Centene Corp (CNC) 2007 Q2 法說會逐字稿

Good morning.

My name is Nicole and I will be your conference operator today.

At this time I would like to welcome everyone to the Centene Corporation second quarter earnings conference call.

All lines have been placed on mute to prevent any background noise.

After the speakers' remarks there will be a question-and-answer session.

(OPERATOR INSTRUCTIONS).

I would now like to turn the conference over to Mr.

Ed Kroll, Senior Vice President of Finance and Investor Relations.

Please go ahead, sir.

Thank you and good morning, everyone.

I am Ed Kroll, Senior Vice President, Finance and Investor Relations, at Centene Corporation.

Thank you very much for joining us today for our Q2 conference call.

You should have a copy of the press release issued this morning.

If you haven't received it yet, please call Libby [Abelt] in our New York office at 212-759-5665 and we will get one to you immediately.

Our press releases morning includes a table reconciling our GAAP financial statement presentation to non-GAAP amounts.

We have included that table for comparability purposes because it allows us to present our 2000 results, excluding the FirstGuard activity.

We will refer to those non-GAAP amounts at various points during this call.

Michael Neidorff, Chairman and CEO, Eric Slusser, Executive Vice President and CFO, and Per Brodin, Senior Vice President and Chief Accounting Officer of Centene Corporation, will host this morning's call.

The call should last about 45 minutes and may also be accessed through our website at www.centene.com.

A replay will be available shortly after this call's completion on that same website, www.centene.com, or by dialing 800-642-1687 in the United States and Canada, or 706-645-9291 overseas, and the access code for both of those is 1100685 for the replay.

Any remarks that Centene may make about future expectations, plans, and prospects constitute forward-looking statements for purposes of the Safe Harbor provision under the Private Securities Litigation Reform Act of 1995.

Actual results may differ materially from those indicated by these forward-looking statements as a result of various important factors, including those discussed in Centene's form 10-Q dated July 24, 2007, that is today, and other public SEC filings.

Centene anticipates that subsequent events and developments will cause its estimates to change.

While the Company may elect to update these forward-looking statements at some point in the future, we specifically disclaim any obligation to do so.

With that, I would like to turn the call over to our Chairman and CEO, Michael Neidorff.

Michael?

Thank you, Ed.

Good morning, everyone, and thank you for joining this morning's call.

Let me make some overall remarks and then I will turn the call over to Eric and Per to comment on the financials.

To summarize, overall results for revenue, membership, growth, and earnings were consistent with our expectations and our HBR improved by 170 basis points sequentially.

We have Dr.

Mary Mason, our Senior Vice President and Chief Medical Officer, available this morning to answer any questions that you might have on our medical management programs and improving HBR.

Jesse Hunter, Senior Vice President, Corporate Development, is available to address questions regarding new business opportunities.

I want to remind you that one should expect the HBR to move around, owing to seasonality, the addition of new business, and new members.

And expect it to fluctuate in a range of 81.5 to 83.5.

The HBR in this instance is slightly below the range, which may happen on an occasion.

Importantly, I want to stress that we have a long runway for growth with respect to our existing book of business and are maintaining a focus on margin expansion, balanced with investments to grow our business.

We have and will continue to take a disciplined approach to our pipeline of new opportunities, which are substantial.

In Texas, we continue to see growing membership in both SCHIP and SSI.

The Texas STAR+PLUS membership is 31,400, as anticipated.

Recently we announced that the state of Texas intends to delay the implementation of the foster care contract award, which we won this past March.

We now expect operations to commence in 2008.

This delay recognized that the state was changing their enrollment agent and that it was prudent to avoid the kinds of issues that they had seen in the past.

The state is currently working on its readiness review and we are supporting them in this process.

We remain confident that our technology platform will enable us to provide the state more effective tracking of these members and offer a more consistent quality of healthcare for the foster care recipients.

We also believe that we can offer this platform to other states that require this type of service for their foster care children.

In Ohio, the ABD rollout is proceeding as expected and we recently entered the fourth and final region.

We are now serving 19,500 ABD members in Ohio.

In Georgia, membership at quarter end declined sequentially to 281,400 as the state completed their eligibility review of SCHIP members.

With these members -- while these members were lost in SCHIP, we expect that they will become eligible for Medicaid coverage upon reenrollment.

As we stated historically, these membership fluctuations emerge on a temporary basis from time to time as states make adjustments to requirements for Medicaid recipients.

As previously guided, we believe this membership will fluctuate between 270 and 290,000 lives.

While the utilization and cost trends may still appear high in Georgia, particularly in the Southwest region, we are seeing indications that they are moderating.

We have been using a medical database as it matures to effect appropriate, responsible medical management techniques and are seeing the appropriate and expected results.

For example, while this is an exception, we have elected to comment about the performance for the month of June to tell you that the data was encouraging and provides reason to believe that these techniques are working.

These trends should continue to moderate further as our medical management initiatives take hold and we will look at opportunities to negotiate and implement margin protection strategies with the state.

We are also negotiating with the state on rates and we will provide an update when we have more details.

Recently we received a sanction by the state of Georgia for $3.7 million for 37 pre-authorizations for medical services such as speech therapy and audiology that exceeded the 14 day allowance for medical review.

These were and are transitional issues of a new plan and we believe that they have been resolved and that preauthorization process issues are behind us.

We are appealing the state's decision and expect that we will be able to reduce the dollar amount of the sanction.

As previously indicated to you we experienced continued membership declines in Wisconsin and Indiana primarily due to adjustments made to our provider base.

This demonstrates our willingness, when appropriate, to be smaller, but more profitable.

In South Carolina we are currently managing recipients on a non-risk basis until the state's conversion to managed care.

We plan to participate in the rollout, which is expected to commence in October of 2007.

As of June 30, 2007, our membership in South Carolina was 31,100.

We received a 3.3% rate increase in New Jersey, effective July 1, and are in discussions with Texas and Georgia about our rate increases there.

We anticipate the rate increases in those states to be consistent with our planning.

We do not anticipate rate increases during the second half of the year in any of our other markets.

Our Specialty Coverage segment continues to perform and meet expectations.

While disappointed about the outcome of Maricopa County, we are working with the state to understand the obvious discrepancies in their rating system.

We are pleased to have found through Access Health Solutions the appropriate entry into our eighth state, Florida.

Florida, as you know, has a large Medicaid population and access is uniquely positioned within the state.

With that, I am going to turn the call over to Eric for some brief remarks.

I also want to acknowledge the working relationship he and Per have and recognize that we have the depth and breadth in our financial function that allows us to continue our growth while protecting the integrity of this important function.

Eric?

Thank you Michael.

I am very pleased to be here and to be a part of the Centene senior management team.

In the short time I have been here, I have spent a lot of time focusing on second quarter results, reviewing the guidance that we are providing for the second half of the year, as well as thinking about the Company's upcoming fiscal '08 planning cycle.

I have been in discussions with Michael and the senior management team and as a result of those discussions, we have decided to change the timing for giving fiscal '08 earnings guidance.

As you all know, in the past it has been Centene's policy to give annual guidance for the following fiscal year as part of our third quarter earnings call.

In the future, we plan to move the guidance from late October to early December and we will do so through a press release.

Our quarterly guidance policy will not change with quarterly guidance being given for the subsequent quarter on the current quarter's earnings call.

We believe this change makes sense due to the growing complexities of our business.

We also believe this is a logical step as we continue to expand and react to changes in growth in both our -- in our business in both the Medicaid and Specialty company segments.

Finally, as a reminder of our policy, any questions or inquiries after the call should be directed to Ed Kroll, who is our main contact for investors and analysts who need financial or other information.

With that, I will turn the call over to Per.

Thank you Eric.

Good morning, everyone.

To recap the highlights of the 2007 second quarter, revenue was $727.7 million, an increase of 46.9%, compared to $495.3 million in the 2006 second quarter.

Revenues, general and administrative expenses, and related financial ratios continued to reflect premium taxes on a gross basis consistent with our past reporting practice.

We continue to evaluate a possible reporting change to net reporting and we will provide advanced communication of any intent to change when and if applicable.

Our second quarter earnings from operations were $16.9 million compared to $6.3 million in the same quarter last year.

Our health benefits ratio for our core Medicaid and SCHIP population was 80.6% for the three months ending June 30, 2007 compared to 84.0% in the same period in 2006, a decrease of 340 basis points.

Remember that the HBR for the 2006 second quarter includes a $9.7 million, or 220 basis points, of adverse medical cost development from the first quarter of 2006.

The remaining decrease is primarily attributable to the effect of increased premium taxes.

On a sequential quarter basis, our Medicaid and SCHIP HBR decreased from 82.3% in the first quarter to 80.6% because of decreases in our Indiana, Texas, and Wisconsin markets primarily related to inpatient and pharmacy cost trends.

On a net of premium tax basis, the 2007 second quarter Medicaid and SCHIP HBR was 83.1%.

You will note we provided a table in our press release that shows are quarterly Medicaid and SCHIP ratios on both a gross and net basis for comparative purposes.

For the second quarter of 2007, the HBR for our SSI population decreased from 87.6% in the second quarter of 2006 to 87.5% due to the effect of higher premium taxes, partially offset by the new business in our Ohio and Texas health plans.

Our Specialty segment HBR was 75.9% compared to 83.7% in the second quarter of 2006.

The decrease is caused by the diversification of business in that segment, which now includes OptiCare beginning July 1, 2006 and Bridgeway beginning October 1, 2006.

Turning to general and administrative expenses, our G&A for the Medicaid managed care segment as a percent of revenue increased to 14% in the second quarter of 2007 compared to 12.3% in the same quarter of 2006 because of higher premium taxes, partially offset by the effect of better leveraging of our expenses over higher revenues.

2007 second quarter G&A includes a $3 million contribution to our charitable foundation, funded from the proceeds of our FirstGuard Missouri sale.

The 2007 second quarter also includes our estimate of the expense associated with the Georgia sanction.

In the second quarter of 2007 for Specialty Services the G&A ratio was 15.8%, a decrease over last year's same quarter figure of 17.4%, and is attributable to the overall growth of the segment.

As we discussed last quarter, the sale of the operating assets of FirstGuard Missouri was completed effective February 1, 2007.

Under the terms of the sale agreement, we received an initial payment resulting in a gain of $4.2 million in the first quarter of 2007.

In the second quarter, we received a final contingent payment resulting in an additional $3.3 million gain.

Investment and other income for the second quarter of 2007 increased $2.1 million primarily as a result of an increase in market interest rates and larger investment balances offset by a $0.7 million asset write-off associated with the stock abandonment of our Missouri health plan.

Interest expense increased $1.8 million due to higher debt levels.

Net earnings were $17.8 million, including the gain from the sale of our Missouri plan, a $6.4 million tax benefit from the stock abandonment of our Missouri health plan, and other activity associated with exiting the Kansas and Missouri markets.

Earnings per diluted share were $0.40, including an after-tax benefit of $5.7 million, or $0.13 per share, for FirstGuard-related activities.

Balance sheet highlights at June 30, 2007 include cash and short-term investments of $279.8 million, long-term investments worth $313.9 million.

At June 30, 2007, cash and investments held by our unregulated entities totaled $65.8 million.

Our total debt was $201.1 million and debt to capitalization was 34.0%.

Our medical claims liabilities totaled $295.3 million, representing 46.8 days in claims payable, reflecting a four-tenths increase from the prior quarter.

This remains slightly above our guided range of 40 to 45 days.

We expect to remain slightly above our range as we continue to bring on new business.

For the quarter cash flows generated from operating activities were $23.9 million compared to a net income of $17.8 million, or 1.4 times.

Keep in mind that the operating activities of the second quarter reflect an increase in premium and related receivables related to the $26.8 million June capitation payment from the state of Wisconsin, as they hold this premium over their fiscal year-end, consistent with prior years.

This payment was received in July.

If we exclude FirstGuard activity and add back the Wisconsin premium payment, our 2007 second quarter cash flow from operations would have been over four times net income.

For 2007 we expect normalized cash flows from operations to range from 1.7 to 2.0 times net income.

Our year to date net income includes a total tax benefit of $36.3 million associated with our FirstGuard stock abandonments.

That benefit will be realized through tax payment reductions over the next three quarters.

During the second quarter of 2007, we recognized a tax benefit of $6.4 million associated with the abandonment of the stock of our Missouri health plan, resulting in a net tax expense of $0.8 million, despite having $18.6 million of pretax income.

If you exclude the effects of the Kansas and Missouri health plan stock abandonments and the gain on sale of our Missouri health plan in both the first and second corners of 2007, our effective tax rate for both the three and six months ended June 30, 2007 was 38.0%.

Lastly, our guidance is third quarter revenue of 740 to $750 million and earnings per share of $0.35 to $0.38 and full-year revenue of $2.9 billion to $2.94 billion and earnings per share of $1.36 to $1.45.

This guidance anticipates continued in-line HBR performance, reasonable rate increases, continued SSI earnings growth, and G&A focus.

The tightened guidance ranges also reflect the delay of the Texas foster care program from Q4 2007 to 2008 and the expectation that our Access Health Solution investment will be neutral to earnings in the second half of 2007.

With that, we can open the call up to any questions.

(OPERATOR INSTRUCTIONS).

Josh Raskin, Lehman Brothers.

Hi, thanks.

Good morning.

It sounded like there were a bunch of one-timers and I just want to make sure I sort of understood everything in there.

In the press release, you talked about $0.13 from the tax benefit, the gain on the Missouri sale, and the charitable contribution and I was wondering if you could just sort of break out all those individual items?

Well, perhaps the best way to look at it is in the press release there is the reconciliation from the GAAP earnings to the non-GAAP.

You touched on the high points.

There are some other smaller G&A-related FirstGuard items, as well as you will see a little bit of medical costs related to the FirstGuard run-out, but the gain on sale of $3.3 million is certainly the big piece, along with the tax benefit of $6.557 million, the $3 million of charitable contribution, as well as some other admin expenses and then approximately 7 to 800,000 of the asset write-offs for the stock abandonment, offset slightly in the -- this is in the investment and other income line -- offset slightly by some remaining investment income from the portfolio for those two health plans.

And then, Per, it didn't sound like you mentioned, or at least just now, you didn't mention the additional cost.

I think you said there was another $3 million included for the Georgia sanction.

That is in SG&A and you are sort of including that in what we will call recurring earnings, or quarter earnings, this quarter?

Our recurring earnings include the expense related to the Georgia sanction.

Okay.

So that is in the earnings.

That's helpful.

And then just a quick question on Access Health.

I know you are sort of purchasing a piece of that.

What is the accounting for that?

Is that enough for an equity method sort of consolidation or how you going to account for that?

We will initially account for that as an equity method investment.

Okay.

That's helpful.

And then just last question, the Texas foster care, you guys are saying 2008.

Should we assume that is 1/1/08 or is that still up in the air?

We are still working with the state on the date, so we don't have enough clarity to give a date at this time.

We are working, Josh, to be ready when they are.

And you know we have a lot of respect and appreciate the approach they are taking to make sure the enrollment is as flawless as possible with this transition.

Okay.

So whenever they get back to you, it sounds like you will be ready for the date, but it doesn't necessarily mean January 1?

I mean, we have enough experience with how these things go that it is difficult to put any date certain on it.

Fair enough.

Okay, thanks.

Greg Nersessian, Credit Suisse.

Good morning.

My first question was just on the South Carolina membership.

Could you just remind us what the financial relationship is there?

I think you mentioned it was a non-risk.

How much revenue did you book on that membership in the quarter and what was the impact on the financials?

From a consolidated standpoint, it was relatively very immaterial because of it being not-at-risk and based on those 30,000 members, it is a negligible amount at this time.

So it will be a larger amount as members convert to at-risk.

Okay.

I would think of it in terms of a normal ASO-type premium.

Okay.

And then I think you mentioned activities in Georgia related to margin protection.

Could you just talk about that a little bit more in detail?

What specifically -- what type of initiatives you have in place or you are implementing and what -- any update you have on the Georgia rates.

Okay.

Let me do the easier of the two first.

The Georgia rate, met with them last week, they still have Aon taking a look at it actuarially.

[Bursar] had done some work and they are taking another view at it.

We are looking at a whole series of things that we can pre-authorize where it is appropriate to.

We are looking at drug formularies and appropriate changes there.

Mary, anything you want to add to medical management in Georgia that would be in that category of margin protection?

Sure.

I think that the leveling of care and the significant training and auditing that we have done in order to maximize the benefits from leveling is really starting to show, especially in the area of NICU.

What we have seen is avoidance of cost-outliers.

Because we are shifting the authorized days appropriately using guidelines, when the hospital would put them into NICU or special care nursery, they really are more appropriate for well nursery.

And just to give you some data from Georgia, we have actually put our nursery base have doubled since Q3 of last year if you look at Q2 this year by doing this appropriate leveling.

Yes I think it is a case, Greg, of getting the state to approve the policies that allow us to do these things and they are working very cooperatively to try and do this on a very fast basis.

Okay.

And then just one follow-up on the rates.

Is it your understanding when, and if, Georgia does come back to you with a rate adjustment that that would be retro to July 1 or would that be implemented as of the date it settled?

We had -- I am smiling because we had a lot of discussion about that.

I don't think anybody likes the state to use the word retro as such, but I think they are going to determine the appropriate way to compensate us on a -- what I read into what they said -- and this is my -- but we talked with -- I think we'll get the benefit of a 12-month rate increase and how they do that, they are still discussing.

Okay, great.

Thank you very much.

Scott Fidel, Deutsche Bank.

Thanks.

First question, if you could just provide some more details on the medical cost improvement that you cited in the three markets, Indiana, Wisconsin and Texas, maybe what some of the component drivers were?

And then also if you saw all the benefit there related to the current quarter and the MLR related to those markets?

Well, there are three areas that we have focused on throughout all of our plans -- NICU, which I just talked about; with OB, case management to prevent those premature births; and also high-dollar specialty drugs, Synagis growth hormone factor for hemophilia.

And what we have found is that, especially with the area of OB, with aggressive OB case management, pregnancy notification so we can get these women into case management, identification of the highest-risk women who have had preterm birth previously.

If we can get them on an injectable called 17P, we are seeing some dramatic decreases and our utilization of 17P across our markets, with aggressive campaigns by the plan, has gone up about one third this year.

And we are seeing those women are having babies that are not 24 weeks and 25 weeks gestation, they are 36, 37 weeks.

So really what we have done is we have actually looked throughout the plan.

We have many different projects in play now, for example, the growth hormone initiative is going to expand out to eight other disease states, taking where we have a preferred product, lower unit cost, the outcomes will be the same.

It is going to result in significant savings.

Okay.

That's helpful.

And then just relative to the back half guidance and, Per, I know the last couple of quarters you have given us some of the puts and takes in terms of some of the key drivers there.

I wonder if you could walk through that just in terms of thinking about the back-half improvement?

Maybe just to simplify it too, think about how much of that comes from improvement in the MLR in the back half relative to the second quarter as compared to the G&A leveraging you discussed?

Well as we discussed at the investor day, there is, say, four key drivers for the back half guidance -- HBR, rates, the reaching more of a full-year run rate with the ABD product in Ohio, as well as some SG&A leveraging.

So in terms of maybe Q3 versus Q4, Georgia, I think some of the improvements we're starting to see will be a driver of that, as will -- we expect to see continued improvements in our Indiana plan as improvements in that plan continued to have traction.

And then we also will benefit from the rate increase, effective July 1, of New Jersey as well as 9/1, the rate increase in Texas.

And then we also will expect at some point to see a rate increase that will affect the second half for Georgia.

And as I mentioned before, the better leveraging of our G&A ratio will happen more in the -- you'll see that more in the fourth quarter than in the third quarter.

Okay.

And had a follow-up too, just in terms of the paid claims data that Georgia has been releasing, just interested in how you think we should think about the sort of claims denial levels that are showing for Centene, where it has showed those tracking above some of the peers?

I guess, should we expect to see those come down now in the back half of the year and if so, how would that impact DCPs and claims inventory per member?

I have in the room anticipating that question would come up, Scott, Patti Darnley, who drives our claims systems operations side and claims shop.

So Patti would you like to comment on that?

Sure.

Yes, I think we will definitely see that coming down.

Part of that really did stem from some of the cleanup issues that you are aware of that we did during the first quarter.

Many of those allow us to really dig down into where our claims are and work with any of our providers where we are seeing bumps in that.

Some of it having to do a lot with different billing practices at providers, different systems that they are getting used to, and we have really reached out to any of those providers and are working through with them.

And we found that in that working through that we were really able to really tell what our claim level is and what their claim level is and it has really given us a probably a better picture than we have in many other markets because of that direct working relationship.

I think also that the current claims, Patti, are getting paid appropriately and a lot of those denials and things they saw were duplicates, right?

Right.

We have a high level of duplicates that came in and most of that is just working through with the providers and understanding their billing system and our billing system to make sure that we are working together.

If you look just in our turnaround time, on average, we pay a claim that comes in in less than eight days.

So we are very current with any of our claims that we are paying.

Okay -- sorry.

To speak to the latter part of your question on the day's claims payable, the cleanup efforts with respect to Georgia will continue to have some downward pressure on the day's claims payable, however we still have enough new business coming on and reserves building there that I say will offset that and keep that above our guided range as I mentioned.

Okay.

And if I could quick in one last question here.

Just looking at the Specialty MLR, definitely looks pretty attractive here at 76%.

I guess as you look at the mix of business, is this a good run rate now to think about the Specialty MLR or were there some factors in it that benefited it in the second quarter?

I think it is in the range of where you may see it operate.

It may tick up.

As we talk about any of our businesses, I think that, but as we have added and diversified that portfolio, the additions that we have had are more in line with the ratio you are seeing now versus the contract that we have in Arizona.

And some of it is -- do you want to add something, Mary -- I was going to say, some of it is the product mix within that total group.

You have long-term care.

You have the behavioral health.

So as you see the shifts to -- we brought on a lot more long-term care.

But you also have OptiCare, the optical program which is growing very nicely.

As that grows is has difference, so some of it -- and we will have to be sure going forward to help people understand what is driving it at a particular point in time.

It is very much a product mix issue.

Okay.

Thank you.

Matthew Borsch, Goldman Sachs.

Good morning.

Thank you.

I got a question on the utilization patterns in the second quarter and, you know, I heard your comments on your care management efforts.

I guess a couple of things here.

One, would you characterize where you have seen favorable trends, that that has been more the result of your intervention efforts or equally or more the result of, you know, just favorable trends as you have come into the month of June.

And I'm a little bit trying to correlate this back to a hospital company that reported yesterday and had seen a drop-off in volume in June and just curious if, you know, you saw that or this was something that was more spread out through the second quarter?

Well, you always are going to have seasonality.

However I have to say, especially with OB, we are seeing very positive trends.

We are seeing more women being identified earlier in their pregnancies that are being aggressively case managed and are having better outcomes.

Okay.

Would you say, though, generally with regard to where your trends have been favorable in Texas, Indiana and Wisconsin that it was weighted towards the month of June or was it sort of spread out throughout the second quarter?

It was really spread out throughout the entire quarter.

Okay.

Fair enough.

And can you give us a cash flow number for -- operating cash flow number for the first half that excludes the various items related to FirstGuard?

I don't have that at my fingertips, but let me dig that up while we're answering some other questions.

Okay.

I think we are good for now.

Thank you.

Doug Simpson, Merrill Lynch.

Good morning.

I just want to try and sort of connect the dots with some of the comments that have been made.

If I heard you correctly, it sounds like you don't see a huge dip in the MLR sort of over the next two quarters and what I am trying to get at is sort of this really steep ramp into Q4.

And you were at 81.3 this quarter; that is a little bit below sort of the ranges that you have been talking about sort of longer term and you might get some updates from Texas, Georgia, and South Carolina, but it sounds like that probably doesn't go too much -- down too much and then if you sort of look at the revenue guidance, there is not a huge uptick there sort of from Q2 to Q4.

So it is sort of leads us to an SG&A leverage really driving the increase in EPS from sort of the $0.27 run rate now to like a $0.48 to $0.54 number for Q4 to get to your guidance range.

And just over the last year, we haven't really seen that come through.

So we are just sort of trying to get our arms around what is going to drive what really is sort of a doubling of EPS potentially in a six-month period really it seems like driven by the SG&A line.

What specifically is going to be behind that rapid increase?

Well, as I spoke earlier, there is a number of drivers, it is not just G&A.

In the SSI product mix, you have a big driver being getting to a run rate.

In Ohio, we brought on the last of four regions during the second quarter, so there is still ramp there and you also have the issue in both SSI and ABD populations of the continuity of care.

We have seen that as we have gotten past the first 90 days of the continuity of care issues in our newer SSI markets that the cost trends come down dramatically and that is in line with our expectations, but they are initially high for those first 90 days until we can start implementing some of our medical management practices.

So that along with just hitting run rate is the driver in the SSI population product mix in the second half.

We spoke to the rates in Georgia, Indiana, and New Jersey.

If you think about the size of the book of the business in Georgia and Texas, you know, those increases could have a significant effect because those are very large businesses for us.

So that MLR then could go -- are you saying, then, the MLR, despite the growth in SSI, which I would guess would pull that MLR up, you are saying the rate increases it sounds like would pull the MLR down meaningfully from even the 81.3 this quarter?

It could, yes.

And also remember that we have our specialty companies there and they are growing and making a contribution of some significance.

And when you add a new SSI member, there is a big drug component.

And you are going to start to see that margin accruing to us.

I mean, there's a number of factors.

There is no one thing, but I mean, as Per said, the rate increases in Texas, rate increases in Georgia are important aspects of this.

Okay.

Thanks.

Matt Perry, Wachovia Securities.

Good morning, guys.

Can you hear me?

Yes, good morning.

Great.

First question, just housekeeping issue, on Georgia you said you have reserved for the sanction amount.

Can you tell me the amount you reserved for?

When you are in negotiations, Matt, with the state on that, I would not be smart to tell them what I expect.

Okay.

And second --

As I understand it for their benefit, we expect a small one.

I'm not saying what I am what I am going to put in it.

Okay.

And then qualitatively, you talked about Georgia cost improving in June.

Can you give some more detail around what buckets those improvements, you know, came from and whether -- kind of going back to a similar question, how much of that you think might be normal seasonality versus kind of your own medical management efforts?

I think it is a combination of both.

There is -- with any June, as we have said on the call, there is going to be some seasonality in there.

However, we saw improvements across buckets, including utilization, so that gives us optimism that some of that or a fair amount of that is related to our medical management efforts and that that will continue in the second half.

And then I guess another thing that in Georgia that will we believe influence the results in Georgia is there are some medical management or margin protection items that will take effect August 1.

So those items would not have affected the second quarter, but certainly we expect them to influence the second half.

And just -- I want to make sure I understand margin protection items.

These are efforts that you needed state approval to do, so you have only been able to implement them as of August 1.

Is that right?

Correct.

Right.

And there is also a provider notification that must go through as well.

And just going back, those were like formulary changes, things of that nature?

Right.

We have spent, I would say, the last six months refining our formularies.

We have had over 600 new step edits, quantity limits, age limits that have been put in place over the last six months and we are seeing these come through now and they actually seem to be bringing the pharmacy costs down.

We are also -- around hemophilia I know there has been a lot of talk about that over the year in Georgia.

We are doing some aggressive what we call assay management and partneringship with Caremark.

We have been able to bring down those costs significantly for factor.

And you know, if I get too to look into your back half guidance, do you expect Georgia to reach a company average margin by Q4?

.

Our guidance does not anticipate it hitting our overall range, but we see improvement, but not that significant of improvement.

It does not have to get to a fully-normalized margin for us to get there.

Okay.

That's helpful.

And then just last question, you know there seems to be a lot of talk about SG&A leverage.

You know, if I look at just the dollar amount of SG&A on the income statement, would you expect that the Q2 dollar amount of SG&A is the highest level of the year?

I guess what I am asking is would we expect the dollar amount of SG&A to go down in the second half of the year versus Q2?

No, I would think of it as being in line.

In-line?

Okay.

All right.

Thanks.

That's all I had.

Bill Georges, JPMorgan.

Good morning.

Just a couple more questions around your medical loss ratio.

I guess you already touched on where you see Specialty Services going.

Could you give a little bit of color around the directionality of both SSI and the Medicaid and SCHIP MLR's?

Both of them being directionally -- moving around obviously a fair amount.

What kind of ranges do you see those going forward?

Will we have classically stated that the SSI would be in a 84 to 86 range and that we would have 81.5 to 83.5 for the TANF and SCHIP.

I think on the 84 to 86 SSI reflects more of a normal run rate, so you are seeing that we are outside of the range, as we would expect given the two new states in which we are operating that program.

So we expect to get that to come down toward our guided range for the SSI product.

Okay and can you just --

If you look at the effect that premium taxes has had on our Medicaid and SCHIP, you know, you get a little bit of a flavor that there is a 250 basis point delta there at the present time.

So there's a big effect to those premium taxes.

Can you give us an update as to sort of how you think about that regressing to the mean or the expected range?

Are we talking about by the end of this year, or is it an '08 phenomenon?

In the SSI population, it will get down, I think, toward that level, doesn't necessarily have to be within that level by the end of the year.

Let me just comment, though, from a medical management standpoint, for example pharmacy in ADD in Ohio.

There is -- and when we get these members, for 90 days we cannot shift them to our PDL.

Once we do shift them, then we do see a dramatic drop and it comes down to where we would expect it.

With case management, many of these patients have 5, 6, 7 different disease states and sometimes it takes two to three months to get these members stabilized -- to get them to a place where we feel that we are managing them well.

So that would -- two, three months is really what we are looking at once we get a member.

To make some of the, I'd say, initial (multiple speakers)

Right (multiple speakers)

When we talk about pharmacy within the SSI population, particularly of Ohio because pharmacy is carved out in SSI -- for Texas.

It is a significant component of the $1100 premium in Ohio, so as we influence that significantly, it has a large effect on the medical costs for that product line.

Okay.

And then if you could comment -- both in the prepared remarks and the press release you talked about the sustainable, long-term growth opportunities that you see.

So from a revenue growth perspective, can you give us a sense of what that looks like over the next couple of years and where those opportunities might come from?

Yes, Jesse, do you want to comment on that?

Sure, sure.

Yes, I think for those of you that we talked to at the investor conference, we touched on this a little bit, but we continue to have a full pipeline, as we said, for a while and I think that is evidenced by the announcement that we made on Friday with respect to entering into Florida.

So we -- over the long term, you know, we continue to see opportunities in the 20% to 25% growth rate for both revenue and earnings and that is going to come from a combination of organic growth, RFP or procurement activities, and select M&A opportunities.

Okay, great.

Thanks very much.

Melissa Mullikin, Piper Jaffray.

Good morning.

Can you give us -- tell us a little bit more about your expectations for your for Indiana enrollment and Wisconsin enrollment as you see maybe some of the impact of that provider repositioning maybe waning a little bit and when you might expect, or do you expect growth to return in those markets?

I think what we have done is we -- I expect to see it sort of stabilized at the level it is that and then we will over the next couple of quarters look at the opportunities to grow it back with the right provider base in a way that will maintain the margins there, which are now starting to approach the appropriate levels.

So you see it stabilizing at around current levels and you're going to look for an opportunity to grow, but you wouldn't necessarily expect it to grow appreciably in the balance of the year?

Well, it is going to be -- I expect it towards the end of the year we could see it start to grow, as I said, as we get the network right and we find the right opportunities.

Okay.

And you mentioned the continuity of care provisions that you are restricted by in Ohio.

Were those also in place in Texas?

Did you have to wait the 90 days there as well for those SSI populations?

Well, there's not pharmacy in Texas, so we did not have to do that.

They don't have a pharmacy, but Wisconsin where we have SSI, there is a 60 day continuity of care period --

Correct.

So do those continuity of care provisions only apply to the pharmacy piece?

No because we can apply in Wisconsin to all aspects of the care.

Okay and then the 90-day continuity of care in Ohio applied across the board or just to pharmacy.

Just to -- well, pharmacy, but every time we get a patient, we evaluate what is in process but if something has been -- we want to make sure that patients have the treatment they need until we can evaluate them and then get a care plan developed and executed.

I think there is state-mandated continuity of care issues and then there is good healthcare management when you take over the cases with somebody who has multiple morbidities to say let's make sure we figure out and take the right action and so there is a combination there.

Okay, okay.

And then you talked about reserving for the Georgia sanction.

You have already done -- is that include in your Q2 results, or is that something that --

It is in the Q2 G&A.

It is in the Q2 G&A?

Okay.

So it is not expected -- okay, great.

I just didn't know if you included that in your guidance for the second half or if it was already included in Q2.

No, it is in our Q2 results.

Great.

Okay, that's all I have.

Thanks.

Carl McDonald, CIBC.

I was wondering if you could quantify the impact of start up costs in your 2Q earnings?

The startup costs associated with South Carolina and Texas foster care was approximately $4 million, or $0.06 per share, in the quarter.

Okay.

So no change relative to the prior and then the revised impact of start up costs for the full year?

For the remainder of the year, we expect approximately for, again, those two efforts about $0.06 in Q3 and $0.06 in Q4.

Okay.

And then finally, what was the deterioration in the medical loss ratio in Georgia relative to the 85.8 in 1Q?

On an overall basis, you will see that closer to 90.

Okay.

So about 600 basis points, give or take -- I'm sorry, 400 basis points?

Right.

Great.

Thanks very much.

Brian Wright, Jefferies & Co.

On the Specialty premiums -- or on the Specialty revenues in the quarter, can you break that out between premium revenue and fee revenue?

We generally don't give that level of granularity.

I think we have talked about that the biggest piece of the segment revenue on the service line is the PBM side of things from an external standpoint and that is 60 to $70 million annual business.

I think that will help you get what you are going for.

Okay, thanks.

And then on the -- on the -- that's good, thank you.

(OPERATOR INSTRUCTIONS).

Tom Carroll, Stifel Nicolaus.

Hey, good morning.

Thanks for taking my question.

Just a couple of follow-ups and I think Melissa just got at this.

It looks like provider recontracting efforts in Wisconsin and Indiana are driving some of the enrollment attrition.

I guess, is that the case and, secondly, when do you expect that to stabilize?

I think, Michael, you said 4Q, is that right?

Q3, Q4 we will see it stabilize.

So that is correct, what I just said?

Yes, I mean, I don't have precisely, Tom, there's a notice requirement for providers to get the members transitioned if they want to stay with us or if they don't.

So it is a -- but I think the majority of that action has been taken.

Great.

And then in South Carolina, a follow-up there, you say you have 31,200 members and that you expect to transition them in October, I guess.

Will all 31,000 go full risk in October or will it be a slower transition kind of bleeding into 2008?

Right, this is Jesse.

That is right.

That is not going to happen all at once.

We are working with the state and with the providers within the [Fitrust] network to transition those members over, but that is going to be a county-by-county transition that will take place over the balance of 2007 and into 2008.

How many counties are -- the 31,000 people are spread across how many counties?

There are almost 30 counties in terms of their existing network, but obviously there is a concentration across -- you know, it is the 80/20 rule, so 80% of the numbers are in 20% of the counties.

So obviously we are focusing there.

Got you.

And then just lastly, as you have grown the Ohio ABD business, what is emerging as your top medical cost driver in that population?

We talk about NICU really driving TANF population cost.

What are you guys seeing in this new business in ABD as being the top driver?

Well, I think when you have somebody who is complicated with so many disease states as these members, making sure that we have all the coordination of all the benefits together to prevent admission and to keep them out of the hospital and keep them in their homes where they have a better quality of life.

And really that is what we have focused on is having good case management in order to keep the patients out of the hospital.

You can't point to one specific or two specific things?

They are all -- I have to say we are still watching, but we haven't seen one trend emerging or one cost driver at this point.

Can we think about it and terms off like the three or four typical chronic conditions for an older population?

Sure.

I mean we are seeing a lot of diabetes.

We are seeing a lot of congestive heart failure and a lot of heart disease.

I mean, we have talked about before you have the multiple morbidities, you have so many as a brittle diabetic that can have COPD, could have AIDS or other infectious disease issues, could have all the neuroses that those kinds of conditions could give someone.

And so you deal with those multiple morbidities and the permutations that are available, Tom, are significant recognizing the mix of disease states.

And we are working very closely with Simpatico because the mental health issues here play such a role with the compliance for these patients, because especially congestive heart failure, if you aren't compliant, you are going to end up in the hospital.

One last one, your Florida expansion, any visibility on when premium revenue, full risk revenue will start to flow in that market?

Jesse?

Yes, we are looking at a conversion somewhat similar to South Carolina.

We will be working to build up and get licensed as a full-risk managed care company and then working with the state and the members and providers in Florida to effectuate that conversion, but that is going to be a 2008 transition.

Okay.

Thank you very much.

At this time we have no further questions.

Mr.

Neidorff, are there any --

All right.

Thank you very much for being here and Per wants to answer I think one other question.

Yes, I just wanted to clarify that question on the cash flows.

I did mention that in the quarter, we were over four times, let's say, the non-GAAP net income number.

And so that it implies about a $50 million cash flow number in Q2.

On a year-to-date basis, that cash flow from operations, ex FirstGuard, is $68 million.

I think it was Matt had that question.

I thank everyone for being here and we are looking forward to the Q3.

Thank you.

Thank you.

This concludes today's conference.

You may now disconnect.