Seeking Alpha
We cover over 5K calls/quarter
Profile| Send Message|
( followers)  

Executives

Drew Asher - Senior Vice President of Corporate Finance

Allen F. Wise - Executive Chairman and Chief Executive Officer

Randy Giles - Chief Financial Officer, Executive Vice President and Treasurer

Michael D. Bahr - Executive Vice President of Commercial Business

Analysts

Doug Simpson - Morgan Stanley, Research Division

Thomas A. Carroll - Stifel, Nicolaus & Co., Inc., Research Division

Carl R. McDonald - Citigroup Inc, Research Division

Joshua R. Raskin - Barclays Capital, Research Division

Charles Andrew Boorady - Crédit Suisse AG, Research Division

Kevin M. Fischbeck - BofA Merrill Lynch, Research Division

Matthew Borsch - Goldman Sachs Group Inc., Research Division

Coventry Health Care (CVH) Q4 2011 Earnings Call February 8, 2012 8:30 AM ET

Operator

Good morning, and welcome to the Coventry Health Care's Fourth Quarter 2011 Earnings Conference Call. Today's conference is being recorded [Operator Instructions] Today's call will begin with an opening remarks by Chief Executive Officer of Coventry Health Care, Mr. Allen Wise, after a brief forward-looking statement read by Mr. Drew Asher. Please go ahead, Drew.

Drew Asher

Ladies and gentlemen, during this call, we will make forward-looking statements. Certain risks and uncertainties, including those referenced in our press release and described in the company's filings with the SEC on Form 10-K for the year ended December 31, 2010, and Form 10-Q for the quarter ended September 30, 2011, may materially impact those statements and could cause actual future results to differ materially from those anticipated and discussed. Allen?

Allen F. Wise

Good morning, and thank you for your interest in Coventry Health Care. Today, I'd like to share with you our outlook for 2012, and in addition, some very brief comments and overview of 2011.

We're increasingly positive about the opportunities ahead of us, which includes our projected double-digit revenue growth in 2012. On an overall basis, we ended 2011 above our previous forecast at $3.02 of earnings per share, of which $2.87 of the EPS represents our core 2011 results, as presented in our press release, excluding the private fee-for-service runout. And we're also pleased to forecast 2012 EPS of $3.10 to $3.30, which is an 8% to 15% growth rate compared to 2011's core EPS of $2.87.

I want to spend most my time this morning talking about the 2012 and the future, which much of the groundwork is based on work that we completed in 2010 and 2011. Randy Giles, our CFO, will review the quarter and provide more detailed guidance.

2011 is a year where we're able to surpass our early financial expectations, and more importantly, lay the foundation for prospective growth. If early 2012 financial expectations were a bit cautious, it's because it was a year marked by a transition to the first major impact of health care reform with a very considerable task of implementing minimum MLRs in our commercial business.

I'd like to begin a more detailed discussion about our future, discussing our Medicaid business and the various significant progress that we are making in seizing opportunities and growing this business.

We were awarded the Kentucky contract in July of 2011, with the contract commencing in November of the same year. Based on our positioning and network efforts throughout the Commonwealth of Kentucky, we're able to achieve an outsized membership allocation compared to the other participants. In fact, we've grown again this past month, and we're now up to approximately 232,000 members.

One of the key elements to this recent growth was our ability to rapidly execute on building out a cost-competitive network. We're able to bring our collective resources to bear, including leveraging our centralized operational functions, and we imported one of our experienced executives to Kentucky from our existing business. The point to all this is that we're a resourceful company with over 14,000 employees with experience in all lines of business and the ability to execute simultaneous opportunities. It's really early in the Kentucky contract, and we're still refining operational processes and programs as this was a previously unmanaged population entering managed care. Even though it's really, we're very optimistic and confident that we'll have a successful partnership with the Commonwealth of Kentucky for years to come.

I want to continue on the Medicaid topic, and we have some additional news to report, which is another recent win that we would like to highlight this morning. Our company has been notified by the state of Nebraska of its intent to award a contract to Coventry to provide services for the state's expansion of the existing Medicaid managed care program. The Nebraska Department of Health and Human Services intends to expand managed Medicare services from the existing 10 county program to cover all 93 counties in the state, which is an estimated incremental 70,000 additional Nebraskans.

As you may recall, we won a bid in 2010 for the original program and currently serve approximately 50,000 members in the existing Medicaid program. So subject to the finalization of the contract with the state of Nebraska, we expect to be 1 of 2 managed care contractors providing services to this expanded population later this year.

Staying with Medicaid, also during 2011, we were able to seize an attractive 2-state Medicaid acquisition opportunity by acquiring Family Health Partners and entering into a long-term relationship with its previous owner, Children's Mercy of Kansas City. This acquisition, which closed effective January 1 of 2012, has Medicaid contracts in both Kansas and Missouri. We were able to expand in Missouri, a state we have served for over 15 years, and entered the Kansas Medicaid program, where there's an expansion opportunity for 2013 and beyond.

Including this acquisition, we have a meaningful multiline presence throughout our Midwest 7-state region, which now serves 1.5 million members. We were able to execute on this multifaceted transaction for a reasonable net investment of approximately $50 million, net of tax benefit and statutory capital we were able to leave behind based on the structure of this transaction.

To summarize the Medicaid discussion and quantify the growth for the year, we started 2011 with 470,000 Medicaid members and reported $1.38 billion of Medicaid revenue in 2011, which represented approximately 11% of our total revenue. We expect to double these figures with more than 915,000 members beginning in 2012 with a full year revenue forecast of around $2.7 billion.

Medicaid is projected to represent just under 20% of the company's revenue in 2012. I think that investors should think of Coventry as having a meaningful exposure to Medicare growth and penetration opportunities with a proven track record of winning new business, executing and operating these Medicaid businesses but without the concentrated risk and the inherent volatility and contract alliance of a single-line carrier. While the process of winning new business is competitive, we very strongly believe that we'll get our share in the future. We know both how to compete and how to manage this business.

Moving away from Medicaid and talking about Medicare. We're equally enthusiastic about the recent results in Medicare. As you may have seen in our press release a few weeks ago, we had a very successful 2012 annual election period. As most of you know, a lot of this work to achieve success is done well in advance. And as we have previously promised, we focused on laying the foundation during 2011 to grow both Medicare Advantage and Part D in 2012.

In Medicare Advantage, we're in 15 states, and we have seen 2012 growth across 14 of those 15 states. The most recent enrollment for Medicare Advantage is approximately 250,000 members, which is ahead of our previous estimate, and results in membership growth of about 13% so far in 2012. We've grown from 137,000 Medicare Coordinated Care members at the end of 2008 to 250,000 today for a compounded annual growth rate of 16%. We're well proportioned -- or positioned to continue taking the advantage of this attractive demographic growth opportunity where we're able to provide a tangible value proposition to seniors and to the federal government.

On Part D, we had a successful enrollment period, growing membership of about 25% out of the gate and adding almost 300,000 members.

2011, as you know, we spent a lot of time talking about the work we were doing on product design and developing, creating partnerships, and we had successfully launched the third product with a preferred network in 2012's annual election period. We increased both our auto-assign footprint and our mainstream membership coming into 2012. Our company has consistently been profitable in Part D in both membership channels since we launched in 2006, and 2011 was no exception, with an aggregate Part D loss ratio of 81.7% for the year.

During 2011, a lot of effort went into forming an attractive set of products and establishing partnerships with Walgreens, Walmart and Target for our newest product. We also renegotiated our PBM contract with an improved Part D cost structure and enhanced other areas of Part D, including distribution. I think Part D is a great example of our abilities to successfully execute on multiple growth opportunities given our focus on resources, touching multiple product lines. Our cross-functional teams went back to the drawing board after 2010 and created a product that is low-cost structure and which is proven to be attractive to the senior population.

And as you might well imagine, we're currently hard at work on our products and positioning for 2013 and very optimistic about our prospects in the future.

Think about our company with Medicare at about 30% of the company revenues and Medicaid at about 20%. So we've evolved about half of our revenue coming from government programs. There continues to be attractive opportunity to grow in the current programs, while there is a significant longer-term opportunity to serve the dual-eligible population. Medicaid and Medicare experience, footprint and capabilities are all important ingredients in positioning to serve dual eligibles. We are currently in 10 states for Medicaid and 15 states for Medicare Advantage. 8 of our 10 Medicaid states have filed letters of intent with CMS to integrate the dual-eligible population in their states.

And for decades, we have provided complex care management and have served members across population, products and geographies with a cross-section of chronic condition, diseases and needs. We currently serve aged line to disabled members and other high-risk patients in Medicaid. We currently serve Medicaid members up and down the risk score spectrum, including dual eligibles.

Serving members with the most chronic and debilitating diseases should not be taken lightly, but this population is one that can significantly benefit by coordination of care or active chronic condition management, pharmacy management, social services and all the programs that we have built over the past decade to manage our current diverse population.

Managed care should be able to make a meaningful, positive impact on the lives of dual-eligible population, and therefore, provide a valuable -- a value proposition for the states and federal government. Based on our footprint, exposure to both Medicaid and Medicare capabilities and a history of managing diverse populations, we like our early positioning for this longer-term significant opportunity, and our company will continue to invest in Medicare and Medicaid growth, along with dual-eligible populations.

Moving to our commercial business. Our Commercial Risk revenue was up 8% for 2011 with stable membership versus 2010, which is reasonably satisfying given the first year impact of health care reform, including minimum MLRs, which were effective January 1 of last year.

We knew it wasn't going to be easy managing 121 different measurement sales in our Commercial business and dealing with the burdens imposed by the new laws and regulations, many of which fell very short on clarity coming into the beginning of 2011. As Randy Giles will cover, as expected, we ended the year with significant minimum medical loss ratio rebate accrual, which will get finalized and paid out in 2012. Our goal for 2012 and beyond in the commercial business is to maintain margin and see the growth opportunities that we expect to develop as a result of consolidating market conditions driven by a commitment in this sophistication required to operate health care in the health care reform environment.

And in this context, we're actively preparing for the potential 2014 expansion [indiscernible]. We'll continue to work on attractive commercial expansion opportunities, both through acquisitions and organic growth and increase our footprint with providers and high-performance networks, which will drive lower-cost products to complement our product portfolio.

As of today, we have signed approximately 30 high-performance network contracts across our product lines. These arrangements run the spectrum from large-scale health systems to local-based primary multispecialty provider groups. 17 of these 30 high-performance networks covers our commercial product in 14 states and we feel should position us very well, especially in an exchange environment.

As you can tell, we're very positive about our opportunities across our diverse footprint in Medicare, Medicaid and commercial lines of business. We feel that the commercial business could represent a meaningful growth opportunity in 2014 and 2015 and allow us to be diversified in addition to key substantial Medicaid and Medicare growth opportunities.

In addition, we have over $1.1 billion in higher-margin and diversified fee-based revenue that complement our risk business and provide free cash flow for deployment to increase shareholder value.

Continuing on my comments regarding our future plans, we're going to pursue organic growth in our existing businesses. We're going to pursue selected RFPs. We're going to deploy capital for acquisitions, and in addition, consider future share repurchase. I think we're not only positioned well from a business and growth perspective heading into 2012, but we also accomplished a good deal relative to our balance sheet in the past year, and Randy will address that later. We sit here with $900 million in deployable cash, and that's after posting on a meaningful transaction, buying back over 10 million shares in 2011 and paying off our 2012 note that recently came due.

We're exiting 2011 on track after increasing EPS guidance 3x during the year, and we're able to provide 2012 guidance, which results in 18% to 15% core EPS growth in 2012, coupled with double-digit revenue growth. We continue to have a strong and flexible balance sheet with a combination of free cash and additional debt capacity.

I like our positioning and balanced exposure across Medicaid, Medicare and the commercial line, as well as our capability in seeking and seizing the right M&A opportunities. We're getting results from the work we have done, and we'll continue on this path to deliver more growth.

So what does it take to deliver growth? Well, it takes capital. It takes capable, experienced executive team. It takes experience in the M&A area. It takes focus. It takes discipline. It takes the ability to move quickly. These are all capabilities our company has. I am more optimistic about our future than I have been any time in the recent past.

Randy Giles is going to walk you through the results and provide detailed guidance with additional commentary on our business. And with that, Randy?

Randy Giles

Thank you, Allen. I'll begin this morning by discussing our performance in the fourth quarter and then spend a majority of my time reviewing our detailed guidance for 2012. Before I go through the details for each of our businesses, I want to first start at the consolidated level. Our GAAP EPS for the fourth quarter was $0.60, which includes $0.02 related to the runout of the Medicare Advantage Private Fee-for-Service business. For the full year, we reported EPS of $3.02, excluding the litigation gain in the second quarter, compared to our previous EPS guidance of $2.95 to $3. This includes $0.15 of earnings related to Private Fee-for-Service and $2.87 of core EPS for 2011.

Similar to last quarter, we have provided a table and reconciliation of these earnings metrics on Page 3 of our earnings press release. I'm very pleased with these results for 2011 as we were able to outperform our earnings guidance each quarter during the year, grew our Health Plan membership by more than 7% from the prior year, position ourselves for continued growth in 2012, deliver the largest Medicaid RFP win in the company's history and utilize the strength of our balance sheet to seize an exciting growth opportunity while repurchasing more than 7% of our outstanding share count.

These successes have positioned our portfolio of businesses very well for 2012, which I will highlight in detail after first giving you a little more color on the 2011 performance.

In our commercial business, first, one housekeeping item. You'll notice that we have now aligned our reporting of revenue PMPM and MLR percentage metrics to be consistent with the rest of the industry by disclosing Commercial Risk as opposed to our historical disclosure of Commercial Group Risk statistics, which excluded the commercial individual business. In addition to creating a better comparison to our peer group, we also wanted to recognize the growing impact that the individual business is having on our commercial results as we continue to increase our market share and invest in building out our capabilities in advance of the potential membership opportunity in the exchanges.

In 2008, for instance, we had 123,000 individual members. Whereas today, we have slightly more than 200,000 members. Also, the individual MLR has become much more comparable to the small group MLR due to health care reform regulations. This new disclosure structure is reflected in the earnings release issued this morning for both the current period as well as all historical periods disclosed.

Our commercial MLR was 83.7% in the fourth quarter and 81.6% for the full year, which is slightly above our previously provided guidance. As we continue to gain clarity on the minimum MLR regulations during the back half of 2011, we had to refine our rebate calculations to reflect the allowable underlying cost of certain internal and external medical-related vendors. We began the year expecting to be able to reflect medical-related payments to internal and external vendors in their entirety as such in the minimum MLR calculations. But based upon clarity we gained in MLR rules in Q3 and subsequent data gathering from our vendors in Q4, including our external PBM, we made adjustments that increased the medical loss ratio. I highlight this for you as it had about a 50 basis point impact on our full year 2011 commercial MLR relative to our initial guidance.

Within our commercial book, our view of fundamental prospective trend remains unchanged in the range of 8% plus or minus 50 basis points with unit cost trend continuing to be the largest driver, albeit stable. In the rearview mirror, we can see trends the mid-7s that continue to move higher off of the extreme low levels seen during the second half of 2010. These trends include the impact of the health care reform regulations implemented on September 23, 2010, which has had between 150 and 200 basis points of impact on the trend this year that will not recur in 2012.

Inpatient utilization, realized at[indiscernible] the lows of late 2010, continues to show a negative trend, as it has throughout 2011. Similar to what we disclosed to you last quarter, we're seeing outpatient physician trends creep up and move from negative into slightly positive territory. Just to put in context, remember today's trends are being compared to the lowest level of utilization trends seen in years, a historically low base line from late 2010.

And probably most importantly, our pricing structure is predicated on a forward view of trend in which we have anticipated a return to more levels -- normal levels of utilization above what we've seen in the rearview mirror. This pricing is expected to generate higher absolute rate increases than what we're seeing throughout 2011 as we've established a new baseline with many of the adjustments related to health care reform already addressed and the benefit of the extremely low utilization late 2010 has already been passed through to our experience-rated customers.

Finally, the commercial results. I want to share our customary statistics around health care reform, which are consistent with the projections from the last call. For 2011, we generate total Commercial Risk revenues of just under $6 billion. Of that total, individual business generate approximately $375 million of revenue with the vast majority of this business in a rebate position. The remaining $5.6 billion of group risk revenues were split roughly 40% small group and 60% large group with approximately half of our small group business in a rebate position and a little less than 1/4 of our large group business in a rebate position.

It's important to note that rebate exposure is something that we've been managing carefully with a number of actions taken to utilize rebate capital during the year, including providing more value to our customers, also promoting quality initiatives with hospitals and providers to improve risk scores, strengthen overall quality of care and to create opportunities to lower future medical costs. This has driven our rebate estimates down significantly from our initial view in 2011. In 2012, we expect to benefit from certain renegotiated external vendor contracts, which will serve to decrease our overall cost structure and reduce our rebate accrual in 2012. We view our estimated rebate for 2011 as reasonable given the size of our book of business, this being the first year navigating these new regulations, and the inherent loss ratio variability that exists when calculated at the market size segment and state level.

While we did not assume any benefit from the multiple states that had minimal MLR waiver request pending with HHS, we were disappointed to see waiver request denied in some of our larger states, including Florida and Kansas. This result creates a more challenging operating environment for the individual business in these markets or force us to continue to evaluate our participation in that product on a market-by-market basis. Of the states with waivers currently pending with HHS, North Carolina is the only state where Coventry has an individual presence.

Moving on to government programs, our Medicare results for the fourth quarter were a continuation of the strong results that we saw throughout 2011 and an even better result than 2010. Our Medicare Advantage MLR of 82.3% for the quarter and 82.9% for the full year was a very strong result and one that gives us confidence in our bid positioning as we look to towards 2012. Our Medicare Part D results were also strong as the fourth quarter MLR of 60.5%, full year MLR of 81.7% were both better than our expectations and an improvement from the prior year.

As Allen already highlighted, we are excited about that growth trajectory that we've built for the Medicaid business with revenue growth of more than 20% and membership growth of nearly 50% in 2011. Our Medicaid results in the quarter were consistent with our expectation as we saw an uptick in our reported revenue PMPM, as well as MLR percentage, with the inclusion of the new Kentucky contract, which was effective on November 1.

Finally, we closed out 2011 with another excellent SG&A result, reporting a full year expense of $2.015 billion as compared to our initial guidance of $2.02 billion. This accomplishment is particularly impressive when you consider that while we were holding absolute SG&A spend just below our initial guidance for the year, we were simultaneously able to grow revenue above the initial guidance midpoint by more than $425 million.

Full year expense, including the elevated level of spend during the fourth quarter related to the successful Medicare enrollment period and the launch of the new Kentucky Medicaid contract, which together, bought more than 0.5 million new members to the company.

Before we get into 2012 guidance, let me first review some metrics on our balance sheet and cash flows. Our investment portfolio remained in a high-quality position with a net unrealized gain of $97 million at year end, an increase from $90 million in the prior quarter. As of January 31, we had $900 million of deployable free cash available, which is after retiring $234 million of senior notes earlier in January, as well as the deployment of $100 million during the fourth quarter for share repurchase. Recall that one of our accomplishments in 2011 was repositioning our balance sheet by issuing 10-year $600 million senior notes in June 2011 and renewing our credit facility.

We have no scheduled debt maturities now until 2014, having an undrawn $750 million credit facility that isn't scheduled to expire until 2016. This gives us a great deal of flexibility as we pursue capital deployment opportunities. And as you have seen throughout 2011, while acquisitions remain our first priority for capital deployment, we're also committed to returning capital to shareholders through opportunistic share repurchases, as seen through our deployment of $328 million in 2011.

Moving on to our cash flow results. You'll recall that we received an extra payment from CMS in the third quarter, so you can see the impact from that on the deferred revenue line in the fourth quarter results and then in the immaterial impact from deferred revenue for the full year. The full year result was impacted by the second quarter litigation settlement. So after adjusting earnings for the litigation items, our cash flow from operations was $496 million or 112% of net income for the year. As you can see on the other receivables line of the balance sheet and cash flow statement, cash flow from operations was negatively impacted by the timing of certain Medicare Part D receivables related to the 2011 program year that we will collect from CMS in 2012.

So with a successful 2011 behind us, let's now discuss our outlook for 2012. Today, we are providing initial 2012 EPS guidance in the range of $3.10 to $3.30, which is an increase of 8% at the low end and 15% at the high end, versus the comparable 2011 EPS of $2.87. In that aggregate, we are projecting total revenues are nearly $14 billion, a growth of approximately $1.75 billion, which is up roughly 15% at the midpoint. We are forecasting an increase in consolidated MLR percentage, which is driven by changes in the mix across our portfolio businesses towards the growth in government programs.

In 2011, commercial revenue represented approximately 50% of the company total with an additional 30% Medicare, 10% Medicaid and 10% other, including Fee businesses. Our guidance for 2012 projects around new composition of just over 40% commercial, 30% Medicare, 20% Medicaid and just under 10% Fee and other. This is consistent with our goal to have a balanced portfolio with the ability to seize opportunities across the product spectrum.

On the topic of medical cost structure, we have recently renegotiated and extended our PBM contract with Medco for a multiyear period effective January 1, 2012. We were able to secure an improved cost structure and contract terms that give us more flexibility as we continue to react to the rapidly evolving health care marketplace. Given that pharmacy spend represents nearly 20% of our medical expenditures, this is an important improvement to a critical part of our overall cost structure across our product portfolio.

Moving on to SG&A. I'm particularly pleased with the efforts that the organization has put forth on driving down our SG&A percentage of revenue from 16.5% in 2011 to a midpoint of 15.4% on our 2012 guidance. I've been personally involved in working to identify cost reduction opportunities across the company that have allowed us to forecast a strong result for 2012 while simultaneously also making critical investments for the future in our core businesses. These investments include improved direct distribution capabilities from the individual business, enhanced care management tools, the addition of substantial Medicare and Medicaid resources, not to mention the ongoing increased compliance costs. And that's just to name a few.

On the non-operating items, you'll note that the tax rate is increased over 2011, which is primarily driven by a shift in the mix of earnings towards states with higher tax rates and also about compliance with new health care reform regulations.

Finally, you will see our share count guidance which assumes that we essentially hold the share count flat from where we ended 2011. It's important to note that today's EPS guidance range does not incorporate any meaningful deployment of the free cash that is sitting on our balance sheet.

Now moving more specifically into our largest lines of business. For Commercial Risk, we are forecasting membership levels to be slightly down for 2011 levels with a decrease in Q1 2012 driven by a handful of large group terminations followed by growth during the remainder of the year. We continue to price ahead of trend and remain disciplined in our objective of maintaining margin over pursuing membership gains.

On the expense side, we are projecting MLR of 81.5% plus or minus 50 basis points. This MLR guidance incorporates mechanics of the minimum MLR rules, our view of pricing by market, a forward view on medical trends, our mix of business and a pragmatic view that you always have deviations from the mean as you manage your portfolio of 121 measurement cells. This is a slight improvement from 2011, and it's that '11 that we view as sustainable under health care reform in today's operating environment.

In Medicare, the membership story is excellent for both Medicare Advantage and Medicare Part D. As Allen noted earlier, we're starting the year with approximately 250,000 Medicare Advantage members, which is an impressive growth result of about 13% from 2011. Our Medicare Part D business was also very successful during the annual election period as we grew by almost 300,000 members, or about 25%, and we are forecasting continued growth throughout 2012. This growth is a nice mix of retail purchases in our innovative new value plus product and partnership with Walgreens, Walmart and Target, as well as our increased auto-assignment presence in 23 regions for 2012, up from 15 regions in 2011. Based upon our bids and our view of where we exited 2011, we are forecasting MLRs in the low to mid-80s for both Medicare Advantage and Part D.

Staying within government programs, our 10-state Medicaid business is the biggest part of our 2012 growth story with total revenue expected to nearly double from just under $1.4 billion in 2011 to nearly $2.7 billion in 2012. Today, we are just about 915,000 members and expect to be in the zone of 950,000 Medicaid members upon implementation of the new Nebraska contract. We are projecting MLR of approximately 90% in 2012, which is a combination of our same-store business, which runs in the mid- to high-80s, and MLRs in the 90s for the year 1 RFP wins and the newly acquired Family Health Partners business in the Midwest.

So now we've covered the large risk business, you'll notice that although we are still forecasting over $1.1 billion of fee-based revenue, our guidance for fee revenue is down a little, more than 3% due to the loss of one Workers' Compensation Services account. However, you also see a decrease in cost of sales expense item directly associated with Workers' Compensation Services, which more than offset the aggregate fee revenue reduction. Our Fee businesses continue to be an important component of our overall product portfolio, providing valuable unregulated cash flows and are an area that we intend to grow and invest in prospective.

So in conclusion, our efforts in 2011 lay the foundation for the 2012 guidance that we provided today. We firmly believe that growing the top line is critical in today's environment and are pleased to see 2011's efforts bearing fruit in 2012 with the revenue guidance midpoint of nearly $14 billion, coupled with an increase in both operating earnings and EPS. So while we may be pleased with the 2012 growth outlook, by no means are we satisfied. We will continue to invest in the future, focus on managing our portfolio of businesses in a manner that allows us to seize growth opportunities while also maintaining the right balance, limiting our exposure to any one area. We will continue to introduce growth opportunities, both organically and through acquisition, to strategically position Coventry to deliver the long-term results that our shareholders have come to expect.

Operator, this now concludes our prepared remarks, and we are ready to open the line for questions.

Question-and-Answer Session

Operator

[Operator Instructions] We'll go first to Doug Simpson with Morgan Stanley.

Doug Simpson - Morgan Stanley, Research Division

So Randy, maybe just to expand a little bit. I think you said 81.5% for the commercial MLR in 2012. Did I hear you right?

Randy Giles

Yes.

Doug Simpson - Morgan Stanley, Research Division

Is that -- okay. So can you just sort of walk us through -- the Q4 MLR came in, I think, on the commercial side higher than people were expecting. You talked about the inclusion of -- or the inability to include certain costs in the rebate calc, and that obviously, I think you said 50 bps for the year. So roughly 200 basis points into the Q4 number. Is that fair?

Randy Giles

It's more like 140 into the Q4 result.

Doug Simpson - Morgan Stanley, Research Division

So it added 140 to the commercial MLR in Q4?

Randy Giles

Yes.

Doug Simpson - Morgan Stanley, Research Division

Okay. So can you just help us sort of think about a map from the 2011 experience into 2012? Just how -- sort of maybe walk us through your thoughts around the commercial MLR from 1 year to the next given sort of those dynamics and your Q4 jumping off point.

Randy Giles

As we think about 2012, there were certain trend drivers that we think are not going to recur into 2012. One of the things, was you might recall, we experienced lower prior period of volume during 2011 and 2010. And you can see from today's earnings release that our DCP increased by 4% from the prior year end. So I feel comfortable that, that pressure is not going to recur. As we go in, we've also improved our cost structure, as I mentioned, around our pharmacy particularly, and we have some other actions we're taking around cost structure that give us a pretty good feeling about where we're going to be in 2012 versus 2011.

Doug Simpson - Morgan Stanley, Research Division

Okay. And then -- and just in terms of your commentary on utilization and trend in the Q4 period, it didn't sound like you saw anything new or different there. But can you just give us maybe more color on that front?

Randy Giles

Sure. As we think about trend in general, what we're seeing, as I talk about inpatient, commercial bed days were down low- to mid-single digits in Q4 2010. Medicare Advantage bed days were down low- to mid-single digits. And commercial admits were down mid-single digits from Q4, and Medicare Advantage admits were down low- to mid-single digits from Q4 2010. So the position we're seeing is somewhat uniform utilization trends across primary care, surgical specialists and lab. And on the outpatient side, the areas that we see higher utilization in include areas like dialysis, injectable drugs and cardiovascular, other areas we're seeing trend pressuring.

Doug Simpson - Morgan Stanley, Research Division

Okay. And then maybe just switching gears on the use of capital. You guys obviously bought back some stock in Q4. I think the cash balance is right about $900 million now. How do you think about deploying that, thinking about the M&A backdrop, the opportunity to buy back stock? I mean, if you look out 12 months, would you expect to still have that sizable of a cash balance? Or if you don't see things out there on the M&A front, would you look to kind of bring that down and think about keeping your debt capacity as your dry powder for deals to the extent they present themselves. How long would you guys kind of run with a heavy cash balance?

Allen F. Wise

I think you can expect 2012 to look like 2011. We spent $328 million in share repurchase, did a major transaction and worked on some things that didn't materialize. We will continue looking for significant size to M&A transactions, and if those opportunities don't present themselves, we will opportunistically do share repurchase. Are we going to use the whole $900 million up and live with our credit line? I doubt it because we think that there's going to be continuing consolidation. The margins are under pressure. The business is going to get tougher, and we feel like there will be opportunities to grow our business substantially, and we're going to keep some dry powder.

Doug Simpson - Morgan Stanley, Research Division

Okay. And then maybe just sneak just one last one in. Just on, I think, this call you probably talked a little bit more about the duals than you have in the past. Can you just give us a sense, I mean, how -- what's your expectation for that in terms of timing with respect to your book of business and how much effort are you making on that front at this point in terms of resources?

Allen F. Wise

Well, we're making -- what we're doing today is making certain that we can absorb almost a 0.25 million of new members that have never been in managed-care before across the whole spectrum in Kentucky. We are investing in a new IT system that improves our patient management capabilities. And we think that we can't predict exactly what dual-eligible population will be, but we work on it all the time. The timeframe when these things present themselves are uncertain. We worked on an opportunity in Kansas, which has not yet born any fruit, but we're working on RFPs in -- all the time. And so we'll have opportunities. I can't predict which quarter they present themselves, but we're investing in experience. We're investing in systems. We're investing in staff and infrastructure for the Medicaid business, and we're going to grow it.

Operator

We'll take our next question from Tom Carroll with Stifel, Nicolaus.

Thomas A. Carroll - Stifel, Nicolaus & Co., Inc., Research Division

I wanted to come back to your commentary on the Kentucky Medicaid business. It sounds like things are well there. But I guess maybe just 2 questions. Was Kentucky the primary reason for the large MLR increase in your Medicaid book? And then secondly, it seems like there might be some issues in the market transitioning from Fee-for-Service to Managed Care. I think we saw that the secretary of Health and Family Services resigned yesterday. Just maybe just, again, reiterate, is there any reason we should assume or any reason to believe this could drag earnings a bit in 2012?

Allen F. Wise

I'd answer that by saying there are no surprises in Kentucky. We understood what it would be like to convert. I think we had more enrollment success than maybe we would've guessed, but we understood when we embarked on this that it would be an arduous, difficult first 6 months or 8 months or 10 months to convert the population and the providers and the experience base there to a managed population. We have only 2 months of experience in terms of cost there, and with that 2 months of experience, there are a lot of unknowns and a lot of gaps in terms of the billing process to the providers, do we have the bills on the same schedule that we would have on existing businesses. And so there are a lot of questions because it's so new, and I think that our reserves on that front would reflect Coventry's -- in my own personal, long-term view, which is make certain if you don't know that you're properly reserved, and those will come down as we gain experience and as we get data and as we know more about the population. But there are no surprises there. It's -- we understood what we are embarking on, and I would say that it's going reasonably well with a lot of work left to be done.

Thomas A. Carroll - Stifel, Nicolaus & Co., Inc., Research Division

That's great to hear. Do you expect any type of MLR improvement throughout the year? Or is this more of a 2013 effort?

Allen F. Wise

No, I expect us to gain experience and knowledge and improve our ability to make progress there as the year progresses. It's something I can't predict by month or anything like that. But no, I have a high degree of confidence that we will improve the care for that population, improve communication with the providers, get to know the Commonwealth of Kentucky better. And just a lot of work to be done there, but we have every confidence that it'll get better as the year progresses and that long term, this will be a good opportunity for us. There haven't been any surprises. We understood when we bid and was awarded the business, we had a lot of work to do.

Thomas A. Carroll - Stifel, Nicolaus & Co., Inc., Research Division

One last one on your commercial rebates. Is there any chance you could quantify that for us?

Randy Giles

We generally don't disclose the amount of our rebate. I would just say we're at a normal level of what we would anticipate, and that was significantly reduced from our initial view going into 2011.

Operator

We'll take our next question from Carl McDonald with Citi.

Carl R. McDonald - Citigroup Inc, Research Division

On the cost trend, it sounds like you're seeing the same type of utilization that pretty much everybody else in the industry is seeing, which is, say, not very much. And yet, your overall cost trend at, call it, 7%, 8% is meaningfully higher than the sort of 5% to 5.5% that a lot of other companies are talking about. So within the unit cost, can you talk about where you think the biggest area of differential is and what's driving that?

Randy Giles

I really can't comment on what they're including in their numbers, Carl. But as far as ours are concerned, we feel like we're reporting them on a consistent basis. As it relates to unit costs for inpatient, we're seeing high single digits, which is -- it's mostly unit cost driven in terms of what we're looking at in inpatient, outpatients, low double digits, which is mostly unit cost driven. Positions mid-single-digit, which is kind of split evenly. So we're kind of seeing -- we don't really see a change there. We see -- one of the things contributing to the trend year-over-year for us is the impact of the -- as I mentioned in my script, was the impact of the health care reform changes from September 23 of 2010, that required us to go to 0 copays on preventative and other things. It had a up to 200 basis point impact on our trend number. So depending on the mix of business between us and the competition and the benefit designs that they may have had with us having more small group business with maybe higher deductibles and copayments to begin with, we might have had a bigger impact from that than they did. But that's speculation on my part.

Carl R. McDonald - Citigroup Inc, Research Division

And then back in Kentucky, what loss ratio did you assume for November and December there?

Randy Giles

We don't really break out loss ratios by market like that. I would just say that we've assumed a loss ratio in the early months with normal transition of care and phasing in of managed care processes, a higher loss ratio in the first 2 months that would -- we would expect to go down throughout the year.

Allen F. Wise

As consistent with our long-standing practices, adequate.

Carl R. McDonald - Citigroup Inc, Research Division

And then if you -- I'm just going to pick a number and say it's 100% that you assumed in the fourth quarter. It looks like the loss ratio in the other Medicaid the markets would have deteriorated something like 350 basis points. Is the driver there?

Allen F. Wise

You shouldn't make those assumptions.

Randy Giles

I would just comment on that, that the loss ratios in our other Medicaid markets did not deteriorate in the fourth quarter.

Carl R. McDonald - Citigroup Inc, Research Division

Did not deteriorate? I'm sorry, I didn't get that. You said did not deteriorate in the fourth quarter?

Randy Giles

Did not deteriorate.

Operator

We'll take our next question from Josh Raskin with Barclays.

Joshua R. Raskin - Barclays Capital, Research Division

Just on the 2 big new drivers for 2012, Kentucky and PDP, when do you think you're going to have enough claims data to start getting a better sense of where those trends are relative to sort of your underwritten expectations?

Allen F. Wise

I'll feel better in 3 or 4 months. It's -- I'm -- we're learning about billing practices, and it's new to all the providers, so I think that the -- heard but not received information is not going to be good for a bit. We have a large team on the ground there in the next couple of weeks, making the rounds with all the major large provider groups. And -- but I think if you would think of 3 to 4 months, we should have a much better feel on cost.

Joshua R. Raskin - Barclays Capital, Research Division

Okay. And then I guess in Kentucky, I hate to sort of keep harping on this, but it's a big win for you guys. There was a pretty big movement in the member selection period. And so I'm just curious, have you guys put in some consideration, changed your thoughts around potential adverse selection or what some of these members you're doing based on the difference in benefits in the market?

Allen F. Wise

No, the benefits are very close to the same. We think that the outsized enrollment period has a direct proportion to the large team we put on the ground there and the numbers of providers that we got early at competitive rates. And we did not use a third party to do the contracting. We've got a lot of health plans and a lot of people and a lot of experience there, and we put 60 or 70 of our own people on the ground there for 2 months. So we think the enrollment is unrelated to very, very minor difference in benefits and much more directly related to having people's current primary care physician or physician groups in our network earlier.

Joshua R. Raskin - Barclays Capital, Research Division

Okay. And then just last quick question on the PBM contract. Could you just give us the length on that and that any color on the improvement in terms of your costs for drugs now?

Randy Giles

In terms of the contract extended for Medicare through 2015, the commercial contract will be extended through 2016. And I can't really comment on the impacts on our cost structure, but just to say that it was a key driver for our product positioning in Part D for 2012 and a key factor for us in terms of our cost in preparing for the exchanges going forward. And the other aspect about it is really increased flexibility that we have regarding elements of the contract for the future as we're able -- so we can adapt more easily to health care changes in the marketplace going forward. So Medco has been a critical partner for us and strategic partner for us, and we continue to work that relationship and work with them to try and get to the best possible results.

Joshua R. Raskin - Barclays Capital, Research Division

Okay. Is that through the end of '15 for Medicare and end of '16 for commercial?

Randy Giles

Yes.

Operator

We'll take our next question from Charles Boorady with Crédit Suisse.

Charles Andrew Boorady - Crédit Suisse AG, Research Division

Not to harp on Kentucky but I just wanted to recall. Was that in your original guidance? It couldn't have been, right, because you were awarded it during the year? But basically, it looks like the fourth quarter and your full year results would have been much stronger without Kentucky. While you're not saying it, we can back in to the fact that it was pretty dilutive to your quarter if that's what drove up the Medicaid loss ratio that wouldn't have deteriorated without Kentucky. Am I reading that right?

Allen F. Wise

Yes.

Charles Andrew Boorady - Crédit Suisse AG, Research Division

Got it. Good. And then the Nebraska expansion, did you say that is in your 2012 guidance?

Allen F. Wise

It's not a case of new information. At this particular point in time, we don't know, and no one -- neither would anyone else after 60 days. And it's just consistent with our current practices here to not overpromise and to make certain that our reserve position is adequate. It's nothing more than not knowing, and I don't know how else you would know. We started -- acquired new businesses for 15 years here and started new businesses, maybe one not quite this large. We just don't know at this particular point in time. But there isn't any unknown, adverse information that we have.

Charles Andrew Boorady - Crédit Suisse AG, Research Division

Got it. Totally understood, and I think it's a prudent way that companies book new business in new markets, especially in that space. I was really more getting at what your results would look like were it not for that new business because it would be ironic to be penalized by investors for a big win just because of some upfront dilution.

Allen F. Wise

It's very short term, and it's going to all roll out here in a few months. And I would rather that people wonder if we're too conservative today and then sit in front of you 2 quarters from now and say we didn't know and we're not going to make our numbers. So it's very consistent with the prudence that we run our business here, and it will develop relatively quickly.

Charles Andrew Boorady - Crédit Suisse AG, Research Division

Got it. Got it. And in terms of the comments on the minimum MLR and the 50 bps higher impact from classifications, did that get offset by SG&A? Or was there a net income impact because of the need to rebate some of the impact of that 50 bps?

Randy Giles

Yes, there was a MLR impact of that additional rebate.

Charles Andrew Boorady - Crédit Suisse AG, Research Division

There was an MLR impact. But was there net income impact also?

Randy Giles

Yes.

Charles Andrew Boorady - Crédit Suisse AG, Research Division

Okay, got it. And then finally, in the Workers' Comp business, we didn't really talk about this in a while, but could you just tell us a little bit more about what your prospects are for that business? You talked about your desire to grow your fee-based services. But what drove the account loss in Workers' Comp? And can you tell us about your backlog or give us other indications of your growth prospects in the fee-based businesses broadly?

Allen F. Wise

I'm going to let -- most of you have not met Mike Bahr. Mike runs all of the commercial business in our company, which includes Workers' Comps. And that's relatively new since October of this year Tim Nolan is not new to our company but is new to running all of our government business. I'm going to let Mike Bahr answer the question about Workers' Comp because we changed it in October because there's so many common network issues and development of network resources that -- across the 2 companies, and we think it will run better integrated with the management and leadership in our company and the commercial area. Mike?

Michael D. Bahr

Charles, Workers' Comp, it is an area we're looking to grow. It's an area we're looking for opportunities to grow. As you said, it's unregulated revenue, and that's a great place to be these days. So the loss of the group, it was our second largest group, if I recall, and it was just a competitive environment. And so for us, it's -- we're in a position where we continue to look for opportunities to grow and invest in that line of business. But there's nothing specific with Workers' Comp that created the issue. So I mean, it's a line that runs well. We're centralizing some of our businesses to improve our network structure, particularly in areas where we don't have health plans. And so we're pretty optimistic.

Charles Andrew Boorady - Crédit Suisse AG, Research Division

I know that's a long lead time sale, but can you give any give a sense for what your backlog looks like generally in either Workers' Comp or the fee-based business more broadly?

Michael D. Bahr

I really can't. To be honest, I'm not in the detail on that side of it. So I can't answer that. I know that the large group we lost, some of the employers they work with are looking to come back to us for services, and we're certainly open to doing that.

Randy Giles

It's been stable for a number of years, stable meaning slight increases in revenue. We're heavily affected by the recession and the employment market and employers being much more careful about occupational safety. So it's a transaction-based business that's an acronym for claim-based or accident-based business. And in a tough environment, it's continued to add new customers and grow revenues slightly and EBITDA a little more than revenues. So it's working well for us, and we're trying to figure out how to make it better.

Charles Andrew Boorady - Crédit Suisse AG, Research Division

Was the capability or price that you lost the business on when you said things are getting more competitive?

Randy Giles

No, no, no, it was price.

Operator

And we'll take our last question from Kevin Fischbeck with Bank of America.

Kevin M. Fischbeck - BofA Merrill Lynch, Research Division

You mentioned that the rebate position, it sounds like, in Q4 was actually kind of similar to where it was, I guess, in Q3. But -- and you said that in 2012, it will be probably a little bit lower. Can you just give a little -- a sense of where you think your pools will be across the 3 areas of business?

Randy Giles

Yes. I think the -- as we look at the rebate and where we do have rebates that are concentrated still in our top 5 rate cells and small business, large group and individual. And it varies by state where those are located. But generally, if you think about the rebates, for us, they're predominantly in small group and then individual and in large group kind of in that, relative size. In terms of rebates, we think we've done a good job of managing them. We think we can get better at it in 2012, and we'll continue to work on that.

Allen F. Wise

We need to get better, and we will.

Kevin M. Fischbeck - BofA Merrill Lynch, Research Division

Is it a matter -- do you think the blocks of business will be relatively similar as far as percentage in rebates, it's just that they'll be paying a little bit less of a rebate? Or would you expect that to change?

Randy Giles

No. We would hope there will be less in the way of rebates, and we translate that to being better positioned in the markets from a price standpoint. But not an exact science, not easy.

Allen F. Wise

And remember, your averaging over the multiple years as you move out to 3 years, so it becomes more predictable.

Kevin M. Fischbeck - BofA Merrill Lynch, Research Division

Okay. And then given that this is the first year of rebates, 2012 being the first year actually paying the rebates, can you just go through the kind of the cash flow, maybe bridge for 2012 for us?

Randy Giles

Well, as it relates to rebates, there's a runout period in 2012, that will firm up the rebate calculations to what the actual results are. Once that's finalized, the payments will be made midyear. So that's the timeframe for when that gets transacted.

Kevin M. Fischbeck - BofA Merrill Lynch, Research Division

But I guess is there a way to think if you have $900 million of cash at corporate as of now where that number might be at year end if you don't deploy any capital?

Allen F. Wise

All of the rebates are in regulated subs, so accrued forward the cash backing in, separate and apart from the $900 million, which is sitting at the corporate entity. So it will have no impact in the $900 million.

Kevin M. Fischbeck - BofA Merrill Lynch, Research Division

Okay. So -- but I guess it's still too early to kind of say at this point where the dividends of the subs might be for 2012?.

Allen F. Wise

Typically, we run 85% to 90% of the current year net income, and so we're scoping out the level of dividends that we expect, inclusive of our free cash from nonregulated subs. We don't expect it'll be any different than that historical zone.

Allen F. Wise

One more question, please.

Operator

Okay. We'll take that from Matt Borsch with Goldman Sachs.

Matthew Borsch - Goldman Sachs Group Inc., Research Division

Yes. Just wondering if you could talk a little bit about the dual opportunity and how you see yourselves positioned. And I'm curious if you think that growing there is going to be more a function of your Medicaid markets, your Medicaid experience or Medicare? Or do you really think it's important to build to blend the 2 together? I guess alternatively, is this going to be wide open where companies that you wouldn't normally expect to participate will be competing for this -- with a solid basis for being in that business?

Allen F. Wise

I don't know if I can say much more than I did in my prepared comment. And I think that the fact that 8 of the 10 states that we currently do Medicaid in are applied to CMS, so to dual eligibles into managed care that some of the new RFPs are going to -- where they didn't in the past, are going to include dual eligibles as part of what we're bidding on. The -- and so over time, there'll be plenty of opportunities. We'll get some. You did -- it's just unpredictable in terms of when the RFPs come out or they keep their original schedule and how quickly we can grow the business. And I wouldn't mind having a little more experience with what we have, too. And so not like I'd like to take on 300,000 dual eligibles tomorrow, but we will, over time, get our share. The timeframe is just not predictable. But I think in terms of where we do business, the resources we have now to respond to RFPs, what we've learned about this business in the last 3 years. If you think back, we didn't add any Medicaid business for 5 years at one particular point in time. And we didn't have any infrastructure, didn't really have a department, any people, any expertise 3 years ago. So we're learning quickly and adding resources quickly, and we'll get our share.

Matthew Borsch - Goldman Sachs Group Inc., Research Division

Okay. And -- okay. Just last on a different topic on the commercial. When we look at the Commercial Risk per member revenue, is that -- how much has that impacted the PMPMs statistics? How much are they impacted by the rebating? Are they a little bit lower because of the rebating? And I was just wondering if you would be able to provide the fourth quarter group Commercial Risk, PMPM and MLR, just given that, that would tie up the year on the old basis of reporting?

Allen F. Wise

In terms of -- the rebates does impact, obviously, the revenue level. Then in terms of tying up the MLR on a Group Risk basis, we anticipate that the MLR was -- would be 40 basis points higher on a separate basis.

Allen F. Wise

Thank you for joining us today. Operator, we're complete. Thank you.

Operator

All right. Thank you. This will conclude today's conference call.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!

Source: Coventry Health Care's CEO Discusses Q4 2011 Results - Earnings Call Transcript
This Transcript
All Transcripts