least.

Michael Neidorff

As a (inaudible) assumption, that’s what we’re working with the state on. And I want to emphasize though it’s 20,000 lives, so we’re working with them on it, we’re putting attention to it, but it is 20,000 lives, on a lower-premium product.

Operator

The next question is from John Rex of JP Morgan. Please go ahead.

John Rex - JP Morgan Chase & Co.

Could you just step me through it in the cash flow, so think about the first half, and can you roll me through where we are in July? Just I want to see where we are now. So I think you said, so if we’re about $100 million negative in operating cash flow for the first half, you said I think you got a $57 million cap payment early July, right?

Thomas Carroll

Right. Two things I would say. The states paid us in advance in 2009, so we had a very strong cash flow from operations in the fourth quarter of 2009, and for all of 2009, and I think it was like 2.8 times earnings in 2009. So obviously if we got $92 million in 2009 that was not paid to us in this year at the June 30 quarter end. The $57 million was deferred from June until July. We received that in the first few business days of July and it’s all in the bank by I think July 7. The real question on cash flow is what the states are going to do at any quarter end, so at September 30 or December 31 will they pay us an advance or not? I have no way of telling whether at December 31, 2010 we would receive another $92 million at year end like we did last year or whether we got it the first week of January. So that’s the issue, is just the variations at any quarter end in terms of what the states will do.

Michael Neidorff

I think an important factor, John is that this is not a matter of a payment that’s in dispute in any way. This is non-disputed cash, which is essential, is just the state deciding on the timing. I know last December, I remember in January we talked on the year-end call that we had gotten all this strong cash flow, that it would impact the first half of ’10 and maybe longer. So I mean it’s the same kind, if we get paid June 30, as you know, if we get paid June 30 or July 1 it’s how it’s reported on the quarter but it’s still the same company with the funds in the bank.

Thomas Carroll

And this is applied equally to all managed care organizations within a state, it’s not just us.

John Rex

Right, so but if you look at yourself through where we are in July, right now, are you still ahead on payments for calendar 2010? That is or behind, I mean shouldn’t you be evening out here?

Thomas Carroll

We will even out in the second half of the year we believe. We’ve got the $57 million we said which was not paid at June 30 but again the $92 million we received in 2009, related to 2010, was benefitted in 2009.

Michael Neidorff

Yeah, I’m not forecasting this is what will happen, but if one of the states, Georgia or Texas or somebody, says we’re going to pay you October 1 instead of September. That’s not something we really control.

Thomas Carroll

It’s part of the state’s budgeting system and in all honesty we would prefer they push it back a week or something rather than have lower rates, so . . .

John Rex

So if you were on a normal payment pattern, let’s say you get on a normal payment pattern over the course of the 3Q, are you going to be in a meaningfully positive cash flow position by the end of the 3Q? It still seems like you’d be kind of lagging even with the 3Q on a normal payment pattern.

Thomas Carroll

Well we’re minus $100 million roughly going into the third quarter so we’d have to make all of that up. We do expect to have a strong cash flow quarter but whether we make up the whole $100 million that we were short for the first six months, we’ll have to wait and see on that.

Michael Neidorff

If we got that $100 million plus all normalized payments for the quarter and they didn’t drag in any others, it would be a cash-strong quarter. If we get $100 million and they drag fifty of it, it’s still a good quarter. You just can’t, it’s just not something easy, a lot has to do with how their tax revenue comes (inaudible).

Thomas Carroll

As I said I think at Investor Day, this is really, it’s not even an economic issue because it’s a matter of days that they defer the payments in most cases, so it’s really more just the metric for cash flow that’s impacted.

John Rex

Okay, and then back on your rate commentary, so based upon the discussions you’re having with the states that remain in 2010, is your expectation that you won’t get a flat rate update from any of those major states, that they’ll all be somewhat in positive territory at this point?

Michael Neidorff

Well obviously we’ve commented that we went from a 0-2 to a 1-3 based on 30% of the . . . so yes we expect that all the states we’re talking to will show positive movement.

John Rex

And when will Georgia be done is your expectation?

Michael Neidorff

Well they did better last year than they did the year before.

John Rex

Where would you put it in terms of how far along, are you 80% of the way there in terms of being done?

Jesse Hunter

I think they’re ready to seek CMS approval. How long that will take is unclear. I would hope and expect to see it in the third quarter but can’t be positive.

Michael Neidorff

And with CMS approval they can drag their feet. The person could be on vacation. What’s important is did they get the rate, did they approve it? And they will retro it to July 1, which will help cash flow.

John Rex

And has Georgia given you any indication yet how the RFP process is going to work? I guess this contract, what, renews in 2012 for the first time since you won it. Is that right?

Jesse Hunter

Yes, that’s correct.

John Rex

And so is your expectation that they’ll be putting out an RFI or anything at the end of this year, or will that lag into 2011 when you see that, and have they let you know if that will be a full blown re-procurement?

Michael Neidorff

John, you have an election. The governor’s termed out, and you have an election coming up and you’ll have a new governor absolutely for certain come January, and he’ll probably have some new people working for him. And that’s when you find out how they want to go about it. Anything I speculate now would be probably premature.

John Rex

Is it a given, though, that it has to be, do they have an option to extend another year or is it a given that it has to re-procured at this point?

Michael Neidorff

Sure. Mark?

Mark Eggert

I believe they do have an option but I would expect that they’ll re-procure.

Operator

The next question is from Josh Raskin of Barclays Capital. Please go ahead.

Joshua Raskin - Barclays Capital

Question around exchanges and you know, as regulations are going get put in place over the next few quarters or years even, and you guys have a little experience obviously in Massachusettes, so what should we be watching out for as the regulations come out around exchanges? What are some of the key important facets of a successful exchange that you guys are looking for? You guys have been more than obvious about your intent to participate, just want to make sure as those regs are coming out that they’re sort of moving on the right pace. What should we be looking for?

Jesse Hunter

Josh, this is Jesse. So I think there’s a few things, we’ve talked about it a little bit at Investor Day, just kind of a refresher on some of the highlights. I think, you know, as we’re looking at the structure, I think in a lot of the exchanges are we talking about, you know, what is the platform if you will? Is it going to be primarily a Medicaid platform, or a commercial platform? And so I think that one of the big variables there is the composition of the network and the reimbursement of the network. So network is going to be one of the key variables I think as we look at the model and particularly in the context of how do you try to manage costs within the exchange program. So obviously there are certain network strategies and network reimbursements that would impact the underlying cost structure. Benefit design and flexibility of benefit design is going to be another key variable. So what is going to be articulated by the state or the entity who is managing the exchange and then what is flexible, and what is kind of available for the participants in the exchange to create or modify the benefit design. So I think those are the two that I would put towards the top of the list as we’re looking at the various states and alternatives and discussions that we are participating in this state-based exchange rule-making process.

Michael Neidorff

I think what I would add to that is at some of the governor association meetings, governors approached us to get our thoughts and we talk to them about some benefit designs depending on the percentage of poverty level, about carving in the pharmacy, carving in behavioral and other things, and how, you know, alternatives around that, though there’s, though we’re kind of participating but at, and to draw on some of our experience we have a voice in it but ultimately they’ll decide what they want to carve in, what they want to carve out, and just how they want to go about it.

Joshua Raskin

I know Michael, you said some of the states were already sort of working towards that. I know the states kind of have an out if I guess they want to sort of punt it and put it to the feds to create the exchanges and I know we’re still a couple of years away but it doesn’t sound like there’s been a ton of progress yet. Do you think there’s a chance that some of these are federally run, or do you think this will all be done at the state level?

Michael Neidorff

You know it’s really interesting because I think there’s 12 or more states that have referendums where they’re saying they don’t want to participate at all in the state program. Missouri is one of them and there’s a vote August 3 that we’re looking at. And polls for what they’re worth at the moment are snapshots. So I think that states want to be able to manage it themselves, without the federal help unless the federal government is going to guarantee they’re getting all the money they need long term. What they’re worried about is unfunded mandates.

Joshua Raskin

Just switching gears to Dallas ABD, what is the total membership opportunity there?

Mark Eggert

In Dallas Fort Worth ABD is about 45,000. I may have that here…

Joshua Raskin

And what do you think is reasonable share for you guys?

Mark Eggert

Well there’s two other players. I’m sorry, I’m looking at my notes. It’s 50,000 potential in the region. Two other players. We’re still working on developing the network there, so a little hard to anticipate what membership we’ll get at this point.

Joshua Raskin

But a third is not unreasonable.

Michael Neidorff

No, we tend to do well with the networks we’ve put together and how we manage it.

Joshua Raskin

And then just lastly the Indiana, I guess you guys have been invited for the contract negotiations, what’s the timing on that, when do we get final resolution on that?

Mark Eggert

The state is still talking with all the plans, so I would think in the next several weeks, but we don’t have a hard date.

Michael Neidorff

I mean the states, while they get fussy on how you articulate it, the reality is they’re sitting down with us talking through how to make it work, showing us what they want. We’re looking at the language, they’re looking at the language. You know, you’re in the summer months and we, I’ve typically seen in other states, because I asked the same question Josh, when are we going to know, and they say well, you’re heading into August, and they don’t have a sense of urgency. They’re dealing with all enforced players. All three, so it’s really a re-up with the three, so it’s just a matter of getting through the technical side of it.

Operator

The next question is from Doug Simpson of Morgan Stanley. Please go ahead.

Melissa McGinnis - Morgan Stanley

Good morning this is Melissa McGinnis in for Doug Simpson. I guess going back to the rate environment, in those three markets where you’re currently having rate discussions how is the uncertainty around the FMAP factoring into those negotiations? So how are those states sort of thinking about the non-extension or the extension of FMAP and what they would do to offset any loss in FMAP funding?

Michael Neidorff

We’re not seeing what they’re talking about in that context. I think I said earlier that these are states that have had plans, recognize the savings. It’s no secret, for example, that Georgia’s talked about bringing in SSI membership, doing an RFP in that some time, so they’re looking at their alternatives to expanding the markets. Oh and they’re focused on the medical cost trends and actuarial soundness.

Melissa McGinnis

And then I guess more broadly, how should we think about potential margin pressures in 2011 or 2012 given that states will eventually have to be weaned off of this incremental FMAP at some point in the next 12 to 24 months.

Michael Neidorff

I think we’ve seen the weaning process now, as I just talked about, in these states. We did take our guidance on margins from 4-6 to 3-5. They want to see the plans be actuarially sound. You have to have given reserves and so they recognize that the insurance division talks to HHS and says keep these people healthy or else we’re going to have far bigger problems, so it’s very iterative and there’ll be pressures but I don’t think it’s any different than what we’re seeing right now.

Operator

And gentlemen at this time I show no other questions in the queue.

Michael Neidorff

Well we thank you and we look forward to the Q3 call. Have a good summer.

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