Magellan Health, Inc. (MGLN) 2019 Financial Guidance Conference (Transcript)

Dec. 07, 2018 4:08 PM ETCentene Corporation (CNC)
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Magellan Health, Inc. (MGLN) 2019 Financial Guidance Conference Call December 7, 2018 8:30 AM ET


Joe Bogdan - SVP, Corporate Finance

Barry Smith - Chairman and CEO

Jon Rubin - CFO


Dave Styblo - Jefferies

Ana Gupte - Leerink Partners


Welcome and thank you for standing by for the 2019 Guidance Call. At this time, all participants are in a listen-only mode. [Operator Instructions] Today’s conference is being recorded. If you have any objections, you may disconnect at this time.

Now, I'll turn the meeting over to Mr. Joe Bogdan. Thank you, sir. You may begin.

Joe Bogdan

Good morning. And thank you for joining Magellan Health 2019 guidance call.

With me today are Magellan's Chairman and CEO, Barry Smith; and our CFO, Jon Rubin. The press release announcing our 2019 guidance was distributed this morning. A replay of this call will be available shortly after the conclusion of the call through January 7, 2019. The numbers to access the replay can be found in the earnings release. For those who listen to the rebroadcast of this presentation, we remind you that the remarks made herein are as of today, Friday, December 7, 2018, and have not been updated subsequent to the initial guidance call.

During our call, we'll make forward-looking statements, including statements related to our 2019 outlook. Listeners are cautioned that these statements are subject to certain risks and uncertainties, many of which are difficult to predict and generally beyond our control. These risks and uncertainties can cause actual results to differ materially from our current expectations, and we advise listeners to review the risk factors discussed in our press release this morning and documents we filed with or furnished to the SEC.

In addition, please note that Magellan uses certain non-GAAP financial measures when describing our financial results. Specifically, we refer to segment profit, adjusted net income and adjusted EPS, which are defined in our SEC filings and in today's press release. Segment profit is equal to net revenues less the sum of cost of care, cost of goods sold, direct service costs and other operating expenses and includes income from unconsolidated subsidiaries, but excludes segment profit from non-controlling interests held by other parties, stock compensation expense, special charges or benefits as well as changes in the fair value of contingent consideration recorded in relation to acquisitions.

Adjusted net income and adjusted EPS reflect certain adjustments made for acquisitions completed after January 1, 2013 to exclude non-cash stock compensation expense, resulting from restricted stock purchases by sellers, changes in the fair value of contingent consideration, amortization of identified acquisition intangible as well as impairment of identified acquisition intangibles. Please refer to the tables included with this morning's press release which is available on our website for a reconciliation of GAAP financial measures to the corresponding non-GAAP financial measures.

I will now turn the call over to our Chairman and CEO, Barry Smith.

Barry Smith

Thank you, Joe. Good morning and thanks for joining us today.

This morning, I'll provide highlights of our 2019 guidance as well as some updates on our strategic priorities. I'll then turn the call over to Jon to provide more details on these topics. In our press release this morning, we announced that net income for 2019 is expected to be in the range of $52 million to $79 million, which translates to earnings per share of $2.14 to $3.25. We expected adjusted net income of $90 million to a $114 million, and adjusted EPS of $3.70 to $4.69. We anticipate 2019 segment profit in the range of $270 million to $290 million, and revenue for the year in the range of $7.2 billion to $7.5 billion.

Overall, our strong revenue growth over the last few years is the result of our successful strategy to focus on the management of complex populations, specialty healthcare and pharmacy. We have successfully diversified our business and demonstrated our ability to compete both in our healthcare and pharmacy segments. While Magellan operates in an extraordinarily dynamic and competitive environment, we still have significant long-term opportunity for continued revenue growth in both our healthcare and pharmacy businesses in the coming years. Magellan has material earnings power in our current portfolio. However, as we recognize that our margins are not at industry competitive levels. As a result, we've begun a multiyear margin improvement plan.

We have three strategic initiatives underway to unlock the future earnings opportunity. First, within healthcare reduced our cost of care with attention to MCC and in particular, our Virginia plant. Second, within Magellan Rx, continue to grow our PBM while retaining specialty carve-out contracts and lowering our cost of goods sold. And third, drive operational improvements across the organization to enhance efficiency.

Let me provide you with some additional details on our early progress in these areas, which will begin to have an impact in 2019. In Virginia, we are beginning to see leading indicators of progress and several key initiatives focused on appropriateness of in-patient admissions, outpatient behavioral health utilization, and claims integrity audits.

In pharmacy management, we’ve worked proactively with key specialty pharmacy carve-out customers to deepen relationships and renew contracts. We are flattening the organization and better aligning talent with our business strategy. This includes additional leadership with managed Medicaid expertise in areas like operations, analytics, clinical and finance. Lastly, we are standardizing our healthcare administrative functions and identifying opportunities to automate processes and claims, clinical and call centers.

Beyond 2019, we anticipate further progress in all of these areas. Our goal is to increase the adjusted net income margin on Magellan’s current portfolio to approximately 1.3% to 1.5% in 2019 to over 2% within two to three years.

Before I turn the call over to Jon, I’d like to add a personal perspective on where we are as a company and where we will be in 2019. Since I became CEO, Magellan has evolved considerably to meet the challenging demands of our clients and changing demands of our clients and members. In the midst of giant healthcare conglomerates, we continue to have an important role to play in ensuring effective, cost-efficient specialty care. Our ability to win new business in a very competitive environment is evidence of that. I am convinced that the efforts being put into these three strategic initiatives will yield positive results, not only for 2019 but beyond, and that will remain my singular focus.

With that, I’ll turn the call over to Jon to discuss our 2019 guidance in more detail. Jon?

Jon Rubin

Thanks, Barry, and good morning, everyone.

For our 2019 guidance, we’re projecting net revenue of between $7.2 billion and $7.5 billion. Net income for 2019 is expected to be in the range of $52 million to $79 million, which equates to a diluted EPS range of $2.14 to $3.25. We expect adjusted net income in the range of $90 million to $114 million and an adjusted EPS range of between $3.70 and $4.69.

Our 2019 guidance for segment profit is a range of $270 million to $290 million. We’re confirming our 2018 full-year guidance including segment profit of $290 million to $310 million. As a reminder, this range includes the following: $26 million of net favorable out of year adjustments through third quarter 2018; $6 million related to the provision for the non-deductibility of the health insurer fee, which will be suspended in 2019; and $10 million to $20 million of expected severance and other related non-recurring costs in the current year. Adjusting for these items, the midpoint of our 2018 segment profit guidance range would be approximately $280 million, which is in line with the midpoint of our 2019 segment profit guidance range.

Year-over-year, segment profit is expected to be favorably impacted by the following drivers. Projected new business effective in 2019 of approximately $600 million in revenue, of which approximately 60% has been sold to date; the annualized impact in 2019 of new business revenues sold and implemented during calendar year 2018 of approximately $120 million; same store growth within existing contracts; the cost of care initiatives in MCC of Virginia and other healthcare contracts; administrative cost reductions related to the operational improvement actions that Barry discussed earlier; and pharmacy network rate improvement actions.

These favorable items are expected to be essentially offset by the following: Contract terminations with year-over-year revenue impact of approximately $660; the previously announced reduction to our MCC Florida footprint, which will result in the contract providing an immaterial contribution to earnings in 2019; and the impact of the lower level of discretionary benefits in 2018, which we expect to normalize in 2019.

With that, now, let me discuss the specific drivers of our 2019 guidance for each of the individual segments, beginning with pharmacy.

For our pharmacy management segment, we’re expecting 8% decline in revenue, despite solid net business growth in our core employer PBM business for 2019.Year-over-year decline is largely attributable to the planned reduction in our Part D coverage area, the loss of a health plan PBM customer due to a merger, and the loss of specialty curve-out business discussed on our second quarter call. We expect that 2019 pharmacy segment profit margin as a percentage of revenue to be relatively consistent with 2018.

For the healthcare segment, we’re projecting revenue to increase by 2% year-over-year in 2019. This is primarily due to the following: Growth in MCC Virginia including the Medicaid expansion in Magellan 4.0 TANF population and continued membership growth in the Massachusetts, New York and Arizona, partially offset by a reduction in number of regions served in our Magellan Complete Care of Florida contract. Segment profit margins as a percentage of revenue are expected to be comparable to 2018.

2019 corporate expenses, excluding stock compensation expense, are expected to increase approximately $5 million compared to 2018 as discretionary benefits are assumed to return to normalized levels.

Turning to other items in our forecasted earnings. 2019 stock compensation expense is expected to be in the range of $29 million to $33 million. We project depreciation and amortization expense to be in the range of $126 million to $136 million in 2019. We expect to incur interest expense of approximately $34 million to $38 million and to generate interest income of between $12 million and $16 million in 2019.

The effective income tax rate for 2019 is projected to be approximately 32%. The effective rate is higher than the federal statutory rate, primarily due to inclusion of state taxes and non-deductibility of a portion of a portion of executive compensation under the 2017 Tax Act. The 2019 EPS and adjusted EPS calculations are based on our estimate of 24.3 million fully diluted shares for the year. This estimate contemplates the impact of share repurchases and option exercise through December 3, 2018 but does not reflect any potentially future activity.

Since the end of third quarter through December 3rd, we repurchased 278,000 shares for $17.6 million, meeting a balance of $193.4 million in our repurchase authorization expiring on October 22, 2020. Note the pace of any future repurchases will vary based on a variety of market and company considerations.

During our third quarter results call last month, I mentioned that we were developing a multiyear earnings improvement plan to bring Magellan’s margin in line with inventory competitive level. The midpoint of our 2019 guidance suggested adjusted net income margin of approximately 1.4%. As Barry noted, we believe we can achieve a margin of over 2% within two to three years on the current portfolio. I’d note that our actual overall company margin may differ from this level to the extent we achieve any significant MCC new business sales or experience material mix changes in our portfolio over the next few years.

I'll now discuss what we believe are the two key areas of opportunity as we work towards achieving our targeted objective of over 2% adjusted net income margin for our current portfolio. First with respect to the improvement in cost of care, the Virginia contract has the most significant potential future impact. On a projected revenue base of approximately $800 million, achieving a mature 3% to 5% segment profit margin compared to a 2018 loss of $45 million would result in approximately $80 million of improved pre-tax earnings. While approximately half of this improvement is expected next year, we still have significant opportunity beyond 2019.

Next, with respect to operational efficiency, our 2019 plan already includes approximately $25 million of administrative savings as a result of the initiatives Barry discussed. Beyond 2019, we're projecting additional operational improvement across the organization. On a base of approximately $1 billion of administrative costs, we're targeting a minimum of $30 million to $40 million of additional efficiencies.

The combined impact of these last two areas would yield at least $75 million improvement in segment profit after 2019, which would represent a 70 basis-point increase in our total adjusted net income margin. We'll continue to provide updates on our earnings improvement plan as well as more detail about our multiyear outlook during our 2019 Investor Day planned for May in New York City.

In summary, we feel confident in our ability to deliver our 2019 guidance for revenue and segment profit. Our guidance includes the initial benefits of our margin improvement initiative offset by some of the temporary headwinds discussed earlier. Entering the year, we are highly focused on execution of our key business priorities and the multiyear profitability improvement initiative. And we look forward to updating you on our progress when we report 2018 year-end results in February.

And with that, I'll now turn the call back over to the operator for questions. Operator?

Question-and-Answer Session


Thank you. [Operator Instructions] And our first question today will come from Dave Styblo of Jefferies. Your line is open.

Dave Styblo

Hi there, good morning. Thanks for taking my question. Barry, maybe I'll start out with one for you. Can you talk a little bit more about what you are planning to do differently in the healthcare segment, particularly on the Virginia Medicaid contract now that you're taking a more active role over the operations and duties following the termination of Sam there? Maybe more specifically, how involved are you going to be and what is that going to look like on a day-to-day basis?

Barry Smith

Great, and thanks for being with us today, Dave. Yes. I'd like to address that very specifically. I'm very grateful for the wonderful contributions over the last many years of Dave -- of Sam. And I think we gained a lot at the company because of Sam's contributions over the last several years. That said, I also think it’s important as an organization to become faster and more efficient, flattening the organization and have a much more direct link and contact with managing the operations of the company, I feel that personally. With respect to Virginia and globally, I will have the President of MCC -- the enterprise of MCC nationally, Sharon Muscarella, report directly to me. I’ll take over all of the functional direct reports of Sam. And I’ll be very involved as I have been over the last several months as we implement cost of care, initiatives in Virginia and looking at how we can execute more crisply. We have been seeing recently some good momentum in Virginia. We’ve seen increases in terms of the impact of our initiatives for outpatient to behavioral health, with metal health skill building, for example authorizations, where individuals have been on for 24 months and it’s not being affected further. We’ve been able to reduce that to its appropriate level clinically. We’ve looked at acute in-patient admissions, qualifying those admissions and having our physicians qualify each of these to take a look at what was appropriate in terms of the length of stay and admission, and we’ve seen some positive there.

There’s a lot of specifically with claims integrity, and we’ve been able to identify claim overpayments and have actually been seeing some significant traction during the fourth quarter and actual cash and coverage from those overpayments for providers. So, there are a number of initiatives that I personally have involved in and participate in a pretty detailed way to make sure that we’re on track in Virginia.

I think the good news about MCC globally, Virginian particularly, is that as we get MLR to the point where it needs to be, that normalizes the MLR across all of MCC. We’re not that radically off except for Virginia. As you’ll recall, we had some similar challenges in Florida when we initiated. The difference between Florida and Virginia is that Virginia, while we were head of the curve in Virginia, we’ve had multiple implementations and the same staff that has been involved with the rates reviews with the state -- with Commonwealth of Virginia have also been responsible for managing care. And that’s been very challenging just to have both of those going on simultaneously. It’s a high class problem because we’ve been able to gain a lot more business and we have a wonderful relationship with the Commonwealth. But it has caused us a delay in being able to effectively manage cost of care. But personally, I’m very involved with Virginia. I spoke with the President yesterday, I speak with hear many, many times a week and involved in very detailed operational details of Virginia. It’s just because it’s so critical to be entire company. So again, I’m personally very involved.

Now, beyond just Virginia, just to let you know and everybody on the call know, I have four new direct reports in addition to my current direct reports. I have the President of Behavioral Health and Specialty reporting to me Gus Giraldo, a very capable leader. As I just mentioned, the President of MCC, Sharon Muscarella, who is reporting directly to me, again I’m very involved, not only in Virginia but across all the MCC sites with our new start-up also in Arizona. I also have John Littel that you probably know John -- I mean you know John. He is just an extraordinary talent, and we’re thrilled to have him on board as the Head of External Affairs who reports directly to me. And of course, the new head of healthcare service operations. Beyond Sam, we’ve also made other changes on the healthcare services side. And most recently, we’ve brought on Ashok Sudarshan [ph] who has extraordinary Medicaid, Medicare managed care experience operationally. So, it’s a combination of both technology as well as people to make sure we're doing the right thing. So, again, I'm very involved within the healthcare services globally but specifically within Virginia.

Dave Styblo

Okay. And that’s helpful, but actually helps to bridge into the second question I had about Virginia Medicaid and the progress that you're starting to see there. Is there a way for you guys to quantify, maybe the MLR on the different cohorts, since it’s being implemented at different times, I think it would help investment community understand, okay, the first cohort that came in the fall of 2017, where did the MLR start, where is it now, maybe the same type of calculus on cohort that came in January. And then, obviously, it just has some new lives come on in the fall of this year. So, the detail on that I’m sure would be slim. But, is there a way to at least give us a sense of where MLRs are trending by those cohorts?

Jon Rubin

Dave, it’s John. Let me take a swing at it, it may not be quite the level of detail you’re looking at -- looking for. But just the way we think about it is really in the major phases of the program. So, the first phase is CCC Plus, which phased in between August and January. It’s a little hard, as you could imagine, with members phasing in anything in by region and to really separate things month by month. But, we do look at it, CCC Plus and then obviously the TANF population, Medallion 4.0 that came in the summer, and will do the same thing with the expansion population that comes on this year. What I’d say is, it’s we very earlier, as you know in the TANF population. But, given the nature of that population, what we’ve seen to-date, I would expect that to be relatively immaterial to the overall financial picture. So, really, the key driver is that CCC Plus population.

Again, I don’t have the break down by month. But, looking at the program in total, that’s really where we’re focused on and that’s where we’re starting to see some of the initial success that Barry referenced on the outpatient behavioral health, the acute in-patient and the claims integrity. If you look at the total, book for Virginia, which again is largely driven by the CCC Plus population, the MLR has been at or little bit above 100% for the first three quarters of the year. We’re not through the balance of the year yet but at least half way through quarter four, we’re on track to see improvement below a 100, in the quarter. So, think of it in the high 90s and that obviously will continue to improve as we execute into 2019. So, that’s at this point how I’d break it down. As we get more maturity on the TANF book and -- we can break it down further as we go forward.

Dave Styblo

And then, my last one, I’ll let others jump in. But, as you guys bridge to your 2% plus net margin target in two to three years, I guess that’s -- is that sort of exiting 2020 or full-year 2021. And as part of that, I think everyone would appreciate the Virginia lever that you can pull with the administration savings. I think, this is the first time you’re really quantifying that. Can you talk about the sources of the savings, what that entails, finding those administration expense savings from?

Jon Rubin

Let me first answer your first question, if we think about the two to three years, that would sort of put it in that framework. So, think of it as 2021 or thereabout, it wasn’t meant to be precise in terms of a calendar year projection. But, I would think of it in the general terms of 2021 timeframe. But again, we think we can make significant headway. As we mentioned -- or as I mentioned in my comments, these improvements here, we sort of look at as the minimum, and there is a lot -- especially I’ll let Barry comment on some of the specifics around the administrative expenses. I think that today, we’ve really scratched the surface on the plans here. I think as we think about some of the longer term improvements, some of those might require some short-term investments. But, I think there is opportunity beyond that. Barry, I'll turn it to you, if you want to comment maybe on some of the potential opportunities on that side.

Barry Smith

We do think that we have some very significant opportunities. We’ve identified about $25 million in savings in 2019 upon the additional work that we've done. And we are focused really on two areas. One is personnel, people; and the other is processes and technology. Now, when I mention people, I don’t mean that we are going to simply go out and do a bond run and reduce headcount, quite the contrary. While there will be a more rational approach to headcount, we will combine that with the smarter process technology capability. In our areas particularly where we must make progress, we are going to make sure we retain the good quality staff that we have, for example, Virginia, to make sure that we get down the path.

It is challenging. I mentioned earlier, we are flattening the organization. In my view, I think over the last several years, we’ve been standing up new programs, we’ve grown radically. And you can get a little out of sync structurally in the company where you have too many levels in the company. And that causes two issues. One, of course, it’s expensive to do that and then secondly, it’s not as sufficient to operate the company like that.

So, for example, in my taking over directly healthcare, I’m not going to replace myself. I intend to have those functions report direct to CEO at this time going forward. It allows me a much better feel and direct connecting what's going on operationally, and they have very direct impact. The decision-making that occurs in an organization that’s too vertical [ph] is just not crisp. So, by flattening the organization and broadening span of control, we have several levels with the span of control is inappropriate and used to broadened. What that does is make both execution, decision-making far more crisp, and it saves money to move.

So, it is rationalizing the people part of it but it's also focusing on the talent in key areas. It’s reallocating resources. So, for example, I mentioned Ashok. Ashok comes in with a great deal of Medicare experience, not just general operating which he does, he is an extraordinary operator but he’s going to bring his expertise that we haven’t had. Chrissie Cooper, for example, who is coming in from the outside, was an operator for WellCare, very experienced, also a financial leader as well. So, she is coming in to be the CFO of MCC. I can go several people beyond that but these are good examples of simply not taking people out but it’s that allocating resources to individuals, we have leadership capacity specifically for what we need in the future.

One of the challenges that I see not just here but elsewhere in fast-growing organizations is that the needs and demands of the organization grow beyond individuals’ experience. And while it's good to have people who can learn on the job, critically, you’ve got to have leadership who's been there, done that and can lead and guide the organization in a more predictable way. And that’s really what we are about doing. So, it's not just a matter of reducing headcount, but it’s reallocating resources to have expertise and leadership that can make a material difference. We, for example, have recently hired very experienced Six Sigma Black Belt, we have a team of seven now that are working with Ashok in operations to make sure on the healthcare side specifically but they’ll help out across the board as well. But the point is, is that these are individuals who have come into organizations historically that we have worked with full time here that will really help us understand, both the technology and the processes to create much greater efficiencies than you’ve seen here at Magellan. So, I think there is a lot more opportunity here to create kind of a normalized admen [ph] overall for Magellan.

If you look -- you just heard the comments of Jon, I just mentioned $25 million of savings in 2019, but if you take a look at the total overhead of Magellan, and if you normalize that to industry standards as we will do, we see enormous upside for the company. Again, I’m going little long on this question, I think it’s a good question. In a way, it’s a bit of a high class problem. People ask me, what do you think about your strategy? Our strategy I think is running on target. Being able to address the needs of complex, clinical circumstances and complex populations, that’s something that’s not just in the demand today but will be increasingly in demand in the future. We have the solutions the market is looking for. We have the IP. It’s just the matter of the execution to bring down admen [ph] to industry normal levels, not more, not better than the industry, but normal levels in the industry. And also bringing cost of goods sold, both in pharmacy and MLR on the medical side to industry norms will yield enormous upside for us in the company. So, it’s -- we’re still out cultivating new opportunities. We’ve got a lot in the future, but we’re also metering out those opportunities in a way that allows us to digest that we have.

Given the portfolio that we have, we have extraordinary earnings power. It’s just a matter of extracting those -- those two industry norms, both admen [ph] and cost of goods sold and MLR. Hopefully that answers the question, Dave.


Thank you. And our next question will be from Ana Gupte of Leerink Partners. Your line is open.

Ana Gupte

Hi. Thanks. Good morning. So, you have good plan it sounds like with the new hires and all, appreciated hearing that on margin expansion. We certainly have seen that succeed as a strategy for some of the slightly larger Medicaid managed care companies. I wanted to move to pharmacy here and the strategy next year, for 2019 the PBM selling season has been competitive. The larger PBMs are being cautious around the profitability, not just for the next year, but I think just more broadly on a normalized basis with the competition intensifying with also the managed care plans integrating PBMs. We just published the survey this morning, which points to price discounts driving, switching to a more bundled offering. Can you talk about how the strategy is still viable in context of pretty much of transforming landscape at this point?

Barry Smith

Sure. As you point out, the market -- the landscape is changing dramatically with these large consolidations. I view it as much of the same impact. CVS was already very, very large. Now, CVS -- that larger, it’s true, but they already had a very substantial base and platform to operate from the competitive front. The same is true for Express Scripts, Express being combined with Cigna. Clearly, that’s larger entity. But, again Express on its own was already formidable, and it had great scale, great volume and great capability. So, I don’t know if that today's world of aggregation. And be assured with the PBMs as really materially different competitively, although it does give them an advantage but also gives them a disadvantage. The advantage of course is that Cigna can now sell Express in their book of business and that’s a clear strategy and a smart strategy. CVS with Aetna obviously can drive volume with CVS stores but also transform CVS into more of a healthcare provider rather than just a pharmacy provider. And I get that strategy; I think this is strong strategy as well. That’s the benefit of both those joint aggregations of capability.

The flip side of that is, there is a lot of the market that is looking for independence and they don't want to give their business to their competitor across town. And so, from our standpoint, it creates a significant level of channel conflict for those guys. And indeed, we see the benefit of that. In the face of these great -- joining of great powers within the industry, we’re having our single greatest year of employer business coming on board as of the first of the year, more than we ever have by quite some margin.

And what we are seeing and hearing is that we’re being invited to parties, to the table in circumstances that we might not have historically because the buyers of pharmacy want to have this level of independence. We also think they are inviting us because we’re unique in our clinical sophistication and approach to go specialty and mainline of PBM pharmacy. And we’ve maintained that competitive stature; we’ve amped up our game. We think that we’re very good at doing what we do. And so, we would expect to continue to see continued success in the marketplace. Again, our total number of lives are going up at the fastest clip they ever have as we go into 2019. We wouldn’t expect that to abate. I would expect that to grow. We’ve got a very effective sales force and a very effective product and services to sell. Now, that’s -- hopefully I included in my comments to answer some of your questions, but the other parts of your question I can give further insight into?

Ana Gupte

I guess, I think my point is being not just being missed a little here, it’s not just about scale, it’s about at least in the employer market -- and there is two different markets, there is health plan market and the employer market. There is -- in the select or even the mid market up to 500, a great desire, based on all survey data for years, to have simplicity in one stop shopping. And you take the plans with Cigna and Aetna, they are now able to monetize -- the business model is changing. It’s not -- no longer just the scale game of CVS getting somewhat bigger with Aetna or Cigna getting somewhat bigger Express Scripts. It’s about a medical member with $4,000 to $5,000 of revenue each year, offering them a huge underwriting margin, and they would be happy to discount their PBM product to get that. And the employer on their side, and the brokers are clearly saying this, would be the latest switch for reasonable prices discount. So, that’s a different point I’m making than I think what I heard you say.

Barry Smith

It is true, it is true that the larger players can essentially cross-subsidize product lines and be competitive. That’s absolutely true. But, what you describe is actually a strong suite of Magellan. We decided to go into MCC because within Magellan we provide 70% of what a health plan does. So, that’s why we went to the MCC and we’ve built out the rest of the network to be able to be a health plan. So, when we go to our employer, as well as our MCO clients, we aren’t just selling pharmacy; we are selling pharmacy, radiology, musculoskeletal and on it goes, a complete set that suite of services into the employer and into the MCO. And we have clients that use our entire suite of services. So, we have been able to play that card. And I would suggest, we are bit further advanced today and that we have been doing this for years, and that’s the strength of Magellan. Even though the pharmacy piece of it, the whole medical pharmacy management is really where we've been able to see reach ourselves because we do understand the medical side and it’s implication on physical medicine across the board. Again, that was the promise on which we began MCC and that was just a very short period of time ago. So, we have seen this cross-selling products and services. So, I don’t think that that’s inherently only a benefit to Aetna and CVS or Cigna and Express Scripts. I think that’s a great strength of Magellan and why we have seen success the way we have, and why we’ve been relatively resilient in the phase of significant competition in the marketplace. So, I agree with your point, that it is a benefit.

The other thing that I'd say, just one other quick to add is that we have focused historically, although we have had recently much, much larger wins, but we have been focused historically on the TPA, small business side of the pharmacy business where service really matters. We are very good at delivering service to our client base in a very unique and more personalized way. We're not a generalist. We work both as the specialty pharmacy but we also work in a way that is very client-centric on the TPA small employer side. I think that we are distinguished from the guys, given our capability there. And those TPAs out there, they don’t want to do business with Cigna or Aetna, they are competition. So, they have a significant issue of channel conflict that we are able -- that we don’t have.

Ana Gupte

Okay. Thank on that one. So, on the regulatory side, just staying with the pharmacy side for a minute is, what are your rebates? I think I see a disclosure of 95 million. Can you confirm that that’s right? And what types of conversations are you having with your clients if those get eliminated? I mean, we’ve had CVS Express Scripts and Optum talking about some pretty extensive pilots and contracting changes of employers.

Jon Rubin

Yes. It’s John. Let me take the first part of your question and then I'll turn it over to Barry to talk about more of the regulatory piece. In terms of the carve-out rebates, if you looked at -- you are correct, if you look back at ‘17, we would have been in the low 90s. We are in sort of the -- after some of the announced losses we talked early in the year, since then the book has been very stable but the handful of the issues we had earlier in the year. We are now in the 70s in terms of the actual carve-out rebate number. And that number, that 70ish number will continue into next year.

Barry, I don’t know, if you want to talk more about the regulatory impact and some of the things going on in the industry.

Barry Smith

Yes. With the -- obviously, there’s been a lot of talk about the Anti-Kickback policy anti statute exceptions for the drug rebates as well as the rebates at point of sale. With the recent Medicare Part D rule -- and this has been picked up by the media and talked about a lot about the rule and what it really entails, it doesn’t entail. There are certain things that it does. We think that they’re on a right track and allowing for step therapy and other issues surrounded Part D and more general PBM administration. But, it does not address at all, although it’s been talked about and people say the administration is considering, it does not at all address the issue of rebates at point of sale, nor does it eliminate the Anti-Kickback Statute exceptions prescription drug rebates.

Now, is that a possibility? Yes. I do think it’s relatively thorny particularly for the commercial population and that it likely would not be able to be implemented by executive order, but will require congressional approval and process. Just given more recent challenges with the election for both parties for the administration, we think it’s increasingly less likely that that will happen. Could it happen? Sure, but likely not.

That said, let just say it does happen, and again, I don’t -- I personally don’t think it will, but let’s just say it does happen. The other part of it is that the function that a PBM serves in terms of working with payers of drugs to negotiate aggregate volume and negotiate with pharma is still a very important function. Just because you eliminate rebates, and you know this very well Ana, doesn’t mean manufacturers will necessarily not -- will alter their list prices lower. You see some like Gilead Sciences who have a two-tier NBC pricing, one for rebate, one for non-rebate. So, you see some pharma, playing around with that a little bit. But the reality is, you don’t see that across the board, because it’s just too much I think on the part of pharma to lose.

And so, I think that function of the PBM that allows the aggregation and strong negotiation with pharma will be an important attribute that will have to be in the market as well along with all the clinical administrative stuff. In my mind, it would be a different pricing structure that might be implemented, if you indeed were completely to eliminate the rebate, the portion of it. But, we will simply reprice our services to have a very similar margin. It’s not like the PBM industry has the same margins that the pharmacy industry. So, you’ve got margin of 3 to 5 points. My strong feeling is that those services will simply be repriced and repackaged in a way that there is still delivered and that we still earn -- we have earnings power from that relationship with the client.

Ana Gupte

Okay. That’s helpful. And then one final one on the Florida contract. There was feedback from the provider outside of the house that Magellan was deigning claims, I mean are admissions and land stay and so and that might have influenced OCA and Florida Medicaid to not renew that contract in its entirety but the protest offering a little bit of a brief. Any comments on that?

Barry Smith

Yes. I think that any managed care entity will deny claims if they’re not clinically appropriate. That’s robust of us, it’s true of anybody in the marketplace. And generally, I have not even heard that. In fact, it was quite the contrary. We’ve got a lot of support from the provider community in our protest process, and really have very strong relationships with the provider of our community. And indeed a lot of provider community was up in arms because they realize that if you have a generalist trying to manage behavioral health issues, they don’t have a level of sensitivity from a client -- from a managed care organization to the -- enrolling themselves or to the provider. So, we have historically had very strong support and relations with providers. So, I have not heard that whatsoever. I think, the issue for the state of Florida and OCA, and we have a great relationship with them. And I’m thrilled that we’re able to retain a portion of our business. I think the issue was one of being able to have a limited number of special need plans and to make sure that it was calibrated in a way that would not disrupt the general plans that are there in state of Florida. I think that in terms of provider disruption or any issue like that, I literally have not -- never heard that.

Ana Gupte

Yes. No, it was from one of the two largest behavioral providers, one of which I cover, it’s publically traded, and it’s been said multiple times actually. But, -- and I know, it does not matter. We can talk about that later. The other aspect of it was on what is the associated impact of that loss or any of those, particularly SMI on the PBM side of it, on claim, which I’m assuming you were on PBM side, you were managing it yourself.

Barry Smith

Yes. We of course managed -- Magellan Rx was used in our Florida plan. And as recovery cure lies there in the state, you have less flow of Magellan Rx claims, and top line and bottom line of Magellan Rx. So, it would have that impact, but that’s already built in 2019 plan.


Thank you. And I’m showing no further questions.

Barry Smith

Great. Well, we appreciate you all joining us today for our guidance call. We look forward to speaking with you again in February when we discuss the full year in 2018 results. Thank you. Bye, bye.


We thank you all for your participation in today's conference. That does conclude the call. You may now disconnect. Thank you.

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