Jim Truess – Chief Financial Officer
Julie Trudell – Senior Vice President, Investor Relations
Scott Green – Bank of America Merrill Lynch
AMERIGROUP Corporation (AGP) Bank of America Merrill Lynch Global Technology Conference Call May 15, 2012 11:00 AM ET
Scott Green – Bank of America Merrill Lynch
We are going to go ahead and get started here. Thank you all very much for coming out to the Bank of America Merrill Lynch Healthcare Conference. My name is Scott Green and leading off this morning is AMERIGROUP. AMERIGROUP is the largest Medicaid managed care company. With us today is CFO, Jim Truess and Senior Vice President of Investor Relations, Julie Trudell. So, I'll kick it off to Jim and then we'll just stay right here for Q&A.
Jim Truess – Chief Financial Officer
Alright, thanks Scott. Good morning everyone. We appreciate the invitation to the conference this morning and are happy to be in the leadoff slide here taking everything off. Its 8 o'clock, so it's great to see everybody here although I know a lot of your earnings calls time, so this is – this actually isn’t that early.
What I want to do this morning is I've got a few prepared remarks that I’d like to cover, just give a little overview on the company, talk about some of our most recent results in the first quarter, and talk a little bit about how we see some of the growth opportunities in the future, and then we are happy to open it up for questions and cover whatever is on your mind this morning.
So, I think it is customary at these functions. We do want to put out a Safe Harbor statement. We are going to make some forward-looking statements this morning. And I think as you know there are lot of uncertainties and our outcomes can differ from our expectations that we discussed this morning.
Okay. So, let me kick it off here and I want to talk a little bit about what we saw in the first quarter. We were certainly pleased with our results in the first quarter. You can see on this slide here that our memberships approaching 2.2 million members now with premium revenue of about $1.8 billion in the quarter. As we talked a fair amount, over the last few quarters, we are on a fairly steep revenue growth trajectory this year and we certainly started to see the beginning of that in the first quarter.
Our health benefits ratio at 85.3% was actually a little better than we expected. We recorded a certain amount of favorable development in the first quarter that helped that ratio. Our G&A ratio was 8.4% that in contrast is a little elevated, because right now we are providing a certain additional – we are making certain additional expenditures associated with new market expansions. We have a lot of business development activity going on and what generally happens in our business when you are entering a brand new market you are making expenditures in advance of actually having revenues. So, for example, we started in Louisiana in the first quarter. We are hiring staff and bringing people on even prior to our first dollar of revenue, which occurred in March.
Our net income was $33 million for the quarter. And as I say, ahead of our expectations coming into the quarter and our net income margin was about 1.9%. So, all-in-all, a solid quarter for our organization, nice start to the year and I certainly feel like we are headed in the right direction.
Let me talk a little bit about our capital deployment strategy and if you've followed the company, you've seen us used this slide before. This is our basic hierarchy that we have had in place for quite a few years and its how we think about deploying capital on our organization. First and foremost, when there was good opportunities to expand our business and reinvest in our own organization, we find that, that generally provides the highest return, and so that's really where we go first. And at the moment, we are doing a lot of investment, let's call it, in that first category and that's because our business is expanding so much this year. That primarily what we need to do is we need to increase the level of statutory capital, that's in a health plan that's growing. So, for example, as we have entered Louisiana, we startup a health plan there, we invest statutory capital. So, the nice thing is it's not as though you lose those dollars, but you need to take cash flow generated in the business and put into that regulated subsidiary. Texas is also growing substantially this year as well as some other markets.
Now, we also this year have done a significant acquisition. We just announced on May 1 that we closed the Health Plus acquisition in New York, which is allowing us to substantially expand the membership that we cover in that market. And over the years, we have done acquisitions at different times when we found attractive opportunities. We are certainly pleased about the New York situation, because we have had a business in New York for many years, have a good footprint there, but we candidly probably never quite have the scale economy that we would have liked to have seen, so we were able to announce an acquisition last year and close it in May and so we are integrating those businesses and now have a much bigger footprint in one of the largest Medicaid states in the whole country.
And then finally, when we are doing everything, we want to do in those first two categories and we still have excess cash available. We'll periodically engage in share repurchases. Over the last few years, we have done a fair amount on the share repurchase side. In the first quarter, we didn't do much on that side at all and that's really just because we are investing most of our available free cash flow in the first two as the opportunity set so deep in that category right now.
One of the things that we wanted to communicate to make sure people understand where we are at and what sorts of things were likely to change in subsequent months, you noticed at the end of the first quarter on this slide, we had unregulated cash of $824 million. And for our organization that's a relatively high number. We raised some debt at the end of last year. We have done a variety of other things really to position our organization for a series of expected expenditures that we are going to make during this year. So, the first thing is our convertible notes are maturing on May 15, so that's right on top of this year. So, those are just at their natural maturity date and those will get paid off, so that's going to be a use of cash.
As I mentioned, we also completed the Health Plus acquisition, the acquisition price is $85 million. So, that's the use of cash as well. And then as I just was describing, we are also making incremental capital contributions to our health plan. Now, you see on the slide I say net and that's because we are still collecting dividends from some of our health plans, so that's creating unregulated cash. We are also making investments. So, on balance, we are going to make more incremental contributions than we receive in dividends this year, because of the substantial growth for the company.
So, if you add those all up, there will be a variety of other smaller pluses and minuses on that number. We have – we earned administrative fees and that sort of thing in our parent company level was also generates incremental cash, but ignoring the smaller items you can see that places us about $300 million of unregulated cash, which is much closer to our historical norms.
Let me touch on our outlook parameters that we provided on our earnings call. As we can see maybe the most impressive number here on the page is the first line there, where we are expecting top line revenue growth of approximately 40%. That's one of the largest revenue growth numbers we have seen as an organization, and particularly, when you are coming off exactly, we did in excess of $6 billion in revenue last year. That's a very impressive revenue ramp and that's really due to a lot of business development activity that we did last year as well as the acquisition that I just mentioned.
Our health benefits ratio range 85.6% to 86.8%. We have lowered that range a bit on our last earnings call based upon our strong results in the first quarter. The SG&A ratio at 7.3%, you will notice that's quite a way down from what we've reported in the first quarter and that's really because as our revenues are growing through the year, we aren't having to add administrative cost at nearly the rate of revenue growth. So, we expected that ratio to come in quite a bit in subsequent quarters and put us in that 7.3% range and that's for the full 12 months of 2012.
Our net income margin were continuing to hold the range of 1.5% to 2.5%, that's a little below our historical averages, and again largely a function of the substantial amount of new business development, which as we mentioned on our earnings call, we are growing about 45 basis points of what we have called transitory cost associated with all this new business development. And our diluted share count range that we have for the year 49.5 million to 50.5 million shares.
We have wanted to describe for folks this kind of unique scenario, I think, we see in 2012, that's a little different than a normal year and it's certainly affecting the trajectory at our earnings profile quarter-by-quarter. As you can see on this slide, we have laid out a variety of the startup activities that are going on in the first half of the year. And as I mentioned, those startup activities involve higher administrative costs, and in many cases as well, we are going to have higher health benefits ratio that we report on new business and we've recorded higher health benefits ratios in the first month of the new market, because first and foremost we do expect that underlying medical costs are going to be higher on a percentage basis than our more mature business. As we are getting acclimated in the market, we are optimizing our care management efforts and we are doing all the things we do that in long run ultimately achieve medical cost savings, but those aren't fully matured and developed in a new market when you start.
In addition, when you are bringing on new business and you are building your claims liability is building, initially. You are also establishing auctorial margin on top of that claims liability estimate and so that's also a one-time effect. Once you have that claims liability established, you don't need to re-establish it again, but that also increases the health benefits ratio when you are bringing on new business.
So, in this first half of the year, Louisiana is expanding, Texas is expanding in a substantial way, Health Plus transaction that I just mentioned, and then of course, our convertible notes matured – are maturing right now, but that's also implied that we have carried sort of double interest expense to the first part of this year, because our new financing that we did last year, we issued – we have about $475 million of high yield notes outstanding. We are paying interest on those. We are paying interest on the convert at the moment that will – but the convert now comes off.
So, all of those factors are causing the first half of the year to have a lower earnings level than we otherwise would had – had all this growth not happening. And as we move to the second half of the year, we are going to go live in one more market if those ones already mentioned, we are in an (upper edge) you are going to expand and begin operations in Washington, but that’s a smaller market in your passive start-up phase in these new opportunities. And so as we get to the second half of the year, we do expect that these transitory costs will begin to come off and that will be reflected in our earnings profile.
We did provide in the second quarter some fairly detailed information with regard to how this is going to move quarter-by-quarter. And I think that's something we historically haven't done probably not a practice we are going to get into in the long run, but I do think because of all the activity going on, it has been more challenging than normal for folks in the investment community to really see what our profile is likely to look as we move through quarter-by-quarter.
So, you can see here, I won't go through all this in tremendous detail, but let me just touch on a couple of the key points. We do think that our revenue growth sequentially from the first to second quarter is probably going to be more than $400 million and that's because the most substantial amount of revenue growth comes in, in a full quarter basis in the second quarter. So, we also – and this is normal. We expect that there will be a favorable impact – favorable sequential impact on medical costs as we move to the more favorable seasonal time of the year. That's slightly – the change between the quarters is a bit more significant this year, because the first quarter with the extra day this year had a more extreme seasonality factor than it normally would in a normal year.
Nevertheless, in spite of that favorable fact, we do still expect that the HBR, our health benefits ratio was going to rise sequentially and that’s again to speak as you bring on so much new revenue and that new revenue comes with a higher than average – higher than our company average health benefits ratio. So, that’s going to affect the statistics.
The G&A ratio is going to come down. As I mentioned, first quarter was elevated and that we generally can expect that to decline as we move through the year and then interest expense will be down as I mentioned just a moment ago. We’ll continue to see further revenue growth in the third quarter and part of that is just getting the full quarter's impact. We are only going to recognize two months of revenue in health plus, because that closed in the second quarter and there will be some other factors that will continue to push revenue up as we move into the third quarter. And then the third quarter also generally has when we look at our history, the most favorable medical cost from a seasonality perspective. As we move into the fourth quarter now, that’s when we actually expect earnings to start to taper a bit and that’s again primarily driven by the seasonal uptick in medical costs as you move forward the winter months.
And then finally, we did want to know that our investment and other income is expected to average about $7 million per quarter for the remainder of the year and that’s the combination of both what’s happening on the investment income line, which ended up itself is expected to change that much, but we are going to start recording some other income associated with our Health Plus transaction. So, lot of detail there. I know that's a lot more granular than we normally get and – but we did want to provide that out there to help people understand what our likely trajectory is for the remaining quarters of the year.
Let me wrap up here before we go to questions and I just want to talk a little bit about the growth horizon that we see. As you can imagine when you are in the Medicaid managed care space and all that’s going on right now, it’s a pretty exciting time to be in this business and the number of opportunities that we see ahead of us is really substantial. And I think get when we look at the business development activities, we gain – we engaged in last year and the success we had we are certainly pleased to see how much progress we've made in a relatively short period of time and that fundamentally what's driving this large revenue growth rate in 2012. But it’s not as though all the activity happened in 2011 and it's over now, there is a substantial amount of additional business that’s going to be awarded over the next few years.
And candidly, there is also a substantial amount of business that maybe you can't sit here today and say, I can see exactly what RFP is going to come out or what specific procurement is going to be happen, but you look at the volume of revenue that continues to be in fee-for-service and the Medicaid space and the fact that the states are really bought into the side, yeah, that managed care can actually improve quality and save cost that we continue to believe that there will be a substantial volume of opportunity even in places that you may not be able to specifically point through today.
So, the first box on this chart, you can see we've laid out the pipeline and we have sized that at approximately $50 billion over the next few years and that's based on expected RFPs and other opportunities that we can see in states. And so that’s a substantial amount and we certainly look forward to the opportunity and participating in those RFPs and other expansions and potentially wining some of that business.
The other thing that's going on, then I think sometimes maybe it’s a little below the radar screen is the second box we have here related to long-term services and support. I think in managed care, we generally kind of think just in the industry we often think about the world of doctors and hospitals and medical coverage for those services, but Medicaid is a little bit unique in the sense that it’s the most substantial purchaser and payer for long-term care and support services for Medicaid beneficiary. And those are activities that happened outside the traditional acute care setting, outside the doctors' office and those locations.
And so one of the things when you look at – when states look at their Medicaid expenditures and where their dollars are going, they can really see that a large percentage of their money is going to pay for these services and when they look at the demographic way of it coming, you see that the number of people that are going to be pursuing these services and that there are ultimately the states are ultimately going to be financially responsible for. There is a lot of focus now on how to provide these services more effectively and then of course how to do it in a less expensive fashion. So, we’ve been doing, we have contracts in many of our states to manage and coordinate these services. And we really expect that over the next – we've framed it here over the next decade that as more and more of the services come into managed care and organizations such as ourselves takes responsibility for managing these services. This is a substantial opportunity. And I think it sometimes not fully understood how big this opportunity really is. This is the part of the Medicaid budget that today has the least penetration.
So, if you think about the Medicaid expansion is having sort of three phases. The first phase was the TANF and CHIP population. Lot of those individuals were managed care today. The second phase was acute care services for the aged, blind, and disabled population. And really the third way is long-term services and support also for the aged, blind, and disabled population. So, it's an exciting opportunity that we are really looking forward to. Now, the third – the third block here is something that is getting a lot of coverage and I think people are well aware is the dual demonstration opportunity. The CMS has been spearheading and working with the states. Many of our states that we currently operate in want to run demo projects and so we are certainly looking forward to that opportunity. We provide care to many dual eligibles today both on the Medicaid side as well as their Medicare benefits. And those expenditures as we have on the slide here, $300 billion for this population, and by the way, that’s a $300 billion number that's expanding of course substantially in subsequent years. We think that’s a great opportunity for us.
And if those three boxes weren't enough, that wasn't going to – wasn’t going to keep us busy. We have this other thing called healthcare reform that we've all been following for the last couple of years here. That implies a substantial expansion for the Medicaid population. We've talked about the potential of up to a million additional members in the markets that we operate in. We think nationally that’s about a $90 billion opportunity when the expansion happens scheduled for 2014.
And then finally, there is the subsidized exchanges that's a little bit of a different business. That’s obviously something that's being developed right now. We continue to be interested and potentially participating in the exchanges and as much as anything it's a question of trying to evaluate how are these going to function, how the states going to operate them and is that good opportunity for us, but it's certainly something that we are monitoring closely and I feel like we have the potential to participate in that area and be successful. So, huge amount of opportunity – as I opened up with this morning a huge amount of opportunity in the Medicaid space these days, with a really diverse set of opportunities.
And just on this chart here, this shows the country. And I think the takeaway from this chart is there is a lot of dots in many different states across the country and that speaks to the growth opportunity that we can see. So, with that, let me sit down and we are happy to take few questions.
Scott Green – Bank of America Merrill Lynch
Great, thanks, Jim. If you have a question, please raise your hand and we'll bring a mike over to you. I wanted to kick it off with a question, you are growing revenues 40% or more this year and it's based on RFP wins that you won things to high-quality scores like Texas or Louisiana or benefit card rents or an acquisition, which is somewhat unique. You haven't really won anything, that’s going to be augmented this year due to a low price did. What is the advantage of winning revenues or your style of growth that’s driven by quality scores or acquisitions? I mean, it's easy to say that margins might be higher. I don’t know if you agree with that Georgia and Tennessee you had price components to their bids way back when, but is there an advantage to your style of growth that you are achieving?
Well, I think it's interesting. We tend to look at each one of these RFP opportunities on a case-by-case basis. And I think it's – what's interesting is how diverse each of the opportunities are with regard to the structure. The – what the states ask for as far as what you provide in your bid, how the pricing works. It's pretty diverse and – we have in the last four or five opportunities that we bid on, each one of them have been pretty different. And so I think that one of the things we've continued to feel very good about is we look at our technical capability and the way that we have been awarded points or been scored on these areas, RFPs.
Our pointing on the technical side has been very high. We’ve in many cases been in first position or right at the top of the stack and particularly when there might be 10 or 15 claims that are bidding to be right at the top of the stack in those bids is great. Now, of course, obviously the financial component is important in many of these bids well. Some of the bids the states have the rate. So, there is no – you don’t have to bid a financial component. And so our analysis in that scenario is analyzing the pricing the states that's determining whether we think that's appropriate and prudent, can we get comfortable with those prices. And if so then we'll move forward. In the instance, where you do bid a price again they are pretty diverse, some of them, the states will have very tight ranges within, which you bid. Some cases, they are totally open ended. In other cases, they have wider ranges and you can even bid outside the range. So, you have to look at each one on an individual basis. And I think we try to be very thoughtful and careful about how we bid. And I think it's back to what I was talking about as far as how we deployed cash and capital and how we want to reinvest in the business.
We are really trying to expand our business in order to provide superior returns in the future. It isn't' just we'll grow top line revenue and kind of figure it out later. We do need to have a path to profitability on this business and that doesn’t mean that you won't start a new business in a new market and not have superior returns in the beginning. There is a lifecycle for this. We often find it can take 12 to 24 months before you have stabilized performance in a new market. But we are pretty careful about how we do it. And I think that's been reflected in the performance of our business over time. And the fact that matter is the opportunity set it so deep that I also don't think you need to sort of bid foolishly to just to win business, because there is enough opportunity set. And I think when you have the skills and competencies that we have you can be prudent about that and provide good returns on the capital you have to invest and then have a very robust vibrant business. And I think that's certainly been our experience today.
Scott Green – Bank of America Merrill Lynch
Sure. In the back?
I was just wondering you mentioned about return expectations of the business, what's the minimum return you would expect to get in terms of net margin on a piece of business, when you bid it? And then secondly where do you think these margins sort of ask them sell to over time, your 1.5 to 2.5 net margin, is that where they go or is there opportunity beyond that?
We've been talking about for quite a few years that we think our business can produce net income margins in the 2.5% to 3.5% range. And when we look over the last five or six years, we've generally been in that range, couple of years we've been about it, and couple of years we've been slightly below it. So, we continue to think that, that's the range at which we can operate in. And I think the reason I kind of stress we – that's above the industry average. And I think we generally are able to perform a little above the industry average due to the fact that we are able to manage medical costs more effectively and run more favorable benefit loss ratios as well as particularly as the years have gone on, we've gained so much scale on the administrative cost side that we are able to often times pickup a little bit there as well.
It's interesting when you look at the way that states rate the business because as much as we talk about pricing an initial business, states are going to re-rate the business every year and you are going to get a new price generally in subsequent years. And so how the states rate the business is very important as you move forward. What we generally find is and there is variation of course as there is always is in the business, but we generally find that states in their actuarial analysis will rate the business to 1% to 2% margin. And so in order to get to the level that we want to perform at and have been able to perform at, you do have to have that relative outperformance. But it isn't you have to be 5% or 10% more couple of percentage points 2, 3 percentage points can get you into our range. So, I think that's what we've been able to do and we continue to really focus our effort and think about the way we organize our company and the target we set for ourselves and the way we work with our leadership team is really towards that end of relative outperformance in order to put us in that range.
Scott Green – Bank of America Merrill Lynch
In the front?
(indiscernible) if it's contracting with providers or owning providers how you actually see that happening?
Yeah, the way we are pursuing it and it's interesting we've been doing it for a long time, but we are also feeling as though we are continuing to kind of build in our competencies in that area. Our basis for how we manage those long-term care services is really service coordinators that we put out in the field, that in most cases are meeting with members in their homes. In almost all of these programs, there is an extensive assessment analysis that we do, that is in most cases is required by the states and that really requires staffs that are getting in their cars and going out to people's homes and meeting with them and understanding their situation and figuring out what services they need and then really coordinating to make sure those happened and doing follow-up and then monitoring patients as their situation changes. So, that’s really the nexus of that whole effort as the service coordinator.
Today, we are generally not engaged in the direct delivery of care and we are really staying in the balance of this sort of coordination and management of services. And so far that’s proving to be very effective, but it's a very hands on approach and it's a lot different than I have been doing managed care for a long time now and when you think about the classic models again which you’re based on managing a pure episode working on what’s happening in physician office in that’s sort of thing this is pretty different and in a lot of cases, which you’re also managing for this people is not care provided by clinicians with high clinical training. And I think it's how do you help somebody live on a daily basis. In fact, I guess our picture rate here on the slide on the left there is exactly that. How do you help someone have some mobility so, they can move around and live their life and not end up in an institutional setting.
And so that the people in a lot of cases that provides that care and not necessarily people with high levels of life insure and so, it’s pretty different and I think that one of the things that we think as an organization is because we've been doing this long enough and it's just because we've been in the Medicaid space and the space maybe services and we develop the skills and competencies over the years. This is a powerful set of experiences and capabilities, particularly when you think about the dual eligible population, because so many of those dual eligible are using a substantial amount of these services on the Medicaid side right now. And when the states think about who they want to have as their dual eligible health plans, they want health plans to have this competency. And so we think we have a lot there and we are actually building our capability pretty quickly as we move on.
No, average this year is the startup cost that's associated with some of the revenue opportunities, given all the revenue opportunities that you talked about coming in over the next few years and what are the odds that we should be thinking about consistent start-up costs or ramp up in new business and that the target margin that you are going to be – ultimately be able to achieve really – will be little bit below that for the next several years, when should we expect normalized margin in the revenue growth opportunity?
Yeah, I think part of it, the way that’s all going to play, it's obviously tough to say with precision, because lots of different opportunities in the sensitive way, the revenue growth profile may look over the next few years, but it's probably going to be a composite of the new business that we are taking on this year and how it develops and migrates and how it hopefully moves to more favorable margins as the years go on and we move more to normalized margins. And what’s the sort of the relative waiting between that maturity versus new business that we may bring on that as the new piece of business in 2013 or 2014. So, I have to wait and see. I think when you look back over when we think about our 2.5% to 3.5% margin that we talk about as sort of our long-term range that we've been able to operate in, while we are growing a lot in 2012, the company has also grown a lot generally, I don't really probably say certainly in excess of 20% over the last 10 years. So, even at that fairly impressive growth rate we have been able to operate in that range over that period of time. So, we have to wait and see we’re obviously having got into the point of developing our budget for 2013 and thinking about our profile then that will happen later on this year and we will be able to begin to speak more definitively about some of those things, but I just think it’s a great situation for our business in the way it's developing and there is a huge amount of opportunity that we certainly look forward to.
Scott Green – Bank of America Merrill Lynch
Alright, out of time, thank you so much.
Jim Truess – Chief Financial Officer