Centene Corp (CNC) 2011 Q3 法說會逐字稿

Good morning and welcome to the Centene Corporation third-quarter 2011 earnings conference call.

All participants will be in a listen-only mode.

(Operator Instructions).

After today's presentation there will be an opportunity to ask questions.

(Operator Instructions).

Please note, this event is being recorded.

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

Ed Kroll, head of investor relations.

Please go ahead, sir.

Thank you, operator, and good morning, everyone.

I'm Ed Kroll, Senior Vice President, finance and investor relations at Centene Corporation.

Thank you for joining our third-quarter earnings call for 2011 this morning.

Michael Neidorff, Chairman and Chief Executive Officer and Bill Scheffel, Executive Vice President and Chief Financial Officer of Centene will host this morning's call.

The call is expected to last approximately 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, also on our website, www.centene.com, or by dialing 877-344-7529 in the US and Canada and 412-317-0088 from other countries and the playback number for both numbers is 10004770.

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 October 25, 2011, which is today, and other 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'd like to turn the call over to our Chairman and CEO, Michael Neidorff.

Thank you, Ed.

Good morning, everyone, and thank you for joining Centene's third-quarter 2011 earnings call.

We delivered another quarter of solid financial results, growing our third-quarter earnings per share 25% year over year.

Our continued emphasis on medical management programs, along with our investments in IT, has allowed us to consistently produce steady and reliable results.

Before discussing third-quarter financial results, I would like to briefly comment on some topics of interest.

First, we feel the rate environment is still actuarially sound.

We engage in ongoing discussions with our states and believe our 3% to 5% pretax margin guidance is still appropriate and attainable.

Most rate cuts are related to pass-throughs or provider fee cuts.

Our vigilant management of medical and G&A costs allow us to substantially offset those cuts that are not related to pass-throughs.

Our latest rate updates include a decrease of 2.9% for Texas and an increase of 4.4% for Florida, both effective September 1.

For Georgia we received a rate increase of 1% retroactive to July 1.

Please note that the Florida and Georgia rate adjustments I just described are still subject to CMS approval.

We estimate that our composite rate adjustment for all of 2011 will fall within the previously-indicated range at minus 1%.

States have been operating under a strained budget environment for some time now.

While it is certainly not the ideal situation, our states are taking the appropriate measures needed to deal with the situation.

They know that by moving their beneficiaries into a managed care setting improves quality of care while producing significant cost savings.

It is important to understand that there is no rate increase a state could provide that would overcome ineffective medical management.

At Centene, we pride ourselves on our IT systems and the resulting enhancements of our medical management capabilities.

These systems and capabilities ensure that we have an accurate and timely view of both unit costs and utilization trends.

Next, an update on our growth pipeline.

We continue to see a pipeline filled with an abundance of growth opportunities.

2011 has been a busy and fruitful year for us, winning contracts in brand new states like Kentucky and Louisiana, and expansion in existing states, including Texas and Arizona.

We have enjoyed great success in winning contracts based on quality scores and our ability to be a total low-cost producer.

We have won all 6 of the Medicaid health procurements that we have pursued in 2011.

To recap our most recent contract starts and wins, we commenced operations in Illinois on May 1, serving the state's ABD recipients across 6 counties.

At September 30 we served 13,600 lives in Illinois, a significant ramp up from the 700 lives we served at June 30.

We expect to serve approximately 18,000 by the end of 2011.

During the year we received extensions of our Celtic Commonwealth Care and Bridge contracts.

Both contract extensions commenced on July 1.

At September 30 we served 34,700 lives in the Commonwealth of Massachusetts.

Centene was a successful bidder in the re-procurement of Arizona Long-term Care program.

We increased the number of geographic service areas that we serve from 2 to 3 and increased Bridgeway at-risk, long-term care membership by 50%.

We expanded LTC presence in Arizona commenced October 1, and it's tracking according to plan.

In July we were awarded a contract with Kentucky to serve the state's TanF ABD and CHIP [lives] in 7 out of 8 regions.

The contract implementation is expected to start on November 1.

In late July we were awarded a contract with Louisiana to serve the state's TanF and ABD lives.

The launch of this contract is now expected to commence on February 1.

In August Texas announced the winners of their RFP.

In addition to attaining all of our service areas and products, Centene won new STAR and STAR+PLUS and CHIP product offerings across the state.

Specifically, we will be providing services to STAR and STAR+PLUS recipients in the new 10-county Hidalgo service area, also known as the Valley, and STAR+PLUS recipients in the Lubbock area.

We will also be serving Medicaid recipients in the rural service areas of the West Central and Northeast Texas.

All of these service areas and products will now include management of pharmacy benefits for Superior's members.

Additionally, the state has added inpatient facility services to the managed care structure for the STAR+PLUS program.

We expect operations to commence in the first quarter of 2012.

This Texas expansion will deliver significant incremental revenue growth for Centene in 2012, which we will discuss in more detail at our December 16 Investor Day.

We have the systems and other resources to successfully manage simultaneous startups while selectively pursuing new profitable growth opportunities.

In anticipation of generating in excess of $7 billion in 2012 revenue, we have added significant jobs in both corporate and in our local markets.

A robust pipeline of future RFP opportunities remains and we will carefully invite all of them.

These include RFPs in new states, such as Washington and New Hampshire, with other announcements still pending.

RFIs in states like Michigan and California for dual eligibles.

And several of our large existing states -- Georgia, Ohio, and Florida -- are contemplating new procurements and expansions that could lead to incremental business for us in 2013 and 2014.

Let me quickly comment on activities of the so-called super committee in Washington, D.C.

While we do monitor the committee's actions closely, we do not anticipate any negative major impact on our business.

We remind you that our growth is a function of state-related budget issues.

Now, onto third-quarter financial highlights.

Third-quarter premium and service revenue grew by 17% year over year to $1.3 billion.

Our consolidated third-quarter health benefits ratio improved 120-basis points compared to last year's HBR, reflecting continued lower utilization in 2011.

Our new HBR guidance for 2011 is 83.2 to 83.6.

This anticipates a normal flu activity and a mix change in Q4, mostly related to the addition of Kentucky.

We will discuss our 2012 outlook for medical cost trends at our December 16 investor day.

The third quarter G&A ratio increased 110-basis points compared to the same period last year, reflecting expansion and start-up costs.

It is important to note that we continue to win new RFPs there will be additional expansion costs that are necessary to aid Centene's growth.

These will be reflected in our 2012 financial guidance.

Over the long term, however, we remain committed to improving G&A efficiencies.

Earnings per diluted share increased to $0.55 compared to $0.44 in the third quarter of 2010.

In summary, we believe we are well positioned for future success.

Centene's recent contract wins and robust pipeline will continue to drive strong profitable growth.

Our systems and medical management programs will enable us to grow while maintaining or enhancing our margins.

We look forward to seeing all of you at our December 16 investor meeting in New York City.

Thank you for your interest in Centene.

I will now turn the call over to Bill, who will provide additional color on our third-quarter 2011 results and full-year 2011 guidance.

Bill?

Thank you, Michael, and good morning.

For the third quarter of 2011 premium and service revenues were $1.27 billion, an increase of 17% compared to the third quarter of 2010.

This year-over-year increase was driven by three primary items.

First, the addition in 2011 of new operations in Mississippi, Illinois, and the Dallas STAR+PLUS program.

Second, the acquisition of Citrus Health Care last December.

And third, the expansion of Cenpatico service area in Arizona also effective last December.

As Michael indicated in his comments, Georgia and Florida rate increases are still subject to CMS approval.

Consistent with prior years, we did not record rate increases for Florida and Georgia in the third quarter.

We expect to record these increases retroactive to their effective dates in the fourth quarter.

Of course, this is contingent on the timing of CMS approval, which is not under our control and could occur after December 31st.

With respect to the issue raised in the second quarter related to retroactive membership adjustments in our Georgia health plan, we continue to accrue for the estimate -- estimated amounts due to the state for membership adjustments, as we have done for several years, with no significant impact to our third-quarter results.

Our consolidated health benefits ratio was 83.0% for the third quarter of 2011 compared to 84.2% in the third quarter of 2010, and consistent with the second-quarter ratio this year of 83.0%.

The decrease between years is due to continued levels of lower utilization and effective contracting.

We do expect our HBR to increase in Q4, primarily as a result of the addition of Kentucky, along with normal seasonality.

Our general and administrative expense ratio for the third quarter of 2011 was 13.3% compared to 12.2% in the third quarter of last year.

The 110-basis point increase in the G&A ratio is primarily a result of the additional costs incurred for business expansion, including start-up costs for Kentucky and Louisiana.

Our G&A ratio decreased by 10-basis points from the second-quarter year-to-date ratio of 13.4%.

Our third-quarter investment and other income was $2.7 million, an increase of $2 million from last year.

For the third quarter of last year investment and other income included an impairment charge of $5.5 million related to our investment in Casenet and security gains of $2.3 million.

Interest expense was $4.6 million in the third quarter this year compared to $4.9 million last year.

The decrease reflects a reduction in the net interest rate on our senior notes and associated interest rates swap, although on a higher outstanding balance.

Excluding the effects of non-controlling interest, our third-quarter effective tax rate was 38.9% compared to 37.0% in the third quarter of 2010.

The increase in effective tax rate between years was primarily related to an increase in state income taxes.

Our diluted earnings per share was $0.55 compared to $0.44 one year ago.

As a reminder, the 2010 results included a $0.04 net charge for investment write-downs.

On September 30 we had cash, investments and restricted deposits of over $1.1 billion, with $36 million held by our unregulated entities.

Our subsidiaries had aggregate statutory capital and surplus of approximate $587 million compared with the required minimum aggregate statutory requirements of approximately $322 million.

We have estimated our risk-based capital percentage to continue to be in excess of 350% of the authorized control level at September 30.

Our total debt was $351 million at quarter end and our debt-to-capital ratio was 23.2% excluding our non-recourse mortgage note.

Our medical claims liability totaled $499 million, representing 44.6 days in claims payable.

This compares to 44.4 days at June 30.

As we discussed during our investor day in June, our targeted range for DCP is now 40 days to 45 days.

For the third quarter, cash flow from operations was $36.5 million, which was 1.3 times earnings for the quarter.

Year to date cash flow from operations totaled $89.7 million, which was 1.1 times earnings year to date.

As the states may decide to delay or prepay payments based on their cash position or other timing issues, we continue to expect potential volatility in our cash flow provided by operating activities from quarter to quarter.

I will now review our updated guidance numbers.

For 2011 we expect premium and service revenues of $5.1 billion to $5.2 billion.

We estimate our diluted earnings per share from continuing operations to be from $2.09 to $2.13, the health benefits ratio to be between 83.2% to 83.6%, a G&A ratio of 12.9% to 13.4%, and 52.4 million shares outstanding for our earnings per share calculation.

Our guidance numbers anticipate receiving CMS approval in the fourth quarter for the Florida and Georgia rate increases, a November 1st start date in Kentucky, and includes start-up costs in the fourth quarter for the Kentucky, Louisiana, and Texas business expansion.

As is our normal practice, we will provide 2012 guidance on December 16th during our investor day in New York.

At that time we will also provide information on our plan to revise our classification of medical costs consistent with the NAIC medical costs definition developed last year.

We expect to make this change in the fourth quarter and report our full-year 2011 numbers in February, reflecting the new classification.

Operator, you may now open the line to questions.

(Operator Instructions) Our first question will come from Joshua Raskin of Barclays Capital.

Please go ahead.

Hi, good morning.

Good morning.

You are obviously seeing consistent cost trends and stable MLRs.

I'm just curious, there's been some suggestion that maybe office visits or even birth rates have picked up.

I'm just curious if -- or even flu season.

Have you seen any data that suggests you're getting anything more than just normal patterns of utilization yet?

Yes, I'm going to ask Mary to comment on that, but I will first just say, of course, the data we're reflecting, I want you to remember, reflects our systems and pretty real-time data, so Mary, would you --

All right.

Good morning, Josh.

As Michael said, since we do have the systems in place to be able to identify these trends or high-risk numbers and quickly get them into our clinical programs, that really is what makes the difference for us.

But your question on birth rates.

We have seen them slightly trend down comparing Q3 2011 to Q3 2010, but we've seen a slight increase just recently from Q2 to Q3.

That's exactly in line with what we've seen historically as you see increase in births from September and October, so that's very much what we would expect.

As far as flu, no flu activity as of Q3.

We expect a normal flu season and we have our proactive flu prevention program actively in place right now.

Okay, that's helpful.

(Inaudible) mentioned a -- well, you mentioned a $7 billion number for top line next year, so I just want to understand what was included in that.

Is that just simply known wins and program expansion, et cetera, and just premium plus service revenues as you like to guide to, or is there an expectation of additional contract wins?

I'll let Bill answer that.

I think what Michael said was we would expect it to be in the $7 billion plus category.

We're not prepared to give 2012 guidance at this point.

Obviously, you can do your own math relative to the wins that we've announced individually so we do expect it to be a strong year.

But our guidance when we do give it will only include those items that we have known wins and not for additional RFPs that might be still out there.

And that's kind of our standard policy, Josh, but it's -- we do see 2012 as a strong year and I wanted to put that $7 billion out there as a good starting place for you.

Okay, it's a good starting place relative to where I was.

And then just one last clarification on Florida and Georgia.

What is the actual fourth-quarter accrual -- I'm sorry, the retroactive portion of that?

How much in the fourth quarter should have been back to the third quarter by your estimates for those two (inaudible)?

Assuming we obtain the CMS approval by year end it would be about $0.04 that probably be in the fourth quarter related to the third quarter.

Okay, thanks.

Our next question will come from Matt Borsch of Goldman Sachs.

Please go ahead, sir.

Yes, I'm just wondering could you just touch on what else you see in your pipeline beyond what was reflected in your initial view of 2012 already that you see either coming in or on the horizon that you can specifically refer to?

And if you can in there touch on the Georgia contract re procurement timing, it would be great?

(Inaudible) take that?

Yes, obviously there's not a lot of specificity, Matt, that we can provide in terms of pipeline beyond what Bill stated in terms of those things we've already won.

I think we've -- suffice it to say there is a tremendous amount of activity on the development front and we're actively engaged in that and to the extent that those things come together then we'll be in a position to comment when they're in.

Maybe if you could also just comment on the smaller plans that you have ongoing dialogue with that may be interested in partnering with you or being acquired.

How have you seen the appetite for that evolve with the view of economies of scale in the industry?

I think it's really an M&A question so I think that we're -- we are seeing a good amount of activity.

We've continued to see a fair amount of activity.

Obviously, on the sell side there's a whole combination of drivers for potential transactions.

So we have seen some of that's related to scale, some of it is more market-specific factors so it's hard to provide real specific attribution for any particular driver, Matt, but there's --

Okay.

But I'd say it ongoing activity on the M&A front and we're a part of that.

I would say that it's -- we have a full plate there and I remind you we have very rigorous criteria in terms of the IRR and ROI's and things.

Has to be accretive in the first 12 months that we acquire it.

So we continue to focus on those and where it can be realistically done and meet those criteria and not be dilutive, you'll hear about it.

Great, thank you.

Our next question will come from Tom Carroll of Stifel Nicholas.

Please go ahead.

Hi, good morning.

Just I want to come back to you on 2012 again and see if you can give us maybe a little more of a hint at 2012 pretax margins.

Centene's got a lot of growth next year plus you've highlighted a handful of startup costs so maybe could we expect margins to be up, down, or flat into next year, maybe tell us at a high level?

The only comment we've made on margins is that we see the rate environment as such that our guidance of 3% to 5% is still relevant.

And that 3% to 5% is pretax, right?

Yes.

Okay, great, and then just one other thing.

Remind us of your strong Texas enrollment, both sequentially and year over year?

In terms of?

In terms of a little more color.

You're getting some nice --

We won a considerable amount of new service areas across multiple products, And, Bill, do you have those numbers handy, the exact ones he's looking at?

More recently what we have is there was a September 1 geographic expansion and we've added membership in some of those surrounding counties when that happened and that's driven a lot of the more near-term membership gains that we see from Q2 to Q3.

That's right.

Thank you.

Thank you.

Our next question will come from Scott Green of BofA Merrill Lynch.

Please go ahead.

Hi, thanks for the questions.

So first a question on cost trends.

MLR was flat between second quarter 2011 and third quarter 2011 at 83% and the rates you booked were negative sequentially from Texas.

Does that mean you're seeing negative cost trends between 2Q and 3Q?

I think we have to look at it in our total book of business, and in individual markets you could say we have some decreases in our rates, like in Texas, and others that we've had increases.

Usually the third quarter is one of our best quarters in terms of the lower utilization, lower HVR, so it has been very consistent through the years.

And as Mary indicated, we've not seen really any spikes in utilization, it's really offsetting type things like we could have a slight uptick in NICU but then have a lower length of stay, so we really haven't seen anything overall.

That obviously will change in Q4 as we add in Kentucky and probably 75%, 80% increase of our increase in HVR for the Q4 that we're looking at will be driven by the addition of Kentucky.

What we've talked about on many occasions are the predictive models, the dashboards, the things that, as Mary stated, allow us to move people into the programs that manage costs and improve quality at very early stages.

When we see a rate increase of course a lot of it's pass-through, we then work with the plans to reduce G&A anywhere they can and also through medical management, improve utilization.

So it's a combination of things that help us maintain that.

But it's not new as it seems because I've presented some charts that show going back to the second quarter of 2008 we've stayed within a 200-basis point range on a consistent basis.

When you're worried about flu seasons and a lot of other things we've managed within the number.

That is not to say you couldn't have a quarter where there's catastrophic medical issues but typically we're comfortable with that range.

Also, Texas really was only for one month in Q3.

Okay, all right, and then I guess just a follow up.

I saw the favorable reserve development on a trailing 12-month basis declined by around $14 million sequentially, was that something that was a headwind in this quarter or is that something that may have just rolled off in the second quarter of 2010?

It's a little difficult to tell.

I'm going to let Bill give you some additional comments, but I'll just remind everybody that that is a snapshot of what it was -- the conservatism we had when we booked the numbers 12 months ago, so it's just a double check that says that it's -- that's where we booked.

And, Bill, you might talk about the development and what we're seeing.

Sure.

This is something we've seen over the last six months developing.

In other words, how were the September 30, 2010 reserves coming in.

We did have about half a dozen of inpatient cases that developed upwards in terms of the severity of the case from our original estimates [of $6 million].

But beyond that I think some of this is just the normal fluctuations that you might see from quarter to quarter and how much positive development might be.

I will say that as we've looked at this we watch very carefully.

For example, the development for the reserves at December 31, 2010 we are well in excess of the $48 million or so that we've recorded for 9/30 already so I think it was really more just an anomaly for one quarter that was lower than some of the other quarters we've been experiencing recently.

And another thing, it really didn't impact this current -- it didn't really impact this current quarter.

That was a historic look at it, which we think has real value.

Okay, that's helpful.

Will you -- is that something you'll be reporting going forward as more the calendar year development?

We've been -- we've, as long as I can remember, have provided the four-rolling quarter estimates, which we've said -- we assert that we use the same conservative approach in looking at our reserves and this just is a double check that says that 12 months ago when we did it, which gives you the full development over the 12 months, that it was appropriately conservative.

That is really what it says.

Obviously the next quarter we'll give the full 12/31/10 development.

I just thought it was useful today in the context of a slightly lower level of favorable developments for September 30, 2010 to let people understand that we do expect that to be a significantly higher number for the 12/31/10 numbers when we give those at the end of the year.

And I remind you, Bill drilled down and there were a few cases that really drove that.

Okay, that's helpful.

Switching topics, a question on Kentucky.

Could you update us on your progress in building your provider network?

My understanding is that that might have -- not you in particular, but generally network development might have been the partial cause for the delay in the launch, and are you protected against any out-of-network higher unit costs to the extent that maybe your network isn't as robust as you may like when it's implemented on November 1st?

Scott, it's Jesse, a couple things.

One, obviously network was a focal point for everyone given the size and speed of implementation here.

We've been working from -- I'd say from before day one in that regard.

As we sit here today we feel comfortable that what we've provided to the Commonwealth represents [are adequate now].

Number two, with respect to the out-of-network there are specific contractual provisions that address out-of-network reimbursement that we think provides protection for the NCOs from a unit cost perspective.

I remind you that we have a plan a higher health benefits ratio owing to the impact of the start of Kentucky as we do in all new plans.

Okay, thank you very much.

Our next question will come from Chris Rigg of Susquehanna.

Please go ahead.

Good morning, thanks for taking my question.

Just want to circle back up on Texas.

Of the 2.9% rate reduction how much of that would you guys say is automatically passed through versus you having to do some work to adjust what you're paying the providers?

What we give is the net number, so we have a rate decrease and then some portion of that is passed through as reductions in the fee schedules for the providers and we believe that in Texas when we do those calculations the net number's 2.9% decrease.

What was the gross number?

We really don't get into that.

Okay.

In terms of -- just really a maintenance question.

On the tax rate for the year -- for the fourth quarter it's bumped around quite a bit quarter to quarter this year, what are you expecting for the full year?

It could be similar to what we saw in the third quarter for the fourth quarter.

Again, still the 38% for the whole year.

I think what we're seeing to some extent is that we're making more money in some of the higher tax rate states and that really is what's skewing the tax rate more than anything else over time.

Okay.

And then lastly, on the interest expense line is the third-quarter number the new run rate we should expect?

I think that's reasonable.

Thanks a lot.

Our next question will come from Scott Fidel of Deutsche Bank.

Please go ahead.

Thank you, just a first question on the M&A environment.

Obviously yesterday we had pretty significant transaction between a national MCO and a pure play Medicare company and just interested in your thoughts on whether we can see a similar type of development start to play out on the Medicaid set of the business?

It's hard for me to comment specifically on it.

We see ourselves continuing to be a net acquirer of health plans and as Jesse alluded to we have a full health -- a full plate of them that we're looking at, as well as the startups, and we've organized our Company to be able to do both under Jesse's direction.

So we had not seen anything for a while, now there's a couple spats of them that are out there.

We continue looking and when we find one that meets our criteria, that's appropriate, then you'll hear where we've made an acquisition.

Okay.

And wanted to ask a follow-up question just going back to medical cost trends and just want to get your view of what you think the underlying med cost trend has been so far in 2011.

You said that your rates are tracking at around negative1% and looks like just for the core Medicaid CHIP business that you've had over 300-basis points of MLR improvement this year and have been running at sub 81% there, so does that imply that the medical cost [here] has been negative 4% or so on the core Medicaid book, or are there other elements to consider there?

I think you also have to consider contracting enhancements.

What we do is in each of our markets, particularly when there is this pressure on rates and fee schedules and stuff, we want to make sure that our contracts reflect those type of actions, and so that, coupled with where -- if we -- we have made changes in the network to take -- to reduce higher-cost providers and the net of all of that gets us to the relatively flat HVR for the year.

I think the medical cost trends you've got -- inflation is one amount, but I think in terms of overall the pressure on the states to reduce the fee schedules has offset a lot of that and so what we've seen is an amazingly flat level of cost for this year.

So is it fair to say that you think your Company-specific contracting initiatives have been able to improve your trend by a couple hundred BPS this year?

I don't know if I'd give a specific number of basis points but the answer's yes.

We've always talked about how our contracting philosophy in fixed rate and the things that give us the predictability that is necessary to effectively manage this.

Okay, and then just one last question on Florida and maybe an update on how the plan performed there.

I know that there's been some volatility, I think it was improving a bit better recently, and just given the rate increase that we're seeing in the reform counties do you think that that should support margin expansion in the reform book or really just help to cover what's been clearly some higher MLR pressure in the reform counties?

Jesse?

Yes, Scott, Jesse Hunter.

I think clearly what we've seen in terms of the performance of the plan between -- and the state, really, not just the plan between reform and non-reform has been contemplated in the rate setting process so obviously we were pleased to see that.

So I think what we will -- your specific question about margin enhancement and reform, we expect that with the higher rates in the reform counties we will see improvement in the performance in the reform counties.

Okay, thank you.

(Operator Instructions) Our next question will come from Carl McDonald of Citigroup.

Please go ahead.

Great, thanks.

Wanted to get a better idea of how to think about the incremental Texas revenue that's coming on in 2012, whether to think about that --

You're breaking up, can you [fix] it?

Sorry, can you hear me?

Right now I can, that's much better, thank you.

All right.

I was asking, wanted to get a better sense about the -- how to think about the incremental Texas revenue in 2012, whether to think about that as the normal 90% loss ratio and not profitable, or because it's incremental whether it's going to be more profitable than a normal new market?

And I know you don't want to talk about 2012 so maybe if you focus on the contiguous county expansion in September and just give us an idea for that new enrollment.

Where do the loss ratio for that incremental business in September come in relative to Texas and how do the SG&A look on --?

I'll see if anybody else wants to comment.

In Texas some of the incremental business we expect will -- in the Valley and other will have the higher MLR for some period of time, maybe not as much as normal.

We're working to that now and we'll be a position to talk more about it in the overall picture come December.

You talk about the -- what we saw in September in the surrounding counties, while we have some data and real-time data that we evaluated and looking at one month does not a trend make and so I want to be careful to not take one point and try to trend it and mislead one way or the other.

We know where it stands real time and we'll continue to evaluate it.

Bill, you want to add something?

Just one thing.

The other thing to consider is, when we carve pharmacy in Texas that will have a much lower margin than, say, an 83% overall loss ratio we have right now.

That would imply 17% margin.

We won't have that kind of margin on the pharmacy business, so when you add that in that will tend to dilute the overall margin a little bit.

And then also on the SG&A assumption on that incremental September, I assume that comes in at a much lower SG&A than normal?

(Inaudible) a whole new start up and we have all of the hierarchy there, we have a large business with 500,000 lives or so in place and add the balance and flesh it out it's not the same as a Kentucky from a standing start ramping up so sure, it's going to -- the incremental G&A of would not be material to that particular market.

And then just second question.

If we were to see a further delay in Kentucky for another month, how sensitive is that on the earnings?

Big impact on earnings because we will book at the higher loss ratio and Jesse may want to comment on the start date given that it's October the 25th.

Yes, we are certainly anticipating, as we said in the prepared remarks, an 11/1 start date.

Thank you.

Our next question will come from Ken LaVine at UBS.

Please go ahead.

Thanks, good morning.

Just looking at the ABD MLR looks like it's up about 110 points sequentially and is that mostly just the function of mix with the more Illinois ABD lives coming on?

Should we see that roll back and represent a tailwind in Q4 as the Company books less of the business in Illinois and Texas ABD at that higher 90%?

The simple answer to the first part of your question is yes, and you want to pick up?

I think the ramp up in Illinois really began in the third quarter in terms of the numbers of membership and we expect to continue in Q4.

I think that aspect of it will continue at least through the fourth quarter of this year.

And I really won't go into 2012 at this point in terms of the individual HVRs by category.

Got it, but perhaps the Texas AB that started up in February, that should roll off in Q4 at the 90% MLR and perhaps be a tailwind?

I think that that will have aged enough to give us the normal HVR that we would be looking for there offset by increase in Illinois and a few other markets.

Got it, thanks.

I know you talked earlier about the M&A pipeline, but how do your thoughts change around M&A and perhaps some bolt-on or smaller deals here given how much con -- how many contracts you won this year?

You're already getting some pretty significant growth via the RFP process, does that impact your -- how you view M&A?

No, I don't think there's a need to worry.

We have some rigorous calculation valuations we do, and we do look into the IRR and that's for new startups and in turn the ROI on startups.

We look at that on the M&A side.

We are structured to do M&A and startups and we told you several -- I don't know how many quarters or years ago that we were positioning ourselves to do two, three, and more startups and RFP responses and maintain the acquisition program when we find the right one.

So we see no change in that mix.

We have the capability and we'll continue to do it.

Great, thanks for the time.

Our next question will come from Charles Boorady of Credit Suisse.

Please go ahead.

Hi, thanks, good morning.

Morning.

First question just on the contracting and the fixed rates that you pay to providers, which has offered tremendous predictability in your cost trend.

Does that -- is there something in your contracts that would also allow you to pass-through to providers any future rate cuts, or does the fixed rate contracting work better for you in a rising rate environment than in a falling rate environment for any reason?

Mark, do you want to comment on that?

Yes, sure.

In general we can pass through the rate cuts in a lot of our contracts.

There are probably a few small situations where a rate increase is better than a rate decrease but even in Texas we found that we were able to go back through our network and make adjustments as necessary when the rates -- state rates are going down.

Okay, great.

And as you look to expansion markets, in particular Texas where you have a footprint, how should we think about the scalability of your existing platform and G&A structure in terms of --?

We'll give you some specifics, a little more color on it when we meet in December, but obviously as I said earlier when you have a headquarters operation in Austin and a lot of regional offices set up and been managing this so well the addition materially different than a startup.

We have one President and one CFO, one Vice President of Medical Management, that type of thing, so when you add in incremental nurses and member services that's not as costly.

So it's good business in the long term.

Do you know yet the way Texas will establish the rates?

Would they take that scalability into consideration when establishing the rate that they'll pay --?

We sit down and talk to the state about margins and where we're at and what's acceptable, and we look at our medical trends and they like talking to us because our material is so real time and we're not taking something that's three, four months old and trending it as much as showing real time data.

And it all comes into the mix, absolutely.

And keep in mind, they also have the rebate program and so they look at the total bottom line at that point and as the margins -- if the margins go up then we start to share it and we like that.

We've encouraged Kentucky and other states to adopt those kinds of programs.

There's nothing better than having actuarially sound rates, having higher margins than the 3% to 5%, and returning money to the state.

It shows the real benefit of the managed care programs and I think we've continued to demonstrate that in Massachusetts and in Texas.

When will you find out the rates from Texas for the new expansion markets?

There's been no date put out there.

We'll work through it.

We have enough history working with them that it's a very iterative process and when we have something specific you'll be -- not the first to know but you'll know early.

Yes.

Finally, I want to make sure I got what you said -- what you did say so far about 2012, that revenues in excess of $7 billion, you're sticking with your 3% to 5% pretax, so if I use roughly 38% tax rate and 35 -- and 53 million shares I get to $2.45 to $4.08 range in EPS and --

That's a wide range.

(laughter)

Really makes my job fun.

I want to make sure I'm not --

Just don't take the midpoint necessarily.

(laughter)

Right.

And then I would infer, also, based on everything you've said in the past that because of how many new markets you're starting up and you usually book the higher loss ratio that you would probably be more towards the lower end of that range.

And I don't want to put words in your mouth, but am I missing something in what you have said so far about --?

I think you summarized the factors that we're looking at.

The only thing that you don't have is what we'll actually say come December 16 and we're still working through it ourselves.

We have a very detailed, as you would expect, planning and budgeting process and we're probably -- we still need that additional time to get there.

We continue to look at our real-time data, we look at what's in the predictive model, we get the claims data for new markets where it's available and we put it through the predictive model.

So as we get all that real time then we'll be in a position by December 16 to give you what we believe to be the achievable realistic guidance.

That's great, thank you so much.

Thanks.

Our next question will come from Doug Simpson of Morgan Stanley.

Please go ahead, sir.

Just to try to tie together some the comments on the margin visibility.

If you just step back and you look back at the 2003 to 2007 time period the MLR bounced around a little bit more in line with what we saw from the peers and then you look 2008 to where we are today and your MLR's been markedly more stable than some of your peers.

Could you just give us a sense.

You've obviously made infrastructure investments, IT investments, the book has diversified geographically and by business line, is there a way to size for us what you think is -- has driven that moderation in gross margin volatility relative to the peers and how do you think about that?

Given all the business you have coming on, should we assume that that relative stability persists through these new add ons?

I won't put everybody through all the details now, but I remind you that -- and we've talked how we had the issue in 2006 that we had a surprise and we said then you do it to me once so shame on you, so to speak, speaking of systems.

Twice, we're going to do everything we can to avoid.

There's never any bulletproof guarantees, but in that context we invested $40 million, $50 million in our systems.

We have a system that will tell us that a contract can be administered on the system because we want those real-time contracts because we want that data in the system.

It's not just paying quickly but we want the data.

We have the dashboard where we can look today at trends to last night's claims payment.

We had -- and that's down to the subsidiary and even the networks, the -- our actuaries If we see something a little bit.

Mary and the others in medical management having a predictive model so we get a new book of business, we put it through there and you can tell very quickly which cases need to be managed.

If we do not have a lot of claims history, we have the algorithms now that if we had three weeks, four weeks of ICD-9, which is the diagnosis, the CPT, which is the cost, and the pharmacy file, we have algorithms that say here are cases that need to be looked at, they could be high cost.

So when you put all that all together that -- and then in the system we have a case management that's (inaudible) and others that continue to do that, that continue to put us in position to proactively manage the cost.

And I've said many times and I'll -- I said it earlier and I'll say it one more time, you will never get enough rate increases to overcome less-than-effective medical management so it all starts there.

Okay.

Just on the cost drivers, you touched on the birth rate earlier, how important -- obviously the birth rate -- birth is an event and then that hits the radar screen on the medical cost side, how do you all think about the follow on or the echo effect from -- the decline in the birth rate then obviously you have lower follow-on volumes on the toddler front and that is zero to five cohort tends to be a little bit higher of the physician utilization driver.

Does that matter, does that show up as a big enough to move the needle, or --?

I'm going to let Mary comment, but I'll just remind you, we have the healthy start for babies, we have premi prevention programs, we have a lot of things that states are recognizing that are advanced in terms of reducing premature birth rate.

But you can comment on the others, Mary.

Right.

And when we designed Start Smart for Your Baby we were taking into account that it's just not pregnancy, it's those first two years of life that are critical.

It's building that relationship with the mother during pregnancy to make sure that when she is taking care of that child that we are getting all the preventive visits -- all the care that child needs, and so that is actually very critical for us.

Okay.

All right, thank you.

Our next question will come from Peter Costa of Wells Fargo.

Please go ahead.

Hi.

To get to the 83.4% mid point of your loss ratio guidance that means your MR is going to go up about 160-basis points in the fourth quarter.

You said 75% to 80% of that is attributable to Kentucky, which gets me back into the math there at about -- you're booking at about a 95% to 100% loss ratio depending on how fast the business comes on.

Can you tell me what you see that loss ratio doing over the course of the three years of the contract?

Yes, I would say -- we have said publicly that the contract will deliver our normalized margins over the three years of the contract.

We have always said that -- and we said in Kentucky you have a really true virgin territory starting up and you have to work with the network at all -- we have the network in place, but you have to work with them on the policies, the practices, et cetera, so it will be a little bit higher in the beginning and you will see it start to bring in line.

I'd said in investor conferences, we see where it could take three or more quarters to really get it down to its normalized rates, but that's okay.

We're playing a long ballgame.

So sort of a three quarter time horizon before it gets out of --?

Yes, that's a good -- it's not a cliff.

We should say we'll start higher then start to ramp down on a sustainable basis.

What we always worry about is that we do these things that it's sustainable, it's not a seesaw.

Okay.

Then one of your competitors -- your publicly traded competitors acquired about a $1 billion Medicaid plan in New York, did you take a look at that and what were your thoughts on it?

No, we saw the news out and we don't really have any basis.

And obviously, Peter, we don't comment on any specific opportunities that we review.

Okay, thank you.

And showing no further questions in the queue, this will conclude the question-and-answer session.

I would like to turn the conference back over to management for any closing remarks.

We thank you for attending.

We're right on schedule, and we look forward to seeing you on December 16 and we'll talk then.

Thank you.

Ladies and gentlemen, the conference is now concluded, Thank you for attending today's presentation.

You may now disconnect.