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

HealthSpring Inc. (NYSE:HS-OLD)

Q4 2007 Earnings Call

February 14, 2008 10:00 am ET

Executives

Herbert Fritch - Chairman, President and CEO

Kevin McNamara - CFO

Analysts

Charles Boorady - Citigroup

Josh Raskin - Lehman Brothers

Carl McDonald - Oppenheimer

Justin Lake - UBS Securities

Darren Miller - Goldman Sachs

Operator

Good morning and welcome to the HealthSpring conference call to review its financial results for the fourth quarter and year ended December 31, 2007. The financial results were issued yesterday after the close of the market trading. If you did not receive a copy of the press release, you may find a copy under the Investor Relations tab on the HealthSpring website at www.healthspring.com.

Before we begin, HealthSpring wishes to express that some statements made in this call will be forward-looking statements, as defined in the Private Securities Litigation Reform Act of 1995. Actual performance of the company may differ from that projected in such statements. Investors should refer to statements regularly filed by the company with the Securities and Exchange Commission for discussion of those factors that could affect the company's operations and the forward-looking statements made in this call. The information being provided today is as of this date only, and HealthSpring expressly disclaims any obligation to release publicly any updates or revisions to these forward-looking statements to reflect any changes in expectations.

In addition, certain non-GAAP financial measures may be covered in this presentation. These non-GAAP measures are reconciled to the most comparable GAAP measures in the press release, or on the company's website.

At this time I would like turn the conference over to Mr. Herbert Fritch, Chairman, President and Chief Executive Officer of HealthSpring. Mr. Fritch please go ahead, sir.

Herbert Fritch

Thank you, operator. Welcome to the HealthSpring's 2007 fourth quarter and year end earnings call. As previewed in our revised 2007 EPS guidance of last month's Investor Day. The close of the fourth quarter marked the end of a challenging year for HealthSpring. We finished 2007 with EPS of $1.51 which was within our recent guidance range but not where we wanted it to be when we started the year. We are very encouraged by our prospects for 2008 however given the addition of Leon Medical Center Health Plans continued strong performance on our stand alone PDP product and significant growth in PMPM revenue. Kevin will go into detail regarding the quarters' and year's financial results. I'd like to first highlight for you significant developments in the past year and the positive momentum generated so far in 2008.

The 2007 fourth quarter began and was certainly highlighted by the consummation of the acquisition of Leon Medical Centers Health Plans on October 1st. The acquisition of Leon provides a 25,000 plus member presence in the important South Florida Medicare market, a long-term partner with expertise in operating world-class medical centers and an appetite for further growth throughout Florida.

The integration of the Florida plan with our existing operations has gone exceedingly well. We learn more from Leon each day about the importance of consistent customer service to quality of care and member retention. In our increasingly competitive markets the ability to reduce disenrollment levels has become a key part of our strategy and Leon's disenrollment rates are about half the disenrollment rates experienced by the rest of our markets in spite of being in the more competitive Miami market.

Further more the acquisition put our strong balance sheet to work in a way that was immediately accretive to fourth quarter earnings. Leon's operating and financial results will continue to be a significant contributor to the 2008 consolidated results.

As I mentioned member retention is a key component of our member growth strategy. We ended 2007 with 11% organic membership growth in our existing markets. So far in 2008 membership is down about 1,500 or 1% as we expected they would be. Counting on product exits accounted for loss of about 3,400 members. In addition disenrollments in our core middle Tennessee market from our non-preferred panel product which reduced benefits from those previously provided accounted for another 2,100 members lost.

By contrast our preferred network product in Tennessee saw over 95%, retention and so showed significant growth in new membership. We attributed these positives statistics for the preferred network to a combination of organic growth, member transfers from non-preferred primary care physicians and some primary care physicians joining our more organized preferred delivery systems. We except this latter physician transition trend to continue throughout 2008.

All in all we are pleased with the results of our tier network strategy for 2008 and total the number of members in the non-preferred network dropped by about a third, and on the remaining members we are collecting $55 more premium per month. As a result although we were not expecting a similar need to reduce benefits for a meaningful portion of our membership in 2009, we would not rule out employing this tiered network strategy for selective smaller segments and memberships in the future.

Medicare Advantage PMPM premium rates increased on a same-store basis by a modest 4% for the full year 2007 over 2006. We are pleased with what appears to be a 7% to 8% increase in PMPM revenue for 2008 calculated on a similar basis. This increase is further enhanced by the relatively higher premium rates in South Florida such that overall PMPM yields on the membership should be about 10% to 11% year-over-year. A portion of this increase is also attributed to the risk adjusted payment system reflecting a more mature population with more with more acute illnesses, which resulted in part from increased discipline in our risk, coding training initiatives with our network physicians.

Our prototype LivingWell Health Center in middle Tennessee began to get in stride in 2007, ending the first full year of operation in the first open enrollment period in the fourth quarter.

We are encouraged by the improvement in revenue through accurate capture of member risk [or] as costs through more intense medical management and quality of care metrics. We are especially pleased by the member retention rates of the center.

Although slightly disappointed in the rate of new member sales, we were able to validate that once a member experiences the quality of care and comfort at the center, he or she is very reluctant to leave.

Our challenge now is to focus on how to get more seniors to appreciate the higher levels of care available to them. We recently opened a second LivingWell Health Center, this one near Mobile, Alabama and plans are still on track to open a third center this year in downtown Houston.

We continue to be very pleased with the performance of our standalone PDP business. The MLRs and margins continue to be well within our expectations and the large increase in membership assigned on January 1, 2008 appears to have been retained with March memberships standing at 258,000 members up over January numbers.

Medical loss ratio is stabilized on a normalized basis in the fourth quarter, more so than prior quarters in 2007. We are pleased that our MLR deterioration was less pronounced in the second half of 2007 compared to the first half.

I'm also encouraged that the combined effects of the decision to drop some poor performing counties, our tiered network strategies success and moving members to better performing networks and the benefit of 2007's MLR deterioration reflected in 2008's increased premium rates should serve to somewhat stabilize our MLRs going forward. Moreover the higher Florida premium rates and added geographic diversity together with the growth in our PDP business should allow us to better absorb adverse medical trends in a single market. Finally commenting on the political front I believe our efforts in Washington in 2007 has been effective in distinguishing our Medicare Advantage coordinated care model from the less tightly managed private fee-for-service plans. Our commitment to stronger engagement of primary care physicians and a gatekeeper model is I believe the only way to manage costs over the long-term. Additionally we are keenly focused on compliance particularly in our sales and marketing activities. In response to the increasing focus in Washington on a regulating sales and marketing we believe we've made considerable progress in improving our sales and marketing compliance. As the political process unfolds throughout the year we remain confident in the sustainability of our business model. All-in-all we are encouraged by these developments as we look ahead at 2008. With that I would like to turn things over to Kevin McNamara to review the fourth quarter and full year financial results.

Kevin McNamara

Thanks, Herb. Prior to discussing our results I would like to remind everyone of the update to our Q4 and 2007 full year results that we provided during our January 2008 Investor Day. As was referenced in our press release of January 23rd, during the fourth quarter of 2007 we began accruing for the final retroactive risk premium adjustment settlement payment. Previously we've referred to this payment as the in the year for the prior year payment. Prior to this quarter we had recognized this payment upon notification from CMS as we were unable to reasonably estimate the final settlement amounts. However as our analysis capabilities have developed and we have more experience operating under the risk adjusted payment system we now feel we can reasonably estimate the amount of this final settlement payment. Thus our full year 2007 financial results reflect two such final settlement amounts.

One for the 2006 plan year, which was received during the year and recognized during the second quarter of 2007, and the second for the 2007 plan year, which was accrued during the fourth quarter and should be received during the calendar year 2008. These amounts had the following impact on our financial results during the year.

One, the 2006 benefit year final settlement payment, positively impacted the 2007 second quarter EPS by approximately $0.13. Two, the 2007 benefit year final settlement accrual, positively impacted the 2007 fourth quarter EPS by approximately $0.20. Beginning in 2008 we will ratably accrue for the final settlement amount estimated for the 2008 plan year to be received in the late summer or early fall of 2009.

Thus for making apples-to-apples comparisons to our 2007 results in 2008 and beyond one would need to adjust the 2007 financial results to eliminate the 2006 final settlement payment or said another way take $0.13 out of our 2007 earnings per share. To that end we have provided a supplemental schedule in our current earnings release, which adjusts our premiums and medical costs related to all retrospective risk adjustments to allocate them to the appropriate period for the past eight quarters. As these premiums and associated medical costs are the only moving pieces, one would simply need to tax affect them to understand their net impact on your results. During today's call I will attempt to highlight the results on both the reported and on an adjusted basis as reflected in supplemental schedule in the press release.

Moving to the current quarter we reported 2007 fourth quarter net income of $26.2 million or $0.46 per diluted share compared to 2006 fourth quarter EPS of $0.35. Adjusting both periods to reflect the final settlement payments and accruals in the periods in which the related initial premiums were recorded, the 2007 fourth quarter net income would be $17.6 million or $0.31 per diluted share compared to prior year adjusted EPS of $0.33.

Significant factors impacting the 2007 fourth quarter results were the following. On the positive front were, one, the inclusion of our recently acquired Florida Health plant, Leon Medical Centers Health Plans beginning on October 1st, which had 25,946 members at year end. Two, organic growth of 11% year-over-year and 1% sequentially in our Medicare Advantage membership. Three, 57% year-over-year and 9% sequential growth in our PDP membership. Four, an increase in the PMPM rates for our Medicare Advantage members partially offset by 21% decline in the PMPM rates of our PDP members, for the full year our adjusted Medicare Advantage rates excluding Florida were up 4% versus the prior year. And five, a positive impact on medical costs of $4.5 million for the member awards program accrued in prior quarters which saw lower redemptions than expected.

On the negative side, we are one, a significant year-over-year erosion in the MLR PDP business. Two, a sequential increase of $14.7 million or $10.4 million excluding Florida, in SG&A expenses in the fourth quarter of 2007. Three or 40 basis point increase in year-over-year as adjusted Q4 MA MLRs. Four a negative impact on medical cost of $2.7 million from the settlement of a 2006 claims dispute with our PBM. Five decline in the profitability of our commercial business. And sixth, incremental amortization expense of $3.4 million, an incremental interest expense of $7 million related to the acquisition of the LMC Health Plans.

Moving to the details on the membership front, we reported a 153,197 Medicare advantage members and a 139,212 PDP members at the end of the fourth quarter reflecting growth on both the year-to-year and sequential quarter basis. 25,946 of these MA members are from the inclusion of LMC Health Plans in our results.

As we've done in prior quarters, you can find by-market membership detail within the body of the earnings release. On a year-to-date basis, our organic Medicare Advantage membership growth was 11% at the low-end of our targeted 10% to 15% growth expectations.

PDP membership is up 57% year-over-year, which is significantly higher than our expectations at the start of the year. At January 2008 PDP membership was approximately 254,000. PDP membership is up significantly in 2008 due to the additional auto-assignment of membership primarily in the California and New York regions. MA membership reported in January was 151,671 down 1,500 members versus year end. As Herb outlined, this decrease was not unexpected given network changes and our Tennessee market and the existing counties in Alabama and Tennessee as of January 1 of 08. Total revenue in the fourth quarter was $468.5 million an increase of a $132.8 million or 40% versus the prior year fourth quarter. After adjusting the 2007 and 2006 amounts to reflect the retroactive risk payments in the appropriate period, Medicare Advantage revenue was up 47% or a $127.3 million to $400.3 million compared to $273 million in the prior year.

Contributing to this increase was the inclusion of the Florida operations in our 2007 fourth quarter results of 4% organic increase in adjusted MA premium PMPMs and a 12% organic growth in MA member months. For the full year adjusted MP PMPMs were $859 an increase of 6% or $45 year-over-year excluding the impact of Florida adjusting MA premium PMPMs were up 4% over the 2006 year adjusted. PDP premiums were $28.7 million in the fourth quarter of 2007 an increase of $4.9 million or 20% versus the fourth quarter of 2006. A 21% decline in PMPM rates was more than offset by the 57% increase in PDP membership. For the full year PDP PMPMs were $80, a decrease of $20 or 20% versus 2006.

Fee revenue for the quarter decreased $0.7 million as compared to the fourth quarter of last year. For the full year fee revenue declined $2 million versus 2006. The decrease in both periods was primarily the result of the termination of a management contract with an unrelated plan at the end of last year.

In 2006 that contract accounted for $4.3 million of fee revenue during the year. Investment income was up 47% or $1.9 million in the quarter due to the significant increase in cash balances. On a sequential basis investment income was down $1 million or 14% as a result of declines in investment yields and a sequential reduction in cash balances due to the previously disclosed 2006 part D settlement activity and the use of funds to acquire Leon Medical Centers Health Plans on October 1, 2007. Investment income in 2008 is expected to be a little less than it was in 2007 due to lower forecasted investment yields.

Before I discuss the details of our medical expenses let me highlight a few significant items which impacted medical expenses in the quarter. First the accrual of the 2007 final settlement payment has an impact on both the MA premiums and medical costs. I'll refer you to the supplemental schedule on the press release, which highlights the calculations that necessarily reflect premiums and medical expenses in the appropriate quarters of 2006 and 2007.

Second our MA medical expense in the quarter was negatively impacted by a one-time settlement with our PBM of $2.7 million. This amount relates to a disputed MAPD pharmacy claims from 2006.

Third, we also begin offering our rewards program in 2007 as part of our benefits package in select products. We have been accruing expenses for this program to the full potential exposure as the program was new and we had no basis for forecasting utilization in the program. Ultimately, we had much lower utilization in the program than expected, and we reversed much of this expense during the fourth resulting in a positive impact of $4.5 million on our medical costs during the quarter.

The net impact of items two and three on the fourth quarter is favorable to our Medicare Advantage MLRs by 40 basis points. Eliminating these items from our results would yield a fourth quarter adjusted MLR of 80.9% or flat to the adjusted Q3 MLR, this compares to the supplemental schedule in the press release which shows 40 basis points sequential improvement.

Moving to the results, total medical expense in the quarter was $338.3 million, an increase of $104.4 million or 41% versus the prior year's quarter. As a reminder the fourth quarter of 2007 results, include the full quarter's impact of the operations of LMCL plans.

With respect to the components in the relative metrics, MA medical expense was $326 million, an increase of $107.2 million or 49% versus the comparable prior year quarter. As adjusted MA medical expense was $322.2 million, an increase of $103.4 million or 47% for the full year. For the year MA PMPM was $692, an increase of $56 or 9% versus 2006. As adjusted MA medical expense PMPM was $690 an increase of $52, or 8% versus the prior full year, and on an organic basis MA medical cost PMPMs were 7% year-over-year -- up 7% year-over-year.

The MA MLR on a reported basis was 78.1% for the current quarter versus the prior year's 79.6%. As adjusted the current quarter's MLR was 80.5% versus 80.1% in the prior year fourth quarter reflecting erosion of 40 basis points.

For the year, the MA MLR was 79.7% in 2007 versus 78.8% in 2006. As adjusted the MA MLR was 80.3% an increase of 200 basis points from 2006 full year. Much of the increase was due to the previously disclosed higher utilization and medical cost trends experienced during the first six months of 2007.

PDP MLR in the 2007 fourth quarter increased to 78.7% versus the prior year's 45.8%. On a year-to-date basis our PDP MLR also deteriorated finishing at 86.3% versus the prior year's 73.4%.

The increase in the MLR in both the periods was expected due to a number of factors including lower PDP PMPM this year per bid design, and as previously discussed the 2007 results include a significant amount of retroactivity related to 2006 plan year settlements, which were booked in 2007.

This activity if adjusted would make the comparison between 2006 and 2007 PDP results more comparable. All-in-all despite being above our most recent guidance the annual PDP MLR ended within the expected range of 85% to 90% we planned at the beginning of the year. Our commercial medical expense in the quarter also came in higher than expected. The commercial MLRs deteriorated a 150 basis points year-to-year and over 1,600 basis points sequentially to 93.3% in the 2007 fourth quarter. This resulted in a sequential negative impact of $1.8 million on our pre-tax results. SG&A expenses for the quarter were $54.8 million, an increase of $6.3 million, or 13%, versus the prior year primarily as a result of the inclusion of SG&A for the LMC Health Plans in the 2007 fourth quarter.

Sequentially SG&A expenses represented 11.7% of total revenue in the 2007 fourth quarter compared to 11.0% in the third quarter of 2007. Excluding SG&A for the LMC Health Plans and the 2007 final risk payment premium accrual SG&A expense for the fourth quarter of 2007 was higher than anticipated representing 14% of total revenue. Excluding the LMC Health Plans SG&A expenses on a sequential basis were up $10.4 million for the quarter significantly higher than expected. Contributing to the sequential increase for approximately $4.3 million of advertising, printing and postage costs, $2 million of increased corporate costs and $3.4 million in incremental personnel costs including costs related to headcount additions. The excess above our expectations primarily relates to overall higher personnel, legal and professional service costs than expected.

Let me reiterate that we expect SG&A to remain seasonally weighted to the first and fourth quarters as a result of the marketing costs associated with shortened open enrollment period. As we've discussed previously with you, LMC Health Plans has historically operated at much lower SG&A expenses as a percentage of revenue. We continue to set an internal target at or below 11.5% of revenue for SG&A expenses in 2008.

Pre-tax income was negatively impacted by increases in depreciation and amortization and interest expense during the current quarter. Depreciation and amortization expense in the 2007 fourth quarter increased $4.6 million over the 2006 fourth quarter, primarily as a result of the amortization of the intangible assets identified in the acquisition of the LMC Health Plans in the 2007 fourth quarter.

Amortization expense in the current quarter exceeded our forecasted amount by approximately $550,000 as a result of higher than expected amortization on LMC Health Plans intangibles and incremental amortization expense related to our existing intangible assets.

Interest expense in the 2007 fourth quarter increased $7 million over the 2006 fourth quarter as a result of the interest incurred on the companies $300 million term credit facility entered into in the fourth quarter of 2007. Included in this increase is a one-time write-off of approximately $650,000 of deferred financing costs associated with their previous credit facility.

Moving to the balance sheet in cash flow, our balance sheet at December 31, 2007, reflected cash and cash equivalents of $324.1 million. Unregulated cash was $36.2 million. In addition to $300 million of borrowings under our new term credit facility we used unregulated cash on hand of approximately $56 million for the purchase of LMCL plans and related acquisition and debt issue costs.

Accounts receivables are up primarily as a result of our accruing the 2007 final risk payment, days claims payable were 39 days at the end of 2007 compared with 44 at the end of 2006. Of the five day decline year-over-year, three days are attributable to the addition of LMCL plans in our 2007 results.

We will include a schedule detail in the components of the medical claims liability in our Form 10-K which we intend to file later this month.

Finally, total debt outstanding was $296.3 million at year end 2007. Operating cash flow for the quarter was a source of $17.8 million versus, a source of $69.4 million in the prior year fourth quarter. The 2006 operating cash flow amounts for both the quarter and the year include significant favorable amounts related to our entry into the Part D business.

In the quarter operating cash flow was negatively impacted by $27.1 million accrual of current year risk adjustment payments and by the use of $34.1 million to settle the 2006 Part D risk [order] with CMS offset by approximately $8.6 million of net favorable cash flow variances related to changes in working capital accounts and non-cash expense items.

On a year-to-date basis, cash flow from operations was $80.2 million, compared with $167.6 million for the year ended December 31, 2006. The main drivers of this variance were $32.8 million use of cash related to the timing of settlements and receipts of Part D funds with CMS, a $31.1 million negative variance resulting primarily from the accrual of risk settlement premiums from CMS in the current year, and a $26.8 million negative variance in the timing of pharmacy claims statements and the run out in the -- in the commercial claims.

Absence of favorable cash flows in 2006, due to the entry into the Part D business, the negative cash flow impact from 2006 Part D settlement payments to CMS which were paid in 2007, and the accrual of risk adjustment payments in 2007, operating cash flows in both the quarter and annual periods would have been comparable relative to net income in each period.

Lastly on the balance sheet, I would like to comment briefly on our cash and investment portfolio. As of year end, we had little to no direct exposure to sub-prime or other assets that could create the potential for write-downs or liquidity constraints. While we remain focused on maximizing the potential for investment return within the constraints of the regulated environment in which we operate. Our primary concerns have always been minimizing risk and maintaining liquidity. As to the guidance, we are reiterating our prior operating and financial guidance and maintaining our diluted EPS forecasts of a $1.75 to $1.90 for 2008.

Operator, that concludes our prepared remarks, we can now open the line for questions.

Question-and-Answer Session

Operator

Thank you. (Operator Instructions). And now first question will come from Charles Boorady with Citi

Charles Boorady - Citigroup

Thanks good morning. First question on the flu season and you know the obvious sensitivity to not wanting lightning to strike twice straight choice in the same place which but I know we all have learnt a lesson from the last time around. And this year the flu season had a mild start but is really picking up especially in certain areas like Texas, Alabama and Tennessee and I am wondering if you're seeing this yet in your results and how and when we should see it impact your medical costs trends. And do you think that you've priced for this accordingly in light of the late start that it got or do you anticipate the season would remain mild when you price this year's business?

Herbert Fritch

Well Charles I mean I think you're kind of accurately describing the results have -- didn’t hit much in the fourth quarter. We're seeing it in selective markets to the ones you mentioned. Pricing really relates to a bid process and you know the bid process was done back in the early part of last year based on 2006 as a basis for projecting 2008 and all-in-all I mean this is just [what] we've absorbed. I think the good news this year is what we're seeing is with Leon down in South Florida may give you just a little bit of a buffer that some of these other markets because so far I don't think the flu has hit at all down there.

Charles Boorady - Citigroup

How much of an impact can the flu or the flu related illnesses have on your medical cost trends? So what's the delta between a week flu season and a strong flu season in terms of what it could do to your loss ratio?

Herbert Fritch

I don't know and in a particular month I think a strong flu season you could see hospitalization trends up in 15% and other medical costs up somewhat. You're probably looking at 10 points in the particular month that it would hit on a medical loss ratio if it really hits hard.

Charles Boorady - Citigroup

10 basis points some -- 10 basis points on a loss ratio in a month?

Herbert Fritch

No, 10 points.

Charles Boorady - Citigroup

Okay so it's significant we saw the impact last year that, are there certain early warning signs that you can look for and is there a way to be more proactive this year than you were last year. I'm wondering if there're any lessons learned that you can apply to help mitigate the risk of a repeat.

Herbert Fritch

The main thing we do and its almost every year is, try and immunize -- all get the percentage of immunizations up and flu shots up and we constantly are looking for more ways to effectively do that. But even that is somewhat hitting this and just based on the effectiveness of the vaccine in a particular year.

Charles Boorady - Citigroup

Do you know what the vaccination rate is of your vulnerable population?

Herbert Fritch

I think its up, it will land up we think in the 50% to 60% range this year.

Charles Boorady - Citigroup

Okay. And did you comment on just whether you've seen the pick up, impact your results yet or it is something you are hearing about but haven't yet seen it flow through your claims processing yet?

Herbert Fritch

I think it started to hit in mid January. As we look at the first indicator for us is we track almost on a daily basis the hospital admission rates and we have started to see those rise in the middle of January in some of these markets and it's certainly still ongoing right now. I mean the claims won't hit till a month or so later although we do use in setting our reserves and estimates of the incurred claims, the hospital admission data.

Charles Boorady - Citigroup

So when you estimate your incurred claims for Q1 how will you take the information that you have today by the higher flu season in a consideration of what might that mean for the range of EPS in the first quarter?

Herbert Fritch

I don't know if I've got it down to what it'll mean for the range but essentially as we set reserves at March 31st, we'll have fairly complete claim data on January reasonably complete data on February and we'll use the admin rates for March to estimate March incurred claims.

Charles Boorady - Citigroup

Got it. Okay, thanks.

Operator

Our next question will come from Josh Raskin with Lehman Brothers.

Josh Raskin - Lehman Brothers

Hi, thanks and good morning. First question just on your risk scores, you have talked a little bit about the changes in reimbursement as an improvement in risk scores. Could you tell us where were, your average risk scores in 2006 versus what they came in 2007?

Kevin McNamara

See I don't have that off the top of my head. My sense is that they were in aggregate they were probably up 3% to 4% though and it varies by market based on the percentage of duals and that kind of stuff. The duals are quite a bit higher than the normal MA members.

Josh Raskin - Lehman Brothers

And Herb, where does the Leon flowing under that are they higher than typically, or are they lower than your overall [flow level]?

Herbert Fritch

They are pretty close to average.

Josh Raskin - Lehman Brothers

Okay. That's helpful. And then the PDP MLR in the fourth quarter obviously came in a little bit higher -- higher in the fourth quarter than the fourth quarter of '06. That seemed as though it was much smoother through the progression of MCR. Is there a difference, is there something changed in the PDP operations that is depleting that seasonality or were there some one time risks in the fourth quarter?

Herbert Fritch

Josh, I think that what you've got to look out on the PDP, the quarterly seasonality is probably closer right in 2007. In 2006 if you recall you had a lot of plan-to-plan reconciliation and there were a lot of estimates related to that plan-to-plan reconciliation, positive adjustments that were reflected in Q4 of '06 that ultimately a lot of which developed unfavorably throughout '07 and that's reflected in the results.

Josh Raskin - Lehman Brothers

Okay.

Herbert Fritch

So I wouldn't read a lot into sort of a quarterly-quarterly move in '07 versus '06.

Josh Raskin - Lehman Brothers

Okay. You would expect '08 to look more like '07, that's what you are saying?

Herbert Fritch

Yes.

Josh Raskin - Lehman Brothers

Okay. Got you. That's helpful. And then just a last question the CMS data showed you guys data about 1,000 through February first data and you guys talked about another 3,400 in the counties that you exited and the non-preferred networks, but could you give us a sense of sort of gross sales, what are you guys seeing in terms of gross numbers on a monthly basis?

Kevin McNamara

I don't remember those numbers Herb.

Herbert Fritch

Yeah. I don't have that off the top of my head either. I mean I know it was very strong during that open enrollment period, and we're still getting significant sales, but it's down somewhat, not unexpectedly now in 08 and we'll have it with us Josh and we will get back to you on that.

Josh Raskin - Lehman Brothers

Okay maybe I ask in another way the retention numbers you know how much have you seen in terms of disenrollment?

Kevin McNamara

The retention numbers are relatively consistent year-to-year.

Herbert Fritch

My sense is that they would have been down except for that non-preferred product driving some pretty high retention in our core middle Tennessee market.

Josh Raskin - Lehman Brothers

Right. Okay. All right. Thanks very much.

Operator

Our next question will come from Carl McDonald with Oppenheimer

Carl McDonald - Oppenheimer

Well thank you sort of focus on the standalone PDP you see if we could go back and give us a sense of what you think the true run rate to cost ratio was in '7 I am just trying to get a sense for how much of an improvement you need to see from '7 to get 81% to 83% guidance for '8?

Herbert Fritch

I can tell you Carl sort of directionally. You had a lot of adjusting activity flowing through '07 that related to '06 only a couple of which we talked about discreetly. If you remember back in I can't remember if it was the second or third quarter we disclosed when we adjusted the plan-to-plan settlement liability that resulted in the negative impact of about $3.5 million to us. About half of that related to the PDP so if you adjust just for that it's more activity than just that you get to about 85.5 that's about 120 basis points and you know I wouldn't want to go a lot further than that I think the MLRs if you did it truly on '07 activity would be a fair amount lower than that. But I wouldn't want to pin down to a discreet answer of what they had be. I mean we view those, the 81 to 83 is somewhere approximating flattish to maybe down a little over what '07 should have been.

Carl McDonald - Oppenheimer

Any comments or guidance you want to give ahead of the CMS release review '09 rates on February 22nd in terms of what that rate might look like?

Herbert Fritch

Just from what I know I think the underlying inflation in the Medicare business is probably about where it's been the last couple of years. I expect a little less of the negative adjustment for the budget neutrality piece. Still some negative adjustment but that's defining the words not very large. So I mean our expectation is that it'd be up maybe a half a point or so from what last year's was.

Carl McDonald - Oppenheimer

And then just the last question is the Investor Day you had guided the first quarter to a roughly flat earnings with where you were in 1Q '07, are you still comfortable with that, knowing everything you know about medical costs and how things have turned out to this point.

Kevin McNamara

I mean we're not making any adjustments up to our previous guidance.

Carl McDonald - Oppenheimer

Got it. Thank you.

Operator

Our next question will come from Justin Lake with UBS Securities

Justin Lake - UBS Securities

Thanks, good morning, just a couple of questions, one on your special needs products. Just to remind that those are product snips or not?

Herbert Fritch

Well we've had since '05 the dual snips. We introduced this year some chronic snips and got them in all of the markets with the exception of Florida.

Justin Lake - UBS Securities

Okay. And so for 2008 can you tell us how much in your membership special-needs product?

Herbert Fritch

Well we are actually fairly optimistic that we will have some or we think a lot of our growth will be in post lock in period given the negative impact from these exits and product strategies that we've talked about. We are expecting to start growing again in April. And we're hopeful that -- I think we've guided toward 5% to 10% kind of growth numbers and we're expecting to see that a lot of it coming from the special-needs products in the last nine months of the year.

Justin Lake - UBS Securities

Okay. So we could kind of think about half or more coming into the special-needs?

Herbert Fritch

Yeah I think that's fair I mean some of it's certainly agents but in addition to the agents I think the special-needs products should have probably more than half the growth.

Justin Lake - UBS Securities

And can you tell how the MLR trajectory looks on that when you bring them in, the upfront type of costs kind of stabilizing and especially of chronic patients, and how you think about the MLR year one in those products versus year two and year three?

Herbert Fritch

I don't know that we even at this point and especially these are chronic care special-needs products and I'm not sure that I'd want even tell you about that we don't have any experience with chronic care products. We think in general new membership tends to come in and seems to have a little more favorable loss ratio for a period, but I don't know how much that will turn out being the case with these primary care products.

Justin Lake - UBS Securities

Okay. But do you feel comfortable given that it's only going to be let's say it's 5% of your membership that comes in these new products price, even if it has a higher MLR should really have much of an impact or you kind of have embedded that. I guess one of your competitors just said that the special needs product usually comes in a very high MLR and they work it down overtime.

Herbert Fritch

I don't think we've seen that, and you're right. I mean it's a relative small percentage of our membership. I don't think we've budgeted to have exceptionally high MLRs initially.

Justin Lake - UBS Securities

Got it. That's helpful, and just the last question on SG&A. Kevin, I think you've talked about the startup costs in a lot of these new markets and putting on a lot of salary expense in 2006 and in 2007, and was just curios given that the guidance on the SG&A of 11.5% or better. How do you kind of look at that kind trajectory over 2008 [as far as seeing] leverage after that SG&A spending, and maybe even a little bit further down the road, where do you kind of fine yourself?

Kevin McNamara

I mean Justin, if -- we were pretty constant throughout '07 that we didn't think we'd see a lot of leverage in '07 that we thought we were on the tail-end a lot of ramp up costs.

Justin Lake - UBS Securities

Right.

Kevin McNamara

And what I fully expected and what you saw in Q4, I expected by the time we got to Q4, we'll have a flattening to slightly running down SG&A trend which didn't happen. It turned the other way. I would feel better going into '08 about the ability to leverage we feel pretty good the 11.5 and you know we're going to challenge ourselves to try to break through that as we've done in previous years. So the 11.5 the new 12 for us and I am hoping a lot of the build and lot of the expense load that we experienced in '06 and '07 is behind us.

Justin Lake - UBS Securities

That’s very helpful thanks a lot.

Operator

And our final question will come from Darren Miller with Goldman Sachs.

Darren Miller - Goldman Sachs

Hi good morning the member rewards probably you offered in '07 are you offering that again in '08?

Kevin McNamara

We are – it’s touched back and in '08 now we have experienced so we'll accrue for some breakage in it.

Darren Miller - Goldman Sachs

Got it. And then in terms of your county and product exits do you have a sense of as far as you know what the MLR those lives were running out and how much MCR bloom you are going to see from that initiative in '08?

Herbert Fritch

Well clearly they were higher and I want to say they were probably on an average close to 90% and you know we're hoping it will certainly have a positive impact but at this point there is always a lot of things going on in terms of which of the members actually drop versus the ones that stayed and we're still analyzing that.

Darren Miller - Goldman Sachs

Would you expect that population to be at 80% then?

Herbert Fritch

Yeah we would sure hope so.

Darren Miller - Goldman Sachs

Okay and then one last question can you guys provide any color on your commission structure and how you account for that?

Kevin McNamara

I think the accounting is just done…

Herbert Fritch

I mean the accounting the commissions are loaded in at the effective date of the member. So what you get in Q1, all of the sales that are taking place in the tail-end of '07 related to open enrollment and we've got various relationships, some of those we pay, some of those we don’t pay but to the extent we pay and we put them brief aid and it actually flows through on the effective date of the member.

Darren Miller - Goldman Sachs

Till that they're amortized over the course of the year once the member goes active?

Herbert Fritch

No it's not amortized, its front end expensed.

Darren Miller - Goldman Sachs

Okay, great thank you.

Operator

And at this time there appears to be no further questions the queue.

Herbert Fritch

Well thanks we look forward to talking to you again in another three months.

Operator

That does conclude our teleconference for today. We'd like to thank everyone for your participation and have a wonderful day.

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: HealthSpring Inc Q4 2007 Earnings Call Transcript
This Transcript
All Transcripts